Finance: MUTUAL FUNDS
THE PROSPECTUS TRIES PLAIN SPEAKING
When Arthur Levitt Jr. became chairman of the Securities & Exchange Commission, he sold his individual securities and invested in mutual funds. That's when Levitt had his first encounter with the horror that millions of investors face: the fund prospectus. This long and often abstruse legal document purports to explain how the fund invests and operates. "I had spent most of my life in the investment business," he says, "and I had difficulty understanding some of it."
With prodding from Levitt and the SEC, eight mutual-fund companies on July 31 unveiled a "profile prospectus" that is greatly simplified and much slimmed-down. Each company produced this low-fat prospectus for a stock, a bond, and a money-market mutual fund already in its stable of offerings. Instead of pages and pages of eye-numbing gray, the new prospectus can fit on both sides of one 81/2-inch-by-11-inch piece of paper--with room to spare.
INTIMIDATING. No impenetrable legalese here. The language is often simple, if not downright blunt. Under the section "Risks," the profile prospectus for American Funds Group's EuroPacific Growth Fund states plainly: "Stock prices rise and fall." A few lines later, in bold red type, it continues: "You can lose money by investing in the fund; your investment is not guaranteed." No sugarcoating here either.
The profile prospectus is not as comprehensive as the current one and seems to fly in the face of the underlying principle of U.S. securities law--complete disclosure. But it also is obvious that disclosure is ineffective if investors don't understand it or if it's so intimidating they don't read it. According to a survey of 1,000 mutual-fund investors conducted by Response Analysis for MainStay Funds, a majority rated the prospectus unfriendly and hard to understand, and only 28% of them said they used it always or most of the time when purchasing funds.
In developing the profile prospectus, regulators and fund executives are betting a more user-friendly document will be used more often. And even if the slim, plain-language prospectus is eventually adopted, the unabridged version will still be made available to those who request it.
For now, the new prospectus is an experiment, and investors in any of the 24 funds that have them will still receive the standard one. Over the next year, the Investment Company Institute plans to conduct what ICI President Matthew P. Fink termed "heavy research" to determine investor response and if the new format meets their needs and concerns. Levitt said that only after extensive research will the commission consider a formal adoption of the new document.
Fund companies don't have to offer the slimmed-down prospectus now. But if they do--and Levitt says he hopes they will--they must follow the same 11-point organization that's in the prototype (table). The plan starts with more substantive points, such as goals, risks, costs, and historical performance and winds up with operational details such as purchases and redemptions.
EYE ON PERFORMANCE. A big advantage of the 11-point format is that it makes it easier for an investor to compare funds. For instance, fees and expenses are always the fifth point, historical performance, the sixth. In addition, the standard for showing year-by-year returns is a bar chart. Bars that jump around a lot are a visual cue, as well, for fund volatility.
"This prospectus could save trees and lower costs to investors, and that's positive," says mutual-fund maven A. Michael Lipper of Lipper Analytical Securities Corp. But he wonders whether the new document places too much emphasis on past performance and not enough on the portfolio. Even the full prospectus as a rule describes the portfolio in vague, general terms, and a fund is required to give a complete accounting of its investments only twice a year. Says Lipper: "It's the portfolio that's going to produce your future results."
While the final shape of the profile prospectus won't be known for a year or more, there's little doubt Levitt is determined to get a mutual-fund prospectus even he can understand.
The Slimmed-down Prospectus
Mutual-fund companies are testing a prospectus that addresses
the following 11 points and fits on one piece of paper:
What is the fund's objective, such as capital gains or high dividends?
What kinds of investments will be used to achieve the goal?
It can be market, credit, currency, liquidity, or interest-rate risk.
For what kinds of investors is the fund suitable or unsuitable?
FEES AND EXPENSES
What are the sales charges and operating expenses?
Annual historical returns are displayed in a bar chart, and average annual returns are compiled numerically.
Who manages the fund?
How do you buy shares? Is there a minimum investment?
How do you get your money out?
Does the fund make income or capital-gains distributions, and with what frequency?
Are there fund-switching privileges or automated-transaction or check-writing services?
DATA: BUSINESS WEEKBy Jeffrey M. Laderman in New York