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RAY SUAREZ: Through much of the fall the mutual fund scandal has grown increasingly widespread. So far, at least 11 mutual fund companies have been implicated or investigated for questionable or illegal trading practices. State and federal regulators say millions of investors and billions of their dollars have been affected by these cases. What can individual investors watch for while these investigations continue?
Joining me now are Matt Gnabasik, managing director of the retirement practice at Blue Prairie Group, a human resources consulting firm, and the author of “Smart Choices: Selecting and Administering a Safe 401K Plan.” And Christine Benz, editor of the Morningstar Fund Investor, a monthly newsletter for individual fund investors.
Well, guests, why don’t we start with splitting the world into two groups: People who own the funds that have been implicated and people who own the funds that haven’t. What should they do now? First, people who have money in some of the funds that have been invested in, implicated in these news stories.
MATT GNABASIK: Well, for the folks that have money, and I include both plan sponsors, the companies that sponsor ERISA, a qualified retirement plans such as 401K plans, as well as individual retail investors, need to at a minimum be aware of the — if the funds that they own actually are caught up in this scandal, and if they are, they need to be watching the situation very, very closely. Some of the funds have already — in question have already settled and so on, and there are a number of investors that have made a decision to hold their money out and take it elsewhere, and that’s a question that investors are grappling with right now.
RAY SUAREZ: Well, if you’re one of those people who hasn’t pulled their money out, Christine Benz, what should go into the decision whether you stand pat and wait to see what happens, or see if there are greener pastures elsewhere?
CHRISTINE BENZ: I think your first step has to be not to act rashly. You have to understand that the value of a mutual fund isn’t going to change overnight, despite whatever monkey business might have been going on at a fund company. So recognize that you have time to make a reasoned decision, and I think first you want to look at what might have gone on and look at how widespread the trading abuses might have been. So were they a few rogue brokers in an office somewhere, or were they top managers and top fund managers? And then from there I think it’s key that you consider your own particular set of circumstances, make sure you don’t end up costing yourself money by trading out of one of these scandal-tainted funds.
RAY SUAREZ: Has that kind of fact-finding, Christine, been something that’s easy for the average investor to do? Part of the idea of mutual fund investing is that you’re letting somebody else manage a lot of this for you. This idea that you’ve got to be checking on who did what and when seems I’m sure daunting for many.
CHRISTINE BENZ: I think it does, and I think a lot of the fund investors maybe had gotten a little too complacent, hadn’t been doing enough homework about the quality of the firms that they were investing with. But I think it’s absolutely key to look at not only what a firm’s involvement might have been in any of these trading abuses but also what its history of shareholder friendliness has historically been. So is this a firm that charges a lot for its bonds? Is it a firm that’s had a revolving door in the manager’s office? Those are the kind of questions you want to be asking regularly.
RAY SUAREZ: Matt Gnabasik, as you mentioned, billions of dollars have flown out of some of these funds as the stories have continued over the past several weeks, investigations in several states. If you’re still holding shares in one of the named funds and you’re watching this money head out of the door, is there any harm in staying put?
MATT GNABASIK: No, not necessarily. And I would just concur with what Christine said. The current events need to be placed in the overall context of your portfolio as an investor and the overall performance of that portfolio. So if I’m an investor and some of my funds have been caught up in a scandal and they’ve been laggards and they haven’t been performing particularly well, then perhaps this is the catalyst that I need to fire them and make that decision within the context of, you know, looking at tax consequences and so on, and maybe it’s time to clean house. On the other hand, again, some of these funds have been subpoenaed; they haven’t been formally indicted or anything like that, and maybe the performance is good and maybe I just watch the situation closely. So I think — I don’t think there’s a one-size-fits-all response here for an investor. It really comes down to each individual and making that decision for him or herself.
RAY SUAREZ: Christine Benz, take Matt Gnabasik’s point about a catalyst. If you were holding funds that haven’t been implicated in any way, is this your cue to be more diligent about who’s running it, how it’s being run, what fees they charge?
CHRISTINE BENZ: I think absolutely. I think that this will be — if there’s a silver lining to this scandal, it is that investors will begin to do some due diligence on their fund. What you saw in the late ’90s was a big tendency among fund investors to want to take performance, jump on hot performing funds and ask questions later. I think investors really have to learn to ask a lot of questions before investing in a fund and returns should really be secondary. Primary should be who’s running it, how much is this fund charging.
RAY SUAREZ: Well, tell me some more of the questions that they should be asking. What does due diligence consist of?
CHRISTINE BENZ: I think you want to look at the quality of the firm, the quality of the investment managers. So I think you want to invest with people who have demonstrated expertise investing in a given part of the market. And another thing that I would like to see investors pay more attention to is the issue of putting portfolios together. I’ve seen investors do a great job of picking individual funds but they don’t look at how everything fits together in aggregate, and that’s another thing that I would like to see investors focus on, rather than having a lot of funds that are doing the same thing, focusing on funds that complement one another.
RAY SUAREZ: Matt Gnabasik, a lot of Web sites allow individual consumers to compare funds to each other. Which numbers should they be looking at, and which kinds of indicators are signs that maybe there’s a problem with a fund that they should look at really carefully before investing?
MATT GNABASIK: Well, in — given the recent scandal and clearly you wanted to know if a particular fund company has any involvement at all, has been swept up in the scandal at all. You want to look at what their stated practices are concerning market timing and late trading and so on and so forth. But the broader question and I would again concur with Christine is you want to be looking at performances placed in the broader context of risk-adjusted performance and the overall cost of the investment. And Morningstar in terms of a particular Web site is a great place to start if you are an investor that likes to do that type of research yourself, or if you prefer to use some type of financial adviser of which there are many kinds, then you want to have a real heart-to-heart discussion with your broker or with your adviser about your portfolio, about the role of mutual funds and what kind of mutual funds are appropriate, given your objectives.
RAY SUAREZ: Are there any things like rate of turnover of holdings, rate of turnover of managers that should be cautionary as you’re checking things?
MATT GNABASIK: Yeah, I’ve seen that. And people have commented on it that there might be some correlation between the portfolio turnover rate and possibly some kind of involvement. But that’s not necessarily the case, and I would urge caution about using that sole criteria to make a judgment of whether that fund’s appropriate. The issue of manager tenure and manager — manager tenure is an important one though because presumably if you’re looking at historical performance, you want to make sure that the folks that are in charge right now are the ones that deliver that performance that you’re looking at — historical performance that you look at — and as we all know in the retail mutual fund industry there is a lot of turnover, so that clearly is one of the factors that you’re going to look at, along with performance and along with fees.
RAY SUAREZ: Christine Benz, as we close, are there any investors or mutual fund holders that you would say, oh please, don’t do anything right away, don’t sell out right now, even if you’re disgusted, just wait and see what happens?
CHRISTINE BENZ: That’s a great question. I would actually urge investors in 401Ks to think long and hard certainly about pulling their money out altogether. Or pulling their money out of a given fund in a 401K, if they don’t have any other similar options in that 401K, so maybe Janus Fund, for example, was your only growth fund in your 401K — you probably want to stay in that fund, despite the overhang of scandal at Janus because that is your only option in that style.
RAY SUAREZ: Christine Benz and Matt Gnabasik, thank you both.