At Morningstar Conference, Calls for More Mutual Fund Disclosure

Speaking to an audience on Wednesday, June 23, consisting mainly of advisors attending the annual Morningstar Investment Conference to glean insights on the strategies and outlook of leading money managers, a group of Morningstar analysts called for more disclosure on actual mutual fund costs and their holdings. On a panel moderated by Eric Schurenberg, editorial director of CBS MoneyWatch.com, that featured Morningstar's president of fund research, Don Phillips, many of the 1,350 people registered for the event heard Phillips call for "mutual fund accounting to be cleaned up," arguing that such an accounting would be a "statement of where our money goes. And it is our money!"

Phillips was responding to a question from Schurenberg that asked what they would like to see included in the financial services reform bill now nearing completion in Congress.

Phillips went on to say that like any business, advisors and mutual fund end investors want to know "What's the cost of goods sold? What's the cost of distribution? What's the overhead?" but that under the current state of mutual fund accounting, "it's now near impossible to do that," citing as exhibit one an item like 12b-1 fees, which by right should be considered a distribution cost but isn't broken down that way. Phillips said that some mutual fund companies might counter by saying that investors know what the total cost of every fund is by looking at its expense ratio, but Phillips said that if he were, for example, a stock analyst comparing two pharmaceutical companies, he'd like to know not only what the firm's overall costs are, but how much specifically was devoted to R&D on new products, for instance.

Panelist Karen Dolan, Morningstar's director of mutual fund analysis, responded to another question from Schurenberg regarding what the panelists hoped would not be included in the legislation by pointing out that some proposals "go too far," such as wholesale banning of derivatives. "It's dangerous," she warned, "when government regulators are deciding what should or should not be in a portfolio."

In closing the session, Phillips gave a wry defense of the Morningstar star-ranking system for mutual funds, which is just one of the innovations for which he is personally responsible. The stars, he said, are "a grade on past performance; it's an achievement test, not an aptitude test." Moreover, he said, "it's the way you want your fund managers to be graded," over a long-term period, rather than "how they did in, say, March." Morningstar's analyst picks, he pointed out, in contrast "do look ahead; but we've never said it [the star system] is a predictor of future performance. It's been a huge positive for the industry, focusing on long-term performance; we've never said it's a crystal ball."

Don Phillips was named in May 2010 to Investment Advisor's list of the 30 most influential people in the industry over the past 30 years.

Read Morningstar's John Rekenthaler's defense of Morningstar's style-box analysis from the archives of InvestmentAdvisor.com.