The Case for Mutual Funds vs. Hedge Funds

Spitzer accused the funds of permitting favored shareholders to trade rapidly in and out of portfolios, a practice sometimes called market timing. He made headlines for a few months -- and then the scandal disappeared from the front pages.

New York tried a few cases, and didn't win any. No new laws were passed, because none was needed. Instead of howling about lost savings, most shareholders ignored the fuss and proceeded to pour hundreds of billions of dollars into mutual funds in the next few years.

To find out exactly how much shareholders had lost, Spitzer required accused fund companies to hire outside consultants. But no one could figure out if the rapid trading had actually cost shareholders anything.

For example, Putnam hired Peter Tufano, a distinguished Harvard Business School professor, who estimated that the rapid trading might have directly cost shareholders a few million dollars out of the total $250 billion managed by the company. In his final report, the professor acknowledged that his estimate could be wrong. It was even possible that the rapid trading benefitted shareholders generally.

Because of the uncertainty surrounding rapid trading, fund companies should never have allowed it. But instead of calling press conferences, Spitzer could have handled the issue by making a few phone calls.

Once the issue became public, companies installed technology to pinpoint instances of questionable trading. By all accounts, rapid trading quickly disappeared and now no longer poses a problem.

The incident confirmed again that most fund companies are honest. For decades, these transparent businesses have shown that they can adjust to changing conditions and enable retail investors to build sound portfolios.

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