WealthManagement Magazine

Fund Industry Fights Upstarts

The mutual fund industry is grappling with a declining market as well as potential new competitors. Both issues surfaced at the Investment Company Institute’s Mutual Funds and Investment Management Conference, being held this week in Palm Desert, Calif. Perhaps the biggest concern right now is competition from Internet portfolio firms such as Foliofn, which offer baskets of individual stocks online.

The mutual fund industry is grappling with a declining market as well as potential new competitors. Both issues surfaced at the Investment Company Institute’s Mutual Funds and Investment Management Conference, being held this week in Palm Desert, Calif.

Perhaps the biggest concern right now is competition from Internet portfolio firms such as Foliofn, which offer baskets of individual stocks online. The ICI has asked the SEC to examine whether outfits like Foliofn should be regulated as investment companies. Foliofn is registered only as a broker/dealer.

In opening remarks Monday, ICI President Matthew Fink called online folios “virtual mutual funds.” The fund trade group questions whether investors receive individual treatment with the online services. If, in fact, such services are seen as investment pools, they would have to be registered as funds and conform to the investor-protection regulations under the Investment Company Act, the ICI says.

“If it’s 95% a mutual fund, why is there 0% investor protection?” asked ICI General Counsel Craig Tyle, in separate comments to RR.

“We don’t have a spat with Foliofn,” Tyle insisted. But the fund group is concerned that folio investors don’t get disclosure of risk and don’t see a standardized return like they do with funds. Tyle added that online folios don’t have boards of independent directors and don’t face the same rules on self-dealing that funds do. The ICI has no specific regulatory answer, but Tyle is pushing to “tailor the regulatory picture” for online folio services.

Tyle denied that the fund industry is worried about online competition. “We don’t really see [Foliofn] as competition,” he told RR.

But others clearly see the folio concept as an alternative to funds. Some have even predicted the death of the fund industry. Even so, Paul Schaeffer, managing partner at Investment Counseling, a fund consultant in Mill Valley, Calif., noted, “The demise of the mutual fund is overplayed.” Foliofn is moving toward a broker platform, he told attendees.

Avi Nachmany, executive vice president of Strategic Insight, a New York fund research firm, seconded that notion. In comments to RR, Nachmany said a direct business model doesn’t exist for Foliofn, and it won’t make it adding investors one at a time.

Portfolio Transparency
How often brokers and investors can see actual fund holdings is another issue. Paul Roye, director of the SEC’s division of investment management, said the agency has received several petitions for rulemaking requesting more frequent disclosure than the twice-annual disclosures now required.

The ICI is fighting the idea. “We don’t think that would be a good idea,” Tyle said. The trade group worries about disclosing sensitive trading strategies or creating front-running problems if others can see what a fund is buying or selling in the short term.

Victory of Intermediaries
Well accepted in the fund world is the fact that brokers have won. Some 80% of fund sales come from advisory channels, including brokers, planners, RIAs and 401(k)s. And 95% of variable annuity sales are through brokers and agents, Nachmany said.

“It’s all about advice and confirmation,” he added. There’s been a big change of thought in the past five years within the fund industry, he said, recalling a disbelieving group of no-load fund managers when they heard his suggestion to make Merrill Lynch their best customer. Today, “the only reason the no-load funds advertise is to build awareness of their brand for the broker.”

Steven Lipper, global markets director at Lipper Inc., dispelled past notions that the Internet would upset established fund sponsors. The Internet hasn’t caused more investors to invest on their own, he said, and it hasn’t allowed upstarts to take business from established fund supermarkets such as Schwab and Fidelity. Those two firms have done well precisely because they have branches, Lipper said.

Lipper also questioned whether financial institution mergers would help firms build top-notch asset management businesses. Pure management institutions have a different culture than financial conglomerates. He noted that the top three mutual (unnamed) fund complexes in the United States are all independent organizations.

Can’t Ignore the Market
Will market weakness hurt the fund industry? Prognosticators cited some past data that suggests fund assets will at least tread water. The industry has survived before with new products--bond funds in the late ’70s and early ’80s, for example. But the industry is clearly worried about the severity of the current slump.

What about brokers? Will they lose clients who question their advice? ICI execs suggested market troubles will drive more people to brokers. Some investors may be concerned about paying a fee for a declining account, but “where else will they go?” Nachmany asked.

Editor's note: For any comments regarding this article, or to suggest a story idea for RR Online or Registered Representative magazine, contact Editor in Chief Dan Jamieson at [email protected], Online Editor Rick Weinberg at [email protected], Online Managing Editor Cheryl Cooper at [email protected] or Senior Editor Michael Hayes at [email protected]

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