Why I hate Mutual Funds Part 4: LESS THAN FULL DISCLOSURE
Mutual funds lack transparency. Fund management teams and investment strategies can change overnight and without notification to shareholders. It’s a peculiar aspect of mutual funds that they’re required to account for their activities and their holdings just once a quarter. Even then, investors see only a snapshot of a fund’s portfolio. which can change literally the day after the report. An investor may think a fund is doing one thing, as articulated in the quarterly report, but suddenly the fund is off doing something else.
Too big for anyone’s good
Some mutual funds are so big they can run short of investment options. They may hold too much cash on the sidelines, diluting everybody’s performance results. Or, they may add securities that fall outside their stated portfolio guidelines, exposing shareholders to unanticipated risks.
Some mutual funds hold over 5,000 different stocks in their portfolios. Are those securities truly appropriate for investors in that fund? Can the fund expect to grow as diluted as it is?
In his 1930s classic, The Intelligent Investor, Benjamin Graham, who was Warren Buffett’s lifelong friend and mentor, said that an individual can get an average return by simply buying 30 stocks. I certainly agree that you can do well with your own, tailored portfolio of individual securities instead of a mix of mutual funds.
Mutual fund managers make decisions for shareholders as a group. This may work for the individual shareholder, or it may not. Diversification can reduce the amount of investment risk in a mutual fund, but it can also be a disadvantage by virtue of dilution. How so?
If a single security held by a mutual fund doubles in value, for example, the mutual fund itself would not double in value, because the security represents only a small part of fund holdings. This leads to marginal results. “By holding a large number of different investments,” says InvestorGuide.com, “mutual funds tend to do neither exceptionally well nor exceptionally poorly.”
Also, mutual fund managers may migrate from their investment plans. When this happens, investors end up with risk levels all together different from what they had originally intended, but they may never know a thing about it.
Recently, one mutual fund held a particular drug company stock. The price of the stock rose so much that the fund’s stake in the drug company accounted for more than 30% of its portfolio. Later, the stock declined sharply, and the exposure hurt the fund’s performance. “The fact that the long-venerated mutual fund let the position get so large … hurt its credibility with investors,” The Wall Street Journal says.
Wall Street has lulled investors into buying and holding mutual funds for the long-term, but it’s only a mantra. True diversification requires a strategy tailored to the individual.