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In Wealth Scramble, Funds Ignore Core Market

Once touted as the middle class citizen's ticket to market diversification, it seems the traditional, open-end mutual fund has decided to betray its pedestrian roots for the higher side of the road.

Many firms have concentrated efforts almost exclusively on capturing a greater percentage of the wealth market while largely ignoring small-and medium-sized investors.

If funds are not acquiring other wealth management firms, they are developing their own line of products. Last year AIM Management of Houston entered the wealth management race when it announced it would build a separately managed account business.

Van Kampen Investments and Turner Investment Partners are also developing investment programs to cater to the wealthy.

Even Vanguard, a firm that has built its brand on providing low-cost index funds for the average American investor, has been trying to attract the high-net-worth set. It announced earlier this month that it is opening a new private equity investment program with Hamilton Lane Advisors, a Bala Cynwyd, Pa.-based private equity advisor.

Hamilton Lane will provide fund-of-funds management for the program, which Vanguard will offer to qualified investors.

The program is a significant departure from anything Vanguard offered in the past, said Daniel Wiener, editor of the monthly newsletter, The Independent Adviser for Vanguard Investors. "This is a completely different animal," he said. "Vanguard is going after the wealthy individual that wants to invest in venture capital and private placements." (See MFMN, 10/8/01)

Cutting Off the Nickle-

And-Dime Investors

Conversely, many fund companies have taken measures to stem the flow of small investors they attract. This month TIAA-CREF announced that starting Nov. 1, it will no longer allow investors to open accounts for $250 and will raise the minimum investment to $1,500. It has too many small, inactive accounts that are not cost efficient to run, it said.

TIAA-CREF's move is not uncommon. Several firms have taken measures to stave off the number of small investors they attract by raising minimum investments.

Vanguard, for one, now requires a minimum investment of $3,000 for non-retirement accounts in most of its funds. And it offers larger investors breaks depending on the size of their investments.

Small accounts are not desirable for many fund companies because they are generally not profitable business, said Scott Cooley, a senior analyst with Morningstar. "It's clear that shops are moving from servicing the small investor," he said. For a $250 account with a 30 basis point fee, TIAA-CREF was generating 75 cents--not a great business proposition, he said.

While there are many variables to a fund account's margin of profitability, Cooley said that accounts of less than $10,000 are probably not of much consequence to most fund companies and accounts less than $3,000 are probably barely profitable.

Many companies allowed investors to open small accounts believing they would grow over time, eventually becoming profitable business. It appears that many funds "have lost their patience" and are rethinking that strategy, Cooley said.

It's All in the Numbers

The industry's roll-up of the welcome mat for small investors and its all-out race to capture the high-net-worth dollar is understandable from a business standpoint, said Dennis Dolegeo, director of research for the Optima Group. As it is, a small number of fund shareholders with large accounts often subsidize the shareholders with small accounts, he said.

Mutual fund companies face the same dilemma that individual brokers face on an almost daily basis: How to allocate time and resources among the 80% of clients with small account balances vs. the 20% of clients with large balances?

The answer, Dolego said, is fairly simple. Fund companies are dedicating greater resources to those shareholders that have higher account balances and are seeking cost-effective methods of servicing their smaller accounts.

Looking at the demographics, it is easy to see on which side fund companies' bread is buttered.

A report issued last month by the Investment Company Institute reveals that the number of U.S. households owning mutual funds rose to 54.8 million in May, up from 51.7 million a year earlier. That works out to be roughly one out of every three citizens in the U.S.

While there are still a good number of Americans that do not own funds, the argument can be made that the fund industry is reaching a level of market penetration that makes further growth extremely difficult. Moreover, the industry is saturated with product and competition for even small investors is tight.

And consider the type of household that owns funds. According to the report, 74% of households with $50,000 or more own mutual funds while just 35% of households with $50,000 or less invest. To be sure, there is a greater market to be won in the latter category, but many of those investors are more costly to service and market to because of their smaller account sizes.