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If You Can't Beat Em, Sell Em: SMAs, ETFs, Hedge Funds Force Mutual Fund Execs' Hands


WASHINGTON - Mutual funds may be an undisputable mainstay in investors' portfolios - but investment advisors should carefully consider whether they want to also offer complementary or competing products such as separately managed accounts (SMAs), exchange traded funds (ETFs), commingled trusts and/or hedge funds.

That was the message to industry executives who attended one candid panel discussion at the General Membership Meeting of the Investment Company Institute here three weeks ago.

The panel discussed various investment vehicles, their growing popularity and what next-generation products are in the pipelines.

Top-Level Considerations

These are the top-level decisions that all firms are, or should be, considering, counseled Joseph J. Trainor, president of the U.S. Trust Institutional division of U.S. Trust Corp., a Franklin Templeton subsidiary.

Trainor discussed the benefits and drawbacks to sponsoring collective trusts and similar pooled investment vehicles for wealthy investors. U.S. Trust launched a new series of commingled funds on May 12. It also manages the Excelsior Funds group of mutual funds.

Executives must decide if a new investment business model is economically viable and if the new service model being considered meshes with the current culture of the firm, Trainor said.

Then, once a firm's management has decided it does want to break into a new area, it must then decide whether to manufacture the product or be the distributor. It must also determine whether to create a proprietary product internally, or buy an investment capability and provide open-architecture access, he said.

SMAs Sizzle & Siphon

Separate accounts have definitely become a force to be reckoned with, not only because they are likely to siphon off additional assets from mutual funds, but also because of an evolutionary shift in which companies are now top SMA players, said John H. Streur, managing partner of Managers Investment Group, and affiliate of Affiliated Managers Group.

Over the past five years, SMAs have only magnetized roughly 5% of assets previously held in mutual funds. But that trend will likely increase predominantly because mutual funds, as the population's main investment vehicles, are flush with money, Streur said.

Growth of SMAs will also be fueled by investors seeking a home for rollover money. In 2004, 40% of assets flowing into SMAs came from qualified plan rollovers, the Managers Investment Group managing partner noted.

In addition, since Citigroup's late 1990s pioneering development of unified and multi-disciplinary separate accounts, the focus has shifted from SMAs being product-centric to centering on the investment process.

Moreover, the SMA industry has changed dramatically over the past decade, with traditional mutual fund complexes, including Alliance Bernstein, Lord Abbett and Nuveen Investments emerging as top 10 players, Streur added.

So, are SMAs really closet mutual funds?, asked an audience member "No, they are not," Streur declared.

That's because clients can dictate the level of customization they want built into their separate account, from having a simple account that includes individual stock holdings, or choosing customization that includes designated tax strategies, or the exclusion of individual stocks or sectors, he added.

Meteors on the Exchange

ETFs have also seen a meteoric rise to fame over the past five to six years, with the current availability of 155 mostly domestic equity ETFs having garnered a collective $250 billion in assets, said Michael Latham, chief operating officer, U.S. intermediary business for Barclays Global Investors Services.

While ETFs still represent only 3% of the mutual fund marketplace, interest among endowments and pensions is increasing, as these institutional investors look to ETFs as a liquidity vehicle.

In some cases, fixed-income ETFs are now being used for duration management (i.e., used to manage the interest rate sensitivity within the fixed-income portion of a portfolio).

Bank private clients as well as wirehouse brokers are also becoming ETF fans, as are retail investors who are scooping up shares of ETFs through the registered investment advisory community, Latham noted.

ETFs are being used either as the core investment vehicle in a portfolio, around which actively managed investments can be added, or as a satellite product that can complement other investment vehicles, he added.

Hedging Business Bets

Not sure whether to offer a hedge fund? You may want to take a good hard look at this murky world, said Robert I. Schulman , CEO of Tremont Capital Management, an OppenheimerFunds company.

"They are competing with you for your best clients," he noted. "[Hedge funds] are not a business you can afford to ignore. I believe successful mutual fund companies need to focus on both."

Schulman counseled fund companies to leverage what they already have, namely, long-standing relationships with brokers, by offering hedge funds that, by and large, offer the same thing: a defined investment process.