Wealth advisers are uniquely situated to understand that the needs of individual investors are growing ever more diverse. Risk tolerance, return objective, and tax status are but a few of the dimensions that vary widely among investors, with few financial products appropriate to all. Once a prominent investment solution to basic needs for diversification and professional management, mutual funds may not have kept up with the increasing segmentation of the individual investor market. Is the industry, as John Bogle asserts, now a marketing business “primarily focused on salesmanship” as opposed to its original position as “an industry that focused primarily on stewardship”?¹

Some characteristics of mutual funds appear to be legacies of the past. Although the principal regulatory framework governing mutual funds has been revisited and tweaked since 1940, it has never been substantially overhauled. Some argue that the advent of other financial service products that function well without the complexity of the Investment Advisers Act of 1940 regulations raises questions about the continued usefulness of certain aspects of the existing regulations.

What changes, if any, are needed in the mutual fund area to ensure the right balance between market forces and investor needs, including investor protections?

Is the current fund structure one that allows it to be competitive in today’s range of investment offerings, or is a new structure in the best interests of both investors and the market?

From modest beginnings in 1940, investment companies in the United States have enjoyed astonishing growth. According to the Investment Company Institute, assets under management have grown from US$500 million in 1940 to US$12 trillion in 2007. Shareholder accounts have also ballooned from 300,000 in 1940 to just shy of 300 million by 2006. U.S. investors have clearly embraced portfolio investing, with its apparent advantages of transaction ease, diversification, and liquidity.

Leave Well Enough Alone?

Some might argue that the longevity of the current U.S. mutual fund product provides compelling proof of relevancy and attractiveness to retail investors, suggesting that the status quo is acceptable. The growth in assets and number of funds speaks clearly to strong investor demand. Yet, others might contend that the complexity of multiple classes of fund shares and varying costs to shareholders are leaving the average investor a bit confused. Indeed, according to the Investment Company Institute, some 80 percent of mutual fund investors seek professional advice when buying funds (other than through retirement plans offered at work).

Are the Returns to Investors Proportionate to the Costs of Investing?

Some question whether the costs to investors have remained commensurate with mutual funds’ returns, or whether fund investors’ profits have been shaved to further fund the industry. Depending on whom you ask, the costs of mutual fund investing have either increased dramatically over time or decreased significantly as the industry has grown and assumed scale. John Bogle, who founded the second-largest mutual fund complex in the United States and whose perspective has informed generations of investors, notes that estimated average investor expenses from 1945 to 2004 have doubled, despite the industry’s explosion in size. The Investment Company Institute, in contrast, contends that investor expense rates have been cut in half from 1980 to 2006, asserting that economies of scale benefit end investors as well as mutual fund companies.

Are Shareholder Expenses Proportionate to the Services Received?
 
In addition to the aggregate costs of investing, there is also some question about the validity of various expenses that mutual fund investors bear. (If simple trends in expenses are in dispute, is it any surprise that agreeing on the proper components of shareholder expense is also in dispute?) Over the past few years, the measurement of management fees, shareholder transfer agent fees, marketing fees, brokerage commissions, and taxes, to name just a few expenses, have been scrutinized as areas that might need rethinking.

Does the Current Mutual Fund Form Provide the Flexibility Needed in a Global Economy?
 
There also are questions about the regulatory restrictions in the United States applicable to mutual funds that limit investment options. Indeed, non-U.S. investors have access to products much like mutual funds (such as Undertakings for Collective Investment in Transferable Securities, or UCITS) that are organized under significantly different legal and regulatory structures. The Investment Company Institute itself has urged consideration of a new form of mutual fund, modeled after UCITS, that could be offered to investors globally. Could U.S. investors benefit from access to global products that are currently out of reach because of the U.S. regulatory structure?

The CFA Institute Centre for Financial Market Integrity Seeks Your Input on the Areas Most in Need of Reform

The CFA Institute Centre believes that, despite the industry scandals of a few years ago, mutual funds have been largely successful in offering a wide variety of investors cost-effective access to the capital markets. Yet—in light of rapid technological change, the introduction of new market products, and increasing irrelevance of political boundaries—changes to the current mutual fund structure may offer important efficiencies and opportunities to U.S. investors. We seek to consider opportunities for enhanced investor information and protection as well as efficiencies that may make funds easier to manage and easier to buy.

We plan to consider all aspects of the investment company structure and welcome all ideas on the current mutual fund model.

Please give us your thoughts on mutual fund reform by participating in the brief online survey. This survey should take no more than 10 minutes of your time and will provide us with important membership input as we consider the relevant issues in this area. We will be reporting our progress and conclusions in future editions of this newsletter.