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Performance Eases the Sting of Scandal

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The mutual-fund industry, embroiled in its first major scandal in a generation, has one major advantage as it battles to retain the shareholders’ trust — strong recent returns. Heady recent gains for most stock funds will no doubt take some of the sting out of the already bruising rounds of allegations, admissions, and investigations kicked off on Sept. 3 by New York Attorney General Eliot Spitzer. In his bombshell of a complaint, Spitzer outlined “special trading opportunities” that one hedge fund was able to secure from four major fund families. He cites this as evidence of widespread abuse of investor trust in the mutual-fund industry.

Since then, other securities regulators have promised to investigate the alleged trading abuses in the industry, and at least two firms mentioned, Janus (JNS) and Bank of America, have promised to make restitution to any shareholders who lost money in the discretionary trading deals that Spitzer brought to light.

Before the scandal broke, fund returns continued their ascent on the back of a charging bull market. In August, fund investors cheered at improving economic and corporate news, and they relaxed as interest rates, which surged in July, leveled off. U.S. diversified equity funds gained 3.2% on average in August, easily besting the 1.9% total return of the S&P 500. Year-to-date, diversified equity funds are up a stunning 20.6%, head and shoulders above the S&P 500′s 15.9% run-up.

Such strong results give the newly battered mutual-fund industry plenty to boast of in the short term. That will help while Spitzer continues to shine a bright light on what may turn out to be the seamier side of the business.