Investors Demand More Than Performance: Customer Service Needs Rise, Slow Tightening of Expenses
April 17, 2006
PHOENIX - If there's a single, unqualified maxim in mutual fund industry, it's that performance, above all else, sells. But to what extent it keeps on selling has emerged as a topic of some debate, and that discussion, in turn, reveals some surprising factors that motivate investor behavior and inhibit economies of scale.
"When you have great performance, people open an account," said Erik Sirri, a professor of finance and the Walter H. Carpenter Chair at Babson College in Wellesley, Mass. "But if you continue to have good performance, you don't attract a whole lot of new money from existing investors. They tend to stay put."
Speaking at the Investment Company Institute's 2006 Mutual Funds and Investment Management Conference held here recently, Sirri cited academic data that indicates that 58% of people who open an account never make another move until they cash in their chips many years down the road.
"That number is surprisingly high," Sirri said of the data, which appears in a paper from University of Oregon Assistant Professor Woodrow Johnson that's being passed around the industry. "Sure, they'll kick in a little bit more on average, but much, much less than their opening balance."
A key driver to retaining investors, and perhaps even getting them to kick in a few more bucks every year, is positive media coverage, said Laura Starks, chairman of the department of finance and director of the AIM Investments Center in the McCombs School of Business at the University of Texas in Austin.
"Flows depend on performance, [and] expenses are very important, but when there's positive news coverage, you see an increase in inflows," Starks said. "People sell their funds when there are negative stories."
Post-scandal market activity would seem to confirm that argument. While the industry has added more than $2 trillion in assets since January 2003, companies closest to the fire suffered tremendously. For example, Putnam Investments and Janus Capital lost $81 billion and $20.6 billion, respectively, largely attributable to the scandal. Janus has recouped some of its losses by turning to the institutional market, but Putnam's outflows have continued despite performance improvements.
Advertising doesn't help, either, Starks said. Even the best ad campaigns - the fund industry spent $220 million on advertising last year, up $5 million from 2004, according to TNS Media Intelligence in New York - won't net new money, but they will, at least, help keep existing investors, she said.
Avi Nachmany, executive vice president and director of research at the New York consulting firm Strategic Insight, agrees.
"People want to feel good" about the funds they own, said Nachmany, whose research shows that industry-wide redemption rates are the lowest they've been in decades. But while investors need a compelling reason to buy a fund, which is overwhelmingly based on performance alone, they also need a compelling reason to leave the fund. More often than not, Nachmany said, investors don't leave because of negative press or bad ad campaigns, but because they feel neglected. Based on interviews with management companies and brokers, Nachmany found that 80% of redemptions occur because of a relationship failure and not a performance-related issue.
"It's a human context," Nachmany remarked. "Performance will help retain money, but when the management company stops caring about you, or the broker stops caring about you, that's when people find a compelling reason to get out."
Starks offered that a genuine opportunity exists there for ratings firms, like Morningstar. While Boston-based Dalbar provides fund companies with customer service ratings and annually awards the best performers, she said a similar yardstick for retail investors doesn't exist.
"That seems to me to be one of the motivators for an investor to choose a particular fund - what kinds of services they can get," she said.
But customer service is difficult to objectively quantify, countered Tim Armour, a managing director at Morningstar. The Chicago research giant has made several unsuccessful attempts at rating it, he said, and it's unlikely they'll try again anytime soon. That's because from where he sits, Armour sees the market moving in an entirely different direction. Touchy-feely relationships are out, he said, as the industry becomes more institutionalized.
"You're a gunslinger hired to do a good job, and that is going to be of growing importance in the mutual fund arena," said Armour, who suggests that more fund companies will pursue an institutional model, where price and performance will be the chief determinants for an investor.