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Lower Margins, More Mergers Predicted

SAN DIEGO, Calif. - Competition among mutual fund companies will continue to drive down margins and force more mergers and acquisitions of firms and the consolidation of funds, according to mutual fund executives.

Decreasing net flows due to slowing sales and rising redemptions are pressuring mutual fund companies to offer more compensation and services to distribution channels as well as more information and services to investors, industry executives said. This is squeezing profit margins, they said.

The industry leaders spoke at the Investment Company Institute's tax and accounting conference here last week.

While sales are slowing, investors are not taking their savings entirely into their own hands and putting them into the stock market themselves, industry executives said. On the contrary, investors increasingly appreciate the value of financial advice and, in fact, are forcing fees and loads to go by the wayside in favor of asset-based, wrap-fee sliding scales that offer varying degrees of information from basic research to full-blown advice, executives said.

Nevertheless, the decline in net new cash flows is a major concern of mutual fund executives.

"Net new cash flows into equity funds are down from $240 billion as of year-end July 31, 1998 to $110 billion as of year-end 1999," said Timothy Jacoby, chairman of the ICI Accounting/Treasuries Committee and chief financial officer of Liberty Funds Group of Boston.

"With $6 trillion of total assets in the mutual fund industry and 15 percent average annual redemptions, the industry needs to pull in $900 million a year just to break even," said Robert Leo, vice chairman and director of broker/dealer distribution for MFS Funds Distributors of Boston. "The industry is going through a challenging year, the worst since 1994. There is very little positive net flow, and what we have is mostly due to growth in assets."

The new money that is going into mutual funds is going to only a few funds, said Hugh Fanning, vice president of product development and management for Fidelity Investments' advisor funds group.

Of course, this concentration of flows has raised Fidelity's market share from five percent to 15 percent, Fanning said.

Intense competition for the remaining share of the market, meanwhile, is making distribution of funds all the harder and all the more expensive, the executives said.

"We've had to form more strategic alliances, which is a nice way of saying we have had to pay more basis points to distributors," said Leo of MFS. "Banks and financial advisors all want a piece of the money management pie. Soft dollars are no longer allowed because of SEC regulations, so we have had to pay hard dollars - tens of millions of dollars a year."

Five years ago, MFS wholesalers would pay financial advisors four to five visits a year, but they now call on them six to eight times a year with all kinds of programs - time-management tips and how to improve shareholder communications - in hand, he said.

"Because our model is wholesalers dedicated to each distribution channel, we have gone from 60 to 100 wholesalers in the past three years," Leo said.

"Even on the direct side of the business, shareholders expect more service, and all of these tools cost money to develop," said Fanning of Fidelity.

Mutual fund companies are not losing money to individual stocks, day traders or index funds, the executives said.

"Active management is not going away because it's human nature to want to do better" and professionally-managed mutual funds offer investors that ability, said Jeff Lyons, senior vice president of mutual fund relations, operations and marketing for Charles Schwab & Co. of San Francisco.