SAN DIEGO, Calif. - Mutual fund companies are beginning to offer new types of funds - and even other kinds of investment products altogether - to remain competitive, said mutual fund executives at a recent industry conference.
Many of these new products virtually guarantee a given return or aim to deliver at least some return even in market downturns. Such products could be extremely valuable for retiring baby boomers seeking guaranteed income, executives said. These products include tax-managed, market-neutral, prime-rate and stable-value funds. Fund companies are also offering non-fund products - separately-managed accounts, hedge funds, unit investment trusts, spiders and other exchange-traded products - to appeal to the affluent market, they said. Executives discussed the trend at the Investment Company Institute's tax and accounting conference here earlier this month.
With more than 13,000 funds now on the market, it is nearly impossible for a fund company to differentiate its funds or strategy, said Robert Leo, vice chairman of MFS Funds Distributors of Boston. Therefore, "there will be more focus on affluent customers and new products for them," Leo said.
Since mutual fund firms now offer fewer than 100 of each of the new products, now is the time for firms to jump into these new arenas, the executives said.
Currently, for instance, there are only 40 tax-managed funds with $26 billion in assets, said Hugh Fanning, vice president of product development and management for Fidelity Investments Advisor Funds of Boston. But, this is a big jump from 1995, when there were only five tax-managed funds with $2.4 billion in assets, Fanning said. Tax management is "an important niche area" that will experience "significant growth," he said.
Market-neutral funds, meanwhile, are not popular in today's bull market but are bound to appeal to investors in a bear market, Fanning said. Market-neutral funds use a variety of investment techniques - including short sales, options, puts, calls and swaps - to buy under-valued and sell over-valued securities in order to generate positive returns regardless of the market, said Garry Moody, national director of the investment management services group at Deloitte & Touche of New York.
Another type of new fund that could gain in popularity in the event of a bear market is the prime-rate fund, said Neal Andrews, managing director of PFPC Worldwide of Wilmington, Del. Prime rate funds seek to provide high levels of income while preserving capital and are designed to weather market downturns, Andrews said.
Prime rate funds are so-called because they charge interest rates based on a margin above prime rate and are usually reset every 90 days, he said. They can achieve high levels of income by investing in senior-secured bank loans rated below investment grade, Andrews said. These risky investments provide higher yields, he said. Because they invest in bank loans rated below investment grade, these funds are also known as junk money market funds.
In spite of this risk, prime rate funds provide stability because the loans are senior-secured debt, which means they are given preference over other debts, Andrews said. And the loans are rarely "consumer-based," he said. That means they are less susceptible to recession or inflation, he said.
There are now 19 prime-rate funds on the market, up from 17 in 1998 and eight in 1997, Andrews said. The first prime-rate fund was introduced in 1988, he said. Because there are so few prime-rate funds, a secondary market for these funds has not developed and prime-rate funds are largely illiquid, Andrews said. Therefore, they usually register as closed-end investment companies and only allow investors to redeem shares on a quarterly or monthly basis, he said.
Yet a third type of mutual fund that executives expect to fare well in a bear market is the stable-value fund. Such a product is a "guaranteed investment contract with no loss of principal and an assumed market rate - essentially a bond portfolio with a wrapper," said Brian Wixted, senior vice president and treasurer with OppenheimerFunds of New York. Stable-value funds seek to deliver a higher level of income than a money market fund, he said.
Besides expanding a fund family to include more types of funds, a mutual fund company may want to consider offering other types of investment products that are attracting money away from mutual funds, executives said.
Separately-managed accounts pose the greatest threat to mutual funds, these executives said. Currently, a client can open a separately-managed account with as little as $100,000 and financial advisors are increasingly luring people away from funds with customized portfolios, said Leo of MFS. In fact, wirehouses doubled their sales of separately managed accounts in 1998 but had only a five percent increase in mutual fund sales, he said.
Retirement plan sponsors, particularly at Fortune 500 firms, are also increasingly interested in separately-managed accounts because of their lower fees compared to mutual funds, and their style consistency, said Fanning of Fidelity. Separate accounts in defined contribution plans grew 40 percent in 1998 while funds in defined contribution plans grew 28 percent, Fanning said.
High-net-worth clients are also increasingly seeking to invest in hedge funds, which is why MFS is considering developing a series of hedge funds, Leo said.
Unit investment trusts, which invest in a fixed portfolio of securities, now constitute eight percent of broker/dealer sales, Leo said. Unit investment trusts are becoming more popular as they expand beyond bonds to include more equities, he said.
Exchange-traded funds are also attracting interest from investors because they combine "the best features of closed-end funds and open-end, index funds, and are superior to both," said Anne Barr, senior counsel with Barclays Global Investors of London. Also known as webs or spiders, exchange-traded fund portfolios combine indexes and individual stocks and have been gaining in popularity along with the growing popularity of index funds, Barr said. There are now 30 exchange-traded funds with $20 billion in assets under management, Barr said.
These funds are also called SPDRs, or Standard & Poor's Depository Receipts, because the first one that came to market in 1993 tracked the S&P 500. Since then, other spiders tracking other stock indexes have been introduced.
Exchange-traded funds are actually more tax-efficient than indexes because when investors redeem shares in an exchange-traded fund, they receive shares of stock instead of cash, which would be subject to capital gains taxes, Barr said.
"Because ETFs ordinarily redeem [shares] in kind, ETFs do not have to maintain cash reserves for redemptions, [which] . . . allows assets to be committed as fully as possible, which should help the ETF to track the index more closely than other investment products," Barr said.
Exchange-traded funds are also more flexible than index funds because an investor can buy or sell them at any time of the trading day at market value, whereas funds are only priced at the end of the day, Barr said. Exchange-traded funds can also be sold short or used for margin loans, she said. And unlike closed-end funds, which often trade at discounts to net asset value, exchange-traded funds are designed to remove that discount, assuring investors a profit, Barr said.