ICI seeks a protected market for mutual funds

Call me cynical, but whenever I see a behemoth mutual fund industry trade association campaigning in the interest of the lowly retail investor, I find it prudent to consider the notion that there might be more to it.

Call me cynical, but whenever I see a behemoth mutual fund industry trade association campaigning in the interest of the lowly retail investor, I find it prudent to consider the notion that there might be more to it.

In this case, I am referring to the Investment Company Institute’s dogged efforts to alter the tax treatment of an obscure but growing asset class known as exchange traded notes. Apparently, the Washington-based ICI, which represents the $12 trillion mutual fund industry, thinks that the $5 billion ETN market enjoys tax advantages that could somehow lure Ma and Pa Investor into a dark alley to be mugged.

It seems that ETNs, which typically are issued as unsecured debt and are treated much like individual stocks for income tax purposes, aren’t subject to capital gains taxes until they are sold. Mutual funds, by contrast, are “pass-through vehicles” that tax shareholders annually as if they directly owned the underlying portfolio.

As reported by David Hoffman (InvestmentNews, Dec. 3), the ICI believes that the tax disparity between ETNs and mutual funds is unfair to those who invest in mutual funds.

Put another way, the fund industry could lose some business if investors and their advisers start comparing mutual funds with ETNs.

“The potential danger is, investors could be driven to a product based on one factor [taxes] as opposed to investment merits,” ICI spokesman Edward Giltenan was quoted as saying in last week’s story.

The ICI’s focus on ETNs does raise some excellent points regarding the impact of frothy expense ratios, including runaway 12(b)-1 fees and general tax inefficiency on the investment merits of mutual funds.

But that’s not what the ICI wants us to focus on as it lobbies lawmakers for tax changes that would help protect the fund industry’s retail turf.

An effort was even made to attach new ETN taxes to the legislation, introduced last month by the chairman of House Ways and Means Committee, Rep. Charles Rangel, D-N.Y., to limit the application of the alternative minimum tax.

While revenue-hungry lawmakers eventually may try to tap ETNs, they are giving the industry a pass, so far.

Still, the ICI presses on, assured that it will succeed in overturning what Mr. Giltenan described as the “ill-conceived public policy” that allowed companies such as London-based Barclays Bank PLC to start issuing ETNs more than a year ago.

Ironically, the ICI for years has tried to convince the Department of the Treasury to allow taxes on mutual fund reinvestment dividends to be deferred in a manner strikingly similar to the way capital gains are now deferred in ETNs.

Ultimately, whether the ICI succeeds or not, it is worth considering whether the behemoth association’s energy and resources might be better spent helping its member firms become more competitive, rather than just trying to build protectionist walls around what they already have.