Mutual Funds
Morningstar rips suspect funds
The fund-rating firm suggests investors sell fund stakes in four firms named by Spitzer.
September 12, 2003: 7:08 PM EDT
By Jeanne Sahadi, CNN/Money Senior Writer

NEW YORK (CNN/Money) - Fund-rating firm Morningstar issued an unusually critical report Friday recommending that investors consider selling their stakes in the mutual funds run by Janus, Strong, Bank of America, and Banc One.

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Myron Kandel warns that though mutual funds are under government scrutiny, rash selling is ill-advised.

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The report, the first of its kind from Morningstar, comes in the wake of allegations that, if true and if widespread, point to one of the biggest scandals in the history of the mutual fund industry.

New York State Attorney General Eliot Spitzer alleged this month that the four firms engaged in inappropriate and, in some cases illegal, trading by granting hedge fund Canary Capital Partners special trading access to some of their funds at the expense of individual investors.

Spitzer made his allegations about the fund firms in a complaint filed against Canary. Canary's managing principal, Edward Stern, agreed to pay $30 million in restitution and a $10 million penalty to settle the charges against his firm without admitting or denying wrongdoing.

"If Spitzer's allegations prove true, it's a clear indication that all four fund firms were willing to put their companies' own profitability ahead of the interests of their fund shareholders," Morningstar FundInvestor editor Christine Benz wrote in a statement explaining Morningstar's position.

As a result, she wrote, "We think that ... Spitzer's recent allegations of trading misdeeds at Bank of America, Janus, Strong and Bank One should prompt investors to consider selling their stakes in funds run by those firms."

But, Benz added, "Although we believe Spitzer's allegations are serious enough to warrant taking a hard line on these four firms, we would urge investors to carefully consider their own circumstances -- including taxes and transaction costs -- when deciding whether to sell."

The Canary case aside, Morningstar analysts also noted that in several funds run by these firms, investors hadn't been well served because of poor bear-market returns, high expense ratios and management concerns.

When it comes to Janus, Morningstar is recommending selling the firm's funds that are managed by Janus managers. But they are offering a "hold" recommendation on the firm's funds run by outside managers, such as Janus MidCap Value and Janus Small Value.

Mutual Funds
Bank of America Corporation

Janus (JNS: down $1.38 to $14.50, Research, Estimates) shares took a beating Friday. Bank of America (BAC: up $0.23 to $75.83, Research, Estimates) shares, meanwhile, gained on the day, as did shares of Bank One (ONE: up $0.06 to $38.66, Research, Estimates).

Despite its report, Morningstar urged investors not to lose faith in the industry, since, it said, there are many firms that have a long history of treating shareholders' interests as paramount, among them Vanguard, Fidelity, Davis/Selected Advisors and Longleaf Partners.

Wrote Benz: "We continue to believe that mutual funds run by such shareholder-friendly firms represent worthwhile investment opportunities for most investors."

Why selling may not be smart

Certified financial planners Tom Grzymala and Pat Jennerjohn said Morningstar's call was dramatic but too aggressive, especially since the extent of the damages to shareholders is unknown.

"Spitzer made allegations. Nothing's been proven," said Grzymala, whose buy list for clients included a Strong fund and a Bank of America Nations fund.

"I'd consider the tax implications of selling (and) I'd be hesitant to invest new money," he added, noting he would be removing the Nations fund from his buy list. Lastly, he said, "I might very well adapt a yin-yang policy. Sell 50 percent and hold 50 percent. Or maybe sell a third and keep two-thirds. It's damned if you do, damned if you don't. But that's the way life is."

Above all, in deciding whether to sell or hold, assess whether the fund is really working for you, said Robert McCarthy, who heads 401(k) investment advisory firm Kanon Bloch Carre. Among the factors to consider: Has it performed well? Does it fit with your asset allocation? Is it well managed? And are its fees reasonable relative to its peers?  Top of page

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