Given the incentives of the industry to sell shares to investors, one would expect mutual fund companies to broaden their offerings so that they have a fund to meet various investor needs and interests. That is exactly what has happened and why there are now more than 8,000 funds. However, when we count classes of fund shares—that is, the same mutual fund can have various classes of shares—there are more than 13,000 possibilities. This is a problem for investors —sorting out the confusion that can exist over which class of shares to own. The wrong decision can cost you money.

How can you be sure you have bought the correct fund to begin with? Surely the name tells you what you are buying, right? A growth and income fund is going to feature both objectives, a municipal bond fund is going to own tax-exempt bonds, and so forth. In general this is true, but problems exist.

One of the advantages of mutual funds is that an investor can choose one or more funds that match his or her investment objectives. By law, mutual funds must state an investing objective and they are expected to adhere to that objective. Therefore, an investor wishing to combine, for example, international equities with domestic equities and municipal bonds should be able to choose three funds that accomplish those objectives, divide investable funds among them in chosen proportions, and have a combined portfolio that will rise or fall as these three sectors gain or lose. Simple enough.

Or is it? There are slippages here. Consider the Alliance Capital North American Government Income Trust. A reasonable investor would assume that this fund holds government debt securities issued in North America. True, the quality might vary—for example, this fund held Mexican Treasury bonds along with Fannie Mae bonds. In the case of Fannie Mae, these are issued by a quasi-government agency in the United States and there has never been a doubt about their quality. Nevertheless, the fund says it holds the debt securities of North American governments, and Mexico is in North America.

Argentina, however, is in South America, and the Alliance Fund was also holding Argentinian government debt. In July 2001, newspapers carried stories about a possible economic crisis in Argentina. Imagine the shock of the poor Alliance shareholder who suddenly realized his or her fund was holding some of this debt. This was undoubtedly not what they thought they were buying.

The simple truth is that portfolio names for mutual funds have often been confusing and sometimes misleading. Stated bluntly, buying a mutual fund on the basis of its name can be a big mistake.

Here is a classic example: Some funds label themselves as market neutral, meaning they take a position that is 50 percent long and 50 percent short. It would seem that this means that relative to the market the fund has a neutral position. Therefore, if the market is expected to drop, you might well reason that a market neutral fund could be a good haven.

AXA Rosenberg Double Alpha Market Neutral appears to be inappropriately named. This fund had declined 13 percent in value through mid-2001, and showed an annualized decline of nine percent for the past three years—not exactly a description of market neutral.

Consider balanced funds, which are supposed to be conservative funds holding a balance of blue-chip stocks and bonds. However, a number of domestic hybrid funds have not lived up to this description. Some hybrids jumped on the technology bandwagon as enthusiastically as did some other funds supposedly in business to do such things. As a result, more than 40 hybrid funds showed a loss for the last three years as of mid-2001. During that time the S&P 500 had an annualized return of four percent and the leading bond index had an annualized return of seven percent.

Investors simply cannot buy a fund on the basis of its name and assume things are under control because a number of funds are not following the script.

As part of its regulation of the investment company industry under the Investment Company Act of 1940, the SEC mandated that funds must have at least 65 percent of their assets invested in securities matching the fund's name. This meant, of course, that as much as 35 percent of a fund's assets did not have to be so invested. This became enough of a problem that the SEC changed the rule to at least 80 percent of assets, effective July 2002.

Even after the new SEC rule takes place, confusion can remain, but in some cases, little confusion will exist. If a U.S. fund has "foreign" in its name, the presumption is clearly that investments should be in non-U.S. areas. However, "global" and "international" remain ambiguous. A global fund is one that is allowed to invest in countries worldwide, including the United States. An international fund, in contrast, can invest only in other countries, excluding the United States.

Consider an investor who wishes to invest in foreign companies to better diversify a portfolio consisting of U.S. equities. This is a completely reasonable move, and one that is often recommended to investors by financial advisors. However, if the investor buys a global fund, it might have a substantial position in U.S. stocks. The result is an overweighting in domestic stocks and a corresponding underweighting in foreign stocks.

Furthermore, even with the new rule there are no restrictions on the use of "value" and "growth," which are fundamental descriptions of mutual funds in the eyes of most investors. Overall, the SEC guidelines about names remain weak. In fact, the SEC ruling clearly states that fund firms are not required to use names that specifically describe the intended investment policy. However, when the name does suggest an investment policy, the SEC does expect a fund firm to adhere to investments that match the name.

Fortunately, many fund firms are changing their names to better reflect their investment strategy. For example, numerous equity-income funds are dropping the "income" part of their name because of the decline in stocks paying much of a dividend.

The whole issue of misleading fund names is an example of a problem in the mutual fund industry that can be fixed, and it is on the road to being fixed. It illustrates how the industry can slip into complacent practices, probably unintentionally, over time. However, this is also an issue that investors can deal with themselves, protecting themselves by a little due diligence. Taking the time to read the prospectus and semiannual reports issued by the fund can pay significant dividends.