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Funds Won't Be Eradicated, Leading Consultant Maintains

NEW YORK - Despite fund companies facing myriad challenges, there's actually good news to report, said Avi Nachmany, director of research at Strategic Insight, a research and consulting firm in New York City, speaking at a media conference sponsored by The Enterprise Group of Funds of Atlanta.

Nachmany said that equity funds may be down, but they are definitely not out, and that separately managed accounts, registered hedge fund-of-funds and exchange-traded funds have not materialized as the fierce asset-cannibalizing products fund companies had feared.

While investors have definitely been plopping a larger percentage of their assets into bond funds over the last two years amid negative equity fund returns, investors' love affair with stocks is not over by a long shot (see accompanying chart on page 11).

While in the 1990s investors poured 90% of their assets into equity funds and a mere10% into bond funds, by 2002, investors had shaved that equity portion to a still healthy 73% while bond fund allocations increased to 27%. And investors are still optimistic about equity markets; they still believe equity funds offer short-term risk and long-term rewards, Nachmany said.

Can't Stay Under the Mattress

In addition, market uncertainty has caused investors to sideline cash, to the tune of $1 trillion deposited into the banking system over the last 18 months. They are trying to decide what to do next, Nachmany. "It can't stay in the bank and lose purchasing power. They have to do something with it," he added.

Among the trends Nachmany sees picking up steam is the continuing growth of the retirement market, which is fueling sales into mutual funds, especially equity funds being used for strategic asset allocation. Virtually all of new cash flowing into equity funds this year and last were slated for retirement accounts. Still, Nachmany expects the explosive demand for bond funds to continue into 2003 (see "Quote of the Week," page 4).

Also, investors have recognized the need for actively managed funds. "There is no longer the belief that an S&P fund is a one-stop-shopping [answer] and that there is nothing else that you need to do," Nachmany said.

In addition, investors have moved away from investing in individual stocks in favor of investing in both mutual funds and separately managed accounts. This evolution will become more evident as the equity market starts to rebound, Nachmany predicted. Right now, investors are still in "the frozen zone."

SMA Complementary

Also noteworthy is that fund companies that once feared that offering separately managed accounts would siphon assets from their mutual funds have found that managed accounts are not making mutual funds obsolete. Fund companies including Calamos Investments of Chicago, Lord Abbett of Jersey City, N.J., and MFS of Boston have proven that having a finger in both businesses actually fosters cross-pollination, he added. "Separately managed accounts are not the enemy of the mutual fund industry," Nachmany said.

According to Nachmany, while alternative investments have been heartily hyped, registered hedge fund-of-funds have seen tiny asset inflows and currently have $500 million in collective assets.

The research director also believes that 529 college savings plans, which have attracted small asset inflows and have pinched fund company profit margins, are better being used as a great relationship starter (see related story, page 8). One issue fund sponsors will have to deal with will be how to ensure the floor value of these plan assets so that grandpa's money set aside for his grandkids' school will still be there when they are ready for college, Nachmany said.

In the future, mutual fund winners will be those fund sponsors whose funds show stellar risk-adjusted performance within a specific style, and those who turn to top-notch subadvisers as needed, he added.