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Today's Commentary: 06.23.06
Going Private: A Possible Solution to Soft Money

The Investment Company Institute, the lobbying arm of the mutual fund industry suggested recently that the prospectuses issued by these investments be either eliminated or put online. The thinking goes like this: Investors receive these documents and even with advancements in layout and ease of use, they still do not use them as they were intended.

They point out that this obvious under-use would be money saved if the information was already available online. There, not only would the document be accessible and hyperlinked, but the information contained in it could be updated more regularly and be kept current.

Not so fast. While many investors seem lazy and the mutual fund industry has lulled them into this complacency with their follow-the-leader investment style, eliminating the one document that can be referred to much like a snapshot in time is just as lazy on the industry's part.

Those who support mutual funds as the way to invest passively may have been partly responsible for this lack of interest in the document. I am among them. Mutual funds, for all of their faults, one of which I will discuss a little further on, have given many households the opportunity to invest in the markets under the heavy-handed regulations in place by the Congress via the S.E.C. This has given investors a sense, and not a false one either, of security that at least their decision to send money to a fund will be invested and done so with the same eye towards value as they might use when shopping for the best deals.

How well those investments do many investors know is based on a variety of elements at play but that doesn't change the simple fact that fund managers should be trying to their job as inexpensively as possible with the best results ­ for their shareholders.

To their credit, mutual funds have explored every facet of the investor psyche looking to tailor make something suitable for every investor taste. That. although has come with a cost. Many mutual fund companies are publicly held entities beholden to shareholders of another kind.

I was struck by an interview in the Wall Street Journal with the founder of Craigslist and the companys CEO Jim Buckmaster. Brian M. Carney, a member of the Journalıs editorial board seemed increasingly incredulous as the interview progressed. How could anyone responsible for running such an obviously successful enterprise do so without all eyes focused on taking advantage of every opportunity to create unbelievable wealth? How could any company succeed as well as Craigslist had led by a corporate chief with such an un-business-like skill.

To date, Craigslist has been profitable in every year of its existence. Mr. Carney wondered why it was not more so even going so far as to estimate the untapped revenue available with the simple addition of ads on the site. Carney suggested the unrealized profits could exceed $500 million ­ a huge jump from annual revenues of only $25 million.

Mr. Buckmaster's reply was that customers don't want it. When asked how newspapers could compete with his free site, one that essentially offers what are the newspaper industry's bread and butter for free, he suggested they go private, divorcing themselves from shareholders and Wall Street and become more consumer-centric. Buckmaster believed that the end user would keep the paper profitable. You could almost hear the dismay in Carney's writing and Buckmaster went somewhat Zen on the subject.

But Mr. Buckmaster does have a point. When a business is solely in existence for the good of its users, the users are the shareholders of note, not the faceless investors recruited when the company went public. Those masters demand profits and can be ruthless in their desire that you share the same goals ­ at all costs. Removing them from the equation does not deter capitalism one iota and may just be the solution mutual fund investors need whether they realize it or not.

Such thinking would change the face of the mutual fund industry. Publicly traded companies who are mutual fund families are supposed to make money, first for the investors in the funds run by the company and then for the shareholders on Wall Street. That unfortunately is not the way it happens. All too often, it is the reverse that prevails.

Consider the issue of soft money. Christopher Cox, the Security and Exchange Commissioner believes the practice of soft money, a section written into the Exchange Act some 30 years ago, be tightened if not eliminated because it no longer works in todayıs world. His concern should prompt Congress to act.

Soft money referred to by Mr. Cox as an anachronism allows trade commissions to pay for research. The idea was that mutual fund managers would shop for the best price from a broker who in theory, had the best execution. Brokers began adding on services such as research and analysis to make their business seem more attractive to institutional investors like fund managers.

This means that not only are we the shareholders paying for the execution of trades on our behalf, we are also paying for research as well. Once we are paying the bill, everything changes.

The fund manager, who is supposed to be our advocate no longer needs to shop for the best deals for our money but instead shops for the best deal for the company that owns the fund. By allowing clients to pay for services beyond what we think we are paying for, the company becomes more profitable while investors in the fund lose potential gains.

While it is difficult to determine exactly how much we would stand to gain if soft money was eliminated altogether, numbers have run as high as 1% of the total return for the fund. If soft money were eliminated, the costs of such research would appear in the fundıs management fees (and detailed in the prospectus) and not deducted from our gains. Managementıs fees, something investors have been very diligent about to their credit, would be forced lower in a competitive open market place.

This would have the net effect of creating a mutual fund manager who is also a very smart shopper. Not only will trade execution be important but also any bundled services would need to be competitively priced to attract new investors.

Or funds could take Mr. Buckmaster's suggestion and go private. Once the monkey of Wall Street is off their backs, fund families could operate in a more paternal fashion with the understanding that when investors in their products profit, so would they.

BlueMoney Report

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