Jonathan G. Katz, Secretary
Securities and Exchange Commission,
450 Fifth Street, NW
Washington, DC 20549-0609

Comments on Concept Release 33-8349
Comments made by Wayne H. Wagner and Mark Edwards
Submitted February 27, 2004

Dear Mr. Katz,

Thank you for the opportunity to comment on the proposed rule that will require mutual fund companies to disclose key transaction activity figures to the investing public.

The discussions provided herein are the personal observations of the authors. They do not reflect any official positions of Plexus Group, Inc. nor of JPMorgan Chase, of which Plexus Group Inc. is a wholly owned subsidiary.

The discussions reflect opinions formed over thirty years of direct and quantitative observations on the behavior of markets and the trading behavior of institutional investors that operate within them.

The Need for Transaction Cost Information

Transaction costs represent one of the largest erosions of investment value that investors face. We believe it is often the very largest barrier to superior performance.

These costs need to be recognized by current and prospective investors as they evaluate whether a fund will best serve their investment purpose. Revealing data in a manner that influences fund investors will encourage fund management to more carefully consider the effects of turnover and transaction cost on their ability to generate superior returns. Note that for lack of a better metric, fund shareholders currently are forced to select funds on a "rear-view mirror" past performance basis. The result should be a more efficient use of resources and a more effective application of capital assets.

We believe the SEC has in mind some simple measures of current management effectiveness to give fund shareholders a useful view into process. We agree that the implementation shortfall approach, though the most insightful method, is not feasible for these reporting purposes. The SEC can look to the financial press and the fund evaluation services to use this data to educate fund consumers.

We harbor concerns about the application of the proposed daily/next day measure. People will always manage to the metric, so a faulty metric can be worse than no metric at all if it creates unintended consequences and behavioral issues. For example, will traders game it or alter their behavior to the detriment of investors or the markets? We have no crystal ball, but potential problems could arise if "looking good" on this measure gains importance, perhaps as part of the compensation structure for the trader or as a component of fund marketing.

We believe the proposed daily/next day measure may confuse trading costs with the managers' short term selection ability or tactical price momentum bias. We are also concerned that the observations may be random and noisy, thus non-illuminating and confusing.

Rather than try to separate trading from investment management, we suggest a focus on the net benefit of trading activity. We suggest a quantitative and qualitative procedure constructed along the following lines:

Quarterly Quantitative Evaluation

  1. Report the total dollars transacted (purchases plus sales excluding cash equivalents). Express in dollars and as a percentage of fund assets.
  2. Report the quarterly sum of the daily net transaction flows. (The absolute value of the excess of daily inflow over outflow, or vice versa.) Express in dollars and as a percentage of fund assets.
  3. Subtracting (1) from (2) measures the decision-oriented transaction flow. Express in dollars as well as percentage of fund assets.
  4. Each quarter measure the actual quarterly return by linking changes in daily net asset value.
  5. Each quarter measure a buy & hold return by valuing the assets held at the beginning of the quarter as of the end of the quarter. We believe that a quarterly measure is not as subject to unintended consequences as the proposed daily/next day measure could be.
  6. These computations should be performed on auditable, publicly available data, perhaps certified by an independent accounting or evaluation firm. Alternatively, AIMR performance standards dictate a return methodology and imposes restraints on a relevant set of comparable accounts.
  7. For context, these numbers should be put into the form of peer group comparisons, with similar fund groups based on investment objective and size of fund; e.g. the Morningstar categories.
  8. Trends in these variables could guide investors to important insights.
  9. For ease of understanding, we believe the results should be reported as highest third, middle third, and lowest third, or some other simple comparative ranking.
  10. The tables below represent a first-cut possible reporting format. The third table presents an overview.

Table I:
Flow Analysis

$ (mil.)

% of quarterly average daily
net fund assets, annualized

Total transaction volume $150.0 90.0%
Total net daily inflows and outflows $50.0 30.0%
Manager decision activity $100.0 60.0%

Table II:
Returns Analysis

Quarterly change in asset value

Quarterly imputed change in asset value assuming zero quarterly trading activity

% Turnover (Total transaction volume, annualized)

Net value added from current activity(%)

Current quarter 10.0% 9.0% 90.0% 1.0%
Previous quarter 20.0% 21.0% 80.0% -1.0%
Last four quarters Etc. Etc. Etc. Etc.
Last three years Etc. Etc. Etc. Etc.

Table III:
Comparative Analysis vs. Large Cap Growth Funds

Fund XYZ

Peer Group Average


% net daily inflows and outflows 90.0% 70.0% Above Average
Manager decision activity (% of assets) 60.0% 60.0% Average
Net value added from current activity (%) 1.0% 2.0% Below Average

Qualitative Evaluation

  1. Following the AIMR Trade Management Guidelines, funds should be required to form a Trade Management Oversight Committee (TMOC) which reports quarterly to the Board of Directors and/or the Head of Compliance.
  2. The Board of Directors should summarize and explain the TMOC findings to the fund shareholders annually. The proposed measures, properly implemented, appear consistent with the SEC definitions of best execution and the AIMR Trade Management Guidelines.

Te proposed measures directly identify the net benefit of activity on the returns of the portfolio. The ostensible purpose of turnover is to reposition the portfolio to improve its prospects over future intervals. Transactions will not improve returns unless the value of the research driving portfolio transactions exceeds the net cost of implementing the desired portfolio changes. The concept is one of a cost:benefit analysis.

Turnover computations

The historically applied measure of turnover rates, defined as the minimum of purchases and sales, is inadequate for measuring transaction cost effects. If net flows in a given day trigger purchases to invest the inflows or sales to fund the outflows, transaction costs are incurred on this activity. This recently became front-page news as activity by short-term market timers was identified as a detriment to other investors in the fund.

The theory underlying the historical measure is that transaction levels caused by inflows and outflows should not be attributed to the manager. Fund shareholders, however, share the cost of trading to accommodate new entrants and departing shareholders.

Preparing Fund Comparative Rankings

We believe that fund categorization can be prepared by a fund rating agency, without involving the Commission in detailed data gathering. The fund rating services commonly maintain peer groups of similar funds. Both turnover rates and transaction effects can be ranked against these peer groups and updated quarterly to highlight cyclical trends.

* * * * * * *

To summarize, today's investors are called upon to make investment decisions that affect life-long living standards. Too often investors base their decisions on low-predictive value data such as past performance. The proposed measures will over time provide investors with cost:benefit data to guide their decision processes.

Respectfully submitted,

Wayne H. Wagner
Plexus Group, Inc.
Mark Edwards
Director, Manager Consulting Services
Plexus Group, Inc.