Executives at '40 Act funds should not lose sleep over the recent success of their competitors pitching an alphabet soup of ETF, SMAs, REITs and hedge funds. That was the takeaway from this morning's round table discussion at the ICI
's General Membership Meeting. All four of the speakers see mutual funds keeping their spot as Americans' core investment product, with emerging competitors filling niche needs.
The biggest threat in the minds of many fund executives could be hedge funds -- and that is the mutual fund industry's own fault, said Michael Goldstein
, managing partner at Empirical Research Partners (he is also a former Sanford Bernstein executive).
| William J. Nutt, Michael Goldstein, John Streur, Jr., Mark Casady, Peter Cieszko |
"The mutual fund industry, in some sense, left the door open to the hedge fund industry," he noted.
That does not mean that hedge funds will win the fight, though. Indeed, Goldstein sees hedge funds changing their story as the markets evolve from the new economy years of 1999 to 2002, a period he calls the hedgers' "Golden Era." He noted the the average hedge fund beat the average stock mutual fund by 500 bps per year in the five years leading up to 2002. Since then, the places have flopped, with the average stock mutual fund topping hedgers by 500 basis points.
"The claim has changed," Goldstein said. "It is now focused on low volatility."
Other speakers pointed out that hedge funds are very much a niche product. Only investors with at least $5 million in assets can invest in the vehicles, noted Peter Cieszko
, president of global distribution for Evergreen Investments. He added that Wachovia (Evergreen's parent company) sees mutual funds as advisors' bread and butter product, but that the wirehouse has built a platform to distribute hedge products to qualified investors.
"A hundred percent of our advisors -- all 10,000 -- use mutual funds in some way. So it is a significant piece of the business we provide," added Mark Casady
, president and CEO, Linsco/Private Ledger (LPL). "One half of one percent of our advisors are using hedge funds. The real reason for that is the expenses of hedge funds. Good advisors realize they cannot overcome five percent to six percent fees on a consistent basis."
Of mutual fund pricing, Casady said, "We love the transparancy and the consistency."
That does not mean that fund firms are not reacting to the competition from hedge funds. John Streur, Jr.
, senior managing partner at Managers Investment Group, has seen mutual funds adopting more hedge fund strategies over time, a trend he expects to continue in the future. Indeed, his own firm has rolled out a hedge fund strategy using a '40 Act fund -- the First Quadrant Global Alternatives Fund
Goldstein sees one area where hedgers are sapping strength from mutual fund firms, and that is in the fight for investment management talent. He noted that there are now about 7,000 each of mutual funds and hedge funds today, yet the investment staff at hedge funds is two to three times that at mutual funds.
"It is kind of odd that the premise of the hedge fund industry is that these are the smartest guys in the room, but there are two to three times as many guys in the room," he quipped.
Turning to separately managed accounts (SMAs), exchange-traded funds (ETFs) and other products, Streur does not see an emerging gorilla to take on funds head to head. "There is not going to be anything like the disintermediation that mutual funds created in bank accounts in the 1970s and 1980s," he said.
SMAs are already seeing declining growth rates, he noted, and he expects that trend to continue. Meanwhile, he predicts that ETFs will continue to see accelerating growth and that hedge funds will keep expanding in reach, but at a slower pace.
"Growth in SMAs is already falling as advisors and investors discover their limitations and use them as a niche product to solve certain problems," explained Streur.
He sees ETFs held back by their inability to pay a load or 12b-1 fee on their own. That limits their use to fee-based accounts. A second strike is that ETFs currently are limited to following passive investment strategies, he said.
"Things could get very interesting for ETFs if they could offer some form of active management. This is something the fund industry is working on, but whether it can be done remains to be seen," said Streur.
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