WASHINGTON -- The $12 trillion mutual fund industry will hit record sales of 20% or greater in 2010, driven by continued demand for bonds, alternative investments and international equities, Strategic Insight projects.

"The record flows are remarkable, as they come just a year after the world almost ended," said Director of Research, Executive Vice President Avi Nachmany, at a Strategic Insight presentation ahead of the Investment Company Institute's General Membership Meeting, where 1,400 executives gathered.

Not only have long-term funds proven their "established equilibrium, but if improvement in the economy moves forward, the industry will have extraordinary results," Nachmany said.

As fiduciaries, said ICI General Membership Meeting Chairman Mark Fetting, fund executives' focus must be "to rebuild wealth after the market dislocation. Investors have experienced a decade of disappointing returns. The credit crisis shook the foundations of our financial system, our markets and our policies."

'Investment Mission'

"We have a commitment to deliver on our investment mission and the lessons learned from the financial crisis. There's nothing like a bear market to gain a better perspective on balanced risk/return, the hot sector or the sure thing of the moment," said Fetting, chairman and CEO of Legg Mason. "We need to focus on innovation-not just of asset classes but new solutions to tap new markets and to make our core strengths available to long-term and tactical investors."

Rebuilding investors' portfolios won't be easy, however, Fetting said, especially because "investors continue to turn away from risk. In fact, since 2001, Americans have been dialing back their tolerance for risk."

Indeed, Strategic Insight's primary concern for 2010 is whether retail investors-who have largely moved from zero-yield cash into global fixed income, but who still have more than $10 trillion sitting in money market funds and bank accounts-will return to U.S. equities.

"Recently, stock funds have attracted $30 billion to $50 billion a month. Redemptions are back to where they were before the crisis," Nachmany said. "There are early signs Main Street investors are coming back, but will they come back once the gains are exhausted?" he asked.

Since the bottom of the market in March 2009, bond funds have taken in $429 billion, and since the beginning of 2010, equity funds have netted $33 billion, according to the ICI.

"Americans have stayed the course on their number-one financial goal of saving for retirement," Fetting said. "They didn't run for the exits, as many market commentators predicted," and 401(k) balances are almost back to where they were before the crisis.

Financial Reform

The sweeping financial reforms winding their way through Congress, which speakers concurred are needed and expect to eventually pass, are principally focused on controlling systemic risk, said ICI President Paul Schott Stevens. Oversight of the mutual fund industry will remain with the Division of Investment Management at the Securities and Exchange Commission, he said.

But as John Corzine, former U.S. senator, New Jersey governor and chairman of Goldman Sachs, noted during the policy forum, the reform bill at one point had more than 400 amendments.

The Dodd bill has gone through six legislative rewrites since last summer, many 1,200 pages or longer, Stevens said.

"That's a lot of eye strain," he said.

"The details of the legislation are very much in flux, and we at the ICI have been pointing out problems for funds, custodians and financial services firms to lawmakers," Stevens said.

In 2008, Congress was on the verge of doing away with the private sector system of retirement security, Stevens said. "The 401(k) was under attack and would have been replaced by yet more government oversight. The Investment Company Institute helped stem a headlong rush to radical policy change," Stevens said.

Alluding to the SEC and Justice Department criminal charges against Goldman Sachs, the ICI president said fiduciary duty is another area of concern.

"Are market makers fiduciaries? Does proprietary trading compromise an investment banking or asset management firm? Some even refer to fiduciaries as the 'F word,'" Stevens said.

For fund complexes, Stevens said, the fiduciary responsibility is clear. "We are all fiduciaries. We are proud of that fact, and we stand in that light. Trust is precious and necessary. We must earn Americans' trust and confidence every day."

Corzine said the financial reform bill will eventually pass and called it "absolutely essential because we must address serious breakdowns since the financial crisis. Markets have moved. Participants have changed. Globalization dictates something that is different," he said.

Exacerbating the financial failures is a perilous "shrinkage of the middle class. They are getting squeezed over and over, and this is causing a lot of unease," Corzine said. "There is a need for resolute authority not only over financial services and derivatives but consumer affairs."

With regards to the investment bank where he worked more than 20 years, starting in 1975 as a fixed income trader, Corzine agreed with former President Bill Clinton that "it is hard to see how the law was broken. There was far too much crowd psychology with the mortgage market. Goldman is a proxy that will self-correct."

Past Performance Wipeout

Other regulatory concerns that could impact the industry and investors, Nachmany said, include 12b-1 fees, advice fees -"one size does not fit all," he cautioned-and the Department of Labor's proposal for advice in retirement plans.

DOL's directive would effectively eliminate advice in 401(k) plans linked to past performance. "Only concepts that are highly certain to occur would be permitted," Nachmany said. "This is non-discretionary and would have broad consequences for defined contribution, defined benefit and active asset management. This is absolutely crazy, and I have no doubt the comment letters to DOL will reflect these conflicts."

SPARK Institute sent a comment letter to DOL recommending that 401(k) plan sponsors and administrators continue to have the power to select independently managed investment choices and advice.

In essence, SPARK said the DOL guidance will have the unintended consequence of sponsors and fund administrators offering less advice, education and investment tools to workers. SPARK recommends that the plan fiduciary select what constitutes appropriate advice, be it computer- or adviser-based.

(c) Copyright 2010 Money Management Executive and SourceMedia Inc. All rights reserved.

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