Scandals matter to investors, or so we want to believe. And yet there is so much evidence to the contrary. On the same day in March that former WorldCom Inc. chief Bernard Ebbers was convicted in one of the largest corporate fraud cases in history, Wall Street was kicking off a healthy first-quarter reporting period, with Lehman Brothers Holdings Inc. logging record results on strong trading activity.
Had the healing already begun for investors, after five years of recriminations since the great bursting of the stock bubble? More likely, markets move for reasons that go far beyond investors’ disgust, or lack of it, with corporate scandals.
Remember the market-timing scandals in the mutual fund industry? A lot of investors don’t.
“The fund industry’s bad news broke during a bull market [in 2003], and it actually had positive inflows during the scandal, which took away a lot of ammunition,” said Don Phillips, managing director for Morningstar Inc. in Chicago. “If we hadn’t been in a bull market, outflows would have been much worse, Congress would have had a field day and the industry would be facing [tougher] reforms.”
In an April 2004 investor survey by Spectrem Group, 57 percent said they had no particular concerns about the fund scandals.
Investors had $1.2 trillion more invested in mutual funds at the end of 2004 than they did at the end of 2000, according to the Investment Company Institute.
“[As investors] we’re a bit detached,” said David W. Miller, executive director of the Yale Center for Faith and Culture. “There is quick moral outrage when we see this egregious malfeasance, but the irony is we share culpability” by hinging investing decisions on greed ourselves, he said.
A Warsaw, Ind., investment firm recently sent me a letter encouraging investors (by way of the media) to quit worrying about the scandals behind the curtain.
“Scandals are obviously not good, but what is really important is fund performance and fund management,” said Neil Donahoe, chief investment officer for SYM Financial Advisors.
In an interview, Donahoe said he believes investors who let themselves get overconcentrated in certain stocks or industries did themselves more of a disservice than was done by a few bad apples in the scandals.
Agree or disagree, but consider this: What are you doing differently today as an investor that will help insulate your portfolio from future misdeeds?
Morningstar’s Phillips recently told an industry group that three common threads unite the four companies that raked in the bulk of fund inflows last year, and they have nothing to do with active versus passive trading styles. Despite the bull market during the heat of scandal, he said, there is evidence investors are voting with their feet now.
All four firms–American, Fidelity, Vanguard and Barclays–avoided the trading scandals and have below-average costs in their peer groups. None of them has had flavor-of-the-day funds for which the company had to apologize later.
“Investors care about getting a good deal and whether they are with someone they can trust,” he said.
Lynn Stout, a UCLA securities law professor, also believes scandals matter to investors–look at how many plowed money into the real-estate market instead of stocks in recent years, she said. “And yet, where else are they going to put their [tax-advantaged] retirement money? There’s no where else to go.”
Investors may decide to stay engaged in the stock market, but they do have a choice about who advises them and what type of company does the trading. Companies and advisers who stay out of prosecutors’ paths may indeed be rewarded.
“If you believe this is the beginning of a new bull market, ethics may take a back seat,” said James P. Owen, a Texas investment adviser and author of “Cowboy Ethics: What Wall Street Can Learn from the Code of the West.” It calls for a new code among advisers in the wake of the scandals.
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“But what if returns limp along? Ethics will absolutely come to the forefront,” said Owen. “In a low-return environment, you better be able to trust your advisers.”
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E-mail Janet Kidd Stewart at [email protected].