Finally, the finance cops are starting to pay attention to the puzzling -- er, confusing -- oh heck, might as well say it -- misleading advertisements that you see for mutual funds.
You know which they are: "Ginnie Maes, government guaranteed!" "A super 11 percent on U.S. Treasuries!" "Bigwonder Fund, 40 percent a year for 10 years!"
Are those numbers true? Would a salesman steer you wrong? Maybe he wouldn't lie to you exactly, but would he fudge?
Sure he would, and although many fine mutual-fund companies are absolutely straight with their ads, many others aren't -- and they're attracting a lot of business from hopeful investors who like to believe what they're told.
The Securities and Exchange Commission finally is bringing some pressure on the industry to straighten up and fly right. Last October, the SEC's Kathryn McGrath, director of the division of investment management, warned the industry that "some existing fund advertising practices are horrid and must be stopped." (Some of us are cheering from the back benches: "Hear, hear!")
In January, the SEC sent a stiff letter to 56 Ginnie Mae funds, complaining that their ads and prospectuses highlighted the guarantees underlying the investment, but obscured the many investment risks.
In the same month, the Investment Company Institute -- the leading mutual-fund trade association -- adopted a voluntary rule that already has led to more disclosure in bond-fund advertisements.
You still see a current yield for the fund, advertised in big, black type. But the smaller print now reminds you that the market value of your fund can rise and fall, so you have some risk. To demonstrate, the funds often show their current net-asset value compared with what it was a year ago. This is especially important for Ginnie Mae funds, because so many investors seem to be under the impression that with Ginnie Maes, their principal is always safe.
Last week, the ICI made an even more important proposal to the SEC: to standardize the way bond mutual funds compute and advertise their yields.
Believe it or not, "There are about 1,000 different ways to demonstrate yield," ICI general counsel Matthew Fink told my associate, Virginia Wilson. Depending on how you count it, two funds returning exactly the same amount of dollars and cents to investors can show two different yields, one lower, one higher. Or a fund returning less money to investors can figure its yield so as to make it sound like more. Or a fund might use a general term like "returns" and include distributions that are not, truly speaking, interest-rate yields. Fink gives this example: Say that a mutual fund buys a 15-year, $1,000 bond that came out five years ago at an interest rate of 15 percent ($150 a year). The fund pays $1,500 for that bond today because bond prices are up. But when the bond matures in 10 years, the fund will get only $1,000 for it -- so there's a built-in capital loss. What yield should be reported to mutual-fund shareholders?
One fund might decide that because it paid $1,500 and is getting $150 in interest, it's earning 10 percent. Another fund, taking the built-in loss into consideration, might reduce its $150 in interest earnings by $50 every year. That second fund will report a yield of 6.6 percent.
Both calculations are perfectly legal. In either case, the investor winds up with the same amount of money in his pocket. Yet the first fund sounds as if it must be earning more.
The ICI's proposal would come close to creating a single, standard way of figuring yields, so that investors could compare one fund with another and know they are getting a reasonably fair comparison. Above all, that's what investors need.
Unfortunately, the industry plan still doesn't cover all the bases. For example, it leaves unresolved the issue raised by Fink in the example above. The SEC is now considering ICI's ideas and may respond with proposals of its own.
In the meantime, how do you decide which fixed-income fund to invest in? First, suspect any yield that sticks out as unusually high, because there may be some hokum in it. Don't choose a fund for the sole reason that its reported yield is 1 percentage point higher; that difference may be more apparent than real. Go with a well-established mutual-fund company that has been around for a while and has many funds with good track records.
NEXT: Spotting the Tricky Interest-Rate Ads