It's all your fault. That's right. You, Mister Broker, are the problem. You are the primary reason why the average retail investor doesn't understand his mutual fund investments — such as the impact of fund expenses on fund returns or even what an expense ratio is. At least, that's what some mutual fund executives think.
“It's the financial advisor who should bear most the blame for not selling mutual funds correctly,” says one wholesaler from a large mutual fund family. “A lot of brokers I know care a lot more about making the sale than helping the client.”
Remember that the next time your friendly mutual fund wholesaler pops in to take you out for some meat and drink. (Which is interesting: Wholesalers complain that brokers just want to make a deal, and brokers complain that wholesalers think they can buy their business with a steak and a cocktail.)
Now that Congress has joined the SEC in investigating how mutual fund companies disclose their business relationships (see page 18), it's no longer idle chatter. This perception of how brokers choose one mutual fund family over another will surely color the debate over a proposed bill to reform mutual fund marketing practices. And, truth be told, the perception is not unfounded. One broker we know candidly acknowledges, “I have knowingly put clients in a mutual fund that might not have been the immediate best for him because I have a business relationship with the manager. That doesn't mean I'd put them in a bad one, but those relationships matter. I might be rationalizing a bit here, but obviously it's good for the client if I stay in business.”
Wow. But it's important to remember that the cavalier attitude toward fund sales can have serious repercussions. For example, we've talked to a few market watchers who believe that brokers are setting themselves up for trouble by selling short-term bond funds to clients as if they were the equivalent of money market funds. In terms of safety, they are not in the same stadium. Yet, financial advisors of all kinds are putting clients in ultrashort and short bond funds to squeeze out higher yields.
You can be sure that most of the chatter with the client is about yield and not about risk. These funds are a mix of Treasurys and corporates with durations as short as three months, as well as mortgage-backed securities. Some funds even dip into lower-rated bonds. They may feel a lot like money market funds to clients, who can even write checks against them. But, unlike money markets, these funds have some volatility and real downside risk. When interest rates rise, clients could see their principle head south — a feature that may have been undersold to clients. “The returns have been great,” says one wholesaling friend. “But just wait until interest rates start rising…”
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