First, there were online stockbrokers. Now, get ready for online mutual funds. Over the past year, a handful of cyber-startups with hip monikers such as X.com and StockJungle have launched mutual funds exclusively for online customers. "Someday, all funds will be forced to compete with the benefits the Net can provide," says Michael Witz, chairman of StockJungle, based in Culver City, Calif.
StockJungle, for its part, is promoting the Internet's power to deliver cost savings by waiving management fees on its Standard & Poor's 500-stock index fund. X.com is going one step further by depositing $20 in new accounts and promising investors one extra basis point of return--or 10 cents per $100--on its own S&P 500 fund. The Palo Alto (Calif.) firm is also subsidizing a portion of the expenses its money-market and bond funds incur. A third startup, whatifi funds of San Francisco, declined to disclose fees on the five index funds it plans to launch in March. But CEO Harris Fricker says whatifi will "be very cost-competitive."
For those with meager nest eggs, whatifi and X.com's no-minimum-investment policies are attractive. Vanguard charges $20 annually when an S&P account balance falls below $2,500, but "you can put $2.50 into X.com's funds" and still face no monthly charges, says founder Elon Musk. Other cyberfunds are using the Web to open the shrouded world of mutual-fund management to public scrutiny. Although funds are only required to disclose holdings once every six months, Metamarkets' OpenFund and StockJungle's Community Intelligence Fund post trades online as they occur, listen to Web site visitors' investment ideas, and publish frequent reports from managers. Still, this new breed of fund is not for everyone. To cut costs, most require investors to agree to receive communications--including prospectuses and statements--electronically. Although the Securities & Exchange Commission has yet to give its blessing, some Web-based funds, including E*trade's and whatifi's, even reserve the right to cash out investors who demand paper. Others, including OpenFund, may impose extra charges.
Investors also run the risk that funds that are free today may not be such deals tomorrow. The S&P 500 funds run by StockJungle and X.com are free because their sponsors are waiving management fees of 50 and 28 basis points, respectively. Both insist they have no plans to hike charges. The no-cost fund, explains X.com's Musk, is a "loss leader" designed to attract investors who must first open a banking account.
BE WARY. Sales of additional products are necessary because electronic communications are unlikely to generate enough savings to fund the startups' giveaways. John Payne, a consultant at the Boston research firm Cerulli Associates, estimates that doing away with paper and telephone transactions would reduce expense ratios by a mere 5 to 10 basis points. That's significantly less than the subsidies many Web-based fund firms are currently underwriting. Indeed, StockJungle estimates it could lose $1 million a year on its free fund. "You have to be wary of a loss leader, especially when you can get all the service and dependability from a traditional index fund for only 18 basis points," says Morningstar analyst Russ Kinnel. Another concern is the funds' nonexistent track records. Although X.com and whatifi are outsourcing management of their index funds to Barclays Global Fund Advisors, StockJungle is going it alone. "There is some value a good manager can add," says John
Woerth, a spokesman for Vanguard Group, whose 500 Index fund is the largest of its kind. "Our fund actually beat the index last year."
The new online funds have attracted some $250 million--a pittance compared with the $104 billion in Vanguard's 500 fund. If you want to invest in one, be prepared to rely on electronic service, untested fund sponsors, and pitches for other products you may not want. Maybe there really is no free lunch after all.