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E-Baskets Present Another Fund Challenge

Exchange-traded funds are not the only exotic new product shaking up the mutual fund industry. A new breed of customized, web-based baskets of stocks has recently come to market.

These offerings, which are crosses between stocks and mutual funds, include FOLIOfn of Vienna, Va. (MFMN 4/28/00), of Minneapolis (MFMN 5/8/00) and of Las Vegas, Nev. went online in October 1999.

As of June, there were 15 of these e-basket hybrids on the market, according to Financial Research Corporation of Boston. As the public becomes more aware of these products' low management fees, tax efficiencies, personalization and active management, the products will proliferate, FRC said.

"Managed accounts . . . should be treated as an opportunity to matriculate most-valued customers, those with higher account values, into more advanced products," said Steve Cummings, an analyst with FRC.

One or more of these "wrapdotcoms" could do to separate-account asset ownership what Schwab did with supermarkets, Cummings said.

E-baskets are baskets of stocks that investors select for themselves. They can hold them for long periods or trade individual securities within the baskets. All of the trading of the securities is done over the Internet. By going through e-basket providers, investors pay lower commissions on stocks. There are either no or very low minimums for these products.

At some point, one of these e-basket companies will grab a significant share of the billions of dollars flowing into managed accounts, Cummings said. Astute fund companies wanting to tap into the wealth market will realize this potential and will probably either team up with one of these e-basket companies or acquire them, he said.

Earlier this month, E*Trade announced plans to buy one of these companies - of Minneapolis. E*Trade is making the acquisition because it wants to "provide customers with the flexibility associated with separate accounts, previously reserved for institutional investors and individuals with over $1 million," said Amy Errett, E*Trade's chief asset-gathering officer, in a statement. will also offer E*Trade customers access to electronic advice, the ability to create personal portfolios of securities and tax-deferred college savings products, Errett said.

"Smart fund companies will realize that the managed account phenomenon is not an indictment of their product, just a vehicle to provide more service to retain, or even increase, customers," Cummings said.

There are no figures available for the assets held by e-basket companies. FOLIOfn declined to disclose its sales.

E-baskets, a twist on equity UITs, were developed by enterprising broker-dealers in response to the advent of the Internet.

FOLIOfn charges $29.95 a month to create and hold three baskets, or "folios," of stocks containing as many as 50 securities apiece. Trades can be made twice a day in each folio for no additional charge, said Steven Wallman, chief executive officer of FOLIOfn. That gives investors the opportunity to make as many as 180 trades a month, all for $29.95, Wallman said.

FOLIOfn also has tremendous capital gains tax advantages over mutual funds, Wallman said. Investors in mutual funds are subject to the embedded taxes that earlier investors in a fund may have incurred from capital gains, Wallman said. Mutual fund portfolio managers are also forced to sell securities to meet redemptions, Wallman said. In a folio, however, an investor is in control, and even has the option of selling stocks that have dropped in value in order to benefit from losses, Wallman said.

Folios and other types of e-baskets also allow investors to personalize pre-designed baskets, Wallman said. One of the most popular products FOLIOfn offers is a preset folio of all of the top 30 stocks of the Dow Jones Industrial Average, Wallman said. Customers, however, can adapt the folio so that, for example, if they object to investing in a tobacco company, they can drop Phillip Morris, which is in the top 30, from the folio, and invest in the Dow 29, Wallman said.