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Equity Funds Post Third Year of Positive Returns in 2005


Despite high oil prices, the continuing war in Iraq, natural disasters and ongoing hikes in the Fed funds rate, equity mutual funds returned 9.27% and fixed income funds rose 2.06% in 2005, according to a report from Lipper of New York.

The study, titled, "Global Themes in the Mutual Fund Industry: A Review of the Global Pooled Investment Management Industry," also notes that all of Lipper's 56 equity classifications posted positive returns in 2005. Further, U.S. exchange-traded fund assets grew significantly in 2005, taking in $5.2 billion to rise 61% during the year. In addition, the number of these offerings increased 20% to now top 200, and Lipper analysts believe that ETF growth will continue to outpace mutual funds in years to come.

Except for a spike in inflation to 3.6%, last year was an overall good year for the U.S. economy, as employment, housing starts, production and retail sales all did well. The Standard & Poor's 500, Dow Jones Industrial and Nadsaq 100 indexes performed well as a result, respectively up 3%, down 0.6% and up 1.5%, for the year.

Although many expected large-caps to swing to the No. 1 position in the market, small- and mid-cap funds continued to do well, which Lipper believes is a result of investors still feeling the lingering "claws of the bear" as well as the Fed's gradual approach to raising rates.

Last year was also the first in several in which taxable money market securities were among the best-performing investments, returning 2.6%.

Open-end fund assets swelled to over $8 trillion in 2005, a total increase of $428.9 billion, or 5.7%, from the year before, with world funds taking in $134.3 billion to end the year at $840.5 billion. Closed-end funds grew to $234 billion, staying over $200 billion for the second consecutive year.

U.S. diversified equity fund assets grew by 5.66% to $3.159 trillion. Sector equity funds grew by 8.8% to $213.7 billion, and mixed equity funds rose 22.3% to $700.5 billion. On the other hand, taxable fixed income funds ascended only modestly (1.3%), as rising interest rates scared many investors away.

On the fixed income side, taxable income funds returned 2.06% in 2005, surpassed by tax-exempt fixed income funds, which outdid them by 57 basis points. Treasury funds once again had a solid year of performance, as they advanced 3.6%, and target-maturity funds, the most volatile of the group, returned 6.88%.

Institutional separate accounts remained the largest money market in 2005, with assets rising 27% between January 2005 and the end of September 2005 to $14.3 trillion. This growth far outpaced the 8.7% growth in 2004, but came far short of the 60% growth that the high-net-worth market saw in the first nine months of 2005.

Lipper notes that the institutional separate account industry underwent an identity crisis in 2005, as retail separately managed accounts grew in prominence. Although the two are very similar, they are not in fact the same thing.

"In reality, any true distinctions between these segments are being further blurred as money managers who have historically operated on one side or the other have started to offer new products or to blend their product offerings to now appeal to both," Lipper said. "Evidence of this shift toward attracting SMA investments is found in the continued decline in the minimum account size for separate account management."

For all the increased awareness of SMAs, alternative asset classes are now competing for these dollars, with money gravitating to hedge funds, real estate, currency, global real-return and other alternative investments.

Hedge funds faced a year of maturation in 2005, as assets grew by $65.2 billion to top $1 trillion. As more endowments, pension plans and other institutional investors began testing the hedge fund waters, the theme of "institutionalization" of hedge funds, which began in 2001 continued.

Looking to 2006

Lipper analysts predict that for 2006, equity funds will produce only modest gains somewhere between 3% and 9%. They also foresee isolated hot picks "far out on the bell curve," a stronger first half of the year than the second, world equity funds continuing to outperform domestic funds for the third year in a row and some equity classifications going into the red.

Regulatory Issues

Compared to the rapid legislative and regulatory activity of the past three years, 2005 was fairly tame. However, the industry is still trying to figure out how to comply with the Securities and Exchange Commission's pending redemption fee Rule 22c-2, which has a compliance date of Oct. 16, 2006. Thus, last year, the SEC asked for additional comment on many of the unresolved issues of the rule, including a possible uniform redemption fee, monitoring of omnibus accounts and exceptions from the application of redemption fees.

In addition, the proposed 4 p.m. hard close is still mired down in many issues of parity, and the SEC is still trying to figure out what would be the most effective point-of-sale disclosure.

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