The past year was one in which fund alternatives - from managed separate accounts and online portfolio products to hedge funds and exchange-traded funds - earned respect, if somewhat grudgingly, from the fund industry.

While some of the established companies and organizations in the industry derided some fund alternatives as either risky products that fail to protect shareholders' interests or as products that encourage market timing, other industry leaders showed intense interest in those products.

"The industry is completely at odds with itself," said Mercer Bullard, president and founder of Fund Democracy LLC of Chevy Chase, Md., and former assistant chief counsel at the SEC's division of investment management. "Vanguard pooh-poohed [exchange-traded funds] and then did an about face in offering an exchange-traded share class."

Other products, like web-based portfolios and hedge funds, have drawn fire from the fund industry this year largely because they have advantages over traditional funds, said Ryan Tagal, an analyst with Cerulli Associates of Boston. Both The Investment Company Institute of Washington D.C. and Fidelity Investments of Boston have sought to increase regulations relating to web-based portfolio products and hedge funds because these products are a threat to traditional mutual funds, he said.

While some companies have fought the products, others have embraced them. For instance, in July, American Century Investments of Kansas City, Mo. purchased a stake in FOLIOfn of Vienna, Va. The firm, which began operating in May, offers a web-based portfolio of stocks which investors can customize. Because the firm sells fractionalized shares of stocks, investors can purchase a basket of securities for low investment minimums. And, because investors make their own portfolio changes, they have more control over the capital gains they accumulate than traditional fund investors, said Michael Bell, vice president and corporate counsel for FOLIOfn. Also, financial intermediaries can customize for their clients, he said.

Some fund companies have expressed an interest in offering privately-labeled products of FOLIOfn on their own sites, he said.

Financial intermediaries' desire to provide their clients customized products could be one of the reasons that companies including MFS of Boston, INVESCO of Denver,

AIM Funds of Houston, Pilgrim Baxter & Associates of Wayne, Pa. and the Dreyfus Corporation of New York decided to begin offering separately-managed accounts this year, said Christopher L. Davis, executive director of the Money Management Institute of Washington, D.C.

"A mutual fund is a product, the managed account is a process," he said. That process allows financial intermediaries to play a more active role in the management of their clients' assets and so deepens their relationships, he said.

There is substantial evidence that separately-managed accounts are growing more popular with financial intermediaries. Charles Schwab of San Francisco had 500 advisors with $5.7 billion in assets invested with separate account managers as of September, a 300 percent increase over the beginning of 1999, when that figure was only $1.4 billion. (MFMN 9/25/00)

Once reserved for only very wealthy investors, separately-managed accounts are now accessible to a greater number of investors because account minimums have dropped to as low as $100,000, said Davis. They are likely to drop even further next year, he said. Account minimums have dropped because technology is making the product cheaper to manage and operate, he said.

Fund companies are interested in offering alternative investments like separately-managed accounts and FOLIOfn products because many investors have grown wealthy through investments in standard funds and now want products that can be customized, Tagal said.

The increase in high-net-worth investors has been especially beneficial to hedge funds, said Peter Gallo, a bureau chief in the Rye, N.Y. office of Hedge World of Bermuda, a company that tracks hedge funds. In the past year, assets have flooded into hedge funds, he said.

"You have an entire new generation of high-net-worth individuals looking for new products," he said. "There is definitely more money out there looking for products that are less correlated to the overall markets."

More fund companies are offering hedge funds because of their appeal to high net worth investors and because they are an effective way to retain portfolio managers seeking performance-based incentives, Gallo said.

It is difficult to determine which fund companies developed hedge funds this year. But, Kinetics Asset Management of White Plains, N.Y. and Driehaus Capital Management of Chicago both issued funds this year that are hybrids of traditional and hedge funds, Gallo said.

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