What's Wrong with the Fund Industry

The mutual fund industry has long prided itself in staying free of the scandals that have plagued other types of investment vehicles, such as limited partnerships and the less-savory corners of the insurance arena. Any mutual fund executive (or the fund industry trade group, the Investment Company Institute), will gladly tell you about the industry's long history of serving investors and offering products that meet market needs.

But with corporate America and Wall Street under increasing scrutiny, the fund industry has also been under attack. As Morningstar managing director Don Phillips pointed out in a recent article in our monthly newsletter, Morningstar FundInvestor, the fund industry should be doing everything possible to align its interest with those of shareholders, particularly now that investors have been scarred by a three-year bear market and high-profile corporate scandals. But instead, the industry has continued to dig in its heels on key issues such as disclosure of proxy voting (a battle it ultimately lost).

Warren Buffett has also been a sharp critic of the mutual fund industry. In his most recent letter to  Berkshire Hathaway (BRK.B) shareholders, he called the record of independent fund directors "absolutely pathetic" when it comes to selecting the best managers and negotiating lower fees. He adds, "Many thousands of investment-company boards meet annually to carry out the vital job of selecting who will manage the savings of the millions of owners they represent. Year after year the directors of Fund A select manager A, Fund B directors select manager B, etc. … in a zombie-like process that makes a mockery of stewardship." (To read more of Buffett's comments on the fund industry, see page 16 of Berkshire's 2002 Chairman's Letter.)  

In this Special Report, we highlight Morningstar's coverage of some key problems that have recently emerged in the fund industry--and offer some thoughts on how to resolve them.   

Fund Industry on the Hot Seat
The industry has recently come under fire for abusive share-class practices, as well as high expenses, excessive trading costs, and questionable soft-dollar arrangements. 
by Brian Portnoy, Senior Fund Analyst

Five Stupid Fund Tricks
Plenty of good funds are out there, but fund companies do dumb things far too often. Find out why high expenses, bloated asset bases, poor performance, managers that have zero experience, do-nothing directors, and Internet funds make us cringe.
by Christopher J. Traulsen, Senior Fund Analyst

Less-than-Friendly Bond Funds
If you're interested in buying a bond fund, watch out for more than just poor performance. We've found a number of fund companies that have hiked their expense ratios or added costly B shares despite enjoying significant asset growth.
by Eric Jacobson, Senior Fund Analyst

10 Long-Term Losers
High expenses, lousy stock selection, and emerging-markets exposure have been a toxic brew for these funds' shareholders over the past 10 years.
by Russel Kinnel, Director of Fund Analysis

The Case for Better Portfolio Disclosure
The SEC has proposed requiring mutual funds to reveal their holdings once per quarter instead of semiannually as they currently do. The industry is crying foul--but we think their logic doesn't hold water.
by Scott Cooley, Senior Fund Analyst

The Best Market for Mutual Fund Investors
Don't pine for a late-1990s revival.
by Gregg Wolper, Senior Fund Analyst