BOSTON - A form of mutual fund style drift is now being examined by the Securities and Exchange Commission in its review of mutual funds and their performance advertising practices.

SEC examiners are looking for instances of funds having generated exceptional performance by investing outside their investment objective - so-called style drift or style creep - without disclosing that fact to investors, said Gene Gohlke, associate director of the SEC. The SEC is concerned that fund managers may have been tempted to invest outside of their investment objectives in high-flying tech stocks, for example, late last year in an effort to boost performance, Gohlke said. Funds that make such moves should disclose the fact in fund performance advertisements or SEC filings, he said.

SEC examiners may request records identifying all of a fund's trades for one year as part of the exams, Gohlke said.

Gohlke made his comments in an interview and at a conference April 28 on current SEC initiatives in fund advertising and after-tax reporting sponsored by The National Investment Company Service Association of Wellesley, Mass.

Style drift has long been the bane of consultants and registered investment advisors who use asset allocation to guide their investing. Allocating assets among several, diversified classes of investments is thought to reduce investment risk for long-term investors.

Consultants and registered investment advisors who favor asset allocation want fund managers to invest in a manner consistent with their fund's investment objective. When managers "drift" outside of their fund's objectives, consultants and registered investment advisors complain that their asset allocation plans are distorted, increasing risk and potentially hurting returns.

"Asset allocation is becoming more and more the focus," said Christopher Ito, a consultant with Deloitte & Touche of New York who tracks money manager investment style and performance for institutional clients. "It's probably the most important concept that we stress."

The SEC is not scrutinizing all instances of style drift, Gohlke said. Examiners will not concern themselves with cases in which the style drift is not significant or where it is disclosed in SEC filings such as fund annual and semi-annual reports, Gohlke said. But the SEC will expand its advertising review of a fund when it appears that a manager invested outside of his investment objective and promoted the fund's performance without making the style drift known to investors, Gohlke said.

Such conduct potentially violates federal securities laws' prohibitions against fraudulent advertising, Gohlke said. It is unclear to what degree fund managers engage in undisclosed style drift, he said.

Style drift is just one aspect of the SEC's advertising review, an effort that Arthur Levitt, chairman of the SEC, announced in February. SEC examiners and lawyers are conducting the early stages of their review by examining fund ads and public filings from SEC headquarters, Gohlke said. The SEC will conduct on-site exams when troubling cases arise, he said.

The advertising review will continue until the SEC is satisfied that potentially troubling mutual fund advertising practices have ceased, Gohlke said.

"There isn't any cut-off date," he said.

The review now includes instances where fund advisers advertise the performance of closed funds, Gohlke said. (MFMN 5/1/00) The SEC wants to make sure that fund companies are not improperly soliciting investors with closed-fund performance and then trying to sell investors a different fund, he said.

The SEC also wants to make sure that funds are taking steps to insure that shareholders are not misled about performance figures in light of recent volatile markets. Federal securities regulations require that funds advertise investment performance figures through the most recent quarter.

Quarter-end figures may not be sufficient when a fund suffers a significant decline after the end of a quarter, Gohlke said. Funds should consider using additional performance figures when a fund's performance has dropped substantially after the end of a quarter, he said.

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