Funds Just Aren't Having Any Fun

Assets are way down--and a rocky market has exposed a host of industry problems

For most mutual-fund companies, it was the Big Easy. Even those handicapped by poor performers or bond-heavy portfolios had room to make a go of it in the bull market.

No more. Even if the stock market rallies on, the good old days are history. Like other industries, the yearlong bear market exposed a laundry list of ills in the asset-management industry, too--outdated business models, overcapacity, weak distribution, and overblown pay. "There are much bigger problems than the stock market," says Chris J. Brown of Financial Research Corp., "like distribution, or the preponderance of mediocre products."

Meanwhile, competition is as fierce as ever. New alternatives are moving in fast: Exchange-traded funds, index funds that trade on a stock exchange, gained $66 billion last year, double the year before. Brokerage wrap programs--boasting tax efficiency and custom service--also saw assets double, to $53 billion. This while fund companies are retrenching. Marketing budgets are getting slashed, analysts are receiving pink slips, and new fund offerings are being nixed: Wiesenberger Thomson Financial reports that there were 188 fund mergers in the first quarter of 2001, while a record 40 funds were shut down. Only 55 new funds were launched, down from 255 a year ago. Edward J. Boudreau Jr.--a former chief executive of John Hancock Funds Inc. and now an industry consultant--predicts that 50,000 jobs will be lost within a year from a workforce of roughly 750,000.

Trimming at the edges isn't enough. Glenn Schorr, senior analyst at Deutsche Bank Alex. Brown, says those who will thrive will have to pony up. The pressure is on to keep up with technology, broaden product mix, beef up distribution, and expand globally, where retirement markets will likely boom. The scenario favors survival of the biggest as those with the reserves to pay Wall Street brokers more gain coveted shelf space. "Small to midsize companies will get squeezed," says Schorr, who estimates that industry profit margins will fall 30% to 50% this year. Prowling for partners has begun: In April, Zurich Financial Services Group said it would seek a partner for Zurich Scudder Funds, while Mellon Financial Corp., parent of the Dreyfus Funds, will buy bond manager Standish, Ayer & Wood.

Wall Street hasn't lost faith yet. Asset management can be profitable as an aging population supports higher investment demand. But if their investing strategy stopped working, their stocks got clobbered. Shares of Stilwell Financial Inc., owner of the once-hot growth shop Janus Funds, plunged 18% this year, while perceived threats to T. Rowe Price's 401(k) business and its distribution constraints sent shares down 16%. Conversely, Franklin Resources' improving fund performance and broad asset mix pushed the stock up 15% this year, despite an 8% quarterly drop in profits. The darlings are well-adjusted families that grow in any market. Federated Investors and Gabelli Asset Management both raked in record profits and revenues last quarter via top-flight fund performance, the right blend of offerings, and an aggressive push into burgeoning international and high-net-worth markets. "If you want to be a big player," says Thomas R. Donahue, president of Federated Investors Management Co., where 19% of 2001 sales have been in ballooning money-market funds, "you always have to have something to sell."

The most urgent issue is the sheer drop in assets under management. As assets fall, so do fees. That's prompting companies such as Putnam Investments to start streamlining. At the No. 4 fund company, assets fell one-fifth, to $321 billion, in six months through Mar. 30. On Apr. 11, it said it would lay off 256, or 4%, of its workforce. Five fund managers also got the ax. Analysts applaud the cutbacks, but say Putnam's link to financial advisers nationwide, who push Putnam funds for a commission, will go far to bail them out.

The adviser tie-in is key. More investors have shed their do-it-yourself skins and opted for hand-holding, especially during the rocky market: Last year, nearly 84% of industry flows came in through financial planners and brokerage firms, according to Strategic Insight. That's why T. Rowe Price's staunchly held no-load philosophy has hurt growth. It caved last March and introduced some load funds, which pay advisers a commission to sell them. But it wasn't enough to prevent the third-worst net redemptions rate in the industry last year. Poor performance didn't help: Four of its largest funds lagged behind the market last year.

CULT FOLLOWING. Fund families without offerings for all seasons are also under the gun. Janus Capital Corp. saw assets slump by $100 billion in one year and first-quarter profits plunge 22%. No wonder: Janus has 97% of its assets in tech-heavy growth stocks. As 60% of new money went into value funds last year, Janus got broadsided. It now sports the worst outflows, after being the top gainer in 2000 and No. 2 in 1999. Schorr says it's too cash-strapped to strike a deal with a partner and broaden out to value funds. For now, the Denver firm has cut 36% of its operational workforce, as it concentrates on building a growing institutional business. Luckily for them, a cult-like appeal has helped to retain nearly all 6 million retail shareholder accounts. Outflows, as yet, only represent 2% of its $220 billion in assets.

Even companies with the wherewithal to buy out competitors are getting squeezed. Alliance Capital bought Sanford C. Bernstein Co. last October, to add $80 billion in new, mostly value investments to its growth fund roster. But management fees are flat, and assets have fallen by $21 billion in the first quarter as market depreciation offset net inflows.

Mutual-fund families need to get their financial house in order. Still, the best road to long-term performance is solid returns in bull or bear markets. As Cerulli Associates' Chris Brown says, "If you don't have strong-performing products that are currently in favor, whether growth or value, you're not even in the game."

Corrections and Clarifications In "Funds just aren't having any fun" (Finance, May 14), Financial Research Corp. supplied incorrect data about Eaton Vance funds flows: The number in an accompanying table showed $937 million in outflows for the first quarter ended Mar. 31. In fact, the company had $792 million in positive inflows.

By Mara Der Hovanesian

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