Accounting proposal tilts field in favor of index funds

New accounting standards proposed by the Financial Accounting Standards Board would give index funds a substantial advantage over actively managed funds, observers contend. FASB put out the proposal — which would force investment management companies to list their trading costs as expenses — for comment this year. Currently, investment management companies record these costs on their statements of operations as a loss to their investments. The proposed change, however, would require funds to include transaction costs in their expense ratios. Investors often choose funds based on expense ratios. “Funds that are more index-oriented or closet index-oriented are going to stand out even more as low-cost alternatives to actively managed funds, which would see their expense ratios jump significantly in some cases,” said Todd Rosenbluth, a mutual fund analyst at Standard & Poor's Financial Services LLC. BlackRock Inc., Franklin Templeton Investments, T. Rowe Price Associates Inc. and The Vanguard Group Inc. are among the 14 mutual fund companies that have written letters opposing the proposal. The Investment Company Institute also sent in a comment letter voicing its opposition. Funds with higher trading activity will appear more expensive than those that trade less frequently, even though that might not be the case, according to a letter to the FASB from Laura F. Ferguson, senior vice president of Franklin Templeton Services LLC. What's more, executives from the companies claimed that the proposal would make it more difficult for investors to compare fund expenses over different periods of time. Typically, a portfolio manager for a newly launched fund makes more transactions than a more mature fund, Ms. Ferguson wrote in her letter. The proposal also leaves open the question of how firms would account for trading costs for fixed-income funds. Unlike equity funds, which pay explicit commissions to brokers to make trades, fixed-income funds buy and sell securities over the counter, where trades are made on a bid-ask spread basis. “Practically speaking, it would be extremely difficult for funds to develop the contemporaneous fair-value measurements for fixed-income securities that would be required under the proposal,” Gregory M. Smith, director of operations, compliance and fund accounting at the ICI, wrote in his comment letter. The comment period for the proposal ended Sept. 30. The FASB has received more than 1,000 comments on the proposal, said spokesman Neal McGarity. There is no timetable for issuance of a final rule, he said. E-mail Jessica Toonkel at [email protected].