Commentary: Mutual Funds: When Past Isn't Prologue

Past performance may be no guarantee of future returns, but it sure does sell mutual funds. That's why new funds are often at a disadvantage until they've built a track record. Now, the Securities & Exchange Commission has given funds an opportunity to create a history they never had.

In letters to several mutual-fund companies in 1996 and early 1997, the agency's Investment Management Div. outlines the conditions under which a fund prospectus may incorporate info on how managers performed at other funds or how similar investment formats fared. For example, with the approval of the SEC, the Bramwell Growth Fund's prospectus includes the track record of the Gabelli Growth Fund when Elizabeth R. Bramwell ran it. Likewise, the prospectus of two Nicholas-Applegate funds include the records of institutional accounts managed in the same style.

The agency's intent is to better inform investors about a portfolio manager or particular style of stock selection. But it's an ill-conceived idea that does more harm than good.

Plenty of funds are trying to take advantage of the now-portable performance records. In a recent speech before a fund industry conference, Barry P. Barbash, director of the SEC's Investment Management Div., complained that too many funds are stretching far beyond where the agency intended them to go.

"BIG LOSS." Fund companies don't have to seek prior approval before pasting an old record into a new fund prospectus. But Heidi Stam, the division's associate director, says the staff reviews how such data is presented "to be sure it's accurate, complete, and not misleading." Still, it's like taking a tax deduction. If you think you're entitled to it, do it--and be ready to support your claim.

But the issue is not the accuracy of the numbers. The problem? It's not easy to say who can take credit for a fund's results. For instance, a star small-cap stock manager could leave a giant like Fidelity Investments and attach his record to a new fund. But what if much of his past results had come from hot initial public offerings the fund got due to Fidelity's clout? Would that same star have as hot a hand elsewhere?

Portable performance is also troubling because it departs from the strict rules under which funds have reported results. Those rules make fund records more reliable and comparable than those of privately managed accounts. Indeed, both Morningstar Inc. and Lipper Analytical Services Inc., which track funds, say they will not use prior performance in determining much-prized ratings and rankings.

"We're getting calls from investors who fear they won't be able to trust the fund numbers," says Don Phillips, Morningstar's president. "It will be a big loss if investors lose faith." That would be a high price to pay for something that's unnecessary in the first place. With the media attention afforded star managers, top performers are able to attract a lot of money to new funds without having to stitch together a record from the past.

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