The Markets April 14, 2009

Oregon Sues 529 Fund Manager

The state of Oregon has sued OppenheimerFunds Inc., charging the fund manager with understating the risk it took with a bond fund in Oregon's state college-savings plan.
Reported by

Oregon has sued the firm for losses of $36.2 million incurred by participants in the Oregon College Savings Plan, a 529 college savings plan which Oppenheimer manages. According to the Wall Street Journal, at least four other states had hired Oppenheimer to manage parts of their college-savings plans, including Texas, New Mexico, Illinois and Maine. A spokeswoman for Illinois’s state treasurer said the state is working with the other states, “to try to negotiate a settlement,” according to the WSJ.

In the lawsuit, filed in Marion County, Ore., the State Treasurer and Oregon 529 College Savings Board allege violations of Oregon securities law, breach of contract, breach of fiduciary duty, negligence and negligent misrepresentation. Treasurer Ben Westlund and Attorney General John Kroger said the lawsuit was filed on behalf of families and aims to recoup their losses.
“We are taking action on behalf of Oregon families whose college accounts were battered — and their financial futures jeopardized — because of OppenheimerFunds,’ said Treasurer Westlund. “Families were doing the right thing and saving for college, but unknown to them or Oregon, their money was invested in ways that were plainly inappropriate for those saving for college or already in college.’
Investigation Undertaken
Monday’s filing comes after a three-month investigation by the Oregon Attorney General, which found that Oppenheimer Funds represented that certain investments were appropriate for conservative and ultra-conservative portfolios – “but shuttled college savings instead into a hedge-fund like investment fund that took extreme risks in a search for speculative large returns,’ according to an announcement of the action.
In response, OppenheimerFunds said in a statement it was “…very disappointed by the actions of the Oregon Attorney General Office’s in filing a lawsuit against it today seeking to recover amounts lost in investments held in the Oregon College Savings Plan.’ The fund manager said that it had “cooperated fully with the State of Oregon in its inquiry into OFI’s role as program manager for the funds at issue’ over the past several months, and “despite this cooperation and ongoing dialogue with the State, Oregon proceeded to file its suit without so much as a single meeting with OFI or its representatives in an effort to discuss their concerns or potential solutions.’ Noting that it was “deeply concerned with the investigative process followed by Oregon and its decision to file a suit given the fact that the State Attorney General did not conduct the investigation but rather hired and paid an outside attorney to do so,’ OFI said “we are prepared to defend ourselves and our reputation vigorously against these claims which lack legal merit.”

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The lawsuit focuses on the Oppenheimer Core Bond Fund, which was part of five age-based portfolios in the Oregon College Savings Plan. The lawsuit alleges that the character of the OppenheimerFunds Core Bond Fund changed in 2007 and 2008, but neither the state nor investors were alerted that the fund had become “significantly more aggressive and risky”. The Investment Policy for the Oregon College Savings Plan provided that “Ultra-Conservative/In College’ and “Conservative/1-3 Years to College’ portfolios had the primary investment objectives of “protection of principal’ and “income,’ according to the announcement.

Steep Losses
While the Core Bond Fund lost a total of nearly 36% for the year 2008, its benchmark index was actually up 5% for the year, according to Oregon officials – and through March 2009, the Core Bond Fund lost another 10% while the index remained virtually even. Oregon officials noted that Morningstar Inc. gave OppenheimerFunds a grade of “F’ in February for failing to communicate with its investors about the true nature of its funds.
According to the WSJ, Oppenheimer Core Bond fund’s sharp losses in 2008 stem partly from bets on high-quality commercial mortgage-backed securities, which its manager believed would rise in value. To make these investments, the fund used a type of derivative called total-return swaps, which are agreements between parties to exchange cash flows in the future based on how a set of securities performs. But commercial mortgage securities have deteriorated since last year, thanks to the worsening economy.
Unprecedented Volatility
In its response to the suit, OFI acknowledged that “the mutual funds cited in the complaint experienced significant losses due to unprecedented market volatility in 2008, as did other mutual funds and investments’, going on to note that the investment consultant hired by the State of Oregon’s Board noted at a meeting of the Board in January 2009 that OFI wasn’t the only firm that made the types of investments that the fund at issue held and that the fund was hit badly by “the dislocation of the market.’ OFI said that “that consultant went on to state that OFI provided “full transparency in the portfolio, allowing it to be analyzed at both the sector and security level.’’ For its part OFI said it “did not radically change the investment policies of the Fund in 2007 and 2008, as alleged in the suit, and made no changes in the fund’s investment policies and strategies without telling the board. For the Attorney General to suggest otherwise in the complaint is simply a distortion of the facts.’
Also named in the suit are OppenheimerFunds Distributor Inc. and OFI Private Investments Inc. Both are based in New York.
The Oregon 529 College Savings Board voted in January to remove the Oppenheimer Core Bond Fund from the state 529 portfolio.
The Markets April 13, 2009

ICI: Mutual Fund Fees Down, For Now

The average fees and expenses that investors paid on mutual funds fell in 2008 to their lowest levels in more than 25 years, according to the Investment Company Institute (ICI), a mutual fund trade industry group.
Reported by

The report, “Trends in the Fees and Expenses of Mutual Funds, 2008,” claims that investors paid 99 basis points, on average, to invest in stock funds, a 2 basis-point decline from 2007. Average fees and expenses on bond funds dropped 3 basis points to 75 basis points, according to the report, while fees and expenses on money market funds averaged 38 basis points.

However, it should be noted that, in order to summarize the fees and expenses that shareholders incur, ICI uses an asset-weighted average. Additionally, ICI says that in order to “assess appropriately the fees and expenses incurred by individual shareholders in long-term funds, the analysis includes both retail and institutional share classes of long-term mutual funds.’

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Tracking Target-Dates

ICI notes that the market for funds of funds (mutual funds that invest in other mutual funds) has expanded considerably in recent years. In fact, ICI said that by the end of 2008, there were 865 funds of funds with $490 billion in assets, and that over 80% of the assets of funds of funds are in hybrid funds of funds, which are funds that invest in a mix of stock, bond, and hybrid mutual funds. Much of that growth, in turn, stems from investor interest in lifecycle and lifestyle funds, according to the ICI. The report noted that lifecycle and lifestyle funds have proven to be especially attractive for individuals saving for retirement in 401(k) plans and IRAs, and that lifecycle and lifestyle funds account for 62% of the total number and 65% of the total assets of funds of funds.

Considering the growing use of these funds of funds, ICI notes that from 2005 to 2008, the average expense ratio of funds of funds fell from 99 basis points to 92 basis points, a drop of 7%. ICI said that that drop “may reflect competition among an increasing number of funds of funds for investors’ dollars’, and that, with the assets of funds of funds up 60% since 2005, “scale economies may have played a role.’

Declining Value Impacts?

The report did, however, caution that recent drops in asset values could result in a reversal of that trend. “No such increase in fund expense ratios is evident in this paper, but experience from past market cycles indicates that a rising trend is possible,” according to the ICI. “During the market downturn that lasted from early 2000 to early 2003, for example, average expense ratio of stock funds rose several basis points.’

The ICI outlined a number of reasons why declining assets might lead to rising expense ratios:

Some fund expenses are relatively fixed, including transfer agency fees (which tend to be charged as a fixed number of dollars per account), the cost of mailing fund literature, accounting and audit fees, and director fees. “When fund assets fall, these fixed costs will rise as a percentage of assets, tending to boost a fund’s expense ratio,’ according to ICI.

Some fund complexes offer “breakpoints’ in the management fee that they charge their funds. Such a fee structure reduces the fee rate as the fund’s assets grow, sharing with investors the benefits of economies of scale – but as asset levels fall, the fund may lose some of the benefit of those reduced rates, resulting in a higher expense ratio, according to the ICI.

However, ICI notes that any potential increases in expense ratios as the result of these factors should be distinguished from increases in the contracted schedule of fund management fees, since any increase in the fee schedule would have to be approved by fund directors and shareholders.

Finally, ICI notes that the expense and other fee information used in this article are based on 2008 data, and thus do not reflect any fee changes occurring in 2009. Also, the fee data used in the article were based on funds’ fiscal years, which may or may not align with the calendar year.

The report is online at http://www.ici.org/home/fm-v18n3.pdf

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