Mutual funds nowadays are between a rock and hard place when it comes to distribution.

Many are hiring outsourcers to cut costs and handle regulatory headaches. At the same time, they are struggling to keep control of their relationships with investors.

Both issues are creating plenty of business for servicers, such as Foreside Financial Group and Citigroup.

Distribution has always been a hard, but essential, chore. It can include everything from how to go about maintaining relationships with the broker-dealers that actually sell shares in funds to how to manage development and placement of advertising to tracking and distributing Rule 12b-1 marketing fee payments.

For distribution specialists, business is doing so well that fund distributor Foreside completed in late March the acquisition of BNY Mellon's fund distribution business. That comprised a purchase of BNY Mellon Distributors and its four subsidiaries: MGI Distributors, Fairholme Distributors, HighMark Distributors and Sterling Distributors.

"We hear from our clients a similar theme, which is more access to the intermediaries and the platforms, and assistance in navigating the process from distribution agreement through getting on the preferred lists at gatekeepers," such as investment advisers, says David Whitaker, chief operating officer at Foreside. "With increased regulatory scrutiny on broker-dealers, outsourcing distribution services may provide a more cost-effective way of distributing product."

On the other hand, there is fund administrator Citigroup, which sees increasing clamor from fund companies for its compliance support services, for instance. This includes conducting thorough due-diligence of distribution providers.

"There is some tension in the industry that fund complexes don't necessarily feel that they have the level of access into the intermediary's operations [they need] to assess the services being performed by the intermediary on the fund's behalf," says Bruce Treff, Citigroup U.S. Mutual Fund Product Head. "What level of comfort does the mutual fund (chief compliance officer) have that the intermediary is actually following the fund's compliance procedures, including such things as market timing and redemption fee policies?"

Distribution services are getting increasingly complex and expensive. So funds are increasingly outsourcing such services to third-party intermediaries. But once they do that, fund executives become increasingly worried about weakening their ties to investors.

"What level of oversight or access does the fund complex have into these intermediaries to insure that they are properly servicing the fund's shareholders?" asks Treff, who calls it a common client concern.

In the meantime, distributors such as Foreside continue to position themselves for more demand. Whitaker says that the BNY Mellon acquisition was specifically aimed at expanding his company's distribution and compliance support for open-end mutual funds. Foreside, he said, has made similar purchases in the past, including the acquisition of BISYS Fund Services' distribution business in 2007.

This latest acquisition gave Foreside 11 additional employees to its third-party operations, adding 19 new registrants and over 40-new investment advisers. With the new employees, Foreside opened an office in Berwyn, Pennsylvania.

Whitaker says that Foreside aims to continue to expand its distribution business for mutual and exchange-traded funds, as well as hedge funds, commodities pools and other non-traditional products. He sees further growth for Foreside's distribution business, particularly among smaller and niche asset managers that may not want to operate their own broker-dealer.

"We continue to leverage off existing intermediary relationships, where possible, to allow our clients to expand their distribution footprint as quickly and efficiently as possible," he said.

But once the fund hires a distributor, the neuroses start.

The first worry, according to Treff, is governance. From a regulatory viewpoint, he says, there is an expectation that the chief compliance officer and the fund board understand how a fund is being distributed, who the intermediaries are, and whether the board approved compliance policies. Finally, there is concern over whether service providers follow procedures.

Then there is the issue of value. Are funds getting what they are paying for?

"What sort of oversight is appropriate to monitor that the fund and its shareholders are being charged appropriately, receiving the expected level of service and not being disadvantaged from a compliance standpoint?" Treff asks.

Finally, there is the worry over the investor relationship itself.

Treff says that many intermediaries would prefer to manage all aspects of the fund investor relationship, like providing the direct shareholder servicing, including answering shareholder calls and consolidated statements.

This is the point at which automated fund management vendors, such as Confluence Technologies, jump into the picture. They offer software packages that take the place, at least in part, of third-party intermediaries by automating such functions as tracking and paying expenses, developing marketing materials and collecting information on assets, subscriptions, redemptions and underlying holdings.

"Technology is one of the great equalizers that can help fund operations achieve these goals, regardless of the economic environment," says Confluence financial reporting product manager Scott Powell.

Experts say fund distribution services are rapidly evolving.

Case-in-point, according to Treff at Citigroup: the growing use of omnibus accounting, which allows intermediaries to conduct transactions for many clients under one umbrella account.

One of the biggest distribution challenges fund complexes are facing today, he says, is the evolution of shareholder accounts from being fully disclosed to sub-account relationships that are associated with omnibus accounts.

Intermediaries are aggregating subscription and redemption transactions on a daily basis, but maintaining one account. In omnibus arrangements, Treff says, mutual funds don't necessarily have the ability to see their underlying investors. This includes names and locations as well as demographics.

"How do they know that an omnibus relationship is a good deal for a fund?" he asks, expressing a common concern among funds.

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