Mutual funds give individual investors access to a diversified
portfolio of assets that are in line with their investment
philosophy, something they might not ordinarily have the resources
to create on their own. This concept is clearly a compelling
proposition -- the Investment Company Institute estimated that 95
million Americans owned mutual funds in 2002, and in response to an
Oct. 24-26 Gallup Poll*, 55% of American adults said they invest in
mutual funds, either personally or jointly with a spouse.
According to the Investment Company Institute, in 2001, the
median income of a mutual fund-owning household was $62,100, and
many of these households used mutual funds to save for retirement.
At an estimated total value of $2.1 trillion at the end of 2002,
retirement accounts make up a third of all mutual fund assets. By
pooling individual investors' assets, mutual funds are able to
offer the diversification, size, and extensive research capability
that only a professional investor would normally have access to.
But the mutual fund scandals currently being investigated by New
York Attorney General Eliot Spitzer provide a reminder that the
arrangement can be twisted around -- by granting certain traders
and hedge funds "late trading" and "market timing" privileges, some
mutual fund companies have allowed professional traders to profit
at the expense of average investors.
While many Americans look at mutual funds as a means to provide
for their retirement, mutual fund investments are also their ticket
to participating in the equity markets. A study by the Investment
Company Institute and Securities Industry Association** finds that
while 89% of equity market investors own stock mutual funds, only
49% are direct owners of stocks.
The Aftermath of a Scandal
The recent Gallup Poll examined public attitudes toward current
mutual fund fraud investigations, and found that more than one in
four Americans who are invested in mutual funds (26%) said they are
less likely to invest in mutual funds in the aftermath of the
scandal. Interestingly, the vast majority of American mutual fund
investors (67%) are indifferent and said that the investigation of
fraudulent practices will not affect their decisions to invest in
mutual funds.
So even though most Americans said they will continue investing
in mutual funds as they might have done before, a sizable number
may also be looking for other investment vehicles. Demand for
Exchange Traded Funds (ETFs), which track the performance of an
index and trade like stocks, could increase if investors search for
alternatives. ETFs come with lower expense ratios than mutual
funds, are more tax efficient -- and at an estimated total value of
$119 billion, the market for ETFs has nearly doubled from where it
was two years ago.
Lest one take the findings to suggest most Americans have taken
the latest financial services industry exposé in stride and
the mutual fund business will come out unscathed, results of
another Gallup question should be considered. Seventy-one percent
of mutual fund investors said they would definitely (20%) or
probably (51%) move their money out of their current mutual fund
portfolio if the company they are invested in became the subject of
a Securities Exchange Commission investigation, indicating that
mutual funds companies that have been identified by the SEC could
feel the wrath of investors.
Bottom Line
The mutual fund scandal began with the curious case of Edward J.
Stern, heir to the Hartz Mountain pet food fortune, who allegedly
traded mutual funds after hours and received preferential treatment
from financial institutions at the expense of smaller investors.
Stern has agreed to pay a $10 million fine and $30 million in
restitution. The scandal has quickly snowballed (the New York
attorney general has said that charges will likely be brought
against mutual fund companies themselves) and threatens to cast a
shadow over the entire industry. As the markets rally on the
strength of strong economic news, the SEC investigation may be
coming at a bad time for mutual funds.
*Results are based on telephone interviews with 597 mutual
fund investors, aged 18 and older, conducted Oct. 24-26, 2003. For
results based on the total sample of national adults, one can say
with 95% confidence that the margin of sampling error is ±4
percentage points.
**Survey conducted by the Boston Research Group in January and
February 2002 under the direction of the Investment Company
Institute and the Securities Industry Association.
