Mutual funds' 'white knight' image tarnished

No investment is perfect.

Real estate has down cycles, gold gyrates wildly, stock markets crash, antiques and collectibles go out of favor, bonds are racked by interest rate moves, and annuities carry hefty fees.

Investors know this in their hearts, yet hope against hope that investment perfection can be found.

Recent revelations that prominent mutual fund companies cut deals with deep-pocketed clients shouldn't come as a total surprise, knowing human nature. For example, they permitted them to move in and out of funds quickly to take advantage of various time zones and trading abnormalities while average investors were left to play "buy and hold."

The amount of money involved and damage to shareholders isn't the key issue. What is unsettling is that it occurred in an industry with an image of treating all mutual fund shareholders equally. This breach of faith will trigger greater scrutiny and regulation of fund practices.

For example, law requires that investors who buy mutual funds after 4 p.m. pay the next day's price. However, at least one wealthy investor was permitted to buy mutual fund shares after major market announcements had been set and before the news came out.

"It shakes the foundation of an industry that has generally been considered clean," said John Markese, president of the American Association of Individual Investors; www.aaii.com, in Chicago. "It's shocking that this was allowed to take place, since who wouldn't want to buy on tomorrow's news with today's prices?"

There's a need for internal auditing so no one receives special treatment, said Markese.

The mutual fund was long revered as the white knight of investment. It featured diversification, and ease of entry and exit. And its management championed the little guy investor. Inevitably, its armor began to tarnish. Many funds did poorly not only because of market traumas but also because of bad management. Some portfolio managers bet big on sectors or countries without informing investors.

Most troubling has been the fund industry's sneaky habit of tacking on a multitude of confusing fees not easily detected by the army of 95 million shareholders. Fund fees keep increasing, and some fund families focus marketing on lax investors who disregard costs.

Looking at the recent scandal, tens of millions of dollars in profit was derived from improper trading at the expense of individuals.