In a clear sign that insurance companies are having to decide if they should continue to be marginal players in the mutual fund industry sandbox or take their pails and shovels and go home, yet another insurance company has chosen to shut down its U.S. retail mutual fund unit.

AON Advisors, the investment advisory unit of AON Corp. of Chicago, will liquidate all assets in its $1.6 billion three-fund unit on Dec. 3. AON quietly made the announcement in an Oct. 18 filing with the Securities and Exchange Commission, but gave no reason for the funds' termination. Calls to a company spokesman were not returned.

The largest fund in the group is the $1.4 billion AON Money Market Fund, which celebrates its 10th anniversary this year. The group also includes the $138 million AON Asset Allocation Fund, which launched in 1994 and divides assets between equities, bonds and cash, and the $117 million AON Government Securities Fund, which debuted in 1996.

A source close to the company said that AON has decided to get out of the asset management business. It's unclear what will happen to the other $6.4 billion in non-mutual fund assets that AON Advisors currently manages for corporations and pension funds. While there is no official confirmation, AON's $763 million offshore institutional money fund isn't expected to be affected.

AON's decision to close its retail mutual funds comes on the heels of a similar decision made in September by Ohio National Investments, the asset management division of Ohio National Life Insurance Company of Cincinnati, Ohio. [MFMN 10/28/02]. Ohio National pointed to a confluence of events including poor performance, a prolonged bear market and the inability to achieve economies of scale. Ohio National's fund group had also just passed its 10th birthday.

AON and Ohio National may be symptomatic of a broader trend. Insurers are going to have an interesting last quarter going into 2003, said Cindy Saccocia, senior analyst with Cerulli Associates in Boston. Many of the insurance firms that have entered into the fund industry are realizing that unless they can achieve scale, they run the risk of having to continue to support these businesses.

"To become a big player at this point, given the saturation of the mutual fund and even the annuity business, it will be difficult to grow unless through acquisitions," Saccocia said.

"There's a ton of banks and insurance companies that, in the early 1990s felt they had to be in the mutual fund business," said Peter Crane, vice president and managing editor at iMoneyNet in Westborough, Mass. "But five to 10 years later, they've realized they aren't getting critical mass."

AON's money fund is small when compared to the whopping $189 billion Fidelity Investments has collectively invested within its 54 money funds, and the $138 billion No. 2 player Merrill Lynch counts across its 27 money funds. However, with $1.4 billion in assets, AON's money market fund is certainly not the smallest.

$2 Billion or Bust

Achieving critical mass has become the primary goal for many fledgling funds. Where once $1 billion was the asset hurdle most money funds were striving to vault, today, $2 billion might be the new critical mass needed to survive, Crane said. And a broader fund complex would need at least $3 billion to $5 billion to just stay in the game, he added.

Part of AON's challenge to remain a player in the broader fund industry is that its no-load asset allocation and U.S. government securities funds have been mediocre performers. Over the past five years, the government securities fund has returned 6.72%, placing it in the 57th percentile among similar funds, according to Morningstar of Chicago. AON's asset allocation fund hasn't fared much better, having eked out an annualized return of 2.07% over the same five-year period. That has put it dead center among its peer group in the 50th percentile.

It's not like AON hasn't made an effort to puff up performance. Last year its asset allocation fund posted a negative return of 9.8%, meaning 85% of all similar funds had outperformed the fund. So in March of this year, AON hired Ned Davis Research of Venice, Fla. to begin sub-advising the fund. But under the new management agreement and structure, AON tripled the fund's management fee from 25 basis points to 75 basis points.

Lackluster fund performance may be the least of AON's problems, according to industry analysts.

AON has lots of moving parts and has been busy putting out fires, said Bijan Moazami, managing director of Friedman, Billings, Ramsey & Co., of Arlington, Va., a financial-holding company.

Headaches, Headaches, Headaches

The company has been severely impacted by the events of Sept. 11, losing 175 employees at The World Trade Center, he said. AON has subsequently built a retail brokerage operations center, completed a two-year company-wide transformation process and has had the added headache of the blow up of private equity investments. In addition, AON has been the subject of SEC investigations and is also reeling from a failed attempt to break into the property and casualty insurance business, Moazami said.

In addition, AON is facing a $450 million to $500 million pension reserves shortfall, and this summer it aborted an attempt to spin off its property/casualty underwriting activities into a separate, publicly held company to be called Combined Specialty Group. It is now considering selling all or a part of the unit.

Furthermore, the company has $2 billion worth of debt and a $750 million commercial paper obligation. And just last week it issued convertible securities to raise cash to pay down its debt, Moazami noted.

"Too many different things were going on at the same time," Moazami said. "The last thing they wanted to do was be in the mutual fund business. Their mutual funds are not even on our radar screen."

According to a review of past SEC filings, AON's separate account and mutual fund unit was originally set to transfer over to the new, but ill-fated, insurance underwriting spin off this past spring. Plans called for the division to change its name from AON Advisors to Combined Advisors.

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