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In a Harsh Climate, Funds Get Creative

Unwanted adventurism or canny flexibility?

Gregg Wolper 10.09.2012


To avoid potential legal issues, the typical mutual fund prospectus is remarkably broad (or, some would say, annoyingly vague). After slogging through pages and pages of technical details, an investor might conclude that the fund can do anything it wants. For example, conventional stock funds that intend to fill their portfolios entirely with common equities usually allow themselves the freedom to use derivatives, own bonds, or raise large amounts of cash, even if the managers have no intention of doing anything of the kind.

In practice, though, the strategies of most funds are fairly well circumscribed. Most managers would prefer to focus on their areas of expertise, and most advisors and shareholders became less accepting of true go-anywhere mandates over the years. Since the financial crisis that began in 2007, though, it has become more common for managers to use the freedoms their prospectuses provide. Morningstar's director of fixed-income fund research, Eric Jacobson, noted this pattern among bond funds last year.

To a lesser extent, stock funds are taking advantage of this leeway as well. In July, senior analyst Laura Lallos outlined how some equity-fund managers are investing in other funds, both public and private, to gain exposure in areas outside their usual purview.

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About Author

Gregg Wolper  Gregg Wolper is an editorial director and senior mutual-fund analyst at Morningstar.

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