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Mellon: Institutional, Individual Investors on a Crash Course

Advisers Must Learn About, Explain New Products Better

NEW YORK - As millions of Americans begin shifting their savings from company-sponsored retirement programs and Individual Retirement Accounts, they face a crash course in managing their money. And too many are unprepared or unaware of how to navigate the products and services they need for a safe ride through retirement.

"This is the collision between the institutional and individual investor," said Ron O'Hanley, vice chairman of Mellon Financial Corp. and president of Mellon Asset Management, during a presentation last week. "Retirement is not a single date. Retirement is a process," he said.

The challenge for financial advisers is educating the public that if they want to stretch their savings through their sunset years, they will need to continue to invest. For those who have several years in the workforce left, the lesson is that it's never too early to learn what products will help to avoid bumps later in the road.

Continuing to invest is especially critical in an era when defined contribution plans are increasingly supplanting defined benefit plans, and employees have to determine how much of their paychecks they are willing to set aside now to use later. Unlike defined benefit plans, through which employers regularly contribute, on average, 14% of an employee's total compensation, defined contribution programs shift the onus of retirement planning onto the employee, who must then determine how much they are willing to invest.

That shift drops the average savings rate from 14% of compensation characteristic of most defined benefit plans down to, in a good scenario, about 6%, he said. "There is a huge amount of responsibility being transferred," O'Hanely said.

Closing that gap means understanding and investing in the products that will help employees bolster what they have squirreled away in 401(k) and IRA accounts, and it may mean going beyond index funds or hoping to make a million by picking smart stocks, he said. Mellon advocates actively managed products.

"Traditional weighting is not going to get it there. Relying on beta is not going to get it there, and relying on alpha is not going to get it done, either," he said.

Not only are individual investors woefully unprepared to choose from the types of products to protect against a cash shortfall in retirement, but many advisers are ill-suited to serve them, said Tom Eggers, president and chief operating officer of The Dreyfus Corp., the retail arm through which Mellon channels its investment products.

"Most [advisers] are trained to help people accumulate wealth, to put together a nest egg of their own," Eggers said. But many are still learning how to manage the next phase: distribution. "The focus must be to help the customer make the transition," he said

"You've got to take the shackles off the investment manager," said Charlie Jacklin, chief executive officer of Mellon Capital Management. Jacklin advocates a model-first approach, whereby portfolio managers devise products through fundamental quantitative analysis before looking at past performance. Prohibiting short sales or demanding that portfolios maintain a specific mix can also hamstring a fund, he said.

"Value is created by mispricing and changes in investor sentiment," he said. Active managers can capitalize on such shifts, he said.

"Unshackled does not mean without control," said Phil Maisano, head of alternative investments for Mellon Assert Management. For those considering hedge funds or alternative investments, Maisano said, the recent U.S. Court of Appeals for the District of Columbia decision to send back the Securities and Exchange Commission's 2004 hedge fund registration rule will likely add to investors' confusion.

"There is a level of due diligence," Maisano said. And investors savvy enough to invest in alternatives, generally "vote with their wallets and vote with their feet," if they are disappointed by performance. In cases of fraud, investors are already protected by law, he added, and no SEC regulation could prevent or prosecute plain-old poor performance.

American investors and advisers should also look overseas for more opportunity, said Helena Morrissey, chief executive officer of Newton Capital Management. At the end of 2005, half of all equities capital was located outside of the United States, but only 15% of U.S. pensions invested overseas. "By being more focused here perhaps than you should be, U.S. pensions and asset managers have missed out on opportunities," she said.

For example, while the Standard & Poor's 500 Index may have beat returns for Japan, the United Kingdom and Germany, Europe, Asia and Far East funds have returned 36% since 1998, compared to 13% for the S&P.

Newton, which is based in London, makes up its international mix not by region, but by sector, for example, global healthcare, with portfolio managers doing a comprehensive review of company fundamentals, rather than simply plucking the biggest, or best-performing companies from certain areas of the globe. Exchange-traded funds make many of these strategies accessible, for the first time, to individual investors, Morrisey said.

"As the ETF market evolves, active managers have a real opportunity," she said.

In fact, the surge of retiring Americans will result in a slew of new products, which will employ many of these strategies, which advisers will have to learn to use, and most importantly, explain, to investors.

"There are a lot of choices, and having to explain it has not always been in the best interest of the investor," said O'Hanley, who gave the example of lifecycle funds. Many in the investment community scoffed at the funds when they launched, citing the one-size-fits-all-in-an-age-group approach. "Look at the money they've soaked up," he said.

"It's not auto-pilot investing, but it's pretty darn close."

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