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A reader writes:
Your article about style purity was right on and would probably go a long way in preventing mutual fund managers from trading to satisfy the label active. And worse, to show their shareholders that they are truly active managers. But isn't one of the biggest concerns about those trades and their subsequent costs, is the hidden amount of "soft money"? Best Regards,
For those of you who are unaware of what soft money is, let me explain Joy's concern about it. Soft money is simply the cost of trades, more specifically, pre-bought blocks of trades whose cost is passed on to the shareholder and not borne by the mutual fund company as an expense. These large trades are bought at a bargain, but the additional incentive money to buy these trades in advance is kept by the fund management team. In essence, the mutual fund company profits from this deal while the shareholders with ever diminishing returns, pays the brunt of this transaction. Not only does the overall volatility of the fund increase because of the pre-bought nature of these transactions, but the fund company is able to keep their reportable expense ratio down. One economist, Dr. Benn Steil, believes that if these soft money costs were eliminated, the expense of the fund company would soar into the double digits. It gives those with good names, bad reputations because of the efforts of some to profit on investors backs. I believe that some sort of style purity would help eliminate the need for frequent trading to chase the "next" hot investment, allowing the fund manager a shareholder commitment and confidence to do the right thing over a longer period. That confidence would eliminate the need to carry cash in reserve if there was some sort of opportunity to invest. Thanks for writing Joy.
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