Investor's Business Daily, August 14th, 2007
The mutual fund industry may not be a kid any longer, but it's still growing like a teenager.
At the same time, it faces hot competitive challenges. Exchange traded funds, hedge funds and separately managed accounts all aim to take market share from open-end mutual funds.
Still, the fund business shows no signs of succumbing.
"A decade ago, mutual funds held 14% of total household (financial) assets," said Ed Giltenan, a spokesman for the Investment Company Institute, a trade group for the fund industry. "That was up to 25% as of the end of 2006."
Many people, including shareholders, take growth of the fund industry for granted. But the rapid pace of its growth is clear from data from the Investment Company Institute, an industry lobby:
There were 8,023 funds as of June. That was up from 6,684 at the end of 1997.
Fund assets have hit $11.39 trillion, up from $4.46 trillion in 1997.
Shareholders now own 290 million fund accounts.
But competitive products also have grown. From 19 ETFs in 1997 with $6.7 billion in assets, their numbers reached 526 by the end of June. They held $485.9 billion in assets.
ETFs are traded on exchanges, with prices fluctuating throughout the day. Open-end funds trade once a day after assets are valued.
Hedge funds numbered almost 9,800 on June 30, says Hedge Fund Research. These loosely regulated funds ran $1.7 trillion in assets, up from 2,990 funds with $368 billion in assets at the end of 1997.
Separately managed accounts topped $900 billion at the end of the first quarter, according to the Money Management Institute. That was more than double the level at year-end 2002.
Slowing Down
Is the fund industry at a peak? The number and percentage of households investing in funds has been flat since 2002, following the punishing bear market.
Growth will level off in a mature industry, says Fran Kinniry, a principal in investment counseling and research at the Vanguard Group. Overall, funds are still gaining investors and new assets.
"In dollars, mutual funds far outgrow other products," said Charles Roame, managing principal at research firm Tiburon Associates.
But is maturity eroding the industry's appetite for innovation?
For instance, ETFs have unveiled a string of new varieties. But ETFs technically are a form of mutual fund. SMAs don't top funds for innovation, Kinniry says.
What about hedge funds? "A lot of people thought hedge funds hedged you against volatility," Kinniry said. "Now they see that that was misguided."
Several, including two at Bear Stearns, have imploded amid the subprime lending crisis.
In a rising market with low interest rates, the popular hedge fund strategy of investing borrowed money looked brilliant. But that so-called imbedded leverage recently has proved to be a time bomb.
"When hedge funds try to unwind certain positions simultaneously, that forces markdowns," Kinniry said.
What about later? When they retire, will baby boomers abandon funds in favor of individual bonds?
Not likely, Kinniry says. A key reason is that if you reach age 65, the odds are you'll live to be about 84, according to the National Center for Health Statistics. That's five more years than in 1950.
"There's no reason to shift from equities to fixed income overnight," Roame said. "When people do shift, it's just as likely to be to bond funds."
Also, wealthy investors keep aiming for growth. "Our wealthiest investors don't draw down net assets, even in old age," he said. "They may not add as much to their portfolios. But they don't deplete them."
Since the bulk of financial assets belong to wealthy investors, they won't be putting downward pressure on stocks or stock funds.
Further, funds will remain more popular because SMAs appeal mostly to wealthier investors, Kinniry says. That keeps their ranks relatively small. SMAs are just one investment vehicle used by the rich.
Also, members of Generation X and the younger Millennial Generation will imitate earlier generations in seeking growth, diversification and professional management via mutual funds.
Hiring Managers
"People often tinker with individual stocks when they first invest," Roame said. "But as they learn more about investing and about risk, most migrate to a portfolio approach."
If younger investors were drifting away from mutual funds, we'd see evidence. "The opposite is true," Roame said. "At discount brokerages like Schwab, clients have about 50% of their assets in funds. And that's edging up. And younger investors like discount brokerages."
