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Worldwide Growth Falls Short of Expectations

BERMUDA - The expected global growth of mutual funds, particularly in Europe, has not materialized, and growth is being driven by conservative investments, said speakers at the Globalization of Mutual Funds conference here earlier this month.

Business in the European Union is anything but unified. Fund companies are dropping partnerships with distributors, as many are demanding 50% to 75% of management fees. Fund supermarkets and a truly open system exist only in the United States. International joint ventures typically fall apart after merely a few years. The bear market has given countries that were considering using mutual funds for pension reforms serious pause, and investors, for that matter, are not embracing equity mutual funds, speakers told attendees of the conference,

The market correction has "forced us to redefine our role and our distribution," Diana Mackay, managing director of FERI Fund Market Information of London, told attendees at the conference, which was jointly sponsored by the Investment Company Institute and the International Bar Association.

But the worldwide mutual fund industry has changed course to find not only survival, but pockets of growth in unexpected areas.

Asia, particularly China, has replaced Europe as the expected next great frontier. The tightfisted bank channel, which funds had hoped to be overtaken by a more democratic and open distribution system, now seems the ablest, best-funded means to reach investors. And equity funds are losing popularity to conservative mutual funds and a host of other defensive products.

Downside Protection

Investors have been pursuing guaranteed funds, whether they promise money back, as in a principal protection fund; or a bank guarantee, as in FDIC-insured money market accounts; or a reliable net asset value, as with stable value funds, said Udo Behrenwaldt, vice chairman of Deutsche Asset Management of New York.

Income funds, exchange-traded funds that allow intraday trading, funds of funds, hedge funds of funds, and other instruments, including exchange-traded notes that can invest in a wide variety of products, are dominating worldwide sales, speakers said.

Separately managed accounts, lifecycle funds and even traditional funds turning to derivative strategies and short selling have become prevalent - all in the difficult and desperate pursuit of returns.

Driven by investors looking for "best of breed," managers of managers outside the U.S. have seen their assets grow 15% outside the U.S., whereas all funds have grown 3%, noted Simon Jeffreys, a partner with PricewaterhouseCoopers in London. Cerulli expects that figure to jump to 22% through 2007.

Money market funds have also provided one of the few areas of strength in the past few years, said Kurt Schoknecht, EVP and CEO of ACM International and Alliance Capital Management in New York. "They're a safe haven, offer liquidity and even their return of 0.003%" is a plus, he said.

Turning Back to the Banks

Europe has not really embraced open architecture, and other nations are still only approachable through joint ventures, speakers said. That leaves the bank channel in Europe and partnerships in the rest of the world as the only viable means of international expansion.

Most European banks that claim they sell non-proprietary funds are only offering funds of funds "that make no sense because when they're selling non-proprietary funds, they're just layer over layer of fees," said Richard Garland, chief executive officer of Janus International of Westport, Conn. Funds of funds are "a poor excuse for banks in Europe to say they have embraced open architecture. It's a fallacy."

And although bank distributors in Europe demand high fees, Garland said, he doesn't believe they add much value, particularly as they do not offer investors financial advice. "They want a bare minimum of 50% of management fees - with one Swiss bank asking for 75%, which I find quite ludicrous," Garland said. "That leaves us as a fund manager very discriminatory; you cannot be in bed with distributors you cannot afford." As a result, Janus is cutting its distributor partnerships around the world in half, he said.

The Next Great Frontier

Whereas Europe was expected to be the next nexus of growth, some speakers said that Asia, primarily due to its very high savings rates, is where the current action is. Mutual fund sales declined 23% in the U.K. last year, while they fell 16% in Switzerland, 8% in both Germany and Italy, and 7% in France, Schoknecht said. Last year, Taiwan's mutual fund assets grew 20%, South Korea's rose 12%, and India's rose 5%. That should come as no great surprise, as the savings rate in the United States is 0%, but is 18% in Taiwan and 22% in South Korea, Schoknecht said.

China's 1.2 billion people, its inclusion in the World Trade Organization, its hosting of the Olympics in 2008 and its government's easing of regulations give executives at Alliance hope that it will be a viable region in which to expand. But that will be "no slam dunk," Schoknecht added, noting that while China's savings rate is 30%, the average per capita income is $1,000 and 65% of Chinese people's savings is in bank deposits. As well, there are only seven open-ended mutual funds in China right now.

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