Appendix B: Internal Memo Concerning Shareholder Assessment of More Frequent Portfolio Disclosure

October 23, 2001

To: John Rea

From: Sandy West and Vicky Leonard-Chambers

Subject: Results of Survey of Shareholders' Assessment of More Frequent Portfolio Disclosure

Background

Several advocacy groups filed petitions in July and August 2000 with the Securities and Exchange Commission (SEC) requesting the SEC to adopt rules mandating mutual funds to report publicly their portfolio holdings more frequently than the current semi-annual requirement. The advocacy groups contend that more frequent disclosure would help investors assess whether fund investments are consistent with their investment objectives. The advocacy groups also assert that more frequent portfolio disclosure would make it easier to discern if a fund manager is engaging in "style drift," "window dressing," and "portfolio pumping."¹

In August 2001, ICI conducted a survey to assess shareholders' current use of portfolio disclosure provided in shareholder reports and gauge shareholders' interest in receiving this information more often than semi-annually. A total of 500 investors owning stock mutual funds outside employer-sponsored retirement plans were interviewed.² The findings of this survey are described in this memorandum.

Summary of Findings

Detailed Findings

1. Level of Readership of Shareholder Reports
More than three-quarters of survey respondents only skim or read sections of the shareholder reports of interest to them (Figure 1). Fourteen percent read the reports entirely, and 9 percent do not read them at all.

Level of Readership of Shareholder Reports
(percent of all respondents)

Do not read any of the report	9
Skim the report	37
Read sections of interest	39
Read all of the report	14
Don't remember receiving the report (volunteered)	1
Number of respondents	500

The survey respondents who skim, read sections, or read all of the contents of shareholder reports were asked to describe their readership of specific sections of the report. Portfolio disclosure-described to respondents as "the complete list of the name, number of shares, and market value of every investment held by the fund"-was the item least likely to be read thoroughly and the item most likely not to be read at all. Only 22 percent of these respondents read the portfolio information thoroughly, 58 percent read it briefly, and 20 percent did not read it at all (Figure 2). Instead, these shareholders were more inclined to review the average annual total return of the fund and the listing of the fund's largest investments. Forty-seven percent of the shareholders who read the reports said they thoroughly review the average annual total return of the fund, and 43 percent said they thoroughly examine the list of the fund's largest investments.

Level of Readership of Specific Sections in Shareholder Reports
(percent of respondents skimming, reading sections, or reading all of the reports)

	Level of Readership of Section
Section	Thoroughly	Briefly	Not at All
Average annual total return of the fund	47	47	6
List of the largest investments held by the fund	43	49	8
Fund performance compared with that of a market index	35	54	11
Portfolio manager's discussion of factors that affected fund performance	29	58	13
Percentage of the fund's investments by industry sector	24	60	16
Complete list of the name, number of shares, and market value of every investment held by the fund	22	58	20

Note: Number of responses varies.

Moreover, only about half of those respondents who said they read the entire contents of shareholder reports indicated thoroughly reading the portfolio information (Figure 3). Almost all of the rest of this group only briefly read the complete listing. The level of readership of portfolio disclosure is significantly lower among respondents who read shareholder reports less attentively.

Level of Readership of Portfolio Disclosure by Overall Readership of Shareholder Reports
(percent of respondents skimming, reading sections, or reading all of the reports)

	Readership of Shareholder Reports
Readership of Portfolio Information	Read All	Read Sections	Briefly Skim
Thoroughly	51	21	13
Briefly	47	61	60
Not at all	2	18	27
Number of respondents	70	198	184

2. Interest in Receiving Quarterly Portfolio Information at No Cost
Most stock mutual fund owners do not want more frequent disclosure of mutual fund portfolio holdings even if the information were free. Seventy-two percent of survey respondents said they are not interested in receiving portfolio information four times per year at no cost (Figure 4). Twenty-six percent said they would like to receive the information four times per year at no cost, and 2 percent indicated they already receive the information quarterly. Even the majority of respondents who thoroughly read the portfolio information said they are not interested in receiving this information more than twice a year.

Interest in Quarterly Portfolio Disclosure at No Cost by Level of Readership of Portfolio Disclosure Information
(percent of respondents)

Level of Interest in Quarterly Portfolio Disclosure at No Cost	All Respondents	Level of Readership of Portfolio Disclosure Information
		Thoroughly	Briefly	Not at All
Interested	26	40	27	10
Not interested	72	55	72	90
Already receive four times per year	2	5	1	0
Number of respondents	500	100	262	88

The demographic and income characteristics of survey respondents interested in receiving quarterly portfolio information at no cost are similar to those of respondents satisfied with receiving this information twice per year (Figure 5). However, the financial assets and mutual fund assets of the two groups differ significantly. Median financial assets of the group wanting more frequent disclosure is about 40 percent less than that of the group satisfied with the current frequency of disclosure. Median mutual fund assets of the group wanting more frequent disclosure is about 20 percent less.

The group interested in quarterly disclosure at no cost tended to use the direct market channel more frequently than the group not interested in more frequent disclosure. The two groups, however, were about equal in their agreement with the statement "I usually rely on a professional financial advisor when making fund purchase decisions."

Characteristics of Respondents by Level of Interest in Quarterly Portfolio Disclosure at No Cost

Characteristic		Interested	Not Interested
		----Percent of Respondents---
Age of respondent		46 years	49 years
Household income		$69,000	$65,500
Household financial assets1		$113,100	$193,900
Household financial assets in mutual funds		$59,700	$74,400
Household financial assets in stock mutual funds		$36,000	$49,000
Number of stock mutual funds owned		3	3
		--------Median------
Married or living with a partner		79	74
College or post-graduate degree		51	59
Employed full- or part-time		71	73
Own stock mutual funds through:
	Sales force channel	79	81
	Direct market channel	62	52
Own:
	Bond mutual funds	34	35
	Hybrid mutual funds	26	35
	Money market mutual funds	64	54
Strongly or somewhat agree with statement:
	I usually rely on a professional financial adviser when making stock mutual fund investment decisions	74	70
	I know a lot about investing in stock mutual funds	57	59
	I buy and sell shares of stock mutual funds frequently	23	15a

¹Includes assets in employer-sponsored retirement plans.
^aResponses of respondents not interested in receiving quarterly portfolio disclosure at no cost are statistically different at the 95 percent confidence level from those who are interested in the quarterly disclosure at no cost.
Note: Number of respondents varies.

3. Willingness to Pay to Receive Quarterly Portfolio Disclosure
The 26 percent of respondents interested in quarterly portfolio disclosure were asked about their willingness to pay for the information. The cost of more frequent disclosure was specified as $5, $10, and $20. Respondents were initially asked if they would pay $10. If they were willing to pay $10, they were asked if they would pay $20; if they were not willing to pay $10, they were asked if they would pay $5.

Forty-nine percent of this shareholder group (or 13 percent of all respondents) indicated they would not pay for the information; 15 percent (or 4 percent of all respondents) were willing to pay $20; 24 percent (or 6 percent of all respondents) were willing to pay $10 but not $20; and 12 percent (or 3 percent of all respondents) were willing to pay $5 but not $10 (Figure 6).

Willingness to Pay for Quarterly Portfolio Disclosure
(percent of respondents)

NA = Not Applicable

The responses to questions about willingness to pay can be used to construct a demand schedule for quarterly portfolio disclosure. Excluding the 2 percent of respondents already receiving quarterly disclosure, at a cost of $5, only 13 percent of the survey respondents would be willing to pay to receive a list of portfolio securities quarterly rather than semi-annually (Figure 7). These respondents include those willing to pay $5 but not $10, $10 but not $20, and $20. Reflecting the declining marginal value of quarterly information, 10 percent would want the information at a cost of $10, which includes respondents willing to pay $10 but not $20 and those willing to pay $20. Only 4 percent would be willing to pay $20.

Schedule of Demand for Quarterly Portfolio Disclosure
(percent of respondents)

1 Sum of respondents who would pay $5 but not $10, $10 but not $20, and $20. All would pay $5.
2 Sum of respondents who would pay $10 but not $20 and those who would pay $20.

The three cost figures are relatively low. Indeed, for the group of respondents unwilling to pay for the additional disclosure, the highest cost of $20 amounts to only 0.03 percent of their median household income.³ The low level of these costs thus suggests that the 85 percent of respondents who either would not want or would be unwilling to pay for quarterly disclosure must see virtually no value in the information relative to semi-annual disclosure.

That the vast majority of respondents would not directly pay for quarterly portfolio disclosure implies that they would not knowingly pay indirectly for the same information through a reduction in the fund's total return. A lower return might occur from front running, that is, the use of the portfolio information by outside investors to trade ahead of the fund, thereby raising the fund's transactions costs.⁴ At even the $5 direct cost of quarterly disclosure, which 85 percent of respondents would not be willing to pay, the cost would be less than one basis point of the median of stock fund assets held by this group of respondents. This characterization of the cost similarly suggests that the majority of respondents would place an extremely low value on the additional information provided by quarterly disclosure.

4. Concern About Front Running
In response to a question about front running, the majority of respondents expressed concern about the possibility of investors outside their stock funds having sufficient information to anticipate their funds' purchases and sales of stocks.⁵ One-half of the respondents were "very concerned" and 34 percent were "somewhat concerned" (Figure 8). Sixteen percent were either "not very concerned" or "not at all concerned."

For comparison, respondents also were asked about three possible changes in the management of their funds' portfolios. These included a change in investment goals, closing the fund to new investors, and a change in the portfolio manager. Respondents generally expressed much less concern about such changes than about front running. Twenty-nine percent were "very concerned" about a change in investment goals, 24 percent were "very concerned" about funds closing to new investors, and 22 percent were "very concerned" about a change in portfolio managers.

Concern about front running appears to be related to stock fund shareholders' financial situation. Survey respondents who were "very concerned" about front running had greater median household financial assets and median mutual fund assets than respondents not concerned about this issue (Figure 9). The respondents who were "very concerned" also tended to have higher household incomes.

Concern About Front Running and Portfolio Management Policies¹
(percent of respondents)

Type of Concern	Very Concerned	Somewhat Concerned	Not Very Concerned	Not At All Concerned
If investors outside the fund had information that allowed them to anticipate the timing of the fund manager's purchases and sales of specific stocks	50	34	10	6
If the fund's investment goals were to change	29	54	14	3
If the fund were to close to new investors in order to meet its investment goals	24	37	22	17
If the fund's portfolio manager were to change	22	42	25	11

¹If the issue were to arise over the next 12 months in one of the stock funds respondents own.
Note: Number of respondents varies

Characteristics of Respondents by Level of Concern About Front Running

Characteristic		Very Concerned	Somewhat Concerned	Not Very or Not at All Concerned
		----------Median---------
Age of respondent		50 years	44 years	47 years
Household income		$71,800	$62,500	$60,600
Household financial assets1		$250,000	$140,300	$125,000
Household financial assets in mutual funds		$94,700	$60,000	$38,800
Household financial assets in stock mutual funds		$50,000	$40,000	$30,000
Number of stock mutual funds Owned		3	3	3
		--------Percent of Respondents--------
Married or living with a partner		79	72	73
College or post-graduate Degree		58	52	59
Employed full- or part-time		72	78	69
Own stock mutual funds through:
	Sales force channel	83	81	72
	Direct market channel	54	56	57
Own:
	Bond mutual funds	33	39	28
	Hybrid mutual funds	35	32	31
	Money market mutual funds	56	62	48
Strongly or somewhat agree with statement:
	I usually rely on a professional financial adviser when making stock mutual fund investment decisions	70	77	60
	I know a lot about investing in stock mutual funds	57	63	56
	I buy and sell shares of stock mutual funds frequently	18	20	9

¹Includes assets in employer-sponsored retirement plans.
Note: Number of respondents varies.

¹ Letter from Mercer E. Bullard, Founder and CEO, Fund Democracy, to Jonathan G. Katz, Secretary, Securities and Exchange Commission (June 28, 2000); and letter from Consumer Federation of America, Arizona Consumers Council, Consumer Action, Consumer Federation of California, Consumer Fraud Watch, Consumers Union, Democratic Processes Center, North Carolina Consumers Council, Pennsylvania Citizens Consumer Council, and Virginia Citizens Consumer Council to Jonathan G. Katz, Secretary, Securities and Exchange Commission (August 9, 2000).

² A random-digit dial (RDD) national probability sample was used to generate a representative sample of investors owning stock mutual funds outside retirement plans at work. All interviews were conducted with the primary decisionmaker or co-decisionmaker most knowledgeable about household savings and investments. The interviews were conducted by telephone and averaged 12 minutes. The overall sampling error for the survey is plus or minus 5 percent at the 95 percent confidence level. Region and income data from the survey were weighted to match those of a separate ICI survey sample of 1,371 investors owning stock mutual funds outside retirement plans collected in June 2001.

³ Median household income of the respondents unwilling to pay for the additional disclosure is $67,200.

⁴ See Russ Wermers, "The Potential Effects of More Frequent Portfolio Disclosure on Mutual Fund Performance," Perspective, Vol. 7, No. 3, Investment Company Institute (June 2001), p. 2.

⁵ Survey respondents were asked to indicate their level of concern if, over the next 12 months, investors outside their stock mutual funds had information allowing them to anticipate the timing of fund managers' purchases and sales of specific stocks.