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Mutual Fund Commentary

The SEC has stated that industry conflict is one of the agency’s top priorities in 2015. Also, fund distribution happens to be a “particular concern”. Proving true to that statement, the Securities and Exchange Commission is reportedly intensifying investigations into whether money managers are rightly disclosing additional costs they charge to investors.

According to The Wall Street Journal, Oppenheimer Funds, Franklin Templeton and J.P. Morgan Chase & Co. are among the funds that are being reviewed by the SEC. Last month, the SEC’s examination unit referred over a dozen firms to its enforcement division.

However, it is not clear yet if the regulator is initiating any action against money managers who are engaging in charging investors more money than is allowed to compensate for the brokerages required in distributing the products across the US. Nonetheless, the review may have implications on the ways the $16 trillion mutual fund industry sells products.

SEC’s Review

In early 2013, the SEC indicated it will investigate how mutual funds distribute their products. The SEC would look into the arrangements with middlemen and if boards of the mutual funds have proper knowledge of the relationship.

Money managers are largely dependent on Wall Street brokerages, insurers and other intermediaries to push the sales of their products to investors. Regulations do allow money managers to spend certain part of investor money for paying brokers for selling their products. The Financial Industry Regulatory Authority has restricted this spending at 0. 75% of a fund’s average net assets per year.

However, The Wall Street Journal reported that “The SEC now wants to know whether mutual-fund companies are drumming up ways to make extra payments by tapping the assets they manage for investors to pay for services such as consolidating their clients’ trading records, according to the people familiar with the matter.”

Response from Fund Companies

The SEC is worried that if the additional fees are not being properly informed to investors, then brokers may push only those funds for which they receive payments. Money managers can easily deceive the investors, or manipulate the limits by representing them as some other allowable fee.

The fund families in response have said that they do disclose the marketing fees properly. They also suggested that instead of keeping them under the scanner, the SEC should be reviewing the brokerages and insurance companies who ask for high prices for their services.

An Oppenheimer spokeswoman confirmed that the fund family pays for record-keeping services which are not from the mutual-fund expenses. The spokeswoman said: “We believe this is a sound and transparent practice”. However, Franklin Templeton and J.P. Morgan did not comment.

3 Low-Cost, High-Management Rating Funds to Buy

Given the risk of high charges being imposed on funds, it is always a prudent move to buy low-cost funds. Funds should have a low expense ratio and must not carry any sales load. It is obvious that sales load and expense ratio will have an inversely proportional impact on the net return.

Alongside, we will look into funds with a high manager rating. It measures the risk-adjusted performance of a fund's management relative to the fund's peer group. This performance rating is based on the manager's "value added" while with the fund; that is, the difference between a manager's actual average annual return while at the fund and the "expected" return as determined by the level of risk assumed relative to the fund's peers.

The following 3 funds also carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). We expect the funds to outperform its peers in the future. Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but the likely future success of the fund.

The funds have encouraging year-to-date, 1-year and 3 and 5-year annualized returns. The minimum initial investment is within $5000.

Fidelity Select Health Care Portfolio (FSPHX - MF report) seeks capital growth over the long run. FSPHX invests a lion’s share of its assets in companies involved in designing, manufacturing and selling of healthcare products and services. FSPHX invests in companies throughout the globe.

FSPHX currently carries a Zacks Mutual Fund Rank #1. The year-to-date and 1-year return stand at 8.9% and 18.3%. The 3 and 5 year annualized returns are 33.1% and 29.2% respectively. FSPHX’s annual expense ratio of 0.74% is lower than the category average of 1.35%. FSPHX boasts a manager rating of 13.2.

Fidelity Select IT Services Portfolio (FBSOX - MF report) invests a minimum of 80% of its assets in US and non-US firms that provide information technology services. While selecting investments, FSBOX uses fundamental analysis of factors looking into issuer’s financial condition and industry position, and also economic and market environment.

FBSOX currently carries a Zacks Mutual Fund Rank #1. The year-to-date and 1-year return stand at 10.7% and 21.8%. The 3 and 5 year annualized returns are 23.7% and 22.2% respectively. FBSOX’s annual expense ratio of 0.81% is lower than the category average of 1.47%. FBSOX boasts a manager rating of 9.3.

T. Rowe Price New America Growth (PRWAX - MF report) seeks long-term growth of capital by investing primarily in the common stocks of U.S. growth companies. PRWAX invests at least 65% of total assets in common stocks of U.S. companies that operate in those sectors of the economy identified by T. Rowe Price as the fastest growing or having the greatest growth potential.

PRWAX currently carries a Zacks Mutual Fund Rank #2. The year-to-date and 1-year return stand at 4.3% and 7.1%. The 3 and 5 year annualized returns are 17.5% and 17.1% respectively. PRWAX’s annual expense ratio of 0.79% is lower than the category average of 1.18%. PRWAX boasts a manager rating of 6.2.

About Zacks Mutual Fund Rank

By applying the Zacks Rank to mutual funds, investors can find funds that not only outpaced the market in the past but are also expected to outperform going forward. Pick the best mutual funds with the Zacks Rank.