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Taking A Page From A Survivor

BusinessWeek -- Net Worth

Taking a Page from a Survivor

FOLIOfn's Steve Wallman is taking on the mutual-fund giants with a new way of investing--and he's thriving

Steven M.H. Wallman's timing couldn't have been worse. He launched his online brokerage and investment firm, FOLIOfn Inc., last June, using the Internet to offer customers lower costs and more flexibility than traditional financial products like mutual funds. The stock market promptly turned in its worst performance in decades, frightening away many investors. You might think Wallman would be wringing his hands. Instead, he's celebrating. "We're getting capital, customers, and partners in an environment where dot-coms supposedly can't get any of those," he says. "I can only chalk it up to the power of our idea."

That idea is folio investing. FOLIOfn lets investors buy stocks in folios, or customized baskets, prepackaged by the brokerage or selected by the customer. Think of a folio as a personalized mutual fund--a bundle of up to 50 stocks that can be either diverse or focused by industry, geographic region, or investment style. Wallman's favorite example: An investor can use a folio to buy the 30 most promising biotech companies, riding the industry's growth without having to gamble on picking the two or three biggest winners.

Wallman is pitching his idea to investors as a way to cut costs, as well as boost their flexibility. For FOLIOfn's $295 annual fee, an investor gets unlimited trades in three folios, each containing up to 50 stocks. For accounts with $25,000 or more invested, that's cheaper than the 1.35% of assets that the average equity mutual fund charges. What's more, a folio investor enjoys the tax advantages of owning actual stocks instead of shares in a fund. An investor, for example, can decide to hold off selling stocks that have risen sharply to defer taxes until the next year.

Wallman, 45, dreamed up his new way of investing while he was serving as a member of the Securities & Exchange Commission in the mid-1990s. As he saw it, individual investors were stuck: They needed diversified portfolios to minimize market risks, but brokerage commissions to buy even 30 stocks were prohibitive. Mutual funds offered diversification for less cost, but took away investors' control over taxes and strategy. Wallman figured folios could ignite a revolution in investing by using the Net's cheaper trading and investing tools to blend the best features of mutual funds and stocks.

With the stock market in a funk, Wallman is proselytizing more than ever. The Vienna (Va.) startup has poured $15 million into advertising on investor-oriented cable TV. He also has cut deals to allow investors to trade folios through cable channel CNBC's Web site and more than 200 credit unions.

While Wallman continues to recruit individual investors, he now has his eye on an even bigger pool of money: the billions of dollars that Americans entrust to financial planners and other advisers. In January, he rolled out FOLIO Advisor, a Web service that lets professional financial planners set up and manage folios for their clients, with as many as five folios per client. He also signed an exclusive deal with Advent Software Inc. (ADVS), the leading maker of software for professional money managers, to integrate folio trading into Advent's systems.

FOLIOfn's pursuit of advisers flies in the face of a central notion of e-commerce: that the Net wipes out the middleman. Wallman sees the Web differently: In his view, it lets entrepreneurs break down financial services and repackage them in new combinations, with or without intermediaries. "When you buy a mutual fund, you get two things--low-cost diversification and professional stock-picking," he explains. "Folios plus advisers let you buy just one of those, or both, in the combination you want."

Even with the spread of online investing, surveys show that most people still want some help managing money. Indeed, analysts say snaring advisers will be crucial for FOLIOfn's future. "It's a complicated product, and advisers will see the advantages much more quickly than individual investors," says Stephen C. Franco, an e-commerce analyst at U.S. Bancorp Piper Jaffray.

Likely prospects are advisers who cater to investors with less than $1 million in assets--accounts that are too small for professional stock-picking. Folio investing "will definitely fill a gap. It'll be cheaper and more flexible than mutual funds for the client who can't meet the minimums for individual-account money management," says Jay Penney of Phoenix money manager Walker, Hebets & Penney, who says his firm is likely to sign up for FOLIO Advisor.

Wallman isn't the only one trying to change the way investors plunk their money down. James P. O'Shaughnessy, a money manager and author of best-selling investment guides, is launching a similar Web startup, Netfolio Inc., in March. Other brokers--from neophyte to relative old-timer E*Trade Securities Inc. (EGRP)--are figuring out ways to package stocks for the same long-term investors that FOLIOfn has targeted.

Still, Wallman's real competition is not other folio proponents, but the mutual-fund industry. Fidelity, Vanguard, Janus, and other fund companies have $6 trillion in assets and big brand names that investors trust. The mutual-fund Goliaths dismiss the folio upstarts: Folios are "a bit of a niche product" because "they take a lot more monitoring and work than most fund investors are willing to exert," says George U. Sauter, managing director at fund giant Vanguard Group.

But fund companies may need to take notice. Analysts say that folios, with their ability to mass-customize, could loosen the grip that mutual funds have on small investors' savings. Even with 7,650 equity mutual funds to choose from, "funds can't meet the demand for personalized portfolios," says senior analyst Robert F. Sterling of Jupiter Media Metrix Inc. Another e-finance analyst, Jaime Punishill of Forrester Research Inc., predicts portfolio-based online brokers will snatch $1 trillion in assets from mutual funds in the next decade.

What share of those immense riches can FOLIOfn capture? Wallman figures his firm--launched nine months ahead of the closest competitor--has a clear lead, which he's trying to lock in with his CNBC and Advent deals. Some analysts, however, fret that the startup is spreading itself too thin. Wallman "has made a big mistake by pursuing retail customers" instead of focusing solely on attracting the big money that advisers can bring, Punishill says.

Not so, insists Wallman, who believes that folios will work for "the whole spectrum, from do-it-yourselfers to people who just want someone to manage their money." So far, his backers, including venture capitalists from PSINet Inc. (PSIX) and Mayfield Fund, are supporting that notion. Wallman predicts that FOLIOfn will reach positive cash flow sometime this year. If he can manage that, his revolution in finance will have taken firm root.By Mike McNameeReturn to top

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