Most securities regulation aims to boost disclosure. Yet the National Association of Securities Dealers has told bond mutual funds they can’t note risk ratings in their advertising and supplemental sales literature.
No one suggests making the funds disclose their ratings. But the NASD has repeatedly denied permission for voluntary disclosure. Not until Securities and Exchange Commission chief Arthur Levitt Jr. warned that this issue needs to be revisited did the NASD finally ask for public comment.
Risk ratings are highly useful, though imperfect. When interest rates surged in ‘94, “super-safe” long-term U.S. government bonds dropped 12.1% in value in just nine months. During the same period, junk bonds fared much better, falling only 2.6%.
Are government bonds riskier than junk? In some respects at some times, indeed they are. Long-term governments are much more volatile than most junk bonds, because they have a lower coupon and take twice as long to mature.
Standard & Poor’s Corp., Moody’s Investors Service Inc. and Fitch Investors Service L.P. all have their own risk measures for bond funds. S&P, for example, looks at the fund’s sensitivity to interest rate changes plus the variability of its past performance, the quality and liquidity of its holdings, its diversification, leverage, use of derivatives and even foreign currency risk. S&P boils all this into one of seven grades, from “aaa” to “ccc.”
Why won’t the NASD let funds advertise these independent risk ratings? None of its four major objections makes much sense.
Investors will assume that the risk ratings predict future performance. Within limits, they should: Investors weigh just about every piece of data they can get their hands on, from the portfolio manager’s name to the fund’s past performance, to help predict the future.
A fund may choose to publish only a favorable rating. Investors understand —even if the NASD does not—that risk, taken alone, is neither favorable nor unfavorable. Some investors prefer risk because it typically goes hand-in-hand with higher returns. Others seek safety.
And every modern consumer knows to take advertising with a grain of salt.
Investors will be confused by the complex calculations and by a letter format that is too much like the credit ratings. Investors already cope with Morningstar ratings, tax-equivalent yields, beta coefficients, on and on— all of which are now disclosed. And S&P says that it will recast its ratings in narrative form.
Brokers might misuse the ratings to deceive investors. The NASD has plenty of weapons to use against brokers who engage in deceptive sales practices. Would investors be better off if the broker were to dismiss queries related to risk because the NASD wants to avoid confusion? What if the broker purports to rely upon a secret formula?
The weakness of these arguments suggests that concern for investors is not the real motive for the nondisclosure rule. Instead, it looks as if a smug and immensely profitable industry fears that risk ratings will become mandatory—not because regulators insist on it, but because investors will demand to know a fund’s underlying risk, or go elsewhere.
Listen to the chief executive of a giant fund group, as quoted in The New York Times: “This is a self-serving effort by S&P to sell information that’s of limited to no value.”
Yes, the S&P is a profit-seeking purveyor of information. But the fund industry is also self-serving—thank goodness—and virtually every publishing company sells data.
What remains is one executive’s claim that S&P risk ratings are of little value—not fraudulent or deceptive. No person should have the right to force that judgment on the rest of us.
And neither the NASD nor any other government agency is morally or constitutionally authorized to deny investors access to information or an opportunity to evaluate it, act upon it or reject it.
Justice Stevens got it absolutely right in his 1995 opinion in Rubin vs. Coors Brewing Co.: “The Constitution is most skeptical of supposed state interests that seek to keep people in the dark for what the government believes to be their own good.”
To suggest that we as investors must be protected from ourselves is patronizing and offensive. And the misbehavior of the NASD—motivated by a seeming desire to benefit a few large funds—is but one more example of the nanny state at work.