In some ways, today's mutual fund industry hardly resembles the fund business of a decade ago. During the past 10 years, the industry has exploded from under $600 billion in assets under management to about $6 trillion. Alternative products, such as separately managed accounts, have gained favor, while the number of funds has nearly doubled from 3,892 at year-end 1992 to 6,537.
So, what will the fund industry look like a decade from now? Observers envision a fund business increasingly imbued with alternative investments, including yet-to-be-invented products. They see increased specialization among fund companies, new markets for distribution, and assets under management growing at a rate of between 10% and 20% each year.
The changes could be so pervasive and so drastic that some speculate the fund industry won't even be known as such by 2012.
Few fund companies plan so far into the future, observers said. Mike Lipper, principal, Lipper Advisory Services, said performance pressures limit fund executives' foresight.
Still, consultants, whose lifeblood is trying to force clients to think ahead, have devoted considerable time to the future, and some have encouraged fund companies to conduct quarterly sessions designed to help them plan for the decade ahead.
Most significantly, the consultants say that funds will have to radically alter the way they offer their products. Complexes will become specialists in either the manufacture or the distribution of investment products - not both, said Chip Roame, a principal with Tiburon Strategic Advisors, Tiburon, Calif.
"You'll see a bifurcation happen between firms whose core competency is money management, versus firms whose core competency is distribution," he said. "Why should a whole lot of money managers build a distribution capability? It's kind of a waste of money, and Merrill Lynch does a better job than all of them."
The decision to focus on either asset management or distribution could force mergers of the previous decade to dissolve, said Kevin Quirk, a principal at the fund consulting firm Casey, Quirk & Acito in Darien, Conn.
"We've always been fascinated by the tension between distribution and manufacturing," Quirk said. "A lot of that is coming to a head as the industry matures."
Funds will specialize in other ways as well.
Roame expects that complexes will stop trying to be all things to all investors. Instead, they will focus succinctly on building multiple products around one asset-management strategy. For example, he said, a company with a good large-cap growth strategy will build funds, separate accounts, variable annuities, folios, exchange-traded funds (ETF) and other products that employ the strategy.
More still, with so many new products being introduced, fund companies may not even be called fund companies by 2012, Roame said. "They will be called money management manufacturing companies,'" he said, adding, with a chuckle, that somebody should probably come up with a more succinct label.
Charlie Bevis, editor-in-chief of research studies at Financial Research Corp. (FRC) in Boston, is writing a series of reports about the future of the fund business. The last chapter of his latest installment is titled "Is it Still the Mutual Fund Industry?"
Bevis said the answer to that question is "probably not." The reason, he said, is that fund companies will increasingly offer alternative products, including separately managed accounts. In fact, FRC said that the ratio of mutual fund assets to separate account assets has dropped from 15 to one at year-end 1996 to 10 to one at the end of 2001. FRC predicts that the ratio will tighten to five to one by 2005 and narrow even further by 2012.
ICI, MMI Merger?
Bevis suggested that managed accounts will penetrate the fund industry so deeply that the Money Management Institute, the Washington trade association of the managed accounts business, may even merge with the Investment Company Institute, the trade group for the mutual fund industry, also based in Washington.
Still, there are those who say that the buzz about managed accounts, or any other new investment product, is more hype than substance (similar to the ETF obsession of two to three years ago) and that the products will never eclipse good, old-fashioned mutual funds.
Philadelphia fund consultant Burt Greenwald said that the standard fund model, with its efficiently pooled accounts, "disciplined investment policies" and professional management, works too well for any new product to become more popular. It's also a matter of pragmatism, Greenwald said. "Anybody who tells you they can manage thousands of managed accounts, God bless them," he said.
But Greenwald added that the way funds are distributed will likely change, particularly with the advent of wrap accounts.
In addition, Greenwald said that by 2012, the U.S. government will have likely freed investors to sock some of their Social Security into private accounts, something he said the industry has been looking forward to for decades because it would open a new market for funds.
"The closer you get to what, ultimately, is going to be a real crisis in Social Security . . . the responsibility of saving for retirement is going to be transferred to the individual investor instead of Big Brother," he said. That represents a tremendous opportunity for a fund business that will see an influx of assets. But the proposition is not without challenges.
The industry, Greenwald said, will have to figure out how to make money on accounts that are not likely to yield much in terms of management fees. The reason is that the government will probably mandate a conservative approach at first, stipulating that the accounts must be based on indexes, a passive management strategy that does not yield high fees.
To Become a Reality
Distribution will also have to shift even more to the international front. It's no secret that the U.S. mutual fund industry is saturated, with more than 50% of all U.S. households owning shares in a mutual fund. Among high-net-worth investors, some speculate the penetration could be as high as 85%. That has left U.S. fund companies turning to Europe and Asia.
"The emerging markets are crucial," said Tony Evangelista, a partner with PriceWaterhouseCoopers in New York and head of the firm's investment management regulatory compliance practice.
Evangelista said Asian countries are likely to be the chief target for U.S. funds during the next decade, including China, Taiwan, Japan and India.
China is a particularly attractive market for U.S. firms because the government there has eased regulations and invited in foreign complexes. In addition, a liberalized economy has yielded a new class of newly affluent Chinese investor. PriceWaterhouseCoopers said that the Chinese investment management market has grown from between $1.5 billion in 1991 to $10 billion today. The firm expects that 12 new open-end funds will launch in China by year-end. There are currently 17 fund companies operating in the country, compared to only three funds in 2000.
$43 Trillion on Horizon
All of this could add up to yet more growth for the fund industry. Roame, the Tibouron consultant, is bullish, predicting that the $6 trillion industry will grow at a rate of 20% each year, reaching $43.3 trillion by 2012. He based his estimate on his new model for the industry, which combines separate accounts, variable annuities, ETFs and other products.
Greenwald is more modest. Based on a more traditional view of the industry, he predicts that assets under management would grow by 10% each year throughout the next decade and more than double in size to $15 trillion by 2012.
"There's going to be some wiggles along the way. That's inevitable," Greenwald said. "Is it going to be as bad as we've seen in the last 2-1/2 years? Who the hell knows? I hope not."