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Mutual funds: temporary problem or permanent morass?

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  • Paula A. Tkac

Abstract

The improprieties in the mutual fund industry that surfaced in the fall of 2003 prompted the passage and drafting of legislation and regulations that cover nearly every facet of mutual fund pricing and operations. While this regulatory flurry is clearly intended to protect shareholders’ interests, the question remains: How will these scandals and regulatory changes ultimately affect mutual fund investors? ; When considering the problems inherent in mutual fund management and the best ways to address them, it is important, the author stresses, to understand current business practices in the industry, who these benefit, and why they exist. ; Mutual fund investors, the author explains, are legally considered owners of a company that pools the investment capital of many investors. In practice, however, investors are often viewed (and often view themselves) as customers of a management firm that acts as an investment adviser. ; Regardless of which view is taken, inherent conflicts exist between investors and advisers because the two parties have differing objectives: Investors want to receive higher returns on their investment while minimizing risk, and advisers want to maximize their own profits without exerting undue efforts (costs). ; The author reviews a number of possible solutions to these conflicts of interest, including compensation-based fee structures, a separation of functions, proposed regulatory and legislative changes, and monitoring and information disclosure. ; By far the strongest weapon investors have in resolving these conflicts is their own demand, the author concludes. “When unfettered and free of frictions, a competitive marketplace will supply the products and services investors demand at the lowest possible price,” she notes.

Suggested Citation

  • Paula A. Tkac, 2004. "Mutual funds: temporary problem or permanent morass?," Economic Review, Federal Reserve Bank of Atlanta, issue Q 4, pages 1-21.
  • Handle: RePEc:fip:fedaer:y:2004:i:q4:p:1-21:n:v.89no.4
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    References listed on IDEAS

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    1. Diane Del Guercio & Paula A. Tkac, 2000. "The determinants of the flow of funds of managed portfolios: mutual funds versus pension funds," FRB Atlanta Working Paper 2000-21, Federal Reserve Bank of Atlanta.
    2. Louis K. C. Chan & Hsiu-Lang Chen & Josef Lakonishok, 2002. "On Mutual Fund Investment Styles," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1407-1437.
    3. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    4. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
    5. Benjamin E. Hermalin & Nancy E. Wallace, 1994. "The Determinants of Efficiency and Solvency in Savings and Loans," RAND Journal of Economics, The RAND Corporation, vol. 25(3), pages 361-381, Autumn.
    6. Beatty, Randolph P. & Bunsis, Howard & Hand, John R. M., 1998. "The indirect economic penalties in SEC investigations of underwriters," Journal of Financial Economics, Elsevier, vol. 50(2), pages 151-186, November.
    7. Ali Hortaçsu & Chad Syverson, 2004. "Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of S&P 500 Index Funds," The Quarterly Journal of Economics, Oxford University Press, vol. 119(2), pages 403-456.
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    Cited by:

    1. Eric Zitzewitz, 2014. "Retail Securities Regulation in the Aftermath of the Bubble," NBER Chapters,in: Economic Regulation and Its Reform: What Have We Learned?, pages 545-588 National Bureau of Economic Research, Inc.
    2. Kurniawan, Meinanda & How, Janice & Verhoeven, Peter, 2016. "Fund governance and style drift," Pacific-Basin Finance Journal, Elsevier, vol. 40(PA), pages 59-72.
    3. Patrick E. McCabe, 2009. "The economics of the mutual fund trading scandal," Finance and Economics Discussion Series 2009-06, Board of Governors of the Federal Reserve System (U.S.).

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    Keywords

    Mutual funds;

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