Skip to main content


Representing Individual, High Net Worth & Institutional Investors

Offices in Indiana and New York City


Home > Blog > Category Archives: Mutual Funds

Category Archives: Mutual Funds

Risky Business: Alternative Mutual Funds

Alternative mutual funds have exploded in popularity in recent years. But there is a dark side to alternative mutual funds. Last week, the Financial Industry Regulator (FINRA) warned investors about this very issue, cautioning them in an Investor Alert titled “Alternative Funds Are Not Your Typical Mutual Funds.” Among other things, the alert stressed the complex trading strategies and the unique characteristics and risks associated with alternative mutual funds.

“The strategies alternative mutual funds employ tend to fall on the complex end of the spectrum,” FINRA said in its Investor Alert. “Examples include hedging and leveraging through derivatives, short selling and ‘opportunistic’ strategies that change with market conditions as various opportunities present themselves.”

As their name implies, alternative mutual funds are quite different from their traditional counterparts. Alt funds typically use more exotic strategies, including options and leverage, as well as more complex asset mixes.  Alternative funds might invest in assets such as global real estate, commodities, leveraged loans, start-up companies and unlisted securities that offer exposure beyond traditional stocks, bonds and cash.

Some alt funds employ a single strategy. For instance, they may offer 100% exposure to currencies or distressed bonds. Some funds might employ a market-neutral or “absolute return” strategy that uses long and short positions in stocks to generate returns. Others may employ multiple strategies such as a combination of market-neutral strategies and various arbitrage strategies. Still others are structured as a fund containing numerous alternative funds or a special type of “fund of hedge funds,” according to FINRA.

Although the strategies and investments of alternative funds may appear similar to those of hedge funds, the two should not be confused, FINRA says. Alternative mutual funds are regulated under the Investment Company Act of 1940, which limits their operations in ways that do not apply to unregistered hedge funds. These protections include limits on illiquid investments; limits on leveraging; diversification requirements, including limits on how much may be invested in any one issuer; and daily pricing and redeemability of fund shares.

FINRA cautions investors who are considering investing in alternative mutual funds to carefully consider their investment objectives, performance history and fund manager of alternative funds before doing so.

Municipal Bonds: What Investors Need to Know

Investors who are planning to invest in municipal bonds need to do their homework; if not, they may unknowingly give their first year’s worth of income to their broker. A June 7 article by the Wall Street Journal sheds a spotlight on the murky world of today’s municipal bond market – and what investors can and should do to minimize their risks and maximize their net returns.

As the article points out, “yields on the highest-quality, widely traded munis, triple-A-rated, 10-year “general obligation” bonds have risen by 0.45 percentage point since May 1.  And while U.S. Treasury yields also have risen recently, muni yields have truly skyrocketed.”

But before jumping on the municipal bond bandwagon, investors should proceed with caution,  industry experts say. Unlike what happens with stocks, you don’t pay a commission when buying a municipal bond. Rather, you pay a “markup,” which is the difference between a broker’s cost and the price an investor pays.

The markups themselves can be astronomical. And, unfortunately, most brokers don’t disclose their markup. Regulators and market analysts agree that many retail investors have no idea how much they’re getting charged on muni trades.

Securities Litigation and Consulting Group, a research firm in Fairfax, Va., recently analyzed nearly 14 million trades of long-term, fixed-rate munis over a period between 2005 and April 2013. (You can review the SLCG report here.)

The study found that on one out of 20 trades, people who bought $250,000 or less in municipal bonds paid a markup of at least 3.04%, or approximately a full year’s worth of interest income at today’s rates. By comparison, you will pay less than $10 in commission to buy a stock at most online brokers, or 0.004% on a $250,000 purchase; a typical mutual fund charges management fees of about 1% a year.

SLCG founder Craig McCann estimates that investors paid at least $10 billion in what he considers excessive markups since 2005. That is at least twice the normal cost to trade a given bond.

“That’s more than a billion dollars a year needlessly transferred from investors to dealers’ pockets,” McCann said in the Wall Street Journal story.

LPL Financial Fined Over Mutual Fund Issues

LPL Financial LLC is among five firms fined by the Financial Industry Regulatory Authority (FINRA) for failing to deliver mutual fund prospectuses.

As reported Jan. 2 by Investment News, LPL Financial LLC agreed to pay a $400,000 fine as part of the agreement; State Farm VP Management Corp., $155,000; Deutsche Bank Securities Inc., $125,000; Scottrade Inc., $50,000; and T. Rowe Price Investment Services Inc., $40,000.

In the settlement, FINRA stated that LPL relied on its brokers to deliver prospectuses, but had no procedures in place to determine if the documents were delivered late. Over FINRA’s review period of January 2009 through June 2011, LPL was required to deliver 3.4 million prospectuses.

According to the settlement, State Farm was responsible for delivering 154,129 prospectuses during that period, at first through its brokers and later through a service provider. In each case, however, the firm had inadequate supervision, FINRA said.

Scottrade failed to deliver prospectuses in about 14,000 transactions out of 300,000. Deutsche Bank Securities missed delivery in 3,800 cases out of nearly 71,000 trades, and T. Rowe Price had 2,500 failures in more than 68,000 transactions.

Last month, LPL Financial faced sales abuse charges tied to non-traded real estate investment trusts when Massachusetts Secretary of the Commonwealth William Galvin filed civil charges against the firm for failing to supervise LPL brokers who sold investments in seven non-traded REITs.

High-Yield Municipal Debt and Its Inherent Risks

High-yield municipal debt has become an increasingly attractive investment vehicle for fixed-income investors – and with good reason. For the three years ending Oct. 31, funds in that sector returned an average of 9.1% a year, according to Morningstar.

The positive returns do not come without their share of risks, however. And, all too often, investors may be unaware of those potential risks. As reported Nov. 5 by the Wall Street Journal, some of the risks associated with high-yield municipal debt include liquidity issues.

The size of the high-yield muni market is $65 billion, which represents only a small portion of the total municipal market. Moreover, many individual issues are small. “It can be difficult to buy in or sell out,” said James Colby, a senior municipal strategist, in the Wall Street Journal article.

Default rates are another issue facing investors of high-yield municipal debt. Since 1970, the cumulative default rate for high-yield muni debt has been 7.94%. By comparison, Moody’s says the cumulative default rate for investment-grade muni debt – i.e. issues with credit ratings from triple-A to triple-B – is 0.08%.

MSCI Share Price Plunges

On Oct. 2, Vanguard Group announced that some of its mutual funds planned to drop MSCI as the provider of the market benchmarks the funds track and switch to indexes from the University of Chicago’s Center for Research in Security Prices, while six foreign stock funds will begin tracking FTSE indexes.

The news promptly caused MSCI’s share price to tumble. MSCI’s stock price was around $36 in September, but dropped to about $27 following Vanguard’s announcement.

More interesting, however, may be the footnote to the MSCI story. As reported in a blog by the Securities Litigation & Consulting Group, a substantial insider sale took place less than a month before the MSCI/Vanguard news.  The insider was C.D. Baer Pettit. Pettit, according to the Form 4 filed with the Securities and Exchange Commission (SEC), was Head of Index Business at MSCI on Sept. 7, 2012, when the transaction took place.

Pettit sold more 72,000 shares of MSCI – or more than 38% of his ownership. According to the SLCG blog, the average price Pettit received from that sale was $36.61. (The transaction was executed in multiple trades at prices ranging from $36.52 to $36.69.)

The price is nearly $10 more than what Pettit would have received had he waited a few weeks to sell his shares.

MSCI’s closing price on Oct. 1, 2012 was $35.82 and the closing price on Oct. 2, 2012, was $26.21.  The shares Pettit sold on Sept. 7, 2012, would have lost more than $694,572.

Meanwhile, Pettit’s transaction coincidentally accounted for more than 38% of MSCI shares sold by insiders during the 12 months preceding the sale.

Regulatory Scrutiny Intensifies For Morgan Keegan Over Failed Bond Funds

Regions Financial Corp., whose brokerage arm is Morgan Keegan & Company, has revealed in its Aug. 5 10-Q filing with the Securities and Exchange Commission (SEC) that Morgan Keegan, Morgan Asset Management Company and three employees each received a Wells notice in July from the SEC’s office in Atlanta, alerting them to prepare for future enforcement actions for possible violations of the federal securities laws. 

A 10-Q is a quarterly report required by the SEC for publicly traded companies. Generally, firms file a 10-Q 45 days after the end of a quarter. The document itself contains similar information found in a company’s annual 10-K filing, but the 10-Q information usually is less detailed; moreover, in most cases, the financial statements in a 10-Q are based on assumptions, which typically require revisions in future accounting periods.

In addition to the SEC’s notice, Morgan Keegan received a second Wells notice in July – this one from the Financial Industry Regulatory Authority (FINRA). According to that notice, a preliminary determination had been made by FINRA, recommending discipline actions against Morgan Keegan for violating various NASD rules in connection to sales of certain investment products.

In both the SEC and FINRA notices, the “products” in question include a group of seven proprietary mutual funds that are facing a slew of arbitration claims by investors who suffered sizable losses in 2007 and 2008 because of investing gambles made by Morgan Keegan in risky debt and other mortgage-related holdings. 

In their claims, investors allege that Morgan Keegan misrepresented the funds as low-risk and high-yield products, when in reality the funds were tied to the most volatile components of the mortgage loan industry.

When that industry ultimately collapsed, investors lost 90% and more of their money in the RMK funds. According to the pending arbitration cases against Morgan Keegan, investor losses related to the RMK mutual funds total more than $2 billion.

Target-Date Mutual Funds Under Scrutiny

The concept behind target-date mutual funds is simple: Investors place their money in a fund that is managed around the holder’s intended retirement age. Over the years, target-date funds grew increasingly popular as a safe, conservative investment choice, becoming a staple in many 401K plans. 

Enter the financial crisis of 2008. As the stock market plummeted, older investors with 2010 target-date mutual funds found themselves facing losses of 40% or more.

The Securities and Exchange Commission (SEC) is now taking a hard look at target-date mutual funds and whether some companies and financial advisors misled investors about the risks associated with the investments.

As reported June 25 in the New York Times, disclosure policies and regulations overseeing target-date mutual funds are opaque at best. Investment risks vary widely from fund to fund. Adding to the confusion for investors is the fact that mutual fund companies often create target-date funds by bundling them together with existing mutual funds. In doing so, companies or financial advisors are able to collect more assets and fees, while investors are left to figure out what the funds actually contain and exactly how much they are being charged.

 “At the end of the day, consumers need to know what they’re getting into,” said Senator Herb Kohl, Democrat (Wisconsin) and chairman of the Special Committee on Aging, in the New York Times article. “We’d like to see regulation, whether it’s a standardization of target-date composition, or increased clarification of information made available about the plans.”

If you are an individual or institutional investor and have concerns about your investments, contact Maddox Hargett & Caruso at 800.505.5515. We can evaluate your situation to determine if you have a claim.

Top of Page