By Chuck Jaffe
| What to make of new mutual-fund classifications Your mutual funds may have changed categories last week without you knowing it. Normally, that’s a big reason for concern, a sign that something is afoot and that management has been following a new path. This time, however, it’s because the Investment Company Institute – the trade association for the fund industry – “modernized” its investment-objective classifications for funds. Truthfully, this is all about helping the public understand trends in mutual fund investing, and it’s something that the ICI does every 10 to 15 years. The changes won’t actually affect your funds directly either. Ratings agencies like Morningstar and Lipper have their own classifications for funds, and even if ICI has put a fund you own into a new category, that simply reflects what the fund has been doing – and has been allowed to do – according to its prospectus. It does not give management new leeway. The changes do, however, reflect new attitudes for the fund business, and those kinds of things will trickle down to investment advisers and, eventually to consumers like you. As a general rule, when old methods are “refined,” they wind up being pitched to consumers as being “improved.” Under the ICI’s old classification system, there were 33 categories for open-end mutual funds; the new system has 42 categories and while many of the new categories were added to bond funds and related to the funds’ time horizons, the biggest change was reflective of the emergence of “alternative strategy funds.” The ICI now has an alternatives objective within its domestic equity, world equity, hybrid and bond categories. That means, in short, that alternatives are officially mainstream. As such, investors are going to find themselves being pitched more and more of these ideas, which is a shame because the label is so misleading. Technically, most long-time investors would tell you that an “alternative investment” is anything that’s not in stocks, bonds or cash, the three biggest, most general categories. In fact, if you ask individual investors about their alternative investments, most will mention real estate, gold or precious metals and possibly commodities. But that’s not how the powers of the mutual fund world see things. The ICI defines a domestic equity alternative strategy fund as seeking “to provide capital appreciation while minimizing risk while employing long/short, market-neutral, leveraged or inverse strategies.” The other new alternative categories, similarly, include mention of those kinds of sophisticated investment tactics. To borrow from “Cool Hand Luke,”one of my favorite old movies, “What we’ve got here is failure to communicate.” Gregg S. Fisher, chief investment officer at Gerstein Fisher, runs real estate funds, which for most investors would have fallen into the “alternative” camp long ago. He suggests a common-sense definition for alternatives that is unique based on the investor. “People should think of alternative asset classes as things that are different from what they already own,” Fisher said in an interview for my radio show. “If I’m somebody who owns a lot of stocks and bonds, then an alternative might be real estate. On the other hand, if I am someone who already owns a lot of real estate, then an alternative for me would not be real estate, it might be stocks or bonds. “The best way to think of alternatives is not as some exotic derivative instrument, or whatever people are thinking,” he added, “but in fact it’s just something that’s different from all of the other things you own.” When industry types create new categories and come up with new ways to weigh and measure funds, invariably there’s a proliferation of effort to tell investors that they need to change their portfolio to adjust. That’s the wrong thing to take from the ICI changes. The trade association is not so much encouraging the development of more and varied alternatives as it is trying to make sure that the new/different strategies don’t pollute the rest of the data stream and muck up statistics for the rest of the players. It’s reflecting a trend that has been emerging in the fund world for years now, not encouraging investors to adopt the movement. That’s important because as “alternative funds” become their own asset class, they’re being sold as a key portfolio ingredient to folks who don’t want or need the complexity and cost, who can’t understand the strategies well, and who might be nervous if they really knew what they were buying. Investors who go for a portfolio evaluation and review, or who hire a financial planner are more likely than ever to hear that they “don’t have an allocation to alternatives,” when the truth is that their portfolios have gotten along fine without them for years, or when the appropriate alternatives might be real estate or gold. Just because the fund industry has recognized alternative funds as mainstream doesn’t mean that investors should. When fund companies create these funds, “alternative” always sounds like “another way to make money,” but investors should not lose sight of the fact that it’s another way to lose money too. |
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