WASHINGTON, D.C. - The Investment Company Institute's 2002 General Membership Meeting opened last week with a discussion of changing investor priorities and how mutual funds can respond. Recent events - most notably the market downturn and events of September 11 - have caused investors to become less certain about the future and more risk averse, and as their overall priorities are changing, so is their spending and investment behavior, according to industry executives.

"Suddenly we wake up one day and the marketplace has undergone a dramatic shift, and consumers' priorities have changed," said J. Walker Smith, a managing partner at Yankelovich Partners, a Norwalk, Conn.-based marketing consultant firm specializing in consumer trends.

Investors have a different sense of risk today than they did in the 1990s, according to Smith. In the past decade, investors believed a certain amount of risk was good. There was a feeling of control and that dangers were predictable.

Today, however, Smith believes that investors are more anxious and watchful, leading them to believe that risk is bad and potential dangers are unimaginable. Those notions have been fueled by the economic slowdown, which has brought back problems many thought were gone with the emergence of the "new economy," namely unemployment and a lack of job security, Smith said.

"We have lost the ability to feel confident about where the future is headed," Smith said.

Investors' priorities haven't changed, argued F. William McNabb III, managing director of the institutional investor group at The Vanguard Group of Malvern, Pa. What has changed is how they are thinking about getting what they want in the current market environment, McNabb added, responding to Smith's opening talk.

"The thing that struck me about Walker's remarks, is that from our perspective, people have the same goals, but they're looking at them differently," McNabb said. "People are asking, What if I have single digit returns? What happens if I get laid off?'"

The mutual fund industry is faced with several key challenges in responding to changing attitudes of investors, according to Smith. To meet investors' newfound caution and growing risk aversion, firms have to develop and offer products that contain less inherent risk, such as principal protection products.

"Also, firms have to err on the side of over-explaining things," Smith said. "In the past, you could trust that investors would take a chance with a new product just because the market was moving up. That's no longer the case."

Smith also suggests that firms provide more guidance and reassurance to investors about their products. Following recent news about improprieties at Enron, Merrill Lynch, Global Crossing and other firms, investors have a heightened awareness about the underlying securities in which funds invest, according to Smith.

"Consumers feel more and more at sea when it comes to markets these days," Smith said. "According to a recent Gallup poll, 75% of consumers believe that Enron is a sign that most companies are involved in some sort of inappropriate activity."

Investors' new focus on risk may create opportunities for fund companies in the retirement market, according to McNabb. Although 80% of consumers believe they will have to delay retirement because of market downturns, according to Smith, the average 401(k) investor is "pretty well diversified and hasn't been hurt much by the market downturn," McNabb said. Vanguard experienced an uptick in the amount of money set aside for retirement plans in the first quarter of this year, he added.

"One of the reasons for that is the new legislation that added benefits there, but I think investors are also beginning to internalize lower return environments," McNabb said. "There's more of a trend toward saving. I think that's good news for the industry if it's handled correctly."

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