Don't Buy All of Your Mutual Funds in the Same Place

There are some good arguments for spreading your investments across different firms.
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There are some good arguments for spreading your investments across funds offered by different management companies.

Sure, it's convenient to put all of your money to work with one fund family, and if you're investing through a 401(k) plan, you may not have a choice. Plenty of these employer-sponsored retirement plans limit their offerings to a single family of funds.

You might think this is OK, particularly if you spread your assets across funds in a variety of investment classes, such as domestic stocks, foreign stocks and municipal bonds.

That's not necessarily true.

The most obvious argument for spreading your bets around is that each fund family has its own strengths and weaknesses. A mutual fund company may be particularly strong across domestic stock funds because of the expertise of its managers, stock analysts and/or technology group, while others may have superior performance in international or fixed-income funds.

In addition, some fund families may excel at value investing, while others explicitly focus on growth. To construct a well-balanced portfolio of funds, investors are best served by investing to a fund family's strength.

Another argument for spreading your mutual fund holdings across several fund families is that it tends to increase the risk in your portfolio, since funds in the same family often have similar holdings and common characteristics.

In an article published in the June 2007 issue of the

Journal of Financial and Quantitative Analysis

, Edwin J. Elton, Martin J. Gruber and T. Clifton Green found that funds within a single fund family are more highly correlated -- meaning they are more likely to perform in line with each other -- than are a group of funds spread across multiple fund companies.

This correlation tends to offset the benefits of diversifying investments across different asset classes.

The authors suggest it's a good idea to hold funds across

both

different asset classes and fund complexes.

Finally, some mutual funds are better than others at corporate governance, or looking out for shareholders' interests.

Mutual fund governance involves a number of issues, but one that is particularly important is the independence of the board trustees for each fund. Most fund companies have taken steps to ensure that the interests of shareholders are protected, such as placing a premium on trustee experience and independence. In particular, these fund companies ensure that the members of their fund boards are not interested persons (i.e., an employee or employee's family member) and that their directors use best practices in the exercise of their duties.

Why is that important? Independent directors are more likely to critically review the fees and expenses of a fund, tie advisory fees to fund performance, respond to shareholder complaints and seek outside counsel for advice.

Some mutual fund directors are also required by the fund family to own shares in the fund in which they serve as director. Talk about skin in the game!

A survey by

FundVotes.com of 54 large fund families found significant differences in the level of board support for shareholder-sponsored resolutions this year, an important aspect of corporate governance.

MMA Praxis Funds scored very well, with fund boards supporting 81% of shareholder-sponsored resolutions. On the other hand, support at The Berkshire Funds was hardly exemplary; fund boards never backed a shareholder-sponsored resolution, but it backed management-sponsored resolutions 100% of the time.

Unless you are prepared to research the governance practices of a particular fund family -- you understand what constitutes the best practices -- you risk putting all of your money with a firm that has a less-than-stellar record.

Spreading your mutual-fund investments across several firms is a way of hedging your bets.

Lawrence Petrone is director of research for TheStreet.com Ratings. Prior to his current position at TheStreet.com Ratings, Lawrence was a partner and the senior supervisory analyst at America?s Growth Capital, where he was responsible for managing their research team and contributing technology research. Prior to joining AGC, Larry was supervisory sell-side analyst at Fidelity Capital Markets and DE Investment Research, a portfolio analyst at Fidelity Management & Research Company and a senior corporate analyst at The Boston Company. Lawrence was also portfolio manager and founder of a small-cap long/short hedge fund. Lawrence is a Chartered Financial Analyst, and has a B.A. in History and Education from Gordon College, and a M.Ed. from Boston College.