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Executives Outline Future Challenges

New York - One of the most serious challenges the fund industry will continue to face is managing investor expectations, according to Charlie Johnson, president and CEO of Franklin Resources. The combination of scores of novice investors, many of whom have never lost money in stocks, and investors across the board with unrealistically high expectations for returns, could spell disaster for mutual funds, he said.

"At some point we're going to have a serious bear market...and investors are going to lose money," Johnson said. "A huge number of investors who will be disappointed will take their money and not come back for a very long time."

Johnson and other industry executives spoke here recently at a press symposium sponsored by the Forum for Investor Advice, an industry group comprised of financial services organizations that distribute funds through intermediaries.

"We tell our sales reps to be sure not to over-promise," said Johnson. Franklin also makes it a point to pack its shareholder reports with reminders that investments can lose as well as gain in value.

The Internet will present its own particular challenge to those who distribute funds through third parties, said Brian Storms, newly appointed president and CEO of Mitchell Hutchins Asset Management of New York, the money management subsidiary of Paine Webber. The shift has been easier for direct-marketed funds, he said.

But the Internet can present opportunities for third-party distributed funds, said Jeffrey Shames, chairman and CEO of MFS Investment Management of Boston.

"If they use the Internet as a tool to enhance the level of service they deliver, it can have a great impact," he said.

"We view (the Internet) as a service to financial intermediaries and shareholders in gaining information on our funds - not as a distribution medium," said Johnson of Franklin Resources.

NationsBanc Advisors sees promise and is tapping what it considers an overlooked market - fledgling and modestly-endowed investors.

These "under-served" have become an important target audience for his company, said Robert Gordon, president of NationsBanc Advisors which manages $68 billion in 60 mutual funds. While there are financial planners and brokers now serving novice investors, many of these investors will simply fall between the cracks, said Gordon.

"It's a capacity issue," he said. "Our research shows that novice investors are intimidated by working with an investment adviser especially if they have limited assets." Platform financial service programs at banks, once considered simply asset gathering and product-pushing stations, are in a good position to help beginning investors, he said.

"I think we are going to see the importance of platform programs grow, allowing investors to get a foot in the door," Gordon said.

The affluent marketplace, meanwhile, will begin to stratify as those who have been earning and saving are differentiated from those who have been earning and spending, said Gordon. He predicted that a sector of "outcasts" - the formerly affluent who have failed to save - will emerge. This group will have special needs that will again provide an opportunity for mutual fund companies.

Retirement will continue to be a major force, said the executives. Until the year 2005, 401(k) assets will continue to flood into funds, said Shames of MFS. But, between 2005 and 2010, many retirees will withdraw their money, he said. The challenge for funds at that point will be how to keep the assets in-house. Currently, statistics indicate, only 20 percent of individuals keep their assets with the same fund manager after retirement, Shames said.

It may be that Social Security reforms will allow workers to have an "IRA-like account into which they can invest a certain amount of their social security," said Johnson. Like some other industry executives, Johnson is not in favor of having the government invest directly in the equity market on behalf of Social Security participants.

Executives also addressed the future of money management itself. International markets are again beginning to command attention as performance improves, said Johnson. MFS has seen some asset flows back into international, emerging market and world funds, said Shames.

Active managers will be under increasing pressure to manage money less expensively and with greater tax-efficiency, Storms said. The fund industry could double in size to $10 trillion in the next five years, he said.

Index and index-enhanced funds will continue to be extremely popular, said the executives. Index-enhanced funds track a particular index, but add several carefully chosen stocks from outside the index.

Despite the popularity of indexing, though, there will be a shift and active managers will again have their day, said Johnson.