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| | Mutual Funds
Scandal-tainted fund firm does a 180
In the wake of harsh regulatory penalties, the change of heart at Massachusetts Financial Services starts at the top -- and looks to be real.
By Timothy Middleton
Massachusetts Financial Services was socked with one of the harshest settlements for market-timing and late trading in the mutual fund scandals. But, in only a few months, it has radically overhauled its operations, more than satisfied regulators and recruited as the new boss the man perhaps best qualified to restore the companys luster.
Morningstar has raised its opinion of MFS from do not send new money to proceed with caution. My opinion has changed, as well. Overzealous marketing, the chief motive for shareholder abuse at MFS, has been rooted out. The companys funds are ready to compete again with their peers, and many of them are very competitive.
MFS has made a lot of reforms, mainly due to the initiative of Bob Pozen, says Laura Lutton, the Morningstar analyst who tracks the fund family. The former vice chairman of Fidelity Investments is a heavyweight in this industry, she says. So, hiring Pozen as non-executive chairman, as well as other reforms, said to us that this is a company that is looking out for shareholders best interests and trying to put this in their past.
While at Fidelity, Pozen fittingly was the architect of fair-value pricing, a central reform the industry has been forced to embrace in the wake of the scandal. Also fittingly, his post-Fidelity career includes teaching at the Harvard Law School. The course: Critical Decisions for Corporate Boards.
Pozen wrote the book on fund management: "The Mutual Fund Business." Of particular interest is Chapter 9, a case study in market-timing. It was charges of this widespread rapid trading of mutual fund shares, at MFS and elsewhere, that prompted the most sweeping reforms funds have seen in their 64-year history.
A promise
Investors have my word, Pozen says. I didnt have to come back out of retirement unless I felt MFS was prepared to commit themselves to higher standards, and thats what theyve done.
Retirement implies an elder statesman; Pozen isnt old. Hes 57 and might have been running Fidelity except that its a family business and his path to the top was blocked.
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Now hes in a position to joust with his cross-Boston rival for leadership, if not of the industry (MFS is a fraction of Fidelitys size), then of its restoration to public confidence. Fidelity has fought many reforms bitterly, most notably the call for independent fund board chairmen. Pozen and MFS have embraced the reforms.
In short, Pozen has a personal stake in the success of MFS, a unit of Sun Life Financial (SLF, news, msgs), the Canadian finance conglomerate. And he has the credentials for the job. Hes a tough son-of-a-(gun), says Eric Kobren, executive editor of the Fidelity Insight investment newsletter. He took over FMR" -- Fidelitys corporate name -- when it was in disarray, and he turned it around.
He installed a discipline at Fidelity that they didnt have before, says Jack Bowers, editor of the Fidelity Monitor newsletter. Hes a good business manager.
Says Pozen: Our priorities are simple: First, to persuade the world weve cleaned up everything, which we have. Second, to improve investment performance in areas where it hasnt been what we want it to be.
Settling up
MFS has settled charges with federal and state regulators of rapid and late trading in 11 of its most popular funds. The trading was engineered primarily by hedge funds, which with the advent of the bear market in 2000 began shifting the definition of market-timing from years or months to weeks or days. They'd take advantage of pricing discrepancies to make money fast, hurting long-term shareholders. According to regulators, one internal MFS e-mail in 2003 acknowledged the firm had $1.3 billion on hand in market-timing money, far more than most other firms implicated in the scandal.
In one of the largest financial settlements in the scandal, MFS agreed to pay $50 million in penalties and $175 million in restitution to shareholders, and it agreed to cut its management fees by $125 million over five years. In fact, Pozen says, lower fees are likely to continue far longer, since future increases must be approved by shareholders as well as trustees.
MFS was never accused of the sleaziest practices to emerge in the scandal, which at other companies often involved allowing market timing in some funds in exchange for longer-term investments in other funds. The longer-term money generated fees for the fund firms. It likewise wasnt accused of market-timing by the firms own employees, which allegedly occurred at such firms as PBHG and Strong.
Performance of the companys funds has been generally good, and only senior officers were implicated in the scandal, which indeed was resisted by some portfolio managers.
Those officials are gone, some of them banned from the industry for years. Meanwhile, Pozen has reorganized the 200-person investment team, which runs 70 funds with total assets of $93.6 billion, according to the Investment Company Institute, making MFS the 25th-largest fund complex -- as well as one of the oldest fund companies. Expenses have been slashed, including lush brokerage commissions at the expense of shareholders.
A vote for independence
MFS has already embraced a board of trustees of its funds; the chairman and 75% of its members are independent. It has installed a new general counsel and provided, at its own expense, independent compliance officers to fund trustees. All of the reforms were putting in, were paying for out of our pocket, Pozen says.
Trustees, while selected by the fund company, are required by the Investment Company Act of 1940 to represent shareholders. They negotiate management fees and have the authority, seldom invoked, to fire managers and hire others to run portfolios.
MFS has also eliminated payments in soft dollars to encourage brokerage firms to sell its funds. These are inflated trading commissions paid by shareholders. It has imposed redemption fees of 2% on fund shares owned less than six days, reformed its internal code of ethics and restructured the compensation of portfolio managers to tie it more directly to the performance of their portfolios.
Many of these reforms remain at the proposal level for the Securities and Exchange Commission.
MFS funds have performed well over the years, far better than those of rivals such as Putnam Investments that were also ensnared in scandal. (To compare with Putnam, see this recent column.) Nearly 30% of MFS funds carry Morningstar ratings of four or five stars, denoting above-average risk-adjusted performance.
Checking the rankings
Over the last five years, nearly half of the companys funds rank among the industrys elite, those whose performance is better than three-quarters of their rivals.
| How MSF funds compare with peers | | Period | % of MFS funds in top 25% of category | | One month | 12.9% | | Year to date | 35.7% | | 12 months | 15.7% | | Three years | 33.8% | | Five years | 46.8% | | 10 years | 21.4% |
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Notes: Data as of 5/31/2004. Based on 70 distinct portfolios for all periods of 12 months or less, 65 for three years, 62 for five years, 42 for 10 years. Source: MSN Money, Morningstar Inc.
Fair-value pricing adjusts securities prices to reflect events outside normal market hours. For instance, a strong day in the U.S. market often affects Asian markets. The time difference, however, means there's a delay before that is reflected in Asian mutual funds prices. Market-timers took advantage of this, jumping in after seeing the U.S. market climb and jumping back out after the Asian funds' prices followed. Pozen was the Fidelity official who imposed fair-value pricing on that companys funds in the 1990s.
Pozen isn't a firebrand reformer. He resists the idea championed by many industry critics of forcing fund managers to disclose their personal investments, including in their own portfolios, as well as details of their compensation.
He says that unless all financial intermediaries, including banks, insurance companies and hedge funds, are required to do the same, funds will lose talent to jobs where their privacy is protected.
Going after the best
At MFS, he shows signs of being willing to spend freely to recruit and retain top managers. Whereas the firm formerly paid annual bonuses no greater than three to four times the smallest it pays, Pozen has elevated the maximum to as much as 12 times.
This is money that doesnt come out of shareholders pockets, except to the extent permitted by management fees, and its a proper post-scandal reform. The threat that mutual funds will lose talent to less-regulated investments is real, and shareholders wont benefit from dumbing down the talent pool.
The crucial issue for investors is whether their funds are more likely to do well than poorly in the wake of scandal. At MFS, reforms appear to be on target, and Pozens ability in organizing and disciplining an investment team is well established.
Investors can look at MFS funds now the way they would any others. The heat of scandal has passed, and, if any embers remain aglow, Pozen knows how to find and extinguish them.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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