Mutual funds have been under fire in the past few weeks, as the public has learned about some shady practices at many fund families. Those who have long criticized various aspects of fund behavior are suddenly finding more support -- and we investors can now hope for some beneficial reforms. One case in point: increased disclosure regarding holdings.
Fund managers are required to make public their funds' holdings only twice a year. That means you usually have little idea what your funds are actually invested in. Even the twice-a-year information isn't necessarily that meaningful, as it may reflect some "window dressing." Window dressing happens when a fund manager prefers you not know that he's had your money invested in some specific dogs. So, knowing that the fund's holdings as of a certain date will be made public, he sells out of some positions (that have probably lost a lot of value) and loads up on holdings that he thinks you'd like to see. It all boils down to a variation on the ole bait-and-switch.
So you review the disclosure statement and are thrilled to see names such as Wal-Mart (NYSE:WMT), Pfizer (NYSE:PFE), Home Depot (NYSE:HD), Coca-Cola (NYSE:KO), and Microsoft (NASDAQ:MSFT). You just don't realize that although many of these have gone up over the past few months, you weren't enjoying that appreciation, since your shares were bought only recently. You may be relieved to not see names such as Enron or WorldCom, but that doesn't mean your fund didn't hold them most of the way down, until your fund manager bailed out before the day of record for disclosure.
In the wake of New York Attorney General Eliot Spitzer's investigation into funds disclosing their holdings more frequently to selected parties than to the public, support is growing to increase how often funds must disclose. The Securities and Exchange Commission (SEC) has proposed upping it to four times a year.
Keep track of developments at the SEC website and learn more about what makes mutual funds tick in our Mutual Fund Center.
If you've grown sickened by the state of mutual funds, you have some options: (A) Stick with well-regarded, passively-managed index funds. (B) Seek out the rare gems among mutual funds. Or (C) invest in some carefully chosen individual stocks. For some stock recommendations, check out our suite of investment newsletters, which deliver several promising stock ideas each month.
