An obscure book about mutual funds has begun to arouse the ire of the industry.

Louis Lowenstein's book, "The Investor's Dilemma. How Mutual Funds Are Betraying Your Trust and What To Do About It (Wiley, 2008)," levels some serious charges about the self-serving interests of investment companies.

Lowenstein, who has widely written on the financial markets, is the Simon Rifkind Professor Emeritus of Finance and Law at Columbia University. The book slams mutual funds.

Lowenstein's complaint: Mutual funds have wandered too far afield from the core principles upon which they were founded. Those core principles are to provide the average investor with good professional hands-on management and low portfolio turnover at a reasonable cost.

Naming funds and footnoting throughout, Lowenstein carefully detailed the problems with mutual funds.

"In the beginning conflicts of interest were avoided by having the fund managed internally by trustees responsible solely to the fund's investors, trustees whose total pay would be a minor portion of the income generated by the trust...

"Today almost every mutual fund is managed by an external corporation, often a bank or insurance company operating through a subsidiary, which is thus responsible to its own, separate shareholders to maximize fees and therefore income," the book reported.

In the early days, the first mutual fund, Massachusetts Investors Trust, charged an expense ratio that actually dropped to just 0.19% of net assets in the 1960s. Investors initially redeemed less than 3% of their shares, and turnover within the portfolio was just 3.6%. Today, the annual "all-in expense ratio" of a fund is likely to be 10 times that, managers take their cuts regardless of whether the fund turns a profit and investors casually flip in and out of funds, according to the book. Among other faults cited by Lowenstein:

* Fast asset growth and the proliferation of new mutual funds for the sole purpose of reaping fees from assets under management.

* Too little attention to performance.

* Over-reliance on computer programs and portfolio rebalancing-tactics guaranteed to foster only mediocre fund performance.

* A move to team management of funds-virtually guaranteeing to investors that individual funds will not get adequate attention.

* Failure of fast-growing funds to close their doors when they become too big. This, he reported, leads to the fund's ownership of too many stocks and fosters too much trading to perform well.

* Rampant conflicts of interest.

* Manipulation of benchmark indexes, disclosed to help shareholders measure a fund's performance. The benchmarks selected are designed to portray their performance in the best possible light.

With the launch of the book around April, the Investment Company Institute alerted its members, said Edward Giltenan, senior director of public relations.

Despite the book's charges, Giltenan noted that the book acknowledges that mutual funds still "are an intrinsically attractive and flexible vehicle.

"Mutual funds have become the investment vehicle of choice for most Americans precisely because they provide good value at reasonable cost," Giltenan said. "Over the last 50 years, the cost of owning an equity fund has declined by more than 50%. That's due to intense competition...

"Certainly no industry of our size can be perfect, but history has shown that the only way to prosper in this business over the long term is to put shareholder interest first."

One major surprise in the book: The singling out of Baltimore-based T. Rowe Price, a no-load fund group that has stayed clear of any of the mutual fund scandals.

Among Lowenstein's charges: * There's a conflict of interest between T. Rowe Price being a public stock while also trying to attract mutual fund investors. Evidence: The company's chairman, Brian Rogers, appears to invest a mere $1 million in its funds while owning T. Rowe Price stock shares worth more than $65 million.

* The company is simply producing new products that the markets demand rather than focusing on performance.

* Its Science and Technology fund had a young, inexperienced manager at the helm who traded stocks at the "reckless" rate of 128% per year.

T. Rowe Price vehemently disagrees.

"Mr. Lowenstein fails to grasp the fact that an investment in T. Rowe Price Group stock would not be rewarding unless the firm serves its cients well," countered T. Rowe Price spokesman Brian Lewbart.

Rogers, he said, has "significantly" more than $1 million invested in T. Rowe Price funds. The discrepancy in the book, according to Lewbart, appears to be due to the structure of the SEC disclosure form, which merely requires a check next to a category, "over $1 million."

Lowenstein based the group's fund performance on only five of the company's "large-cap growth funds," Lewbart contends. As of Dec. 31, 2005, the period tracked by Lowenstein, 80% of all T. Rowe Price funds actually had outperformed their Lipper peers for the five-year period, with 73% outperforming for the 10-year period.

And while the turnover rate for the Science and Technology fund is accurate in the book, Lewbart said, "he [Lowenstein] omits the fact that the turnover for the Morningstar `Specialty-Technology' category during those years was 226% and 224% respectively-significantly higher.

"From a business standpoint it [the book], has been a non-event. We did provide some background on it to our shareholder reps, so if they did get any questions, they were prepared."

Chuck Freadhoff, director of media relations for Capital Research and Management, manager of American Funds, fends of criticism of fund performance. Its criticized Capital Growth Fund grew at an average annualized rate of 15.1%, and an impressive 9.84% over the dicey market period of three years, he said.

As for not disclosing the portfolios of the fund's 11 separately managed accounts, as the book suggested, Freadhoff said: "If an investor or advisor wants to know how the Growth Fund of America is doing, it's in the paper every day." Meanwhile, he said, his company has 50 people making investment decisions daily, including 11 portfolio counselors. The fund has restrictions so that it can't over-invest in one issue-including a limit of 10% in debt securities that are rated below investment grade and a 15% limit on overall assets that can be outside the United States.

"He [Lowenstein] does not have a fundamentally good understanding of the way we manage money," Freadhoff said. It involves frequent communications with portfolio counselors in meetings and via phone.

(c) 2008 Money Management Executive and SourceMedia, Inc. All Rights Reserved.

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