Netfolio Shuts Up Shop

Done in by the bear market and anxious venture capitalists, the innovative online investing service becomes the downturn's latest casualty

By Robert Barker

"Goodbye, Mutual Funds," proclaims the home page of Netfolio, a leader in the new investment service of stock "folios" -- personalized fund-like stock portfolios that investors can build for themselves at low cost. "Goodbye, Netfolio" would be more to the point. In early September, the New York-based investment firm began telling clients that it is shutting down as of Sept. 14, I have learned.

Netfolio's high-profile chief executive, Jim O'Shaughnessy, a frequent guest on CNBC and author of the 1996 best-seller, What Works on Wall Street, told me that the venture capital he needed to keep Netfolio afloat dried up. A large institutional investor he had been counting on to match the $35 million in private funding Netfolio had raised earlier pulled out of negotiations in August. On Sept. 4, the firm began to notify clients via e-mail of its demise.

"It is with great regret that we write to inform you that due to extremely difficult market conditions, Netfolio, The Personal Fund Company, will discontinue its online investment advisory service," the e-mail says. Client funds, the e-mail said, will be held by Netfolio's clearing firm, Bear Stearns & Co., until clients transfer them to another retail broker.

With much fanfare, Netfolio opened in March. Like Foliofn, a Vienna, Va., online broker run by former Securities & Exchange Commissioner (SEC) Steven Wallman that debuted 10 months earlier, Netfolio promised to give cost-conscious individual investors control over taxable capital gains that they lose by putting their money in mutual funds. For example, Netfolio charged just $200 a year for an unlimited number of "personal funds," or baskets of individual stocks.


  You could invest for as little as $5,000. But at $200 a year, $100,000 is an expense ratio of 0.2%, comparable to what you pay for a well-known market-index mutual fund -- one over which you have virtually no control in the choice of individual stocks. For anyone with more than $100,000 to invest, paying $200 a year for an unlimited number of "personal funds" was a very good deal.

What went wrong? Prospective investors, O'Shaughnessy says, were demanding to see profits. "Everybody is saying, 'Show me profitability. Show me cash flow,'" he told me. But Netfolio had not yet built enough of a client base to cover its costs. In all, Netfolio had opened just 8,000 accounts with an undisclosed amount of assets. AAII's 170,000 members were eligible to use Netfolio at reduced rates, but while 5,500 of them registered to investigate the service, just 150 wound up funding accounts.

Netfolio's failure could impact the future of rival Foliofn, as well as any plans for startup competing services. In August, giant Fidelity Investments rolled out a rival product, and E*Trade has had one in the planning stages for months. Foliofn Vice-President of Web Content Nancy Smith, a former SEC staffer, denies any business troubles there. "Absolutely we're going to stay in business," she insists. "We feel we're in a great position. We have had Netfolio customers call us." Smith says the firm does not disclose its number of clients or the level of assets in their accounts.

As for E*Trade, it still expects to introduce its stock-basket service later this month with an asset-based fee rather than a flat-rate subscription charge. "At the end of the day, it's still a terrific opportunity," Ryan Randall, director of E*Trade's wealth management group, tells me. Netfolio, he says, "just didn't have the right business model."


  O'Shaughnessy told me that he will try to auction off the software that Netfolio built to Wall Street's big retail firms in hopes of recouping some of the $35 million that he and his group of private investors sank into the company. Along with the AAII, his big-name strategic partners included Mark Hulbert's Financial Digest newsletter, Bear Stearns, and Standard & Poor's (which is owned by The McGraw-Hill Companies, parent of BusinessWeek).Among these partners, however, only Bear Stearns put up capital. S&P also is working with E*Trade on its service.

He also said earlier this year that Netfolio would be distinguished and succeed by virtue of its service as an investment adviser. In other words, O'Shaughnessy aimed to help investors exploit the insights he had presented in his books, rather than merely by providing cheap online trades and Web-based account tracking.

O'Shaughnessy still manages some $600 million in private accounts for high net worth individual investors and institutions, a steadier business than developing retail Web sites. "We believe that, ultimately, the Personal Fund concept will thrive and that, in the near future, you will have numerous opportunities to enjoy all of the advantages that Personal Fund investing offers," the firm's e-mail told online clients. Those opportunities just won't be available via Netfolio.

Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His column appears every Friday, only on BW Online

Edited by Beth Belton