Caughtin A Storm

Caughtin A Storm

John and Regina Baker checked with their financial adviser to make sure their funds were scandal free.

On the surface, 2003 was an excellent year for mutual funds. Virtually every fund category posted gains—the first time that’s happened since 1996. The fund categories that held the most money (those emphasizing large-cap domestic stocks) averaged gains of 28%. However, a stream of scandals rocked the industry in the second half of the year, leading to high-profile resignations, costly settlements with regulators, and huge cash outflows from certain fund families.

What was all the fuss about? In essence, some fund families allowed selected investors to benefit from market timing and after-hours trading—taking advantage of loopholes in the mutual fund rules—to make a quick buck. (See “How Do the Mutual Fund Scandals Affect You?” Moneywise, Feb. 2004 or Ivory Johnson, who is a chartered financial consultant and founder of Delancey & Associates L.L.C. in Annapolis, Maryland, says, “Those profits diluted the returns of long-term investors and increased fund expenses.”

But the actual losses may not have been so great. Marc Singer, CFP, a partner with Singer Xenos Wealth Management in Coral Gables, Florida, estimates that an investor with $20,000 in a mutual fund might have lost only $20 or $30 to such practices. Christine Benz, associate director of fund analysis at Morningstar Inc., agrees: “It’s true that the dollar amounts were small,” she says. “What’s more, this type of improper trading probably has been stopped. However, investors in fund families that have been named in serious trading abuses should think hard about making changes.”

Morningstar, the Chicago-based mutual fund research firm, has recommended that shareholders consider selling funds from Alger, Alliance, Bank One, Bank of America’s Nations Funds, Invesco, Janus, PBHG, and Strong. What about Putnam, which has been charged with misconduct and has suffered billions of dollars of investor outflows? “Putnam’s new management has a history of strengthening mutual fund companies,” says Benz. “We’re not saying sell, but we have told investors not to put any more money into Putnam funds, the same as we’re recommending for funds from Federated Investors.”

John Baker, for one, is happy that his funds aren’t on that list. “The news has been worrisome,” says Baker, 37, a manager with a high-tech company in Colorado Springs, Colorado. “When we’d hear about it on TV, my wife, Regina, would ask me, ‘How are we doing?’ From what we heard, some short-term traders were being given an edge at the expense of long-term investors.” The Bakers, who invest for the long term, felt uneasy. “We checked with our financial planner,” says Baker. “He assured us that the funds we held were from reputable companies like American Funds, so we feel better about our investments.” The Bakers’ funds include Capital Income Builder (CAIBX), American Balanced Fund (ABALX), and Capital World Growth and Income Fund (CWGIX).

“These funds are defensive; they don’t make as much money as some funds during bull markets. But they don’t decline as much either when the stock market