| BUSINESSWEEK ONLINE : JUNE 28, 1999 ISSUE | ||||||||
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| NEWS: ANALYSIS & COMMENTARY
Mutual Funds: So Long, Glory Days? Low returns and online trading are slowing the inflow of new cash Is America losing its insatiable appetite for mutual funds? During the 1990s, millions of people got into equities for the first time by gobbling up funds, helping fuel the long bull market. But lately, investors have pushed back from the table. Cash flows into stock mutual funds peaked two years ago, at nearly a quarter of a trillion dollars. The $54.5 billion that flowed into funds in the first four months of 1999 is nearly 40% below the level during the same period in 1998. And May and June inflows could be off 40% to 50% from last year's levels. There's one big reason why investors are looking beyond mutual funds: poor performance. For years, all but a few funds have trailed the Standard & Poor's 500. So investors are looking elsewhere. Some are buying individual stocks--online or through traditional brokers--and some wealthier individuals are handing over funds to ''wrap'' accounts, which are separately managed equity portfolios. And some money that might have gone into mutual funds is simply being spent. REDUCED FLOW. The move away from funds may not be enough to alter the course of equity markets--since much of the money is still going into stocks through other routes. But for the fund industry, the reduced inflow is serious. From January through April, six top-performing companies--Janus, Vanguard, Fidelity, Alliance, MFS, and Putnam--accounted for just about all of the fund inflows, according to Financial Research Corp. ''Money follows performance, and with the explosion of fund information, in print and on the Internet, word travels fast,'' says fund industry consultant Burton J. Greenwald. Most fund companies had no inflows at all, or actually saw cash flow out. Potential buyers for onetime stellar managers PBHG and SoGen scrapped acquisition plans earlier this year as both companies were hit by redemptions. In a way, the fund business has become a victim of its own success. ''We already have 77 million investors, and that's about as far as you can go without getting down to small and unprofitable accounts,'' says fund-industry consultant Geoff Bobroff. What about selling more to existing customers? That could be difficult, says Guy Moszkowski, an analyst at Salomon Smith Barney. He says over the last 10 years, equities as a percentage of households' discretionary financial assets have risen from 30% to 53%--the highest level since since 1968. ''Who knows where the natural level of risk tolerance is, but we're probably close to it,'' he says. Retirement money is a mainstay for funds, and here, too, the explosive burst of new business is history. Veteran fund tracker A. Michael Lipper of Lipper Inc. says the massive conversion from defined-benefit to defined-contribution plans during the 1990s has largely run its course. In addition to these trends, there's the performance problem. In 1998, the average U.S. equity fund was up 14%, about half the return of the S&P 500. In 1999's first quarter, funds lagged again, inching ahead 0.8%, compared with 5% for the S&P. For the five years ending in May, fewer than 2% of U.S. diversified equity funds beat the S&P. Investors have responded by buying index mutual funds, whose performance mimics the S&P 500 or other indexes. In the first four months of this year, nearly half of net cash inflows went toward domestic equity index funds, says Ray Liberatore, an analyst for Financial Research Corp. But even this stream is slowing. Robert Adler of AMG Data Services estimates that over the last four weeks, index-fund inflows have fallen below $1 billion a week. The rise of online trading also works against mutual funds. Fund watcher Charles Biderman of TrimTabs.com in Santa Rosa, Calif., estimates that $40 billion that might have gone into equity funds this year went into brokerage trading accounts. ''If people can afford it, why not give stocks a try?'' asks Tracey Curvey, a senior vice-president at Fidelity Investments' online brokerage services. Fidelity's brokerage trades were up 81% through May vs. the same period in 1998. Jeffrey M. Lyons, a senior vice-president at Charles Schwab & Co., believes that fund investors are diverting some of their new money into stockpicking. Although equity-trading volume at Schwab declined 28% from April, it was still up 78% in May over the same month in 1998. If nothing else, rock-bottom commission rates for online trading have taken away the cost edge that mutual funds once enjoyed. For years, one of the funds' selling points was that they could trade at institutional rates. But now, the maximum commission for 1,000 shares at an online broker comes to about 3 cents a share. Institutional investors such as mutual funds pay 4 cents to 5 cents a share. Sure, fund investors get pros to manage their money, but that costs about 1.4% a year. Many investors think they can do better themselves. Money is also leaking from funds to wrap accounts, which provide management and brokerage for an annual fee. Len Reinhart, chief executive of the Lockwood Financial Group in Malvern, Pa., says individual investors are bringing about $250 million a month to his firm, and two-thirds of that is in mutual funds. Lockwood's managers sell the clients' funds and buy a portfolio of stocks. The average account size is $1.1 million, but Reinhart says the firm can take accounts as low as $100,000 for a 1.25% annual fee. LOWER TAXES. One big advantage the wrap account managers typically offer is potential tax savings--something their mutual-fund colleagues usually ignored. In 1998, Reinhart says, funds made taxable distributions amounting to 12% of assets. For an investor with $1 million in funds, that's $120,000 in distributions. Even if those were all long-term capital gains, the investor would pay $24,000. In contrast, Reinhart says Lockwood's managers deliver a 20% average return without triggering capital-gains taxes, by pairing off losses with gains. The next step may be consolidation. Avi Nachmany of Strategic Insight, an industry consulting firm, estimates that about 40% of funds hold less than $100 million and do not generate enough fees to cover costs. Nachmany says Lipper Inc.'s upcoming overhaul of mutual-fund classifications and rankings will prompt companies to rethink their lineups. ''They might discover a lot of overlap in their product lines, or competitors they didn't have before,'' he says. Investors are not going to abandon funds en masse. But unless the funds improve returns, lower costs and consider the tax implications of their strategies, investors will look to dine on equities at someone else's table. By Jeffrey M. Laderman in New York _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS Mutual Funds: So Long, Glory Days? CHART: The Mutual-Fund Inflows Peaked in 1997...And Continue to Decline This Year INTERACT E-Mail to Business Week Online | |||
