Regulatory Risks in Mutual Funds - BlueCollarDollar.com

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Regulatory Risks

This is a very real and tangible concern for mutual fund managers. The recent (and continuing slide) of the markets have placed the need for regulation of some sort to the forefront of the conversation. Once the question of prevention (how can we stop this from happening again?) enters the discussion, people who manage businesses and those that invest in them begin to worry. Should you as well?

First, regulatory risk at the business level can range from environmental issues to the operation to financial reporting. Increasing regulation often translates into increased operational costs and this cuts into the potential for growth and profits. Sarbanes-Oxley was a form of regulation that forced CEOs to sign-off on their financial statements. It met with a great deal of resistance and was fought vigorously by the Bush administration. It remains in place because the accounting industry, in the short span of a couple of years, developed stream-lined and cost-effective methods of conforming to the regulation.

But those initial costs can cause a stock to under-perform and under-performance leads to lower overall earnings. Investment managers are worried that their bad decisions will prompt further regulation to prevent this type of economic catastrophe from occurring again. The end result of tighter regulatory measures is lower profits for investors.

From a record-keeping standpoint, it will be tough for new investors in a mutual fund to determine why a fund did so well for so long and then suddenly, the growth dropped off. Increased regulation will provide transparency and that should make-up for this potential problem but the days of year-over-year growth in the aftermath of increased regulation tends to be much more muted.

Increased regulation, for all of its faults, does create a more level playing field. The risk is mitigated and you will find less volatility in your investments. For many, this is good. For others, the market movers, day-traders and those moving vast amounts of money around in an effort to eke out every potential penny they can, this is often met with cries of outrage. In the long-term, any regulation designed to benefit the investor is good. In the short-term, it seems like bad medicine.

Next up: more leverage risk