A New Rule for Funds

The Securities and Exchange Commission plans to propose a rule requiring mutual funds to disclose holdings quarterly instead of two times a year. But they only have to do this in their SEC filing online, not in their paper disclosures, which must reveal only "significant" holdings.

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By Tom Jacobs (TMF Tom9)
December 19, 2002

Last week, the Securities and Exchange Commission said it will propose a rule (scroll down to No. 3 in the press release) that would substantially increase mutual fund disclosure requirements.  

Funds would have to reveal, twice a year, the actual dollar amount they charged investors over the last six months. They would also need to present, in tables or pictures, holdings by identifiable categories. And they would have to disclose their holdings four times a year instead of twice.  

The last one is excellent but deserves a closer look. According to various press reports, the apparent quid pro quo to the mutual fund industry -- an industry that, over five years or more, often charges investors for the privilege of worse returns than the S&P 500 -- is that funds will no longer have to mail investors information that includes their entire holdings. Under the proposed rule, a fund must provide, in paper form only, its "significant" holdings: the Top 50 and any comprising more than 1% of the portfolio. The fund would still have to provide the entire list to the SEC, and investors could find the list on the SEC's website or request it from the fund.

Defining "significant"
Hmm. This is a target so big, even I can hit it with my Nerf gun. If we applied this reasoning to our own situations, when you file your tax return, you could list only "significant" stock transactions for the year (woohoo -- "significant" equals losses only!). When you figure up the monthly household accounts, you only present your honey with "significant" expenses. (No mention of the latest trips to the electronics store or racetrack.) Or when getting serious with a new person and proposing something permanent, you only disclose "significant" past involvements. Wait, why disclose anything? Just kidding. 

But no matter the fun -- and that's our middle name here in the Foolish land of "to educate, amuse, and enrich" -- it's important not to take shots just because it's easy. Despite some soon-to-be-departing evidence to the contrary, our regulators aren't generally addled. This part of the rule actually has more good in it than not. 

Investors' responsibilities
If you own anything other than a broad-market, low-expense stock index fund, we assume it's one of the rare funds that outperform the S&P 500 over time, after expenses. It's fine to check the holdings on the Web, and the SEC makes it easy

In the non-mutual fund realm, too many of us have bought and sold stocks without reading and understanding at least some of the financials in an SEC filing. The fact that they haven't proven to be 100% reliable doesn't mean to throw them out. If we've ever done this, we deserve what we get -- and I can say that without wagging my finger, because I'm included. If we don't want to pay attention to our mutual funds that pick stocks and, these days, most likely trade them like baseball cards, well, that's why they invented the broad-market, low-expense stock index fund in the first place.  

Insist on your savings
Not to mention the cost savings for the mutual funds. Should an S&P 500 index fund have to list the 500 stocks in the S&P 500? It wouldn't make sense, and anything that replaces paper with electronic dissemination saves money. Unfortunately, I don't think the management of most non-index mutual funds passes that savings on to investors. They'll argue that the new rule imposes such onerous requirements that they still must maintain or increase fees.

Don't buy it. Insist the fund pass some of these savings on to you. The Web is cheaper than paper, and I'll make the easy bet that a quarterly list prepared and sent electronically is cheaper than a paper list sent twice a year. Write letters and email, and generally bug management. And remember that broad-market, low-expense stock mutual funds are always there for you, matching the market's return.  

I know you, free rider
Some funds, reportedly including Fidelity Investments, oppose more frequent reporting because it offers others the chance to free ride on their investment strategy. Yet The Vanguard Group, which offers both index and non-index mutual funds, says it's on board with what it understands to be the proposed rule when published. It adds that a lag in reporting protects fund investors and prevents "'front-running' by aggressive traders, and by those seeking to copy a fund's proprietary approach and research." I see no problem here. If a fund's strategy and investors are so short-sighted that short-term market movements substantially affect returns, individual investors should have no sympathy. Take your money... you guessed where.

Check the SEC's website to find out when it publishes the proposed rule in the Federal Register. You have 45 days from the date of publication to file comments. Please let the SEC know your views. 

Thanks for reading. I wish you all the very best for the holiday season and New Year, and I ask you to check out Foolanthropy, the Fool's annual charity drive. Enjoy.

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