Fund Performance Follows Stewardship

Can a mutual fund manager loot your assets?

Unnerved by the Madoff scandal, many investors are asking that question. But shareholders of major fund families, such as T. Rowe Price(TROW) and Fidelity Investments, have no cause to fear Madoff-style swindles. Funds are required to keep transparent records, and the majority of companies have always complied with the rules.

To be sure, not every fund has served the best interests of shareholders. As markets collapsed last year, it became clear that some managers had taken unsuitable risks. Other funds held appropriate investments but charged excessive fees.

To decide whether you can trust a manager, consider the stewardship grades compiled by Morningstar. The fund tracker aims to determine whether companies are focused primarily on lining their own pockets or serving shareholders for the long term. Morningstar measures funds according to a series of criteria and awards grades ranging from A to F. Under the system, funds that run into problems with regulators get low marks, while those with clean hands receive A's. In addition, the Morningstar graders frown on boards that pay themselves high salaries.

When the grading system was introduced in 2004, some fund executives scoffed. Shareholders shouldn't care about anything except total returns, the critics said. But recent market history suggests that clean managers may deliver the best results. During the three years ending in January, domestic equity funds with A ratings lost 11.8% annually. Though that may not seem like a winning performance, B-rated funds did even worse, losing 12.8%, and funds with lower grades finished further behind.