A debate is brewing over whether bond mutual fund investors would make more informed choices if prospectuses included ratings assessing the risk of each portfolio.
Standard & Poor's says investors want more information, and it is pitching its own risk rating system. But the National Association of Securities Dealers, the self-regulating body of the brokerage industry, has resisted allowing bond funds to include ratings in their prospectuses.
The debate rages among bankers, too.
"I think it's a good idea," said B. Randolph Bateman, chief investment officer for Cincinnati-based Star Banc Corp.'s Star Funds. "Right now all people have to go on is return."
But Alan Leach, president of the brokerage at Jackson, Miss.-based Deposit Guaranty, says such ratings would "add a false sense of security. When interest rates go up, every bond fund will go down."
The sales literature for a bond fund already includes ratings for the credit risk of single issues in the fund. But the NASD forbids inclusion of a performance-risk rating for the entire fund.
Last week, however, the NASD began sifting through letters it had received after putting the issue out for comment in December. The period for public response expired Monday.
The Washington-based regulator said it will review all the letters, but did not say when it would make a decision. "It's a priority issue for us," said a spokesman.
The NASD wrote in its recent request for comment that "a rating that represents a judgment of how a bond fund will react to changes in various market conditions would be predictive of fund performance and misleading."
The debate stems from 1994's bond market crash, when interest rates shot up and the value of bonds plummeted, dragging down the total returns of bond funds. Many investors didn't understand that their principal wasn't as safe in a bond fund as in a single issue.
Standard & Poor's says investors could have used a rating system then to help avoid losses. The system the company is pitching assesses past performance, the composition of portfolio holdings, and current market factors.
Proponents of risk rating say all disclosure is good.
"Even though more is confusing, I'd much rather risk the sale than say, 'Trust me, everything's O.K.,'" said Nathan Morgan, president of the brokerage at Zions Bancorp, Salt Lake City.
Standard & Poor's sells its ratings to fund companies for $22,000 for the first portfolio and $6,000 for every one thereafter. More than 130 mutual funds use Standard & Poor's risk ratings for their own purposes already.
"If we do a credible job, they will gain value in the marketplace," said Leo C. O'Neill, president and chief rating officer for Standard & Poor's.