NEW YORK - With poor investment management, the mutual fund industry has opened the door for alternative products like Web folios, separately-managed accounts, and exchange-traded funds, according to John Bogle, the founder and former chairman of the Vanguard Group of Malvern, Pa. However, with a return to sound management based on the fundamental principles of investing, mutual funds should be able to fend off these challengers, he said. Bogle spoke here last week at a forum on use of the Internet in financial services sponsored by Forrester Research of Cambridge, Mass.

"The sins of the industry - high cost, tax inefficiency, fad funds - have allowed alternative products to come in and get assets," he said.

There has been a shift among firms from focusing on fund management to focusing on fund marketing, according to Bogle. Fund failures have soared recently and yet firms continue to bring out new fad funds all the time, he said. At the very peak of the technology stock boom, the industry created about 100 new technology funds. That type of investment mismanagement leads to higher costs for investors and is devastating for the industry, he said.

Despite the emerging popularity of alternative products, they should not present serious competition to mutual funds, Bogle said. Folios are for short-term traders, not long-term investors, he said.

"Folios will have more impact on the brokerage business than the mutual fund industry," he said.

Managed accounts, too, which increased assets 20 percent last year (MFMN 6/11/01), are really just another form of brokerage account and should not attract the typical long-term mutual fund investor, he said. In the managed account area in particular, there is too much emphasis on marketing, which raises fees, he said. Fees for intermediaries are typically one percent and 70 percent of that is for marketing, he said.

Earlier this month, Vanguard's exchange-traded fund share classes, called VIPERs, began trading on the American Stock Exchange. (MFMN 5/14/01) Despite Vaguard's entrance into exchange-traded funds, Bogle does not believe exchange-traded funds will supplant conventional mutual funds. Their extraordinarily high turnover is an indication that they are used for very short-term buying and selling, he said.

"Exchange-traded funds are a loser's game," said Bogle. "I don't believe long-term investors will turn to ETFs, but if I'm wrong, fund firms can create their own. We just did."

Still, while mutual funds should remain dominant in the long term over the alternative products, some changes need to occur in the industry in order to ensure this, according to Bogle. One of the areas that needs to be changed in the industry is technology.

"Technology in this business leaves a great deal to be desired," he said. "We have a cornucopia of information at our fingertips, but it rarely leads to knowledge."

The rush to adopt the newest technology has created some negative effects along with some positive ones for the industry, according to Bogle. For instance, online and wireless transaction technology has facilitated trading for mutual fund shareholders. But, investors are valuing their portfolios much too frequently and many have begun trading mutual fund shares like stocks, he said. Financial market technology has led to the creation of many new products, but that too has led to excessive trading and has increased the amount of new funds created strictly for marketing reasons, he said. Financial planning technology has given shareholders additional tools to calculate future yields based on past performance, plan for retirement, etc., but that can lead to unrealistic expectations, he said.

"Even the voguest Monte Carlo' simulations require guessing on something that is unknown," said Bogle.

Firms should be focusing on management and using technology as a tool to reduce costs for shareholders, he said. A return to the fundamental principles such as long-term investing and diversification can ensure success for mutual funds in the future, he said.

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