As mutual fund complexes have reported their first quarter 2002 earnings in recent weeks, analysts say it is apparent that sluggish markets have continued to drag down the industry, making it a real challenge for fund companies to develop and market products.

An informal review of the earnings showed that, in most cases, revenues and profits recovered slightly from last year's dreadful fourth quarter, when the Sept. 11 terrorist attacks bludgeoned the already-troubled markets and further postponed the long-awaited economic recovery. However, first quarter earnings did not match the levels of the same period of 2001. Meanwhile, assets under management continue to languish. And some companies are still cutting expenses.

Still, many firms remain cautiously optimistic that markets will recover later this year and the overall picture for the mutual fund industry will improve.

"We expect these market conditions will continue further into the year. However, signs of some economic recovery appear to be surfacing," said Charles Brady, executive chairman of London's AMVESCAP, which owns U.S. fund complexes AIM of Houston and INVESCO of Denver.

In a written statement, Brady said that AMVESCAP had been hampered by slow global markets "due to the uncertainty in the Middle East, terrorism and the general economic climate."

The firm reported revenues of $540.1 million compared to $606.8 million in the first quarter of 2001. Assets under management totaled $400 billion for the quarter, which the company said was an increase of $2.1 billion from the quarter ending Dec. 31 last year.

Assets under management at AIM rose slightly from $179.8 billion in the fourth quarter of last year to $182 billion as of March 31. At INVESCO, assets also declined slightly to $29.9 billion at the end of the first quarter, from $31.4 billion at the fourth quarter of last year.

Asked when mutual fund companies might issue better news in their quarterly financials, fund consultant Geoffrey Bobroff of East Greenwich, R.I., countered: "You tell me where the market's going to be and I'll tell you if [a recovery for fund companies] is imminent."

Bobroff and other analysts said mutual fund companies have been so hampered by sluggish asset flows that, even as they re-jigger their business models and begin to offer new investment products, such as managed accounts, they will naturally continue to suffer until investors become more confident in the markets.

"The first quarter was a sideways quarter, and so far this quarter doesn't look much better," Bobroff said.

More pain in the markets may be on the horizon, Bobroff said, especially among growth stocks that have already started to rebound. Bobroff anticipates that many investors who have been sitting on funds and stocks that have fallen in value by 50% or more, may begin to sell them as they recover, to take whatever profits they can. Many investors may want to rid themselves of such stocks because of the emotional and financial grief they caused, Bobroff said.

"The Nokias and other stocks are going to get pounded again, even though they've already turned," he said. "It affects the stocks and it affects the emotional psyche."

Saturated Market

Market volatility aside, analysts see bigger challenges for the fund business. Firms must also contend with a saturated market where manufacturers increasingly struggle to get investors' attention, analysts said.

Matt McGinness, a senior analyst at the Boston research firm Cerulli Associates, said every U.S. household with more than $20,000 in investable assets already owns at least one fund. That creates a relatively new, cutthroat environment for fund manufacturers who more than ever will attempt to succeed at the expense of their competitors, he said.

"If the market is as big as it's going to be, then firms will gain market share at the expense of somebody else," McGinness said. "That to me says a lot of the executives think that the fund industry has sort of reached its peak."

One solution has been to leverage distribution horsepower into sub-advisory agreements, he said. Firms, such as Merrill Lynch of New York have been employing that strategy with favorable results.

In fact, Merrill Lynch, despite overall declines, was able to report promising news in its asset management division last quarter. The unit posted pre-tax earnings of $117 million for the first quarter, an improvement of 24% over the same period in 2001 on net revenues of $480 million. Net revenues, however, declined 15% from the period last year.

The company said it was able to improve profitability by redesigning its product line and reducing expenses within the unit. But assets under management remained virtually unchanged between the fourth quarter of 2001 and the first quarter. Officials at the company noted in a statement that "the market environment did not improve meaningfully from the fourth quarter," but "actions we took to re-size our businesses are having a substantial positive impact on our financial performance."

Overall, net revenues at Merrill Lynch declined dramatically across the company's units, even as it cut staff and other expenses over the last year. The company posted net revenues of $5.1 billion for this year's first quarter, a decline of 21% from the same period in 2001.

At John Nuveen Co. of Chicago, gross sales of mutual funds declined from $358,000 in the first quarter of 2001 to $287,000 in the first quarter of this year. But the firm generated substantially more revenue from retail managed account sales, even if those numbers declined slightly. Managed account sales slid from about $1.8 million in the first quarter of 2001 to $1.66 million in the first quarter of this year.

In addition, Nuveen reported record first quarter net income of $30 million for the period ending March 31, an increase of 7% over the first quarter of 2001, when net income totaled $28 million.

But income rose only slightly for Nuveen from the fourth quarter of last year, when the firm posted $29.96 million. In some aspects, Nuveen appears to have fared better in the fourth quarter of 2001 than in the first quarter of 2002. Fees from investment advisory services declined from $85.9 million in the fourth quarter of last year to about $85.2 million in this year's first quarter.

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