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Looking Beyond the Valley


Looking beyond the valley we have been in the past three years, we can say with confidence that mutual funds will remain a preferred investment vehicle for tomorrow's investors.

While equity fund outflows have continued, even reaching $8 billion in February (see MFMN 3/24/03), by their actions, fund investors have shown much more confidence in the mutual fund industry and actively managed funds than most of us believe.

While it is true that the top fund companies, being leaders in the industry, have suffered the worst outflows (see related story, page one), among the entire universe of stock and bond funds, two-thirds experienced positive net inflows in 2002. It is true most of the fund companies that have had net inflows are admittedly quite small, but they are strong in their numbers and have continued to see positive inflows this year.

Money Waiting

When we look forward and up, not backward or dwelling on the stock market and economic troubles of the moment, we can say with confidence that the core demand for mutual funds is poised to increase. Shifts from stocks to "managed assets" will accelerate. And once financial confidence rebounds, many stock investors and those in cash will reinvest in mutual funds.

Once the fog clears around separately managed accounts (SMAs), it will become clear to all of us in the industry that SMAs are not going to obsolete the industry - but help fund managers cross-pollinate and grow.

In fact, 80% of SMA investments come from new cash. Only little is transferred from existing holdings of mutual funds. Overall, SMAs provide an additional savings vehicle for fund companies. Thus, they are a "plus" business. And it should also be noted that national B/Ds, despite their recent upsurge of interest in SMAs, have maintained, possibly even increased, their share of mutual fund sales lately.

Powerhouse of Stability & Strength

The retirement-savings powerhouse is not to be overlooked, either. Retirement-intended investments in tax-deferred accounts have contributed more than 90% of equity funds' $500 billion cash inflows over the past four years, and now control about 70% of equity fund assets. Thus, retirement savings continue to stabilize and strengthen the industry. This is why most U.S. fund investors buy and hold for the long term.

If Congress passes President Bush's new investment and savings rules, they would be a huge boost for the fund industry - and retirement investing could increase even more.

Let's take a moment to review areas of strength in the fund industry, amid this sea of red. The wide yield curve has maintained extraordinary demand for bond funds. Other yield strategies, including leveraged closed-end funds, have also expanded fast.

Closed-end funds with expanded investment mandates, and that can also leverage, have also become a solution for the time being. Offering an IPO calendar, such funds can attract broker/dealer focus - and action.

Equity funds have remained the leading theme within strategic asset allocation of retirement investors. Such allocation benefits will persist, unless we experience a long period of reduced personal confidence, not just negative NAVs, or if the U.S. all of a sudden becomes a nation of pessimists.

The industry has been doing a better job of educating investors. Asset allocation, fund-of-funds, a "need-centric" approach for wealth accumulation and educational savings, i.e. 529s, are expanding as solutions for simplification. As well, equity funds with distinctive return/risk profiles have continued to attract significant inflows.

$5 Trillion in the Bank

Thus, with all of these various pockets of strengths, the industry's overall cash flow numbers mean very little to individual fund managers.

Cash in the bank has exploded, with over $5 trillion in temporary shelters, including more than $1 trillion added after the technology bubble popped. At some point, a portion of these "negative real return" assets will be reinvested - and you can bet your bottom dollar that most of this money will mostly be invested through mutual funds.

So, what should the $6 trillion fund industry focus on to capture some of this tremendous pool of money on the sidelines?

What drives flows into individual funds is typically four magnets:

* The long-term risk/return profile

* Recent performance

* Appetite for the investment category

* A management company that stands behind the fund and raises its visibility

The fund industry should not and cannot give up on its expertise. We have been and will continue to weather this storm.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

(http://www.mfmarketnews.com)