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Six Questions for Your Fund Company
Checking Up on Holdings
If you’re a buy-and-hold mutual fund investor, it’s easy to roll along owning shares in a particular fund for years. As long as the fund is performing at least in line with its benchmark index, there’s little reason to make a change. After all, a major benefit of investing in mutual funds is that a professional manager monitors the holdings instead of you (although, of course, you don’t get to control the manager’s transactions or the tax consequences).
On the other hand, buying and forgetting doesn’t work. Mutual funds, as with any other investments, require regular due diligence to ensure they’re not running off the rails. Fund management involves many metrics and issues besides simple performance that are worth monitoring at least once a year.
Here are six questions you should ask your fund company regularly. Whether you get the answers by talking to a representative or by researching the company’s website is up to you.
1. Have the fund family’s expense ratios fallen in the last five years?
Because of their key role in building retirement and college savings assets for millions of Americans, mutual funds continue to gather dollars at a record pace. The more assets a fund family collects, the more it profits because the marginal cost of serving new accounts goes down once a decent infrastructure is built. Fund comp-any executives love to talk about shareholders benefiting from these economies of scale, the theory being that they would pay less in expenses.
But cutting expenses, especially regularly, is rare in the mutual fund world. Even fund companies with good reputations in this area don’t have much to brag about, and funds with exceptionally low expense ratios haven’t budged downward in years.
If your fund family is cutting fund expenses consistently, bravo. If not, at least find out whether the expenses are low or at least average for the fund category and whether they’re going up instead of down.
Sources of information. The Trend Report of BetterInvesting’s Mutual Fund Data Service and Online Investment Tools. Morningstar.
2 How many new funds has the family launched in the last five years?
Many fund families are quick to launch flavor-of-the-month funds to capitalize on investing fads. Witness the large number of Internet-related funds launched in 1999 and 2000, defense-related funds started up after 9-11 and commodity-based funds introduced since oil prices have peaked.
The mark of a stable, investor-oriented fund family is a prudent, thoughtful strategy for issuing new products. A fund family that carefully considers its current lineup of funds, staffing and how a new fund fits into its existing strategy is investing its resources properly for the long term.
On the other hand, a fund family that regularly churns out new funds that have thin premises and seem to be trying to capitalize on investment fads isn’t acting in its fund shareholders’ best interests. It’s squandering resources that could be used better elsewhere, including supporting a cut in fund expense ratios.
Sources of information. The fund family’s website under news or announcements regarding the creation of new funds. Morningstar.
3 Do managers comment on their successes and failures in fund company literature?
If you’re like most fund investors, you get a pile of literature, including annual and semiannual reports and prospectuses. You probably let the reports accumulate or you toss them, but they can indicate a fund company’s idea of accountability to fund shareholders. Anybody can dash off a page of clichés blaming the fund’s poor performance on “market factors outside of our control” or praising the fund’s strong performance as “management’s best ideas in action” while providing no specifics about whether the managers trade securities based on an actual strategy or readings from a Crazy 8 ball.
In my experience, fund managers who can’t admit they made a mistake and blame their problems on everything from oil prices to sunspot activity are destined for trouble. As the saying goes, those who don’t learn from the past are destined to repeat it. Praise be to fund managers who lay out their strategy and honestly review reasons for a fund’s success or failure.
Read the most recent semiannual or annual report or any commentary from the fund manager. If you’re better informed about the fund’s strategies, successes and failures after reading the material, that’s a good sign.
Sources of information. Shareholder reports at fund family websites.
4 Does the fund family appoint and support independent directors on fund boards?
The vast majority of fund families have executives who suffer from an inherent conflict of interest. These executives and managers are hired by, paid by and accountable to corporate shareholders who want the maximum amount of profit squeezed out of company operations. (Editor’s note: Of course, if you owned stock in such a company, you might expect nothing less.) At the same time, management also has a duty to fund shareholders, who profit most when expenses are low.
So how can you be sure your fund company is watching out for the interests of shareholders in funds? One way is by checking the number of independent directors who oversee the company’s various funds compared with directors who work for the company.
Independent directors have no ties to fund management. Ideally, the fund board’s chairman and a majority of directors are independent. It’s also nice if all directors have a significant stake in the funds they oversee and aren’t overburdened by supervising dozens of funds at the same time.
Sources of information. Fund semiannual and annual reports.
5 On average, how long do managers remain at the helm of the family’s funds?
When you’re investing hard-earned money in an actively managed fund (one in which the managers select which securities are bought and sold), manager tenure is a vital statistic. A manager with many years at a fund is more responsible for its long-term track record than one with only a few years of service, and longer-tenured managers are usually more committed to a particular fund.
Look for a manager with at least five years’ experience at a particular fund. Beware of funds that move their managers about like players in a game of musical chairs. Such a strategy may benefit the fund family by giving managers exposure to different types of funds, but it often isn’t good for shareholders.
To get a sense of how the fund family handles this important issue, take a look at the funds you own shares in as well as a couple of the fund family’s largest funds.
Sources of information. Morningstar. Better-Investing’s fund tools.
6 Does the fund family disclose its proxy voting record?
For years, fund companies generally voted their proxies however the holding’s management recommended they do so. The only types of funds that tended to buck the system were socially responsible ones, which have a mandate to encourage corporations to be more responsive to fund shareholders.
But in the last couple of years, more fund families have been holding corporations accountable for behavior such as approving excessive executive compensation and running sweatshops in developing countries. Because most large mut-ual fund families hold tens or hundreds of thousands of shares in a particular company, they have far more clout to effect change than the average individual shareholder.
Sources of information. Websites of the best fund families. The Stewardship Grade in Morningstar reports, available to premium members.