John Spence

ICI Urges SEC Not to Force More Frequent Fund Disclosures

Investment Company Institute (ICI), the mutual fund industry's trade group, yesterday released a statement outlining why it believes average investors would actually be harmed by more frequent holdings disclosures by mutual funds. Additionally, ICI dropped a letter to the Securities and Exchange Commission (SEC) outlining its position, published a commissioned study as evidence, and posted the results of a survey of ICI members' policies regarding portfolio disclosure. Every document released in yesterday's flurry of ICI moves supports the idea that more frequent fund disclosures are a bad thing for investors.

Currently, mutual funds are required to disclose their holdings twice a year, but many groups have petitioned the SEC for more frequent fund disclosures, and the SEC is considering the proposals. Most organizations are requesting quarterly or monthly disclosures, with at least a 30-day time lag for reporting.

According to ICI, increased portfolio disclosure would lead to more "front running" and "free riding." Essentially, ICI fears that increased disclosure would allow traders to forecast and exploit a fund manager's moves, and give speculators the opportunity to more accurately "free ride" on a fund manager's proprietary research and investment strategies.

Granted, this is an issue that indexers can watch from the sidelines, as one of the main attractions of index funds is that they are required to track indexes, and investors therefore have a clear picture of the fund's holdings. As I noted in a previous article, a transparent index methodology (S&P 500 aside) allows investors to predict, to a certain degree, how inevitable market changes will affect the index, and therefore the index fund. Of course, no one can predict the future, but an index fund's mandate to hug a benchmark makes determining asset class risk a whole lot easier when constructing a diversified portfolio for the long haul.

However, if you read our mission here at IndexFunds.com, it says we're "an advocate for investors of all types." We've also been known to take the occasional jab at active management, and we just couldn't keep our mouth shut on this issue.

"Why are they doing this?"

I sent the ICI statement to two prominent individual investor advocates, and both were mildly confused by the ICI's logic.

"Even if disclosures were more frequent, there would be at least a 30-day time lag before the information is released," said Dr. Paul Farrell, mutual fund columnist for CBSMarketWatch.com. "Speculative traders have windows of 24 hours, or even 15 minutes in some cases. Maybe I'm missing something, but I don't know what the ICI is talking about."

Larry Swedroe, author of What Wall Street Doesn't Want You to Know, echoed those sentiments.

"I think it's just a bogus issue," said Swedroe. "First, just because a fund has bought some shares in a company doesn't tell you they're going to buy more in the future or sell more. Second, while some funds are buying company shares, other funds may be selling. What any one fund does is irrelevant to the marketplace - there's other more significant supply and demand forces at work."

Both writers questioned ICI's motivation for all the noise it made yesterday. Certainly, increased disclosure would make it very easy to identify fund managers who engage in "window dressing," a dubious practice where managers buy well-performing stocks just prior to disclosure dates to inflate returns. More frequent disclosure would also expose managers who buy up stocks their fund already holds on the last day of the quarter to improve returns, an activity known as "portfolio pumping."

"ICI makes it sound like they're protecting investors, and they're really protecting their own self interest," said Farrell. "It's disingenuous to me. ICI and the fund industry do a lot of wonderful things, but I think they're way off base on this particular issue."

"I think a fund shareholder has the right to know what's inside of his or her fund," concurred Swedroe. But old habits die hard. "The only real issue I see is that more frequent disclosure might generate additional costs for funds," said Swedroe.

Like many frustrated mutual fund investors, Farrell believes the current system of semiannual disclosure just doesn't cut it.

"Rather than take this position, I think the ICI should support disclosure every three months," said Farrell. "With the 30-day lag, the information would be four months old anyway. Index components are public knowledge, and index funds beat active management."