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Discover Brokerage creating index funds

In an effort to build its online business, Morgan Stanley Dean Witter is creating a line of proprietary index funds to be sold exclusively through its online brokerage, Discover Brokerage Direct.

The first new fund will be the Discover Brokerage S&P 500 Fund, a no-load index fund that will only be available to Discover Brokerage customers. The fund will be managed by Morgan Stanley Dean Witter Advisors, which will invest at least 80 percent of the fund in the S&P 500 Index.

By introducing the new funds, Discover hopes to gain more market share in a channel dominated by just a few companies. Discover Brokerage ranks third, behind E*Trade and DLJdirect, in a third quarter survey of online brokerages conducted by Gomez Advisors of Concord, Mass., a research and consulting company that specializes in electronic commerce.

"They're pretty highly regarded but probably are one of the more quiet (firms)," said Steven Hall, senior analyst with Gomez. Hall believes that a new product like the index fund could help raise Discover's profile.

Hall says the new fund helps Discover Brokerage set itself apart from other Internet brokerages. It also provides Discover's loyal investors an easy way to invest in a packaged product with just one transaction fee.

Discover Brokerage has given itself the option to create more index funds in the future, according to filings with the Securities and Exchange Commission. Company officials did not return calls.

Waterhouse, which ranks No. 4 on the Gomez list for the third quarter, has also packaged a proprietary fund. Waterhouse has been heavily marketing that fund, the Waterhouse Dow 30, a no-load, no transaction fee index fund, on its website.

DLJdirect offers to its online customers five proprietary funds, managed by Wood, Struthers & Winthrop Management Corp., an affiliate of Donaldson, Lufkin & Jenrette, DLJdirect's parent. The fund family consists of a growth, a growth and income, a small-cap value, an international equity and a developing markets fund. DLJdirect does not offer an index fund. All five are no-load, no transaction fee funds, and they too are heavily marketed on DLJdirect's website.

What has given Discover its high ranking until now has been its spending on infrastructure and its 24-hour customer service, Hall said. It also allows customers to trade U.S. treasuries and gives them unlimited access to instantaneous price information. In addition, the institutional research from Morgan Stanley Dean Witter that it provides is also considered a major advantage over other online brokerages, many of which do not provide much historical data.

Gomez Advisors has been publishing online brokerage rankings for the last eight quarters and is tracking nearly 100 companies. While the competition is tough, the top 10 online brokerages handle about 80 percent of the accounts and transactions, Hall said. The rest of the companies scramble for what is left over. The six other companies in Gomez's top 10 for the third quarter are Datek Online, the Lindner Funds' FarSight brokerage, Web Street, Quick & Reilly, NDB and Charles Schwab.

But what would make an online brokerage customer choose a proprietary fund over the thousands of others typically offered in fund supermarkets?

Hall says that not all funds are offered by all Internet brokerages. Also, the Discover index fund allows Discover customers to round out their portfolios. Since it is proprietary, Discover can also offer a lower expense ratio to its customers than similar funds from other companies.

Kenton J. Hinchliffe, a member of Morgan Stanley Dean Witter & Co.'s growth and income unit, is the fund's portfolio manager. He will be assisted by Kevin Jung. The minimum initial investment is $1,000. Subsequent investments must be at least $100.