The full implications of the US mutual fund scandal are still being unraveled some four months after New York Attorney General Eliot Spitzer first made his allegations of trading abuses. Investor relations officers might be tempted to allow a wry smile as the corporate governance heat falls on the buy-side for once – but there may be a lot more pain to come for corporates as a result of the scandal.
The main problem from an IR perspective lies with the sheer weight of money that has already been pulled out of some of the mutual funds under investigation. Putnam Investments, owned by insurance broker Marsh & McLennan, was one of the first of those funds to reveal investor data for November, indicating that some $4 bn was withdrawn from its mutual funds in just one week. A further $10 bn was taken out of Putnam’s other assets during the same period. Needless to say, such huge investor withdrawals could not be balanced by new business so the group was forced to sell out of some of the stocks in its mutual funds, to the tune of some $7 bn – equaling 3-4 percent of its assets.
Other funds under investigation are expected to report similar stories as fears over the ethics and practices of the mutual fund industry really take hold. Personal finance writers across the US have been advising their readers that market timing and late trading hit funds’ returns by slowing performance and adding expenses. Add in a few more worries about lack of management oversight and you have retail investors speed-dialing their financial advisors to find a new home for their hard-earned money.
But it isn’t just the retail investors that are running scared. When pension funds such as Calpers begin to cash in their investments and look elsewhere you know that the mutual fund industry is really in for a tough time. And Calpers is by no means alone – state funds across the country have been filling out sell orders.
The weight of money being moved out of the mutual fund industry has already caused major IR headaches for some of the stocks most heavily held by the funds under investigation. To compound the misery of those IROs, they had already found that other investors were all too eager to dump their holdings. Switched-on portfolio managers were aware that mutual funds would be forced to realize some of their assets to match the size of investor withdrawal; they bailed out before the going got tough.
The IR problems would remain the preserve of those heavily held stocks were it not for the fact that many commentators see this as just the start of the process. The pessimists predict that the mutual fund bail-out could continue well into 2004, spreading way beyond just the few that have already been named and shamed, as confidence in the industry reaches a new low. Those same commentators see little appetite for equity investment from the pension and other funds currently putting the final touches to their exit strategies.
So, while the corporate governance boot may be kicking out in the other direction for once, it also means that the path ahead for the corporate IRO is anything but smooth. A regulatory investigation into the lack of management control in the mutual fund industry may well seem like sweet revenge for IROs who feel that they have been on the corporate governance receiving end for way too long. But it could also help knock the wind out of the market just as a few bullish signs were beginning to appear. Be prepared for a shaky start to the new year.
