From: SCOTT COOLEY [scott.cooley@morningstar.com]
Sent: Tuesday, February 11, 2003 10:01 AM
To: rule-comments@sec.gov
Subject: File No. S7-51-02

I submit the following on behalf of Morningstar, Inc.
 
  
The SEC has proposed requiring mutual funds to reveal their holdings 
once per quarter instead of semiannually as they currently do. We 
applaud the SEC for this shareholder-friendly initiative.
     
We believe there are a few reasons timely portfolio disclosure strongly 
benefits fund shareholders.

Sometimes updated portfolio information can be critical to investors' 
ability to understand their funds. Woe to the shareholder who, in early 
2000, did not realize that after value manager George Vanderheiden 
retired, his successor made Fidelity Advisor Growth Opportunities into 
a growth-biased fund with a technology stake of 40%. Although Vanderheiden 
retired in January 2000, Fidelity didn't again release complete portfolio 
holdings for the fund until July of that year--well after the Nasdaq 
Composite (and the fund) had begun tumbling from its March 2000 highs. 

Similarly, early on in the bear market for growth stocks, some Janus 
managers were already getting more defensive, and investors, because 
they didn't have fresh portfolios to go on, were flying blind. Moreover, 
over the past few years investors who lacked the necessary information 
to closely monitor--and carefully rebalance--their portfolios may have 
been overexposed to growth issues in early 2000, when they peaked, and 
may currently have a higher allocation to value stocks than they had 
intended.  

It's also worth noting that some of the best evaluators of fund-management 
talent require timely portfolio disclosure. For example, Jeff Molitor, who 
heads up Vanguard's portfolio-review group, continuously monitors the 
holdings of the outside managers the firm hires as subadvisors. By 
examining individual holdings, as well as aggregate portfolio statistics, 
Molitor ensures that managers aren't straying from their stated investment 
objectives. Molitor's team does a fine job of monitoring funds' investment 
approaches and characteristics. Shouldn't the actual owners of the funds 
and their financial advisors have the right to obtain enough information 
to make intelligent investment decisions? (For the record, Vanguard 
supported the SEC's most recent portfolio disclosure proposal.)

The Opponents' Position

Of course, not everyone was as impressed with the SEC's decision as we 
were. The Investment Company Institute and other industry participants 
have in the past decried similar measures.

It is worth recapping the ICI's previous arguments against more frequent 
portfolio disclosure, if only to explain why it is erroneous. The ICI 
contended that with timelier portfolio disclosure, investors could see 
trends in portfolio changes and then trade on that information. For 
example, if investors saw that Legg Mason Value's Bill Miller had added 
shares of  JP Morgan Chase & Co. in the previous quarter, they might 
reasonably assume that he was still buying. Miller's purchases alone 
might drive up the price of the stock, and if investors also buy 
in--hoping to make a quick buck--they'd further drive up the price 
Miller would have to pay for additional shares.

There are a number of problems with the ICI's logic.

First off, fund firms and other investment managers have long had to 
file a form called 13-F that provides a comprehensive list of their 
firmwide holdings. Therefore, the ICI's implausible position is that it 
has prospered in the past while it revealed all of its holdings, but it 
would simply crumble if it provided quarterly disclosure of some of its 
holdings, that is, the stocks in any given mutual fund.

Second, a number of successful firms already provide quarterly disclosure 
to their shareholders. For example, Oakmark and American Century, two 
terrific fund families, produce outstanding quarterly reports that include 
complete lists of portfolio holdings, as well as a discussion of recent 
changes to their funds. To undercut the ICI's argument about the harm that 
would come from quarterly portfolio disclosure, there's nothing quite as 
compelling as successful shops that are already (voluntarily) providing 
such information--and thriving.

Third, portfolio managers collectively accounting for well more than 80% 
of domestic-equity assets already provide quarterly or monthly portfolios 
to Morningstar, which we make available to the public. These include large 
shops such as American Funds, Vanguard, American Century, and T. Rowe Price. 
Are they really engaging in behavior that's detrimental to their business? 
That seems unlikely. At Morningstar, we deeply appreciate the willingness of 
fund families to help us get timely information to our customers, but we 
believe shareholders should also be able to obtain that information directly 
from their funds.

Fourth, portfolio disclosure is not instantaneous. The SEC would require only 
that funds disclose their portfolios with a two-month lag. (Many fund firms 
already provide disclosure to Morningstar with a lag of one month or less.) A 
two-month delay should give a manager plenty of time to build or exit a position. 
If a manager cannot establish or unwind a position in two months, one must 
question whether that stock is a suitable holding for the fund.

We're glad that the SEC, which has so many issues to address, has focused on 
the important matter of portfolio disclosure. By making investing in funds more 
transparent, the SEC has improved the appeal and viability of mutual funds.