Ramifications from the Pension Protection Act's effect on investor inertia, changes to Rule 12b-1's regulation of expenses and a possible mandate by the Securities and Exchange Commission on independent directors are among the top concerns of the mutual fund industry's top executives.
Among them, Paul Haaga, executive vice president and a director of American Funds' Capital Research and Management Company.
In a recent interview with Money Management Executive Associate Editor John Morgan, Haaga discussed the current state of the economy, developments in the mutual fund industry over the past five years and the future of American business.
MME: About 75% of the industry has an independent chairman, though, still, going into five years since the trading scandal set off all of these new regulations, there is no SEC mandate. Do you think independent chairmen are doing a good job, and do you believe an SEC mandate would be a good idea at this time, particularly in light of inflationary fears?
Haaga: I think they're doing a good job, but my view would be that it ought to be up to the organization and the full board as to whether they want to have an independent chair or a lead director or neither. We came out with our best practices seven, eight years ago when we looked at this from the perspective of the ICI committee, and we suggested one of the best practices was having lead director. I think either a lead director or an independent board chair is a good practice.
We have voluntarily adopted the independent chair model, and I think it works quite well.
MME: But you don't think they should require it for everybody?
Haaga: No, I don't think that they need to require it. It's one of those things that could be left up to the individual boards to see which works best. The supermajority of boards are independent directors. If they collectively think it's a good idea, it will happen. I don't think it needs to be mandated, and it may not be the best approach for some groups. I think leaving something as a best practice is a good idea. It's not even a requirement until you have 75% of the people doing it.
If it's a good idea, we'll follow it.
MME: Many retirees are concerned about outliving their assets. What is American Funds doing to help Baby Boomers roll over their retirement accounts into plans that will provide them with retirement income to last 30 years or, as we are increasingly hearing, possibly far longer?
Haaga: Going forward, I think that's going to be the most important issue we face as people live longer, retire earlier and want to have more active lives in retirement. In fact, retirement as we used to know it, is unlikely to be the pattern.
People are going to be doing other things-traveling, getting involved in non-profit activity, etc.
They'll probably need even more money than they had in the past. We have always had funds that emphasize income and stability. All our funds are broadly based. We don't have narrowly focused funds. In addition, we have target-date retirement funds that would be appropriate for people to retain even after they retire. They're designed that way.
Probably the most important thing we do is establish our funds to be used by shareholders who have personal advisers. One of the most important things shareholders need are investments that provide the stability of income but also a measure of growth.
So, they don't outlive their income, they're going to need personal advice, people sitting with them and talking about their plans, their lifestyle, their needs for income over time, and their desires to leave or not to leave wealth for next generations.
I think probably the biggest thing we do is encourage the use of personal advisers.
MME: After the mutual fund trading scandal of 2003, the SEC required chief compliance officers and a litany of other compliance policies, with the goal of encouraging a culture of compliance.
Do you think these requirements have helped the industry to accomplish that goal?
Haaga: I would start by taking some issue with the term "scandal." Two hundred thousand people work in the mutual fund industry, and probably about two or three dozen did something wrong. While it was regrettable, I'm not sure we can call something a scandal with that tiny a fraction of the people. But we'll leave that aside and go on to the real question.
Happily, there was already a culture of compliance in the industry.
Those events and other events, over time, have revealed that there are always going to be a few organizations or a few senior management types who don't get it, and don't think that compliance, integrity, ethics and our reputation are among the most important aspects of our offerings.
So, for those few, I think this has been good. It may have marginally strengthened the compliance at the overwhelming majority of places that do get it. I'm sure it helped the ones that don't and probably was not as helpful but it certainly wasn't harmful for the overwhelming majority who did do it. Regrettably, it was necessary for a few shops.
MME: When Congress passed the Pension Protection Act 18 months ago, a lot of people said positive things about it. What are some retirement savings challenges that still need to be addressed?
Haaga: [Fewer of the challenges] involve legislation and regulation than involve sincere efforts on our parts. The biggest one was the one you alluded to in an earlier question: providing investment vehicles that are appropriate for people who need income stability and growth for a long period, and making sure they don't outlive their money.
Educating people about the need to save for retirement was extremely helpful. I think a big step forward was getting the Pension Protection Act provision for automatic enrollment because, in that case, it gets inertia working on the right side of the issue. Inertia gets people to invest, rather than not invest.
I still think we finished the educational process simply getting people to enroll, getting people to put aside a substantial part of their savings and feel comfortable in times like this.
Continuing to fund their retirement savings when what you read in the papers-the hype-may tempt you to stop saving. Those are the biggest challenges. Few of them are regulatory, most of them are really challenges to the industry, to all of us and to employers, frankly, and to the American public to emphasize the need for time and to encourage people and educate people.
MME: What do you think will be the major economic, competitive and legal/regulatory challenges and opportunities facing fund companies in the next five to 10 years?
Haaga: Retirement savings, and all that involves. Globalization, which is a term that is used so much and probably no longer has a meaning.
Opportunities to invest abroad. If you just look at over time, the shrinking percentage of the total securities market, represented by U.S. organizations, and at the same time, the increasingly global nature of business operations.
It matters less now whether a company is based in the U.S. or not. Exxon has the majority of its operations based outside the U.S., and to understand investing outside the U.S., to understand the nature of the challenges to industry and the way they meet that, and to do good investment research on companies that are truly global. That's probably one of the biggest challenges we'll have.
MME: What do you expect the SEC will do with the 12b-1 Rule? Are there things about that rule that get more attention than they deserve, or less attention?
Haaga: Indications are that they will not attempt to do something dramatic like completely do away with it. You need to remember that the rule is a process rule with some limits. If there were no Rule 12b-1, there would be no limits and no process, but there wouldn't be a prohibition on funds spending money on distribution-related activities.
I think it was wise of them not to try to do away with it. I think that over the longer term, the distinction between sales and distribution activities and expenses and administrative service and advice activities that are performed by personal advisors to our shareholders is going to become increasingly blurry. You already see it being blurred in the [Merrill Lynch Rule] debate going on right now over whether individuals need to be registered as advisers or as brokers.
I think that's going to continue, and I think that having a special rule or a special category of expenses that's tightly regulated and treated differently and subject to a different level of oversight by directors for distribution-related expenses is going to be less and less relevant. It's going to be a distinction without a difference. It's going to be increasingly challenging for directors to do what they need to do now under the Rule, which is identify what expenses are being made for distribution and what expenses are paid for other things.
If we were reinventing the industry or if I were predicting where the industry will be in 20 or 30 years, we won't make the same distinctions, so we won't have a regulatory system that has a special rule for distribution expenses. We'll look at things differently and we'll recognize the activities of the advisers for what they are, which is advice, administration, recordkeeping and really not much in the way of sales.
MME: When we look back on the sub-prime crisis a few years from now, what will the mutual fund industry see as the major lessons we learned?
Haaga: We've had issues with investments before-particularly fixed income investments-and the lessons have often been the same, which is that no matter what the models tell you will happen, or what the stress tests produce as hypothetical results, every instrument of every kind, from the simplest to the most complicated, is worth what willing buyers will pay and what willing sellers will sell it for. When willing buyers stay home, nothing's worth anything.
We keep losing sight of that element. Liquidity is illusory; it's always there for you until you need it. We're really not learning any new lessons from this; we're relearning old lessons with a different fact pattern. And the lesson is the same one: You can't count on people to do what your models tell them would be logical for them to do.
You have to be prepared for overreactions and literally strikes by buyers in these instruments and understand that that can happen.
We may also learn some lessons about leverage, particularly hidden leverage.
Name: Paul Haaga
Company: Capital Research and Management Company
Title: Chairman, Executive Vice President and Director
Haaga is also the Chairman of CRMC's Executive Committee, Chairman of the Capital International Fund, Vice Chairman of the 12 fixed-income funds in the American Funds Group and of the Capital Income Builder and Capital World Growth and Income funds.
Prior to joining Capital in 1985, Haaga was a partner with Dechert Price & Rhoads Washington.
He served a senior attorney for the Division of Investment Management of the Securities and Exchange Commission from 1974 to 1977 and was elected to two terms as chairman of the Investment Company Institute, from 2002 to 2004.
Haaga earned a bachelor's degree from Princeton University, an M.B.A. from the Wharton School and a J.D. from the University of Pennsylvania Law School.
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