THE TRAVAILS of the financial markets could hurt mutual fund investors in more ways than one. In addition to slashing the value of your portfolio, the bear market also has taken a pound of flesh from the companies that manage your mutual funds.
That normally would not be a cause for concern, but it could be if the industry’s troubles linger.
A protracted downturn, some experts say, could mean higher fees, fewer funds to choose from and possibly the downsizing of the companies’ investment research departments. “The market’s problems have become the fund industry’s problems and that can blow back on investors,” according to Russ Kinnel, research director at fund tracker Morningstar.
Until 2008, the fund industry enjoyed years of steady growth. However the upheaval in the stock and bond markets has left fund companies grappling with sharply reduced revenue, record investor redemptions and a sudden apprehension among clients about the financial markets.
Through November, investors in the US alone yanked a net $151 billion from mutual funds last year, the first year with a net outflow in the 11 years that Morningstar has compiled the data. Worldwide, a net $320 billion (£220 billion) was removed from mutual funds in 2008, a record in both dollar terms and as a percentage of assets, in one of the biggest flights to safety the industry has seen.
Equity funds had outflows of $233.5 billion in the year to December 29th, while bond funds had outflows of $58.2 billion. Balanced funds – which include both securities – had outflows of $28 billion, according to Emerging Portfolio Funds Research, which tracks fund flows in most of the world.
Much of the cash withdrawn went into money market funds, which saw inflows of $422 billion during the year, lifting their total assets to a record $3,720 billion.
Coupled with the plunge in stock values, the redemptions pushed the US industry’s assets under management below $5 trillion in November from $8.2 trillion in October 1997, according to Morningstar.
Given that fund-company revenue is tied directly to assets, “the industry has just taken a 40 per cent pay cut”, says Lou Harvey, president of research firm Dalbar Inc. “It’s pretty devastating.”
As rates have tumbled, some firms have been forced to reduce fees to prevent money-fund returns from turning negative. Others have limited new investments in treasury money funds.
Peter Crane, chief executive of research firm Crane Data, says that for the companies, fee cuts have thus far been offset by the tide of money rushing into money funds from investors fleeing riskier holdings. However if rates stay low for a long time, fund managers could introduce monthly account fees similar to those at banks or charges for ancillary services such as wire transfers.
“After a while they’re either going to give you your money back or they’re going to charge you for it,” Crane says
Fees could increase in other ways. As assets shrink, fund companies are likely to reverse price breaks that they have given to investors in recent years, some experts say. When a fund grows to a certain size, fund companies often lower management fees to reflect the operating efficiencies of a larger fund. The price discounts typically kick in after a fund’s assets exceed certain levels – known as break points – such as $1 billion or $5 billion.
The growth of fund sizes in recent years helped lower management fees in the US to an average of 1.24 per cent of assets last year from 1.44 per cent in 2003, Morningstar says, but many discounts tied to break points could be reversed this year because fund assets fell so much last year.
“Fees are definitely going to rise,” Morningstar’s Kinnel says.
Still, management firms are likely to be extremely cautious about hiking fees, said Aaron Dorr, an investment banker at Jefferies Putnam Lovell who follows fund companies.
“I expect fees, in the main, to stay about where they are,” Dorr says. “I do not think anyone has the fortitude to tell investors after they just lost 40 per cent in their equity product that they’re going to raise fees in the coming year.”
Even moderately higher charges could be a slap in the face for investors who “feel like, if anything, they’re owed a cut”, Kinnel says.
Fund companies also could look to cut costs by eliminating smaller funds. Last year, 621 US funds were liquidated or merged, more than in any other year except 2001, Morningstar says.
That dynamic has been most prevalent among exchange-traded funds, which have exploded in popularity in recent years. Only five ETFs were liquidated from 1993 to 2007, according to Ron Rowland, a newsletter writer and money manager who runs an investing website. Last year, 58 ETFs and exchange-traded notes – close cousins that invest in bonds – went by the wayside, and Rowland has 135 more on his site’s “death watch”.
"It's not like giving your money to [Bernard] Madoff, but if you were planning on holding it for the long term, it's a pain on many fronts," Rowland says. – ( Los Angeles Timesservice)
