Mutual Funds Exposed! (Reason 4 of 6 – Mutual Funds Lack Transparency)

A great retirement portfolio owns precise measures of specific investment types, depending on your age and personal tolerance for the ups and downs of the market.

But what if the mutual funds you buy do not hold the investments you think they do? This is known as “style drift” in the finance world, the more accurate word for it is return chasing.

Mutual fund managers get paid for performance. If they do not perform, they do not get paid (as much). Return chasing happens when a fund managers gets punished for doing what he or she has promised to do by following the stated mutual fund investment objectives. When money managers see that other managers and sectors are doing really well they see opportunities to boost their funds performance. Essentially chasing returns.

In 2012, the Wall Street Journal reported, a surprisingly diverse group of mutual funds lined up for Facebook shares. More surprising and potentially disturbing is that many of the funds, given their investment goals, shouldn’t have bought the stock at all. For example, a dividend growth fund bought Facebook shares, even though Facebook doesn’t pay a dividend. Additionally, a good number of value funds bought shares even though Facebook isn’t considered a value stock.

This isn’t just an isolated incident. It happens all of the time.