Karen Dolan at Morningstar.com on the phenomena of mutual fund companies ‘seeding‘ incubator funds. The problem is that you cannot really trust the returns of these funds.
It’s a long-standing ploy in the mutual fund world: Seed a new investment strategy with some money and see how it goes for a while. If the portfolio does well, pitch it to the public. If not, scrap it. After all, the practice is perfectly legal. Fund companies can register a new fund with the SEC under the Investment Act of 1940, seed it with some capital, and simply limit its distribution to keep it out of the public domain–hence the name “incubator” fund. That way, if the fund company eventually decides to turn on the marketing switch and launch the fund publicly, it has an established track record.
Is there something wrong with that? You bet.