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Minimizing Errors Helps Fund Firms Retain Investors

MIAMI - David Driskill doesn't believe in chance. He believes in statistics. The co-founder of National Quality Review of Boston says that statistics prove that even by reducing the margin of error slightly, mutual fund companies can increase investor retention.

"When we make a mistake, we are more likely to lose a shareholder," said Driskill during a presentation at The National Investment Company Service Association conference here last month. And with that shareholder go his or her assets, fees and commissions.

While all investment companies are concerned about errors, few can actually quantify the dollar value of the cost. Yet identifying that number can become a critical tool that separates one mutual fund from another in an increasingly crowded and sideways-moving marketplace. "That's a real prevention strategy," said Driskill in a subsequent interview. "If you know that data, you can go after preventing errors on a go-forward basis."

For retail investors, that means better overall customer service. For fund companies, it's a solid business plan.

"Retaining investors may be less expensive than always being on the quest to find new investors," said Geoff Bobroff, principal of Bobroff Consulting in East Greenwich, R.I.

In the Darwinian world of mutual funds, performance comes first, said Jason Karceski, an associate professor of finance at the University of Florida's Warrington Business School. But the fiercest competition, especially in a down market, Driskill countered, takes place between the funds clustered around the benchmark, where relatively uniform performance makes service the primary means for a fund to distinguish itself.

"People tend to be more forgiving about investment result shortfalls, versus screwing up their account," through posting incorrect performance, misdirecting an order or prematurely liquidating shares, Bobroff said. And a fraction of those clients will respond by pulling their portfolios.

With the average account valued at, conservatively, about $12,000, losing one or two shareholders may not seem like a big deal. But companies that take an honest look at the number of mistakes employees make, and the potential losses, could be surprised, Driskill said.

In 2004, National Quality Review conducted a survey of manual transactions. Based on those findings, the company estimated that an average mutual fund company made 24,400 financial errors that year, not counting non-financial errors, such as misspelling a client's name or failing to change a mailing address. Although Driskill emphasized that figure is only a broad average based on a wide range of data and represents only a tiny proportion of total transactions that a company may process each year, the impact is still measurable.

In 2000, TARP, which later merged with Customer Insites to become e-satisfy of London, found that 20% of retail banking customers who found financial errors in their accounts were likely to pull their money out and go to a competitor.

But because retail fund investors typically scrutinize their statements infrequently - the average investor interacts with his or her fund complex fewer than five times a year - and because moving between mutual funds involves far more energy and paperwork than hopping between, say, checking accounts, when it comes to migrating between mutual funds, Driskill cut that number in half, to 10%.

That statistic, combined with the estimated number of errors, and the average account value, means that processing errors alone may have cost the average mutual fund company about $29.28 million in managed assets in 2004.

Plug in the proportion a specific advisor charges in fees - usually a basis point-anchored figure that varies from company to company - and fund complexes can calculate the bottom-line effect of error on profits.

Some may say that's the cost of doing business. But Driskill calls it "the cost of quality."

It might seem like peanuts at first blush - perhaps only a few hundred thousand dollars in a billion-dollar fund. But it might also mean five fewer employees, or 10 support staff. And if the number of employees drops but the workload remains consistent, more mistakes are likely, and the potential for losing customers continues to creep upward.

Successful funds, however, anticipate errors and control them, Driskill said, and one way to reduce errors is to increase training. Too often, he said, fund executives confuse customer satisfaction with courteous representatives. But service training transcends manners; it means accuracy. "If I've got a fund that outperforms the market, I can be Attila the Hun, but I can't make mistakes," he said.

Years ago, top-performing funds, on average, provided seven days' more training than their average-performing counterparts, he said. In the go-go late 90s, as transaction volumes increased, top performers' errors remained steady, while errors in the average fund spiked.

Today, the strategies have changed slightly. Rather than provide more formal training at the outset, top-performers emphasize consistent quality from day one, through employee reviews, regular reports and quality-strategy meetings. "It's continuously providing input and focusing on quality" through regular internal spot-checks, Driskill said.

Quality control also means making sure not to outsource any task a company's own staff hasn't mastered. "If you don't do it well, what are the odds anyone else is going to it well?" Driskill asked.

Finally, companies should also adopt or devise a "best practice" approach that gels with their own firm's philosophy and culture, and then stick to it. "They all work, and the reason they all work is because at the bottom, they are anchored to statistical tools," Driskill said.

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