Morningstar Director of Mutual Fund Research Russ Kinnel wants investors to get smarter, but it’s going to take a little more faith—and more stringent disclosure requirements—from the Securities and Exchange Commission, according to his most recent column.
Kinnel highlights where regulations fall short with respect to demanding data from fund companies in the areas of turnover, tax-advantage dividends, managers’ holdings in their own funds, compensation, and they way assets under management are measured.
“Were these data points for corporate filings, they would probably have been cleaned up right away, but an overly paternal view of fund investors leads regulators to settle for less,” he lambastes.
Right now, regulators require fund managers to calculate turnovers based only on the lesser of sales or purchases, divided by the total assets. This skews results lower, said Kinnel. To get a true sense of turnover, therefore a better gauge of trading costs, federal regulators should add sales and purchases together and then divide the sum by the size of assets.
Regulators have also made comparing after-tax returns between funds too taxing. Although fund companies have introduced dividend-focused funds in response to the drop in the dividend tax rate to 15%, and have broken out tax-advantaged dividend reporting on shareholders’ 1099 tax forms, Kinnel said it’s too hard to compare between funds. The reason is that funds report distributions through Nasdaq, and systems there don’t make the same distinction. Kinnel said they should.
It’s equally difficult to break out what proportion of assets under management are owned by the fund manager himself, Kinnel complained. Unlike public companies, which report the value of shares executives hold, fund companies report only ranges of what managers own, with the highest figure being “more than $1 million.”
“The bands simply don’t go high enough to draw meaningful conclusions about whether a manager believes in his fund or not,” Kinnel said. While $1 million might mean a lot in a small fund manager, some of the big-shot money-runners make 10 times that each year.
Furthermore, the bands belie how much trading the manager does, and offer opportunities to mask ugly maneuvers, such as buying at the low point and profiting quickly, Kinnel said. Managers, like executives at other public companies, should be required to report how much they own.
Likewise, fund companies typically offer too-vague descriptions of how managers’ bonuses are calculated. “The descriptions typically mention the benchmark and the time period, but they don’t describe how the levers work,” Kinnel said. If managers are paid based on one-year gains, they might take bigger gambles, especially during market rallies, he notes. “The SEC should require that fund companies explain the exact structure of the bonus,” worte Kinnel. “What are those weights, and what percent of base salary do they get for the different performance possibilities?”
Finally, Kinnel urges the SEC to consider tightening the requirements that fund compnies report how much money a manager oversees. Asset bloat often threatens performance. But many fund companies mask the truth about managers who run only a portion of the fund, by reporting all of the assets in each of the funds with which the manager is involved.
“The SEC should ensure that the sum listed only refers to that amount run by the manager across funds,” he said.