bank’ at accused fund families,” says Baptist. “If that happens, remaining investors might have to carry a greater share of the fund’s expenses.”
Repeat offenses: Singer is advising clients to change 401(k) selections in some cases and move away from fund families that have been charged with improper behavior. “Everybody is entitled to a few mistakes,” he says, “especially if steps are taken to correct them. However, repeated errors may be a sign that the fund company is not well-managed. It may lack good controls. There are many fund families to choose from, so why invest with a company that has misbehaved frequently?”
If the reasons for switching seem convincing, you must next decide where to reinvest. There’s not much point in moving from a confessed wrongdoer to another fund family that is soon revealed to be the latest target of regulators. “There’s no way to know for certain where problems will be,” says Don Cassidy, senior research analyst at Lipper Inc., a mutual fund research firm. “However, we have found two factors to be good forecasters of funds [involved in] improper trading.”
First, says Cassidy, mutual fund investors can compare the number of purchases and redemptions a fund has undergone. Both numbers can be found in the fund’s annual report or proxy statement. If those two numbers are about equal, it may be a sign of a lot of in-and-out, round-trip activity.
The second number to look at is what Cassidy calls the churn ratio—the relationship of a fund’s redemptions in a given year to its average net assets. “A fund with a billion dollars of net assets might expect to have $400 million worth of redemptions in a year, for a 40% ratio,” he says. “If a fund has $3 billion or $4 billion in redemptions, for a 300% or 400% ratio, that’s another sign of short-term activity. From our calculations, the fund families that have been charged with serious misbehavior are among those ranking highest on those two factors.”
Such ratios may or may not be signs of improper behavior. “They do indicate high trading costs. And, over time, high costs work against fund investors,” says Cassidy. “If you’re looking for top-performing funds from well-run companies, you might start with those that pay attention to people living within a family budget.