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Funds May Count on Little Guys in Big Way

NEW YORK - Mutual fund companies better start re-evaluating their plans for the next few years or they could be in for a rude awakening, as they are expected to lose wealthier investors' cash and gain more from the retail investor, according to a recent report by Boston-based Financial Research Corp. (FRC).

The shift is expected to coincide with a dramatic increase in separately managed accounts in the next five years.

"The party is over for mutual funds as we know it today," said Dave Haywood, senior consultant with FRC, speaking at Alexandria Va.-based public relations firm SunStar's media conference here. Separately managed accounts, which currently have about $393 billion in assets, Haywood said, should increase to more than $1 trillion by 2007.

This is not good news for the fund industry.

Citing results from FRC's recently released study entitled "The Future of the Mutual Fund Industry - Volume Two: Product Development," Haywood said mutual funds are expected to make up 9% of U.S. household financial assets in the year 2007, flat with its current projected levels, after modest gains the past decade. "Although growth has flattened, asset managers will excel at moving money from one bucket to another," in order for the fund industry to maintain its $6 trillion dominant stance, he said.

Additionally, pension funds are expected to make up 28% in both 2005 and 2007, up slightly from the 27% projected in 2003. Bank deposits are expected to fall from 12% in 2003 to 10% in 2005 into 2007. Similarly, money market funds are projected to drop to 3% in 2007, a decline from the 5% anticipated in 2003.

Bread and Butter

While asset levels will remain stagnant for mutual funds, at 9% of household investment ownership, their concentration in investor portfolios will increase for the mass retail segment, i.e. those with less than $100,000 in investable assets, and decrease for those in higher-asset investor categories.

"In the future, mutual funds will really be for the low-balance investor - those with less than $100,000 in investable assets," Haywood said.

The study surmised that demand for large-cap mutual funds will wane due to open-architecture platforms in combination with portfolio-level precepts, while demand for managed accounts run in large-cap styles will increase. Small-cap mutual funds will generate the most interest across all segments that employ portfolio construction techniques, and will become the product most in demand in the mutual fund area. Meanwhile, mutual funds will retain a competitive advantage to fill the international portion in most investor portfolios.

The mutual fund industry currently has 600 fund companies selling 5,500 long-term stock and bond funds, and those managers can look forward to lower profits and shrinking profit margins as product distributors, in effect, control the market, according to Haywood.

Barrels of Dough

The problem is that the lower-end investor is not as attractive to fund companies as those with barrels of dough. "Most firms consider the mass retail as a lesser profit aspect," said Charles Bevis, author of the FRC report. "There's still plenty of opportunity for growth in mutual funds--it's just going to be more targeted and not across the aboard," he said, noting retirement plans as one such opportunity.

Bevis said that firms need to view themselves as investment managers and that they should plug things into an open-architecture environment.

Rather than sell mutual funds on a one to one basis, he said, companies should try to sell a solution for the small-end investors. "We see more creativity on the end of the manufacturers," Bevis noted.

As fund companies try to garner business in this increasingly tough environment, Haywood expects packaged portfolio-like products comprised of mutual funds to dominate distribution to the lower-end investor. Packaged products are the latest trend among fund sponsors that have shifted from selling the fund-of-the-month to selling products from different sponsors packaged together, Bevis said.

"I'm a big proponent of the packaged program for smaller-end investors," Bevis said. "Whether you package fund programs - fund-of-funds, a balanced fund approach, or the Franklin or Oppenheimer approach of packaging funds - any of those three solve the ills of costly distribution from a manufacturers' perspective."

Additionally, FRC expects more packaged products and distribution programs similar to 529 plans to evolve.

"The market needs to be segmented by investor types," Bevis said.

And while the way funds market themselves and who they market to may change, the funds themselves will not likely undergo major overhauls, according to Bevis. He does not expect an overwhelming number of fund companies to register with the Securities and Exchange Commission to change the bylaws of the funds to allow them to utilize other investment methods.

"I would see more firms developing these alternative product variations as a better approach rather than tweaking the mutual fund product," Bevis said.