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Conservatism Highlights New Industry Trends

There are a host of trends, emerging and continuing, taking place in the mutual fund industry today. What trends have fund industry executives identified as the most notable?

The mutual fund industry as a whole is seeing a "reversion to the mean," with investors today having more realistic expecations, said Karina Istvan, senior vice president of retail investments at Delaware Investments in Philadelphia.

Whereas investors had been chasing high-flying sector funds a couple of years ago, that trend has significantly reversed with the decline of the equity market and the downturn in the economy. Former sector fund fans are now realizing the benefits of diversification and favoring more conservative investments, she said.

In the second half of 1999, when Internet and technology funds were soaring, investors pumped 38 cents of every new dollar into sector equity funds, according to Lipper of New York. Widespread irrational exuberance caused that figure to rise to 41 cents of every dollar during the first six months of 2000, then fall off to 20 cents of every new dollar for the remainder of the year.

Not surprisingly, 2001 was a turning point for sector funds, as investors fled them in droves. During the first four months of this year, a mere two cents of every dollar found its way into sector funds, Lipper confirmed.

In hindsight, the fund industry itself, particularly investment advisors who launched hot sector funds at the peak of the excitement, must share the blame for adding to investor woes. What lesson did fund executives learn? "If we allow [investors] to chase a hot sector, we may not be working in their best interest," Istvan said.

Moreover, that reversion to the mean has led many fund companies to abandon former efforts to shoot for the moon, Istvan said. Now many fund managers are fixated on minimizing downside risk and are working to more closely track benchmarks, she added.

Individualized mutual fund tax lot selling, a new phenomenon pioneered by Fidelity Investments of Boston this past April [see MFMN 4/22/02], is also likely to be a growing trend among funds, Istvan said. Fidelity allows all non-retirement plan investors to dictate what specific lot of shares previously purchased Fidelity should use when investors request a fund redemption. That customization allows them to adjust for desired capital gains or losses depending on their personal tax situation, said Fidelity spokesman Jim Griffin.

Another obvious trend is that fund companies are increasingly offering separate accounts, Istvan said. Furthermore, they are finding they can no longer specialize in only a handful of investment areas, said Mike Cemo, president and CEO of AIM Distributors of Houston, the fund distribution unit of AIM Management. "No mutual fund manager can be a niche player in one style. If you're a growth manager, you'd better have some value funds," he said.

One trend that is definitely continuing is for consumers to seek financial advice, said Peter Jones, president of Franklin Templeton Distributors of St. Petersburg, Fla., the fund distribution arm of Franklin Templeton Funds of San Mateo, Calif. [see related article, page 8]. Moreover, financial advisers are definitely taking a very diversified approach with clients' assets. "For the first time in long time, advisers are turning to a global asset allocation mix." Jones said.

Additionally, wrap fee programs are proliferating, causing mutual funds to experience a shift in A shares as the preferred share class among broker/dealers, Jones said.

A continued trend toward fee-based programs among financial advisers has caused a definite shift in the share class of choice among financial advisers, Cemo said. Ten years ago, A and B shares garnered the lion's share of fund assets. But today, level-loaded C shares are growing in importance and raking in more assets. According to Cemo, B-share sales at AIM now account for a fractional 14% of sales, down from 29% in 2000.

Numbers back up those claims. In 1996, C shares across all mutual funds attracted a paltry $7 billion in new assets, according to Financial Research Corporation of Boston. Sales into C shares increased steadily to peak at $30.8 billion in 2000, then fell back a bit in 2001 to $22.8 billion. But year-to-date, investments made through C shares are again growing at hefty levels. Through the end of April, C shares had attracted $12 billion in assets.

In contrast, B-share sales have dropped dramatically since the beginning of 2000, showing net redemptions of more than $6 billion last year, and still in red ink, already losing $2.4 billion year-to-date through the end of April.

Fund advisors are continuing to grab for a piece of the 529 college savings plan market, as well as the IRA rollover market, and many are jumping into or at least considering the alternative investments arena.