Dear Dagen: Best and Worst Trends in the Fund Industry - TheStreet

Dear Dagen: Best and Worst Trends in the Fund Industry

Dagen likes index and exchange-traded funds and the Internet. She's not so hot on UITs and redemption fees.
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Some mutual fund companies consistently show concern and care for their shareholders. Others just want to make a buck.

The result has been some very encouraging trends in the mutual fund business on the one hand, and a number of disheartening, negative turns on the other.

Here are my nominations for the best and worst trends of the past few years.

Best Trend: Index Funds

Index funds have been around since the 1970s, but during the 1990s they've achieved

Sinatra

-like popularity. At the end of August, index funds, largely ones tracking the

S&P 500

index, commanded 7.5% of the U.S. mutual fund industry's $4 trillion in assets, according to

Financial Research Corp.

in Boston, up from 5% in December 1997.

With an index fund, you pay very little in expenses to own an entire market or part of one. Plus, you don't have to make a judgment about a fund manager's investing acumen, which can be as tough as picking stocks themselves.

For more than two decades,

Vanguard

has been the champion of these low-cost, passively managed investments. But these days, every major fund company offers index funds, a testament to consumers' ability to shape the financial markets.

Worst Trend: Unit Investment Trusts

Unit investment trusts, or UITs, are the perfect product for gimmick investing.

UITs really got their start in the early 1960s, and for years they were known primarily for investing in municipal bonds. But during this decade, equity UITs have risen to prominence.

These fixed portfolios of securities often invest in trendy sectors like the Internet or real estate investment trusts, and gimmicky lists such as the

Fortune America's Most Admired

UIT from

John Nuveen

and the

America's Leading Brands Growth Portfolio

from

Nike Securities

.

With UITs, firms can jump on the hottest area of the market and quickly pull in assets from investors who are chasing the trend. These products often carry fat sales charges and can't be easily tracked like mutual funds.

Best Trend: The Internet

It's almost impossible to imagine getting basic investing information before the Internet.

Just a few years ago, investors were at the mercy of brokers and other financial professionals to get basic facts about their investments. Nowadays, investors can access a massive amount of data for free. They don't have to stand by their mailboxes waiting to find out what stocks their fund owns.

Worst Trend: Poor Overall Use of the Internet

Despite what you do find on the Internet, some mutual fund companies fill their Web sites with the same tripe that comes to you in the mail.

Looking at some fund company Web sites, you see outdated lists of holdings and loads of market babble. This is particularly noticeable on sites from load-fund companies, which use brokers to sell their funds and aren't appealing directly to the consumer.

You

can

conduct transactions on many sites. However, firms should be giving investors discounts for using the low-cost Internet to buy their funds.

Best Trend: Exchange-Traded Funds

These funds, which are listed on the

American Stock Exchange

, allow investors to buy and sell shares during the course of each trading day. Fund buyers don't have to wait until the end of each day for fund firms to price the shares.

First launched in 1993, these products, including the popular

Standard & Poor's Depositary Receipts

, or Spiders,

(SPY) - Get Report

, now control $21.3 billion in assets.

Other such instruments include the

Nasdaq 100

tracking stock

(QQQ) - Get Report

and

World Equity Benchmark Shares

, or WEBS. They carry low costs and tend to be very tax efficient. Hopefully, these products will draw even more attention to the benefits of tax-efficiency and low costs, two things many mutual funds companies seem to ignore.

Worst Trend: Redemption Fees

Some mutual fund companies, such as Vanguard and

Oakmark

, will argue that these increasingly common back-end fees prevent investors from buying and selling shares too often, thereby raising costs for other shareholders. Redemption fees, which are imposed on shares sold within a certain period of time, say six months or a year, go back into the fund and aren't kept by the fund company. That's one consolation.

But it's the intention that's questionable. Some firms are using these fees to benefit themselves, not their investors -- to prevent redemptions rather than deter short-term fund traders. Nowadays, investors are much more savvy and aren't afraid to move their money to another manager if they aren't satisfied with a fund's performance. Fund companies needed a thinly disguised device to keep investors in their funds. And they found one.

Best Trend: Greater Attention to Taxes

Conventional wisdom says that most investors don't think about the tax effect of their investments until they sit down to fill out their 1040s. So investors can thank some corners of the mutual fund industry for turning more attention to the tax effects of investing.

Vanguard just announced that it will begin publishing the after-tax returns for its stock and balanced funds in their annual reports.

Investors shouldn't buy funds or other investments solely based on their tax-efficiency but should always consider the tax consequences.

Worst Trend: Greater Attention to Short-term Returns

Mutual fund professionals frequently accuse investors of being short-sighted and hyper-focused on short-term performance. Well, the mutual fund industry needs to take a good look in the mirror.

I think the fund business has become increasingly obsessed with near-term performance and marketing. Don't tell me that fund executives don't wring their hands over how many

Morningstar

stars their funds are wearing. If performance wasn't important, every generic newspaper ad wouldn't be filled with the most-recent return figures.

Send your questions and comments to

deardagen@thestreet.com, and please include your full name.

Dear Dagen aims to provide general fund information. Under no circumstances does the information in this column represent a recommendation to buy or sell funds or other securities.