Reuters: Mutual Fund scandals may make dull choices sexy  

November 5, 2003

Investors disgusted at the growing tide of mutual fund scandals may be ready to run to companies that specialise in index funds or exchange traded funds says Svea Herbst-Bayliss of Reuters.

BOR-ing can be bliss

By Svea Herbst-Bayliss

BOSTON (Reuters)

As investors grow more disgusted with mutual funds caught breaking their own trading rules, they may be ready to run to companies that specialize in index funds or even exchange-traded funds, analysts said.

Regulators have already charged one big-name fund company, Putnam Investments, the money management unit of insurance broker Marsh & McLennan Cos Inc., with civil securities fraud. Others, including Legg Mason, Janus Capital Group Inc.'s Janus Capital Management, and Fidelity Investments, the No. 1 U.S. mutual fund company, are cooperating with investigators in their probes.

Suddenly firms that specialize in index funds, which mimic the major U.S. stock indexes' performance and are sometimes considered dull alternatives to more actively managed funds, look good.

"Anyone who is an index player would benefit from this turmoil in the short term," said Tim Schlindwein, an industry consultant who was once chairman and chief executive of investment firm Stein Roe & Farnham.

Some investors also may give up on mutual funds altogether in favor of exchange-traded funds, which are baskets of securities that trade like stocks.

Industry statistics already are proving exchange-traded funds' growing popularity, which analysts said might rise even more. In 2002, exchange-traded funds had $93 billion in assets -- a jump of 46 percent from 2000 -- according to data from the Investment Company Institute, the Washington, D.C.-based trade group for the mutual fund industry.

INTO THE VANGUARD

Among the index players, the Vanguard Group's name has been popping up most often, praised by analysts for being a low-cost and honest provider of financial products.

Even before questions about market timing and late trading began dogging the $7 trillion U.S. mutual fund industry this fall, Vanguard's founder and former chief executive John Bogle scolded the industry for letting investors down.

News that Putnam, the fifth-largest U.S. mutual fund company, was caught giving special deals to certain clients and letting some of its managers enrich themselves by breaking company rules on market timing, added fuel to Bogle's fire.

Analysts, however, warn that for individual investors, the cost of the scandal may amount to no more than $10 per $10,000 invested. Still, they agree that the trust the once unblemished industry is losing carries a steep price.

SURVIVAL OF THE CLEANEST

Vanguard, the nation's second-largest mutual fund company with almost $650 billion in assets under management, has so far stayed out of the fray -- in part because of strict rules. Its index funds stop letting new money in at 2:30 p.m. -- hours before the cutoff point that is used by other funds. This lets the company funnel the money to managers before the 4 p.m. market close to avoid any last-minute reshuffling.

Vanguard has also imposed hefty 2 percent redemption fees on its taxable funds, something that has discouraged so-called market timers, who try to profit from stale securities prices through quick-paced buying and selling of shares.

High standards like these are likely to attract new investors, analysts agreed.

"There will likely be a form of Darwinism among investors, who will be smart enough to look for companies that are beyond suspicion," said Harvey Pitt, a former chairman of the U.S. Securities and Exchange Commission.

While retail investors may favor names like Vanguard, institutional investors, including state pension funds, are likely to move first to so-called transition managers, who will keep the assets safe as another permanent manager is sought.

Last week alone, some of the $4 billion that state pension funds pulled away from Putnam Investments went down the street to State Street Corp.'s transition management team, headed by Nicholas Bonn.

While Bonn was mum on how much money he has received so far, as well as on how much he might get as more pension funds, including two in California, consider firing Putnam, some numbers are already public.

Treasurers from Massachusetts and Rhode Island said they sent at least $2 billion to State Street, which along with Barclays, dominates that business.

"You will likely want to swap your funds for other similar funds," said Robert McCarthy, president of Kanon Bloch Carre, a company that tracks mutual funds. "But in the short term, the transition managers are likely to see a lot of money,"