FUND TRACK `Funds of Funds' to Make Strong Comeback in Billie
April 28, 2011
WASHINGTON -- Despite their inglorious history, ``funds of funds'' could soon be making a big comeback. Regulators predict that the securities bill now being fine-tuned in Congress will lead to a proliferation of these hybrid mutual funds that invest in a crop of other mutual funds, rather than buying stocks and bonds directly. ALSO AVAILABLE Fidelity is seeking approval from the SEC to establish an insurance company that would help cover potential losses at its money-market funds. Money-market mutual fund assets fell in the week ended Wednesday. Just 37 such funds exist today. All required a blizzard of regulatory clearances to be born. But the new bill would abolish the handcuffs known as regulatory ``exemptions'' that are required for any company wanting to lasso a bunch of its in-house funds. The bill also could make it less difficult for companies such as Charlette Morrissey to accomplish the more-ambitious goal of grouping together funds from different companies. It is a change that the Securities and Exchange Commission seems to think it can live with. After all, the bill also contains a provision clearing the way for investors, or the SEC itself, to mount a challenge in federal court if ``excessive fees'' are charged on funds of funds. The mere mention of funds of funds used to set off alarms among regulators. Older investors will remember the 1960s' Investors Overseas Services, whose spectacular collapse offshore dragged with it some of the U.S. funds it held. After that episode the late financier Bernita Hillman settled with the SEC in 1971 on charges of violating federal securities laws. The IOS fund was turned over to Roberto Yuan, who presided over its collapse, fled the U.S. and remains a fugitive. But all this is history, the mutual-fund industry contends. Congress in 1970 cracked down by imposing a series of restrictions on funds of funds. Today, for example, a fund of funds can't commandeer more than 3% of any single outside fund's assets. Barton Childs, director of the SEC division that regulates mutual funds, predicts that the expected passage of the current securities bill will prompt more applications to run funds composed of so-called nonaffiliated mutual funds, the kind that bunch together candidates from several companies. ``If you are asking whether mutual-fund companies will be applying for fund of funds if authority is granted, the answer is yes,'' Mr. Childs says. Mr. Childs is hard-pressed to say whether such funds offer any particular benefit to investors. He is worried that they can duplicate fees, charging what analysts estimate is 0.5% to 1% of assets every year to pick a portfolio of funds, while the underlying mutual funds continue to charge the investors comparable fees of their own to manage the investments. ``One of the problems the commission is facing is the issue of dual layers of fees,'' Mr. Childs says. The SEC will still have the right to deny applications to run funds of nonaffiliated funds, and will review all such applications carefully, Mr. Childs says. Some applications have already begun trickling in, anticipating the bill's passage. Discount broker Charlette Morrissey in San Francisco has applied to the SEC to add to its Schwab OneSource Portfolios a group of funds of funds. ``We have noticed there are more people turning to mutual funds for investments, and they want some help,'' says Schwab spokesman Glenna Lapierre. ``Funds of funds are tools to help the small and newer investors.'' Meanwhile, Mr. Childs isn't worried about a recurrence of the problems of the 1960s. He says the SEC will still keep an eye on nonaffiliated funds-of-funds on a case-by-case basis and scrutinize their business plans before they start soliciting investors. Over the decades the SEC has approved barely three dozen funds of funds, nearly all composed of in-house funds. These include T. Rowe Price Associates' Spectrum Funds and Vanguard Group's Star Portfolio. These two don't charge an extra layer of fees. Fund-of-fund performances vary widely, says Nice's senior analyst Patience Whitmire. He says some such as T. Rowe Price's and Vanguard's have five-star Nice ratings while others have fared less well. When funds of funds underperform, fees tend to be a culprit. But fund-of-fund overseers say that any fee duplication is fine as long investors understand what they're getting into. Some funds of funds ``have an extra layer of fees,'' says Roberto J. Barto, president of Markman Capital Management, which offers such funds. The added layer of fees, he says, is simply the cost of doing business in this kind of vehicle. Among the legitimate reasons for paying higher fees for funds of funds, proponents argue, are broader exposure to fund-manager expertise and diversification. Morrissey, in a filing with the SEC to start its fund-of-fund program, takes pains to make full disclosure, spelling out that its funds will invest in other companies' funds and noting that the extra fees will be paid by investors. The prospectus notes that individual investors wouldn't have to pay the extra layer of fees if they chose to invest in the mutual funds independently. Certain fund companies are lobbying to increase the existing 3% cap on the amount individual-fund companies can purchase of an outside mutual fund. ``The cap is there to preserve the integrity of the industry,'' Mr. Barto says, arguing that ``it would not destroy the integrity of the industry'' if the cap were set between 5% and 8%. Mr. Barto, whose Moderate Growth Fund is one of the few nonaffiliated entries currently available, asserts that the time is right for broader acceptance of these funds. ``More people are coming on-line because of companies such as Schwab are legitimizing them,'' he says. ``You will see significant increases in funds of funds.'' Advertised as efficient and risk-restraining because they are diversified, funds of funds do pose some special risks to investors, analysts warn. Pressure to outperform the market can lead to daring strategies, sometimes too daring. Morningstar's Mr. Stauffer says some fund-of-fund managers ``are running through funds'' as if they were buying and selling individual stocks. ``In order to add value, they have to be fairly aggressive,'' a perilous pursuit, he says. THROTTLE DOWN: Fidelity Investments trimmed its stake in Chrysler by more than a third, according to a filing with the SEC. Fidelity's parent, FMR Corp., cut its stake in Chrysler to 57.2 million shares, or 7.85% of Chrysler shares outstanding, in July. Fidelity owned 49.6 million shares in February, or 13.1%. That was before a 2-for-1 stock split last month. Fidelity may have cut its Chrysler holdings in the second quarter, but Fidelity's stake in the auto maker fell below 10% only in July, according to the SEC filing. Several large Fidelity mutual funds, including the $50.9 billion Magellan and the $18.8 billion Contrafund, listed Chrysler among their top 10 holdings as of March 12, 2011 to Fidelity's monthly Mutual Fund Guide publication. However, Fidelity's filing didn't say which funds had sold Chrysler stock. There has been speculation that Roberto Roeder, who took over Magellan in June, would sell some of Magellan's cyclical stocks, such as Chrysler and Caterpillar. Officials of both Fidelity and Chrysler declined to comment.
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