For the past five years the ETF industry has been showered with press, 99% of it positive. Alongside the ETF PR machine has been a string of truly impressive net flows – these days nearly $1 in every $3 dollars coming into the retail asset management industry is destined for an ETF. While ETF momentum seems insurmountable, kinks in the industry’s armor do exist.

• Limited Competition – There really isn’t a whole lot of it. Over 90% of ETF assets are housed at four firms. Furthermore, some of the emerging ETF players are simply restructuring their fund assets into their ETFs.
• Vanguard - It’s easy to envision Vanguard slowly becoming a dominant ETF provider with their cut rate pricing. As ETFs go retail, we think expense ratio and firm brand will be primary metrics when selecting an ETF.
• Volatility and Spreads – Normally not an issue for the vast majority of ETFs but when times get volatile spreads start widening to alarming levels. Think back to October 2008 when the majority of ETFs were trading at spreads over 50 bps, nearly five times the average.
• Index Confusion – How do you measure the market? Capitalization, price, dividend, or fundamentally weighted indexes? There are plenty of PhDs and CFAs on every side of this never ending debate.
• Gimmickry – In the industry’s short-life, 125 funds have been shelved and 9 firms have shut their doors. Remember the HealthShares Dermatology and Wound Care ETF? Or the FocusShares ISE-Revere Walmart Suppliers Index? Obviously, every industry is susceptible to fringe product development but the very short shelf life of many new ETF entrants demonstrates just how dominant the Big 4 are.

1)    The Future Of Online Customer Feedback Has Arrived 
       Retirement Income Journal | 3/3/2010

Because … With all the social media hype that abounds, it’s important to look at actual examples in order to help frame the value of initiatives specific to your firm. 
 
2)    Hedge Fund Assets Back At Pre-Crisis Levels 
       FINalternatives | 3/3/2010

Because … While bouncing back, trends in the hedge fund world such as demand for improved liquidity and transparency, less leverage, and increased fee compression, all have potential impacts that seep through to the mutual fund industry.

Net Flows totaled $5.7 billion during the week ended February 17, which was up 188% from the prior week. Each of the five broad categories captured positive net flows led by both the Taxable and Municipal bond categories. The $2.8 billion net intake into Taxable Bond funds was the lowest number in 49 weeks, while Municipal bond funds remained steady at $1.3 billion. Domestic Equity products were flat for the week, while both Foreign Equity and Hybrid funds captured modest net inflows of $1.1 billion and $522 million, respectively. Through seven weeks of 2010, long term net sales total an impressive $60.2 billion. The breakdown by broad category is:

• Taxable Bond - $39.8 billion 
• Foreign Equity - $12.0 billion 
• Municipal Bond - $8.7 billion 
• Hybrid - $4.4 billion 
• Domestic Equity – ($4.7) billion

Source: Investment Company Institute

Fund company websites have always catered to different industry constituents; however, the trend towards greater web specialization is clear. In a bid to serve each group's specific needs, fund companies are increasingly adding a dedicated web presence for RIAs, research analysts, plan sponsors, etc. While these sub-sites are generally a positive development, they can quickly become an administrative burden or even worse, a detriment to the end user. FUSE recommends considering the following before over-tailoring a dedicated web domain:

• Make sure the intended “special user” actually needs a dedicated web path. Are you truly offering special data/content that isn't already available to general audiences? Diffusing resources and time away from the core web-site could result in a net negative as site navigation and content retrieval become confused from the end user’s perspective. 
• If you are offering exclusive data/content, why not offer it to everyone in a centralized location? Obviously, regulatory and marketing concerns need to be considered and will likely determine the proper course of action. 
• Is the proposed sub-site geared toward servicing existing clients or attracting new ones? If the latter, frequent updating and real content need to be offered to attract any meaningful web traffic. Of course, with good content comes incremental cost.

Net inflows totaled only $406 million during the week ended February 10, which represented the lowest weekly net intake in 47 weeks. Equity products sustained net redemptions across the board. Domestic Equity products suffered net outflows of $5.2 billion, while Foreign Equity and Hybrid products were slightly in the red ($447 million and $793 million, respectively). The net redemptions from Domestic Equity funds represented a 14 week high, while Foreign Equity funds had produced 18 straight weeks of positive flows.

Fixed Income products were once again positive, although the week ended February 10 was the lowest net intake for the category in 2010. Taxable Bond funds continued their dominance with net sales of $5.4 billion, while net flows into Muni funds totaled $1.4 billion. YTD net inflows into Fixed Income funds totaled $45 billion through February 10, as investors continue to allocate their money to safety.

Source: Investment Company Institute

With almost all of the public asset manager quarterly reporting now finished, we pulled out a few interesting stats summarizing the group’s 4Q09 results. 

• Valuations are attractive as the group trades near its historical bottom at 16x forward earnings. The recent market pull back has helped push the group into value territory. 
• The average blended management fee stood at 46.4 bps on higher equity asset weightings 
• Operating profits margins improved marginally quarter-over-quarter to 29.7% on average 
• The average comp ratio in the group stood roughly at a third

Beyond the numbers, the mood among asset managers is tepidly optimistic and, as always, highly dependent on the trajectory of the market. That said, anecdotal evidence points to a modest increase in spending in the coming quarters in the form of increased advertising spend, judicious headcount increases in sales and marketing (tack on related T&E increases), and investments in previously neglected technology improvements.

Source: Barclays, FUSE, Company Reporting

Coming off the strongest net sales year in history, the start of 2010 indicates momentum will continue for the foreseeable future. Net sales totaled $53 billion during the first five weeks, as Fixed Income funds continue to dominate, with nearly $38 billion in net flows. Taxable Bond funds accounted for 84% of net sales into fixed income.

International Equity also got off to a strong start. Net inflows totaled $10.9 billion YTD; however, net sales have dropped in each of the last four weeks. Domestic Equity funds are flat to date. The weeks ended January 13 and January 20 were the strongest for Domestic Equity flows since mid-June with net inflows of $3.6 billion combined for the period.  The sales environment was less favorable in the proceeding two weeks, as net redemptions totaled $2.6 billion from Domestic Equity products.  

Source: Investment Company Institute

Fidelity’s latest competitive salvo: $7.95 equity trades and commission free trades on 25 iShares for at least the next three years. What is the impact on the industry? We have a few thoughts:

• Near-term, those retail brokerage clients pondering a switch to another discount broker will likely put down the phone. Those who already switched might have some regrets. 
• Generally, the moves by Schwab and Fidelity will benefit retail ETF adoption —the barriers to entry associated with rebalancing and reallocation among ETFs have been lifted. Dollar-cost averaging with ETFs is now a possibility although one can effectively argue that no one needs to dollar-cost average ETFs given the availability of index mutual funds with low minimum investments. 
• iShares couldn’t buy any better press or exposure. While iShares might not be the cheapest ETFs you can buy on Fidelity, they are the only ones you can trade commission free. The “compete at cost” ETF competitors will be hard pressed to match this partnership. 
• The move will generate a migration of assets to Fidelity and impart a halo effect upon broader Fidelity services and products. However, we’d have to imagine that some NTF mutual fund assets will migrate to the iShare ETFs and negatively impact Fidelity’s platform revenue. This leads us to surmise that some sort of fee arrangement is in place to subsidize or offset any revenue cannibalizing effects of the deal. 
• For the time being, it appears that Fidelity doesn’t want to manage ETFs, it just wants to make money off them. Consider the fact that commission free ETFs at Fidelity only account for 2% of the tradable exchange-traded fund universe.

We look forward to the next chapter of this story.

In a recent survey of our client base, nearly two-thirds of manufacturer’s indicated that marketing resources were being focused on “developing materials addressing benefits of equities and diversification in long-term investing.” Despite the 160 bps YTD decline of the S&P 500, FUSE believes now is the time to act preemptively and allocate marketing resources toward diversification themed messaging. To that end, consider the following: 

• Re-emphasize your target-risk lineup. Recent history suggests that post bear market net flows tend to be directed towards hybrid vehicles. 
• Related to the first point, consider dusting off the Balance Fund and positioning it as a bridge back to equities for the timid. 
• Think high-quality. It’s hard to believe that the low quality beta driven rally will persist through the next stage of the cycle. Rotate your proven “quality” biased strategies to the forefront of your print and web marketing.

Nearly three-quarters of the funds in Morningstar’s Institutional Leveraged Net Long category performed below their respective category medians over the past year (through December ’09). The initial excitement attached to 130/30 funds and the like quickly faded as the markets headed south in 2008. Even since the equity market surge which began in March 2009, short-extension funds have underperformed both benchmarks and category averages. Of the 10 Morningstar rated funds, eight carry two or less stars. Poor performance and net redemptions from domestic equities in general haven’t helped the niche category’s cause, as the median AUM of the 23 fund category is $41 million. While the outlook appears gloomy, FUSE believes that short-extension strategies will endure given that:

1. Strategies backed by proven stock-picker’s will eventually shine, as the markets exit one of the most volatile and irrational cycles in recent memory 
2. The fact that several short-extension funds have delivered in terms of both performance and sales 
3. The secular trend of retail advisors becoming more comfortable with short-selling

A new year has resulted in more of the same in terms of mutual fund flows. Long-term funds captured net inflows of $23.9 billion during the first two weeks of 2010. Flows were more diversified during that period as fixed income funds accounted for $14.2 billion, while equity/hybrid products gathered $9.7 billion. In fact during the week ended 1/13/2010, net flows of equity funds totaled $5.7 billion, which was the strongest week since May 13, 2009 (35 weeks).

Source: Investment Company Institute

The list of new and or novel mutual fund and ETF strategies continues to expand almost daily – clean energy, nanotechnology, water, Poland, Build America Bonds, FX, etc. While Fuse believes that niche ideas can be successful a number of essential ingredients are necessary for a launch to be considered successful. FUSE recommends considering the following before any niche strategy launch:

• Determine whether the idea or theme can be adequately accessed in existing strategies. For example, if you product team believes clean energy is a secular investment theme worthy of a stand alone fund, study your existing large cap lineup. If you possess a fund with a healthy weighting in energy and a proclivity to clean energy stocks your shareholders may already be participating in the trend and feel no need to “double” down.
• Ensure resources from across the organization are secured and dedicated to a successful launch. Niche strategies often require “story selling” and buy-in from marketing departments is crucial to support a successful launch with the proper collateral and web-based marketing. Concurrently, wholesalers must be convinced of the product’s viability and potential receptivity in the field with the assistance of dedicated product specialist resources.
• Right size expectations. Along with niche products come niche allocations within an advisor’s asset allocation model. Expect a modest AUM raise, as wholesaler’s fish for the biggest allocation opportunities while maintaining the “niche” story in their back pocket for those advisors that are comfortable with their existing core allocations/managers but open to new ideas to present to clients.

 

Amid record net flows and historic yield spreads, 40 fixed income funds were launched in 2009. Attracted by juicy yields and a “get paid to wait” philosophy, investors poured $356B into fixed income funds. Intermediate-term bonds represented the year’s most popular fixed-income sector by capturing over a third of the category’s net flows. Given the relatively tepid forecasts for equity markets in 2010, we expect strong inflows to fixed-income funds to continue (albeit not at 2009 levels) given that (1) historically wide spreads remain (especially in high yield) and (2) the abundance of specific credit opportunities that exist for fundamental managers to unearth. Below we’ve highlighted a few of 2009’s  most promising and interesting launches.

Eaton Vance Build America Bond Fund - The industry’s first bond fund launched specifically to invest in Build American Bonds (BABs). BABs represent a new form of municipal financing that seek to benefit investors by providing taxable corporate bond like income with the credit quality profile of munis.

Hotchkis and Wiley High Yield Bond – H&W’s debut of its first fixed-income offering was an impressive one. The firm poached PIMCO’s lead below investment grade managers, Mark Hudoff and Ray Kennedy, to manage the new high-yield offering.

Pimco Enhanced Short Maturity Fund – Though PIMCO launched six new bond mutual funds in ‘09, we are highlighting its Enhanced Short Maturity offering which debuted in November. The ETF represents the first of five actively managed ETFs the firm filed for in July.  The timely offering represents an alternative for money market investors looking for a higher yielding option.

There has been so much demand for our top ten list, we have decided to release the report in its entirety. In order to see the complete list, click here.

Over the next ten days we will blog about ten trends we anticipate happening during 2010. So without further adieu here is #1:

ETFs will continue to be characterized as a competitive threat to mutual funds despite the fact that they are mutual funds. In addition, many in the press will continue to suggest that ETFs are appreciably less expensive than mutual funds (which is really just a function of index ETFs accounting for 99% of ETF AUM), until they see the fees on the new actively managed entrants. Most firms among the Top 50 will file for an active ETF, with a handful of firms launching new products. The notion that an ETF eliminates the need for revenue sharing will be challenged.

The number 26.46% represents the 12 month return of the S&P 500 as of December 2009. Globally, the numbers are even better, as Asia, Europe, and Latin American all outperformed the US markets (except for the Mid Cap space).

What does it mean? Ultimately, strong absolute performance is typically a precursor to flows. Despite a prolonged run in the equity markets, investors’ dollars continued to be allocated to bond funds (which also produced strong absolute performance). The impact of the market decline resulted in a wholesale shift to safety. We believe investors are poised to take on some incremental risk, and this will result in 2010 being a much stronger sales year for equity products.

The number 7.5 is a part of our recent study on product management. We asked product leaders the degree to which their organization has finished adjusted to the market correction on a scale of 1 (haven't started) to 10 (totally finished). And on average the respondents indicated their firms were moving beyond the market correction, but weren't quite finished adjusting business operations (7.5 out of 10).

Some other stats from the study reinforces the notion that most firms are now looking outward in their business efforts:

• 7% of product leaders had hired staff in the last 12 months while 33% plan to do so in the next 18 months
• 80% of product leaders indicated the need to lay of staff in the last 12 months, while only 7% plan to do so in the next 18 months.

Overall, the industry has reacted to the new business dynamics and is now focusing its efforts on investing incremental resources and innovation.

1)    Brokers As Fiduciaries: The Reality and the Issues 
       Reish & Reicher | December 2009

Because … There continues to be a lot of information coming out on this issue and this piece provides a good, concise view of the issue.

2)    More Employers Considering Annuities in 401k Plans 
       401khelpcenter.com | December 17, 2009

Because … As a longer-term trend, annuities in DC as well as annuitization as a distribution option from DC could greatly affect the DC and IRA Rollover markets.

3)    Ask the expert: Variable annuity changes ahead 
       National Underwriter | December 17, 2009

Because … Despite some knocks, the VA industry seems well positioned for growth. That said, investment managers need to reassess their approach to this market in light of the dramatic changes that have taken place this year.

Given all the buzz surrounding the long-short category, we decided to pull out three interesting alternative tib-bits for you to consider.

87%

Represents the year-to-date (through 12/17) return of the Rebeco Long/Short BP Equity Fund. It is the #1 ranked fund and is outpacing its next closest Long-Short competitor by 3400 bps. Robeco Long/Short BP Equity has $149 million in AUM and was incepted in 1998. It has beat 99% of its Long-Short peers over the 1-, 3-, 5-, and 10-year time periods.

$30 Million

Represents the AUM raised in the Merk Absolute Currency Return Fund during its first three and a half months of existence (Incepted 9/9/2009). Merk’s stable of three FX funds are promoted primarily by the firm’s president and Chief Investment Officer, Axel Merk. The firm is focused on marketing directly to RIAs.

$800 Million

Represents the point at which TFS Capital implemented a soft close on its five year old TFS Market Neutral Fund. TFS Capital is an independent quant manager that was founded in 1997. At least 50% of each of the TFS owners' personal liquid assets must be invested in funds managed by TFS.

Net flows totaled $5.9 billion for the week ended December 9, which was down $1.2 billion from the previous week and marked only the 5th time in 39 weeks that net flows dropped below $6 billion. Taxable Bond funds netted inflows of $4.3 billion, which was down 48% from the previous week. Municipal Bond funds captured net inflows of $1.4 billion. YTD fixed income flows total an extraordinary $372 billion. 

Domestic Equity funds sustained net outflows of $1.2 billion, while the Foreign Equity and Hybrid captured net inflows of $787 million and $549 million, respectively.  

Source: Investment Company Institute

1)     Pimco hires Frankin's Gudefin, Lahr in Push into Stock Funds
        Bloomberg | 12/7/2009

Because ... it is a big hire for Pimco as the firm continues its push into equities

2)     Everybody's Going Active (Except Investors)
        IndexUniverse.com | 12/8/2009

Because ... T. Rowe Price launching a family active ETFs is another giant entering the space

3)     M&A activity to rise 35 percent in 2010: BernsteinResearch
        Reuters | 12/7/2009

Because ... we believe M&A activity will be up in the financial services space as well

The number 52.7% represents the number of large companies, which are restoring its' 401(k) match or plan to do so according to the Profit Sharing/401(k) Council of America. In total 46.7% of companies plan or have already reinstated the 401(k) match.

The results are good news for both plan participants and asset managers. Defined contribution plans continue to be a core source of AUM for investment managers and capturing a incremental 3%+ of a participants salary will drive growth.

Sales results were once again solid for the week-ended December 2, as net inflows totaled $7.1 billion. Fixed Income funds continued their extraordinary run with another $9.5 billion between Taxable ($8.3B) and Municipal Bond ($1.3B) products. Utilzing the ICI weekly net flow numbers, YTD net sales into fixed income flows have totaled $366 billion.

Domestic Equity products sustained net redemptions for the 15th consecutive week. Net outflows totaled $3.3 billion for the week-ended December 2. Foreign Equity funds were $991 million, while Hybrid funds sustained net outflows of $213 million.

YTD through December 2, long-term net flows totaled 353 billion.

Source: Investment Company Institute

Over the last 15 weeks the net sales picture has been very consistent: highly positive long-term sales; Taxable Bond accounting for the majority of net inflows; Domestic Equity sustaining net outflows; while the three remaining broad categories - Foreign Equity, Hybrid, and Municipal Bond - producing modest, positive sales.

For the week-ended November 24, net inflows totaled $7.3 billion, which lagged the previous two weeks (note: there were only four business days because of the Thanksgiving Holiday). Taxable Fixed Income net inflows totaled $7.2 billion, while Municipal Bond and Foreign Equity captured $1.1 billion and $1 billion, respectively. Hybrid funds were relatively flat ($472 million in), while Domestic Equity products sustained net outflows of $2.4 billion. The week-ended November 24 marked the 15th consecutive week of net redemptions from Domestic Equity products.

Source: Investment Company Institute

The number 17% represents the decrease in average production in 2008 versus 2007 for wirehouse reps. The statistic comes from a report by the Securities Industry and Financial Markets Association. Some other stats from an article quoting the report (click here for the article):

• Production in 2007 - $532K; Production in 2008 - $441K
• Earnings in 2007 - $211K; Earnings in 2008 - $194K

The numbers come as no surprise, but further reinforces the challenge of 2008. Despite very solid net flows, there is anecdotal information in the article, which suggests that production will be down in 2009 as well. On a positive note, fee-based advisors experienced a solid uptick in revenues from the market rally.

Net sales totaled $11.7 billion for the week ended November 18, as Taxable Fixed Income funds topped the net sales charts once again with $8.9 billion in net flows. Over the last 36 weeks, Taxable Fixed Income funds have produced net sales in excess of $5 billion 30 times and net sales were $3 billion or greater for all 36 weekly periods. 

International Equity funds captured net sales of $2.2 billion for the week, while Municipal Bond funds netted inflows of $1.3 billion. Domestic Equity products were in the red for the 14th consecutive week, as net outflows totaled $1.3 billion. 

Through Mid-November, long-term YTD net flows total $339 billion. Fixed Income accounted for more than 100% of industry net sales, as net redemptions from Domestic Equity funds offset net inflows for International Equity and Hybrid products. 

 
Source: Investment Company Institute

It has been an incredible year for net sales. Here are some comments on year-over-year YTD sales results from the ICI (through October 2009).

• Long-term new sales are down 4.3%. Equity and Hybrid funds drove the drop, as the two categories are down 24% and 14%, respectively
• Long-term redemptions are down 26%, as all of the broad categories have experienced a decline in redemptions (ranging from 7% for Taxable Bonds to 33% for Domestic Equity)
• YTD net flows of long-term funds totaled $328 billion, while money market funds lost $490 billion
• Total gross sales (new sales + exchanges in) were nearly $2 trillion YTD through October, which lags 2008 by 3.8%
• Total gross sales (new sales + exchanbes in) into Fixed Income totaled $834 billion in 2009, which exeeds the strongest annual period by more than $125 billion
• Ratio of net sales to gross sales for fixed income in 2009 is 37%. For perspective, the ratio has topped 30% only once in the last 20 years (1992, 33%). Therefore, we are not just seeing money move from fixed income fund to fixed income fund, fundamental changes in asset allocation are being made and fixed income is capturing incremental market share.

 

1)    Indexing Patent to Test Fund Firms
       Wall Street Journal | 11/18/2009

Because ... there is some precedent for investment ideas being patentable.

2)    PIMCO's Active Bond ETFs = Institutional Pricing for All
       Morningstar | 11/16/2009

Because ... PIMCO + Active ETFs = Interesting

3)    Frequent Asset Allocation Tuneups Coming
       Pensions & Investments | 11/16/2009

Because ... institutional trends are often implemented within the retail space.

Net flows totaled $8.4 billion for the week ended November 11, which was an increase of 174% from the previous week. Taxable Bond funds were once again the top sellers at $7.4 billion followed by Municipal Bond ($1.5B), Foreign Equity ($1.5B), and Hybrid ($0.8B). Domestic Equity funds were negative for the 13th consecutive week, as net redemptions totaled $2.7 billion.

YTD flows for the five broad categories were:

• Domestic Equity - ($39.7B)
• Foreign Equity - $11.4B
• Hybrid - $17.7B
• Municipal Bond - $63.3B
• Taxable Bond - $274.9B

 

Source: Investment Company Institute

The stat 73% represents the percentage of investors exploring a new way to grow their assets according to a survey by Prudential Financial of 1,000 people aged 45 to 70 with $100,000 or more in retirement savings.

Some interesting stats from the article:

• On average the survey participants lost more than 33% of their assets last year
• 62% feel they can regrow their savings and two thirds of this group feel they can do it within five years
• 66% indicated they will seek advise from a financial professional

We've seen the bulk of the money that was put on the sidelines in the last 12 months be shifted up the risk curve, but only slightly into short- and intermediate-term fixed income. The next step will be equities, but it will be imperative that the products are properly positioned and a sound asset allocation (liability driven) is constructed.

Net flows were positive for the 34th consecutive week, but sales of long-term funds dropped to their lowest level during the week of November 4. In addition, net flows were less than $5 billion for only the third during in the last nine months.

Four of the five broad categories experienced a decline in net sales during the week, with hybrid funds the lone exception (up a modest $119 million to $358 million). Net redemptions from Domestic Equity funds topped $5 billion for the second time in the last 34 weeks. In addition, Domestic Equity products have sustained net outflows for 12 consecutive weeks (chart below combines Domestic and International Equity). Taxable Bond funds were once again the top asset gatherers with net inflows of $6.6 billion. Foreign Equity and Municipal Bond funds captured modest net inflows of $546 million and $899 million, respectively.

Also of note, retail money market funds produced positive asset growth (up $0.7 billion) for the first time since the first week of March.

Source: Investment Company Institute

The number $709 billion represents Exchange Traded Product (both funds and notes) assets in the US as of September 30, 2009. The growth rates of ETPs have been extraodinary but here are a few stats to consider when looking at the ETP space:
 

• The top five firms, iShares, SSgA, Vanguard, InvescoPowerShares, and ProShares, account for 92% of AUM
• On a product basis: Top 10 ETPs account for 37.8%, Top 20 ETPs account for 50.8%, Top 30 ETPs account for 58.1%
• Product launches: 2006 - 145; 2007 - 232; 2008 - 198; 2009 -78. Translates into 75% of the total number of ETPs being launched in the last 45 months.
• 483 ETPs have less than $100 million in AUM (55% of the total number of ETPs).

 So, while growth rates have dramatically outpaced other vehicles, the success has been concentrated. And another scaled asset manager with distribution power (Schwab) recently entered the space.

The run of positive flows continues. It is now at 33 weeks, and during that period aggregate long-term flows totaled $349 billion. It is truly an extraordinary run of positive flows.

The flows by broad category tell a consistent story. Investors are moving glacially slow up the risk spectrum, as  short- and intermediate-term fixed income continue to dominate flows. In addition, the search for yield is on, as the story of high yielding products is resonating with advisors. 

Below is weekly and YTD flows by broad category:

	Week of Oct 28	YTD thru Oct 28
Domestic Equity	-$2.6	-$32.1
Foreign Equity	$1.1	$9.4
Hybrid	$0.2	$16.6
Taxable Bond	$8.9	$260.8
Municipal Bond	$1.3	$60.8
Total	$8.9	$315.5

Source: Investment Company Institute, $ billions

Schwab has thrown down the gauntlet in the passive ETF space with the launch of its eight new products. The stat of the week, 8 bps, represents the cost of the two cheapest ETFs launched by Schwab - U.S. Broad Market ETF and U.S. Large Cap ETF. The cost of the eight ETFs range from 8 bps for the two broad products; 15 bps for U.S. Large Value ETF, U.S. Large Growth ETF, U.S. Small Cap ETF, and, International  Equity ETF; and 35 bps for International Small Cap ETF and Emerging Market ETF.

In addition, Schwab announced it is waiving the commission cost for Schwab clients. While the cost of the commission may appear nominal depending upon the client relationship, it could be a game changer depending upon how advisors are using ETFs and the frequency of trading. 

One question facing Schwab is how committed advisors are to certain indices like the MSCI EAFE and the S&P 500. The answer to this question is not yet determined. 

Two facts are clear: (1) advisors like products that save at the client portfolio level (industry standard fees or very close to it for the Schwab ETFs) and (2) waiving commissions will simplify client reporting and enable an advisor to rebalance and/or trade a Schwab ETF as frequently or infrequently as they desire without concern of building commission costs to their client.

An article in Investment News discussed the liquidation of several target date funds and it has prompted us to write a bit about the topic. Target date products exploded in the last several years, as these funds have dominated DC sales. Net flows of target date mutual funds by year are:

• 2006 - $35 billion
• 2007 - $57 billion
• 2008 - $42 billion
• YTD '09 - 26 billion

Yet, very few firms have gained traction. In 2009, Allstate, XTF, Payden & Rygel, and Old Mutual have all eliminated or are in the process of eliminating their target date fund series.

Why? Asset managers with record keeping platforms dominate the space. The top four firms - Fidelity, Vanguard, T. Rowe Price, and Principal - account for 84% of AUM.

Forty other firms offer nearly 300 target date portfolios and with total AUM of $35 billion (median AUM of $239 million, average of seven funds per firm). In addition, there are twelve series of target dates funds with less than $100 million in AUM and seven funds per series. We anticipate additional liquidations over the next 12 to 18 months, as firms struggle to obtain critical mass.

1)        Jones v. Harris: Supreme Court Hears Oral Arguments Monday 
           MF Directors Forum | 10/30/2009

Because … This is a case that many of us have been following for some time, and on Monday we will finally get to hear the arguments…After which, we can follow the case for three or four more months waiting on the decision.

2)        Target-Date Funds Suffer From Limited Choice, Senate Panel Says 
           Bloomberg  | 10/28/2009

Because … This is another piece of legislation/regulation that remains pretty fluid and has the potential for significant change.

3)        Schwab Prepares to Launch ETFs 
           SEC Filings | 10/26/2009

Because … The expenses on these products arrive as industry leading (tied for the lead in some cases), and while not everyone has a horse in this race, the transformation of Schwab’s asset management business this year has been an interesting story to follow.

Net flows were once again highly positive for the fund industry. Long-term net sales totaled $13.8 billion for the week ended October 21. The breakdown of flows by category:

Domestic Equity - ($1.2 billion)
Foreign Equity - $2.9 billion
Hybrid - $1.0 billion
Taxable Bond - $10.6 billion
Municipal Bond - $0.5 billion

YTD net sales are now over $300 billion. The Taxable Bond ($252B) and Municipal Bond ($60B) have posted their strongest net sales results ever, while equity products have suffered net outflows in the aggregate through October. 21.

Source: Investment Company Institute

6.6 million represents the number of employed Americans who are 65 or older. Some stats that we have taken from a recent New York Times article (link here):

• There are more Americans 65 and older working today than ever before. For comparison 4.1 million were working in 2001
• The unemployment rate for Americans 65 and older is 6.7 percent versus 9.8 percent overall, but up from 1.9 percent early this decade
• Nearly half a million workers 65 years or older are looking for work. The highest level of unemployment for this group since the Great Depression

 

1)        Sea change shifting power to 401(k) advisers
           Employee Benefit Adviser | 10/21/2009

Because … As the decision making power continues to migrate away from recordkeepers, firms will need to shift their distribution models to keep pace.

2)        Morgan Stanley reveals which management teams going, staying
           Pensions & Investments |10/21/2009

Because … The division of Morgan Stanley Investment Management is a complicated piece of this merger, and it will create opportunities to be exploited. MSIM’s layout of the moves is HERE.

3)        Investors Continue to Gravitate Toward Bond ETFs
           The Mutual Fund Wire |10/20/2009

Because … Even as funds pull in significantly more fixed income dollars in absolute terms, fixed income ETFs are winning on a relative basis.

Net Flows totaled $6.8 billion for the week ended October 14. Sales were down more than $4.5 billion (or 40%) from the previous week. Domestic Equity, Taxable Fixed, and Municipal Fixed experienced a decline in net flows, while Foreign Equity and Hybrid funds were up from the previous week.

For Domestic Equity, net outflows grew to $5.2 billion. It marked the ninth consecutive week of net outflows from Domestic Equity funds and the first time since March that net outflows exceeded $5 billion. Despite consistent gains in the equity markets, mutual fund investors continue to pull money on a net basis from Domestic Equity products.

Taxable Fixed Income funds pulled in an impressive $8.4 billion, while both Foreign Stock ($1.9B) and Hybrid ($1.4B) both topped the $1B mark for net flows during the week. Municipal Bond funds were largely flat. The $0.4B net intake represented the first time in 25 weeks that net sales of Municipal Bond funds were below $1B.

Source: Investment Company Institute

Following a prolonged period of rumors, Invesco has agreed in principal with Morgan Stanley to purchase Van Kampen for $1.5 billion. The deal provides Invesco with $119 billion in assets under management, while Morgan Stanley gets $500 million in cash and a 9.4% stake in Invesco. It is the fourth transaction of a large mutual fund/ETF organization to be announced in the last six months (Van Kampen, Delaware, Columbia, and iShares).

We anticipated some large transactions as we entered 2009, but we also thought there would be a greater volume of small, tactical deals. With a couple of exceptions, the large organizations which have been rumored to be on the block have either changed hands or are in the process of doing so. As such, we believe most of the transactions for the remainder of 2009 and first half of 2010 will be firms adding scale to an existing product line or organizations adding incremental asset management capabilities to complement an existing suite of products.

1)    Wealthy Investors Still Like Hedge Funds But Are More Discerning
       One Wall Street | 10/13/2009

Because ... the buying patterns of HNW investors drives a lot of business.

2)    At Ivy, Wholesalers' Comp Marks a Shift from Past Years
       MF Wire | 10/9/2009

Because ... how wholesalers are compensated is a constant struggle for asset managers

3)    Half of Americans Have Stopped Investing
       Money Management Executive | 10/14/2009

Because ... half of Americans are a lot of investors.

Net sales totaled $11.4 billion for the week of October 7, which was up 132% from the previous week and marked the 17th week of 2009 when net sales exceeded $10 billion.

Fixed income funds once again were the dominant sellers. Taxable Fixed Income funds captured net inflows of $12.5 billion, while Municipal Bond funds netted $2.7 billion.

Conversely, Domestic Equity products sustained net outflows of $5 billion. Over the last eight weeks net outflows totaled $20 billion from domestic equity products. During the same period, the S&P 500 gained 5.1%.

Foreign Equity and Hybrid funds captured modest net sales of $583 million and $564 million, respectively.

Source: Investment Company Institute

As the Dow approaches 10,000 (Update: it closed today at 10,016), a couple of thoughts to consider for asset managers and distributors:

1. Market momentum has historically been the impetus for retail investors to reenter an investment space. We believe this will happen again, and there has been some research, which indicates a milestone like the Dow reaching 10K will have an impact.
2. It could be exactly the wrong time to shift money back to equities, as there continues to be some uncertainty about the health of the overall economy. Another market correction is certainly not out of the question.
3. Therefore, we believe it is hyper-critical for asset managers and distributors to be an advocate for clients as they potentially shift dollars back into the equity markets. This does not mean discouraging clients from investing in equities, but we do believe most clients should gradually invest (i.e. dollar cost average) and firms should be vocal about their views on the economy.

Client trust was severely compromised after the most recent market correction (and other transgressions). Another hit would likely prove fatal to many long-term relationships between client/advisor or client/asset manager.

1)        A Power Shift Between Adviser and Client
           The Wall Street Journal | 10/2/2009

Because ... Advisers needing help translates into opportunities for you.

2)         75% of Americans Plan on Working as Long as They Can
            Money Management Executive | 10/6/2009

Because ... If the title is correct and should not actually read "75% of Americans Plan on Working as Long as They Need To," this would represent a significant shift in American's behavior.

3)        Industry Groups Differ on Fiduciary Standard
           Financial Advisor | 10/6/2009

Because ... This issue has direct and tangential implications to all participants in our industry and warrants keeping abreast of.

Net sales of long-term funds dropped to $4.9 billion, which marked only the second time in 22 weeks that net inflows were below $5 billion.

Each of the five broad categories sustained a decline in net flows. Municipal Bond and Foreign Equity funds were relatively flat week-over-week, while the hybrid and taxable bond categories sustained a significant decline in net flows ($5B to $.05B for hybrid; $10.2B to $6.9B for taxable bond).

Domestic Equity funds were once again in net outflows. Net redemptions totaled $3.8 billion, which was the highest level of net outflows since the week of March 11, 2009. Over the past six weeks $15.3 billion has left Domestic Equity products, some of which has been reallocated to hybrid vehicles.

Source: Investment Company Institute

The long-rumored sale of Columbia Asset Management by Bank of America occurred last week, as Ameriprise bought the equity and fixed income asset management businesses ($165B in AUM) for between $900 million and $1.2 billion. The new organization will have a tremendous amount of work associated with the integration of the two companies. Both organizations have undertaken previous acquisitions and in many ways Columbia is a comglomerate of asset managers. Some quick facts about just the two mutual fund lineups:

• Combined the two firms have 179 long-term funds
• 42 funds have less than $100 million in AUM
• Two sets of target date funds with total AUM of $162 million
• Two sets of target risk funds
• 61 funds with 3-year relative performance in the top third of their respective Morningstar category
• 15 Large Blend funds; 32 Large Cap funds

 

For those who were unable to attend the Influencer's conference, here are links to some stories from the event.

1)    Small Fund Firms Share Tips for Success
       MF Wire | 10/1/2009

2)    Investment Manager Valuations are Down Nearly Half
       MF Wire | 10/1/2009

3)    Innovation Must Continue, Product Execs Say
       MF Wire | 10/2/2009

4)    Legg Mason Mulls Active ETFs
       Bank Investment Consultant | 10/1/2009

5)    Mutual funds squeezed by competition from ETFs, pressure from distributors
       Investment News | 10/1/2009

 

Money continues to pour into long-term funds. Net sales totaled $16 billion during the week-ended September 23, as taxable bond and hybrid funds were the top asset gatherers at $10 billion and $5 billion, respectively.

The hybrid numbers stand out. In consecutive weeks, net inflows were $5.2 billion and $5 billion, which is more than four times the previous best week (May 6, $1.2 billion). It appears investors are reentering the equity markets cautiously through hybrid funds, although domestic equity product have sustained net redemptions for six consecutive weeks.

It is now time to look at 2009 as potentially the strongest net sales year on record. Utilizing ICI weekly numbers, net sales total $269 billion YTD. That is only $3 billion short of 1997, which was previously the best year for long-term funds. In terms of fixed-income flows, the best year was 2002, with net inflows of $141 billion. YTD 2009, bond funds have captured net sales of $227, which is 61% higher than 2002.

While momentum could quickly shift, it seems highly likely that annual flows into long-term funds will top $300 billion for the first time in 2009 

Source: Investment Company Institute

While 2009 has been relatively anemic in terms of product development with just 168 funds launched to date, managers have indicated to us that while product rationalization and pricing changes have been the focus for most of the year, product development will take center stage over the next 18 months.

Below is a quick look at the breakdown of product development activity over the last few years:

An article in Friday's Wall Street Journal discussed the improved outlooks that analysts have for the publicly traded asset managers. Overall sentiment is fairly positive. Merrill Lynch has buy ratings on Janus, Calamos, AllianceBernstein, AMG, and Waddell & Reed. Franklin and Invesco are JPMorgan's top picks.

It should come as little surprise. The combination of highly positive flows (albeit concentrated in terms of both firm and category) with a sustained upward movement in the market has buoyed earnings at a number of firms. The table below is a snapshot of the performance of public asset management companies compared to the S&P 500.

1)    Deloitte Says ETFs Need to Grow Assets to Challenge Mutual Funds
       PR Newswire | 9/22/2009

Because interest in ETFs is consistently top of mind ....

2)    Independent advisers drop fees to lowest level in a decade
       Investment News | 9/22/2009

Because if advisors fees are dropping, they are going to look for cost savings elsewhere, perhaps with greater use of passive strategies ....

3)    Two-Thirds Don’t Have a Financial Plan
       Bank Investment Consultant | 9/24/2009

Because we believe there is an opportunity for advisors, distributors, and asset managers to take the lead in converting clients with either a customized approach for the HNW or a scaled approach for the mass affluent ....

Net sales totaled $16.45 billion for the week ended September 16, which was an increase of nearly 125% from the previous week and represented the second best weekly flows of 2009.

Fixed income flows continue to be very strong. Net sales totaled $13 billion for the week, with $10.1 billion going to taxable bond and $2.5 billion for municipal bond funds. Net sales into hybrid funds were $5.2 billion, which is by far the strongest week for the category. Domestic equity sustained net outflows of $2 billion, while foreign equity produced modest net inflows of $0.6 billion. 

Some stats to reinforce how strong fixed income net sales have been in 2009:

• Industry - $253 billion
• Taxable bond - $203 billion
• Municipal bond - $51 billion

Net sales stats for the last 27 weeks:

• Industry - $287 billion
• Taxable bond - $177 billion
• Municipal bond - $42 billion
• Domestic equity - $24 billion
• Foreign equity - $26 billion
• Hybrid - $19 billion

  

In the past year, 25% of HNW investors moved some or all of their assets to a new advisor. We anticipate this trend will continue, as investors assess their current financial makeup.

Compounding the issues for advisors is the standard attrition that occurs when pre-retirees are preparing to exit the workforce and a consolidation of service providers takes place. About 50% of pre-retirees with $2 million in investable assets consolidate their providers, while an additional 20% do it around the retirement event. 

The advisor who benefits from the consolidation will generally fit the following profile:

• High level of trust with clients
• Is the primary source of retirement advise, including wealth disbursement
• Models financial planning around the assets/liabilities of the client
• Compensation model is aligned with goals of the client

 

What happens when investors start to pump money back into equities? The domestic markets bottomed in Mid-March at about 675 for the S&P 500. Since that time, the S&P has climbed to 1,065, or about 58%. Of course, the cash being put back into long-terms funds is predominantly going to short- and intermediate-term fixed income. Equity sales are for the most part flat, with a couple of exceptions (i.e. Emerging Markets), which means investors have missed the run-up.

We've seen a number of stories from both here and Europe where portfolio managers are starting to increase their cash positions and underweight equities, which indicates a potential dip in the equity markets. While this is to be expected, it may come at exactly the wrong time - when retail investors start to either rebalance and/or allocate new monies into equity products. 

Messaging will become very important. Caution should be stressed and a gradual approach to reentering the market should be encouraged.

Standard deviation measures volatility, but retail investors care about semi-standard deviation or downside capture. Another hit to their savings, be it a 401(k), IRA, or non-qualified investments, will be very painful to the retail investor, and the asset manager and/or advisor will also feel pain by losing their client.

1)    Investors are cautious on strength of economic rebound
       MarketWatch | 9/16/2009

Because many mutual fund investors have missed the market runup and professional investors are now trimming equity positions ....

2)    Chief hurdle in fund mergers: Financing
       Investment News | 9/13/2009

Because we anticipate elevated interest level in M&A activity but deals may be held back ....

3)    A few key executive appointments: Alliance Bernstein, John Hancock, and Lincoln
       MF Wire | 9/17/2009, Boston Globe | 9/16/2009, PR Newswire | 9/15/2009

Long-term mutual fund flows totaled $7.3 billion during the week ended September 9, as fixed income products were once again highly positive. Taxable fixed income funds captured net sales of $6.3 billion, while muni bond funds netted $1.9 billion. Foreign equity and hybrid funds were modestly up, with net sales totaling $462 million and $371 million, respectively.

Domestic equity products continue to struggle. Net redemptions totaled $1.8 billion, which is down from the previous week, but still disappointing considering the S&P 500 gained nearly 7.5% in the last two weeks. It is clear that investors are hesitant to put money back into equities and safety continues to be the near-term goal of all dollars moving out of cash. Research from Spectrem Group illustrates the hesitancy.

Unfortunately by waiting, many investors may reenter the equity markets at exactly the wrong time.

The number 115 represents the number of wirehouse advisor teams that Schwab has converted to independent (Investment News story here). This represents a 53% increase from the previous year.

We've talked over and over again about the shift from wirehouse reps to independent. The wires were very aggressive in keeping their top advisors/advisory teams in place and much of the initial movement was small and mid-tier reps who may or may not have been retained. However, it appears larger, more established teams are now making the move to the independent channel.

We believe this movement is going to increase the need for advisor segmentation because the traditional approach of channelizing sales personnel will be insufficient. Firms need to construct sophisticated models, which identify the right advisors and advisory teams to work with in order efficiently allocate sales resources.

It was one year ago today that Lehman collapsed. To-be expected, the anniversary has received a good deal of coverage including stories here, here, and a tangential story here. There has been healthy debate regarding the failure of Lehman and the role of the government in the firm's bankruptcy. Here are some stats about the industry for the last 12 months.

• As of 8/30/2008, long-term mutual fund AUM totaled $8.1 trillion. As of 12/31/2009, it was $5.8 trillion, which represented a 39% decline. 
• Since year-end 2008, long-term AUM has increased by 18% and now totals $6.8 trillion (through July 2009).
• Long-term sales have been positive for 32 of 36 weekly periods in 2009.
• During the last week in February and first two weeks of March, $62 billion left long-term funds.
• During 2009 through September 2, $229 billion flowed into long-term mutual funds. If the industry were to not capture one incremental dollar in net sales, 2009 would be the 5th best net sales year on record.

And while there are many qualifiers to the last stat (dominated by fixed income, particularly intermediate- and short-term fixed income), the industry has been very resilient over the last 12 months. We believe flows will become increasingly diversified, although it may take until 2010 for a consistent up-tick in equity sales.

 

1)    Vanguard tops Morningstar target date ratings
       MarketWatch | 9/9/2009

Because target date funds and Morningstar are consistently top of mind ....

2)    Morgan Stanley Names CEO Successor
       Euromoney Institutional Investor | 9/10/2009         

Because Morgan Stanley Smith Barney is one of the largest distribution systems ....

3)     The Next Five Years in ETFs
        IndexUniverse.com | 9/10/2009

Because it is a forward-looking piece on ETFs ....

Net sales were once again highly positive for the week ended Sept 2; however, both domestic and international equity funds sustained net outflows for the period. Overall, long-term funds captured net sales of $8.4 billion, with fixed income funds posting net inflows of $12 billion, while equity products sustained net redemptions of $4.2 billion (hybrid were net positive of $548M).

Net sales into taxable fixed income products totaled $9.7 billion, which reprsented an increase of 28% from the prior week and was the best weekly net intake for the category during calendar 2009.

Conversely, for the first time since March 11 both domestic ($3.2B) and international equity ($1B) sustained net outflows in excess of $1 billion. The net outflows coincided with a week when the S&P 500 was down more than 3%.

Today marks the one-year anniversary of the launch of FUSE Research Network. It has been an exhilirating 12 months, as we have successfully:

• Launched the Market Intelligence Platform, which is our core research deliverable
• Released our first ConNext study in partnership with Mast Hill Consulting on Retirement Income
• Launched our website
• Are set to launch our first series of BenchMark reports on Product Management, Distribution, and Marketing

In the coming months we will have many more developments including:

• Advancements to the website
• Additional ConNext studies with partners who are thought leaders in sales, marketing, and product
• An advisor-driven research service
• Ongoing content development for the Market Intelligence Platform

The industry has gone through a number of challenges since the launch of FUSE but we continue to focus on our core principles of providing:

1. Ardent Client Advocacy
2. Absolute Candor & Objectivity
3. Decision Support Research
4. Incisive & Actionable Guidance

 

1)        Advisers all a-twitter over online networking? Hardly, IN survey reveals 
           Investment News | 9/3/2009

Because … it’s good to hear advisor’s opinions of social networking mixed in with all the thoughts from consultants.

2)        31% of Wealthy Investors Back in Equities, 26% Waiting for Dow 10,000
           Money Management Executive | 8/31/2009

Because … 26% of folks expressly intending to “buy high” could make for some other interesting findings.

3)        Got alts? Rydex rolls out alternative investment site for advisers 
           Investment News | 9/3/2009

Because … Getalts is a fun site to spend a few minutes on.

Net flows were once again highly positive, although domestic equity funds produced a second consecutive week of disappointing results. Industry net flows totaled $10.4 billion, led by taxable ($7.6B) and municipal ($2.3B) bond funds. International equity and hybrid funds captured net sales of $1.4 billion and $489 million, respectively, while domestic equity sustained net outflows of $1.4 billion. It was the second consecutive week of net redemptions for domestic equity products, which followed a four week period of net inflows totaling $4.3 billion.

The S&P 500 was down almost one percent for the week ending August 19 (which preceded these flow numbers), so perhaps advisors and investors got skittish about the market. Since August 19, the market picked up about three percent (8/27, 1,030.98) and has since given back all those gains, as the S&P 500 closed today at 994.75. While dollars continues to flow out of retail money market funds (another $6.5 billion out for the week ending 8/26), very little is being shifted into equity products. The theme continues to be safety.

Source for all numbers: Investment Company Institute

The numbers 156 and 395 represent the new fund launches in 2009 (156) versus the the number of funds either liquidated or merged away (395) according to Morningstar. The market decline coupled with significant outflows from equity products led to the number of sub-scale mutual funds growing exponentially. Here are some updated stats on funds which have not yet reached critical mass according to Morningstar Principia:

• 1,133 funds with less than $50 million in AUM and a 3-year track record
• 629 funds with less than $25 million in AUM and a 3-year track record
• 847 funds with less than $50 million in AUM and a 5-year track record
• 446 funds with less than $25 million in AUM and a 5-year track record

Firms need to constantly monitor their product line and measure (1) current profitability, (2) outlook for sales and AUM growth, and (3) fit with corporate image and identity. If a product does not measure up, a firm needs to seriouly consider eliminating it.

Rydex AdvisorBenchmarking.com released its August sentiment number for advisors and it was up 9% from July to 104.05. The index now indicates a slightly positive outlook from advisors on four factors:

• Current economic outlook
• 6-month economic outlook
• 12-month economic outlook
• Stock market outlook

The trend in advisor sentiment coincides with the up-tick in the FUSE Industry Sentiment Index, which measures the 6- and 18-month outlook for investment product sales. The expectations of senior executives is highly positive, as nearly three-quarters of our survey respondents felt industry sales would increase by either 10% to 25% or 25% to 50%.

1)    Jefferies Putnam Lovell Projects that Expansion Will Supplant Survival as the Dominant Driver of M&A in the Global Asset Management and Financial Technology Sectors
       Press Release | August 24, 2009

       Because .... it offers a view of several M&A trends that Jeffries anticipates in the financial services space.

2)    More Advisers Ask Investors to Focus on Goals Rather Than Performance
       Money Management Executive | August 21, 2009

       Because .... goal based or liability driven financial planning should become standard practice.

3)    Fidelity Staying Away From ETFs?
       IndexUniverse.com | August 24, 2009

       Because .... Fidelity is an 800-pound Gorilla and it is interesting that they are publicly stating that they have no plans to expand their ETF presence.

Net flows totaled $9.6 billion during the week of August 19, which was a decline of nearly 40% from the previous week and the first sub-$10 billion week since July 15. With that said, $9.6 billion in net sales is still a very solid week.

Four of the five broad categories were positive for the week. Domestic equity was the lone exception, as net outflows totaled $924 million. Municipal bond funds were the only broad category to experience an uptick in flows (up $401 million from the previous week). 

Dollars continues to flow out of money market funds. Overall, money market assets declined by $12 billion and retail money market funds lost $3 billion in AUM.

On August 3rd, Hancock launched the John Hancock Technical Opportunities Fund. It is sub-advised by Wellington Management. According to the fund description on the Hancock website:
 
"The subadviser employs an unconstrained investment approach driven by technical analysis. The fund is non-diversified, which means that it may invest its assets in a smaller number of issuers than a diversified fund. The fund may invest in cash and other liquid short-term fixed income securities within a wide range (0%-100% of net assets) when the subadviser believes that the fund could benefit from maintaining a higher cash exposure, including for temporary defensive purposes."

The fund has received quite of bit of press including articles here, here, and here.

It is impressive that Hancock has been raising money in a fund with zero track record, not even a one month return. Clearly,

1. Timing is very good
2. The sales messaging and investment strategy has resonated with advisors
3. And having a sub-advisor like Wellington helps offset the lack of a track record

Challenges still exist for products like the Hancock fund, particularly finding a place for this type of fund within an asset allocation model. However, we have seen a number of products that afford significant flexibility to the portfolio manager gaining greater traction in the retail space.

We've seen several articles of late (including stories here and here), which pit active management versus passive strategies. This year has favored active managers, but as the Boston Globe article states the percentage of active funds beating passive products drops steeply over 3-, 5-, and 10-year periods. So while it may be tempting for active managers to tout near-term performance gains, we do not believe absolute performance represents the value proposition of an active manager. 

Active management is about an investment process that provides meaningful alpha, which justifies the incremental cost to the end client. Passive strategies have captured a disproportionate share of retail sales, particularly equity dollars, over the last several years. And we believe this trend will continue. Therefore, active managers need to focus on refining both the communication and execution of their investment process because the competitive environment has reached an all-time high.

Update - here is a link to the Standard & Poors Indices Versus Active Funds Scorecard, Midyear 2009

1)        McKinsey Survey Finds 28% of Asset Managers Are “depressed and in denial” 
           Allaboutalpha.com |8/20/2009

Because…if you’re feeling this low, it’s good to know others are too.

 

2)        Merrill Lynch Fund Manager Survey Finds Soaring Optimism
           Planadviser | 8/19/2009
 

Because…smiles are contagious and maybe this group can pull the other 28% out of their funk.

 

3)        Mutual Funds Weather the Storm (Earnst & Young Reports)
           Money Management Executive | 8/17/2009

Because…perhaps you're on the fence and need a third opinion.

The week of August 12 was another strong period for mutual fund sales, as net inflows totaled $15.6 billion. Fixed income continued to dominate with net sales of $11.8 billion between taxable ($9.9B) and municipal ($2.0B) bond funds. Domestic stock flows turned almost flat, with net sales totaling only $318 million.

International equity funds produced net sales in excess of $2 billion for the third consecutive week. Over the last six weeks, international equity products have captured net inflows of $12.3 billion. YTD through July, Emerging Market Equity ($9.2B) and Pacific ex-Japan ($4.4B) were the two top selling international equity categories according to Morningstar.

According to data from MassMutual, retirement plan participants are gradually shifting assets back into equity products. During the second quarter the allocation to equities increased from 35.1% to 38.7%, while the stable value allocation dropped from 36.3% to 31.7%. It is a reasonably subtle shift, but still an important trend, as both the tax status of the plan and the typical long-term investment horizon of a retirement plan participant both favor substantial allocations to equities.

Our analysis of weekly flows has not shown much of a shift in mutual fund sales from fixed income to equity products with the exception of last week. We'll be curious to see if flows into equity products continue to pick up or if fixed income remains dominant.

Check back later this afternoon or tomorrow morning for our weekly net flows analysis.

Investment and brokerage firms ranked 17th of 21 leading industries and received a score of -3 from consumers based upon a recent phone survey by Harris Interactive on client satisfaction. The score of -3 is a 27 point drop compared to last year.  

The survey reinforces the notion that the level of client mistrust certainly isn't isolated; in fact it has become pervasive for the financial services industry. In order to rebuild trust, we have hammered home a couple of points with clients.  

1. Client retention should be a mantra at financial service organizations.
2. And in order to avoid an exodus of clients, firms need to have an absolute focus on client service, which includes a significant up-tick in client touches.

Positioning of portfolio managers is tricky. There have been many instances where portfolio managers are highly marketable, vibrant personalities who are the public face of an organization and/or a fund. Bill Gross comes to mind. There is also the team approach to management, where oftentimes the organization positions the process and philosophy but not the individual managers. American Funds is an example. Is either better or worse? No. But there are certainly risks to both.

The thought of star portfolio managers came to mind following the announcement that Chuck Akre was resigning as sub-advisor of the FBR Focus Fund effective September 22. Akre filed to launch his own fund, the Akre Focus Fund, as he hopes to capitalize on the popularity of the FBR product ($835 million) and is likely anticipating a large percentage of the FBR shareholder base to shift to his fund. FBR has already named his replacements and interestingly enough has hired three members of the analyst team from Akre Asset Management to run the portfolio and become FBR employees.

Some questions to consider:

• How much money will follow Akre to his new fund?
• Many institutional investors are likely to move but will retail investors have blinders on and only focus on the track record of the existing fund, not the portfolio manager who generated those results?
• Does hiring the three analysts from Akre mitigate the loss of Chuck Akre for FBR?
• Will Akre commit to the sales and marketing resources needed to raise money in the retail space?
• Does FBR retain enough assets so that it is a better financial arrangement for the organization? (Internally managed portfolio, as opposed to a sub-advised arrangement)
• Does this become a lose/lose situation for all parties involved, as Akre has lost three analysts, while FBR has lost the primary portfolio manager on its Flagship Fund?

We'll be watching closely.

1)        PIMCO Looks to Add Managers, Expand its Offerings
           The Mutual Fund Wire | 8/12/2009

Because … It’s hard enough competing with PIMCO in the fixed-income space.

2)        33% of household assets held in retirement accounts, ICI reports
           Investment News | 8/11/2009

Because … Not only are retirement assets a substantial component of household investable assets, but in the last decade their share has increased by about 5%, an accelerated growth trend that continues today.

3)        BCG Forecast: Institutions to seek “innovative products” such as HF and PE 
           AllAboutAlpha | 8/10/2009

Because … The convergence of hedge fund and traditional managers is an important trend shaping the industry.

The first week of August marked another solid net flows period for the mutual fund industry, as net sales totaled $18 billion. More importantly, net sales into equity/hybrid products totaled $6.5 billion, which represented the 2nd best week of flows for 2009 and was an increase of 64% from the previous week.

Since July 8th, the S&P 500 has gained more than 14%. During that period, net sales into equity/hybrid products totaled $12.3 billion, although only $2 billion of that went into domestic equity products. The net sales pace in 2009 has been very good; however, Intermediate-Term Bond, Short-Term Bond, and Muni National Short are the top three selling categories and accounted for 61% of industry net flows YTD through July (source: Morningstar). The results of the past three weeks indicate that advisors and investors are beginning to dip their toes back into equity products.

The chart below illustrates what you feel will be the outcome of the ongoing examination of target-date funds. The majority are leaning toward an outcome on the least obtrusive end of the spectrum; a call for increased disclosure and transparency of fund’s investment process, glidepath, etc., while there is a strong contingent of folks who believe that asset allocation ranges (or at least a maximum equity allocation at retirement) is a likely outcome. The likelihood of legislative actions is looked at as remote, and while a few people see an increased opportunity for absolute return funds coming out of the hearings, we think our building mates Putnam may have voted twice.

Predicting regulatory and legislative outcomes is particularly tricky as the motivational and political forces don’t always align with common sense. Still, we think in this case, the alternatives to doing much more than approaching the perceived problems from a disclosure and transparency tactic becomes very problematic to regulators. Despite what we think will be relatively minor regulatory changes, providers should not interpret this as a business as usual outcome. A couple of things to think about:

• Providers of target-date funds will be relied upon to share a greater share of the burden of educating participants about these products. Firms that can deliver their message to gatekeepers, advisers, and participants will have a competitive advantage in the evolving world of target-date distribution.
• Target-date funds, which were looking like the go to as the QDIA solution, will face stiffer competition from managed accounts, customized target-date products, and a variety of ‘balanced-like-funds’ (including absolute return products and principal protected products), as a result of perceived deficiencies following the market correction.

 

 

 

The number 2,996 represents the volume of rep movement in July according to Discovery. About a third of those reps left a wirehouse firm. And amongst the nearly 1,000 wirehouse reps, 72% left the channel, with many going to an independent (18%), regional (16%), or bank (9%) broker/dealer.

The volume of rep movement makes it increasingly difficult for asset managers to segment and focus its distribution relationships. Sales management is going to have to direct behavior through metrics and compensation or wholesalers are likely to take the easiest path of resistance, and that will be focusing on existing personal relationships with financial advisors regardless of their affiliation.

So while one of the fundamental value props of a wholesaler is their network of advisors, we believe sales needs to focus on refining the number of distribution partners and obtaining deep penetration of those systems. The alternative is wide and narrow and we feel that is not a formula for success.

According to data from Jefferies Putnam Lovell, asset management M&A deal value through the first half of 2009 totaled $14.1 billion, up significantly from the $7.7 billion seen in the first half of last year. This is a bit deceiving due to the BlackRock/BGI deal, which if excluded brings 1H09 deal value to just $.6 billion.

With a bit more stability in the market and having asset levels climbed significantly off their lows, the conversion of all the rumors and speculation should increase. Names heard to be interested in acquisitions include: Invesco, Bank of New York Mellon, Franklin, Legg Mason, AMG, Federated, and venture/private equity shops Blackstone, Fortress, and GLG Parnters.  On the other end, acquisition candidates have included Morgan Stanley Asset Management, Janus, Calamos, Pzena, Waddell & Reed, Columbia, and Delaware

1)     Fat Profits May Be History for Asset Managers
        Wall Street and Tech | 8/6/09

Because ... Beyond reduced asset levels, fee pressure coming from a number of angles as well as changes in product mix (passive and fixed income) will compress revenues well into the future.

2)     Downturn Has Changed the Way Most Advisers Do Business, Survey Indicates
        Investment News | 8/5/2009

Because ... Change in the way advisers do business means you need to change how you do business.

3)     Morgan Stanley Smith Barney Finalizing Plans to Unify Brokerages
        On Wall Street | 8/4/2009

Because ... An intimate knowledge of a distributors business is increasingly important for wholesaler success, and the 20,000 rep MSSB is one you are going to want to stay on top of.

Another extraordinary sales week for the mutual fund industry. Net sales totaled $12.5 billion, which is an increase of more than 14% from the prior week. Another 2.8% gain in the S&P 500 during the period contributed to flows, but fixed income products continue to dominate.

The sales in 2009 are reaching historical levels. YTD through July 29, net sales have totaled $167 billion. Fixed income accounted for all of the net flows and then some, as equity and hybrid products have suffered net outflows of more than $10 billion YTD. The best sales year on record was 1997, with net inflows of $272 billion. We do not believe the current sales levels are sustainable for the remainder of 2009, as there is typically a slowdown in flows during the second half of the year.

However, if the industry averages $15 billion per month for the rest of 2009, which is only 1/3 the sales level of recent months, the industry will approach 1993, 1996, 1998, 2006, and 2007 as one of the very best net sales year on record. Two interesting questions:

• Will there be a transition to equity products during the last five months of the year?
• Will there be greater company diversity of flows as well or will PIMCO and Vanguard continue to capture a disproportionate share of sales? Combined, PIMCO and Vanguard have captured $84 billion through June.

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In the last 24 hours we've read about major organizational changes at Merrill Lynch and UBS (as yet unconfirmed by the organization). In addition, the Merrill Lynch/Bank of America and Morgan Stanley/Smith Barney integrations are ongoing. So while we navigate through a challenging economic environment, asset managers also need to traverse organizational changes being made at their distribution partners.

Some things to consider:

• It is more important than ever to strengthen relationships with senior management. Key Accounts, National Sales, and Presidents of Distribution need to increase their visibility with their distribution partners.
• Establish a rapport with the new management team. It is very likely that a new senior manaement team is going to make changes to their direct reports, so you may need to reestablish yourself within the system if the role of your current contact changes. 
• Focus on service. Any near-term service shortcomings are going to impact your relationship with the new management team.
• Be proactive. Don't wait to illustrate your value within the system.  

A recent survey conducted by Charles Schwab of 602 mutual fund investors found that only 39% had rebalanced their portfolios in the last 12 months. Some other interesting stats from the survey: 31% indicated they speak with their advisor on a regular basis and 36% indicated they do not know which mutual funds they own.

We've spoken about proactive client contacts over and over again. And this survey indicates to us that there still is a lack of client contacts from the financial services industry, be it advisors or institutions.

As a part of the client outreach, it is very important for advisors and institutions to assess the current financial situation of their clients (post crisis). Again, the survey indicates these reassements are not occuring as often as they should be or a greater percentage of clients would have undertaken some level of portfolio rebalancing.

The table below shows the breakdown in mutual fund AUM by broad asset class as of June 2009 and June 2008. The combination of outflows and depreciation from equity products over the last 12 months has led to a nearly 8% shift from equity to fixed income products. For some this shift within their portfolio may make sense but for many it will not.

Therefore, the impetus is on both financial institutions and advisors to address their existing client needs. The alternative is a declining client base. 

The Journal ran an article today about the growth of mutual funds using hedge strategies (click here for the article). Of the 132 hedge-like mutual funds, nearly half have been launched since 2006 according to Morningstar. Historically, results have been mixed at best for mutual funds that employ hedge strategies. Many have not delivered as promised, while others have been improperly positioned/marketed.  

There is a place for hedge-like mutual funds but here are some thoughts to consider:

• Market these products properly. There is clearly a place for hedge strategies within the portfolio construction process. We believe research groups, HNW advisors, and packaged products like lifecycle funds will hedge a portion of their portfolio, so segmentation will be a key to finding opportunities for your hedge-like mutual fund.
• A commitment to training and education is a must. Support and messaging at the home office, research group, and financial consultant levels need to be consistent. Therefore, wholesalers, research support, and key accounts must be versed in the product.
• Don't launch a hedge-like mutual fund if it is not a core competency. Under delivering with this type of strategy has the potential to impact the overall brand of the organization, so the downside may be too great if your firm is trying to manufacture a hedge-like fund instead of leveraging an institutional capability.

As we anticipated, net sales were once again positive during the week of July 22. The makeup of the sales favored fixed income and international equity products, while domestic equity funds were only modestly positive. Net inflows totaled $11 billion during the week, which represented the strongest net sales since the week of June 17. Taxable bond continue to dominate with a net intake of $6.5 billion. International equity followed with net sales of $1.9 billion, which marked the third consecutive week (and six of eight) of net sales in excess of $1 billion.

We were mildly surprised that domestic equity did not capture a greater share of net sales during the week, as performance during the prior week was highly positive (5%). We have been using the trailing week performance as a leading indicator of flows into domestic equity products and positive performance has consistently correlated with a positive net sales environment. Last week, there was once again a correlation although the uptick in equity flows lagged the gain in the S&P 500. Next week should be a better period for domestic equity flows, as the core indices have been consistently up, despite some mixed sentiment from both consumers and advisors.

We continue to see money moving out of retail money market products and we believe much of these dollars are going into both fixed income and equity products. Over the last 18 weeks, $159 billion has moved out of retail money market funds and during that same period $189 billion has moved into long-term funds. Clearly, money is being shifted in chunks and dollar-cost-averaged from money market products into long-term vehicles.

Claymore announced a change to its Great Companies Large-Cap Growth Index ETF. Was it a shift to Large Cap Core strategy? No. How about All-Cap Growth? No. Instead Claymore has reengineered its Great Companies Large Cap Growth Index ETF into the Claymore/BNY Mellon International Small Cap Select LDR ETF. Claymore indicated the new strategy "expands our offering into an opportune space for long-term growth oriented investors: international small cap companies."

It is highly unusual for a firm to reengineer a fund into a completely different strategy, shifting both the market cap (Large Cap to Small Cap), as well as the regional focus (predominantly Domestic Equity to International Equity) of the product. So, while there are extenuating circumstances for this product shift, which include a very small asset base (~$3.8 million) and a willingness by Claymore to drop the management fee by 20 bps, we are more than a bit surprised the move received board approval.

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We are receiving some mixed messages from the marketplace regarding the stability of the economy.

• Consumer Confidence Index dropped from 49.3 in June to 46.6 in July, as job worries drove down the confidence measure.
• The Advisor Confidence Index, published by Rydex SGI, declined nearly 8% in July. The six-month outlook of advisors on the economy was primarily responsible for downward movement of the index.
• The Case Shiller Index of home prices rose 0.5% in May, the first monthly increase in 34 months.

The economy has made some positive moves, which have been reflected in both the equity markets and the sales environment for investment products. However, it is clear that near-term outlook remains mixed.

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Earnings reports over the last few weeks illustrate an improving environment for asset managers. We are consistently reading about organizations that are beating analyst expectations, as firms are being buoyed by surging equity markets and an improved sales environment. Some notes from the past several weeks:

• T. Rowe Price reported 2Q09 profits of $100 million or 38 cents per share, which topped analyst expectations of 34 cents per share.
• Invesco reported profits of $76 million or 18 cents per share, which beat expectations by 2 cents per share.
• Eaton Vance reported 2nd quarter earnings of 22 cents per share, which was also better than expectations (21 cents per share).
• And BlackRock, Janus, and Legg Mason all beat street expectations during the 2Q09.

So while we continue to lag the previously lofty financial results, organizations have in large part turned the corner and we anticipate further business gains in the quarters to come.

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1)     17 Percent of Plan Sponsors to Seek Out Index Funds

        On Wall Street | 7/21/2009
 

Because … Whether it is through increased allocations to ETFs in advisor’s portfolios, or more index products within DC plans, the growing use of passive management for most firms represents a business threat.

 

2)    Due to Strong Sales, MFS Plans to Add Analysts, Salespeople

       Money Management Executive | 7/22/2009

Because … Perhaps this represents a turning point for more than just MFS following a tremendously difficult period for the industry.

 

3)    Tax Changes Urged for Mutual Funds

       The Wall Street Journal | 7/21/2009
 

Because … While this is currently just words on paper, they represent significant growth and profitability opportunities for the U.S. fund industry.

Long-term funds captured net inflows of $6.6 billion, which marked the 18th consecutive week of positive flows for the industry. Four of the five broad categories produced positive sales results, while domestic equity sustained net redemptions of $2 billion. Once again, the prior week performance correlated to domestic equity sales momentum, as the S&P 500 dropped nearly 5% for the seven days ending July 8th and net redemptions for the proceeding week were $1.98 billion. Net sales into foreign equity products were $1.04 billion, while taxable and municipal bonds funds produced net sales of $6.06 billion and $1.46 billion, respectively. 

During the past two weeks the S&P 500 has gained nearly 8.5%. If recent trends hold, the move up in the domestic market is very likely to result in positive domestic equity flows over the next two weeks.  

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MFS announced today that Sun Life has committed $50 million for incremental staffing within MFS. Investment management and sales/relationship management are two of the functional areas receiving additional resources.

The news of an organization committing $50 million in capital for incremental staffing is a seismic shift within the industry. While most organizations have completed their internal assessment and adjusted staffing levels down in response to the recession; very few have since taken an aggressive approach to adding resources.

As firms do obtain incremental resources for staffing, here are some of our thoughts:

• Firms should be constantly measuring the impact of both individual staff and functional areas to determine ROI of the different business units (and sub-units).
• Incremental resources are going to be scarce, so a detailed business plan should be in place in order for a functional area to capture additional resources.
• Don't immediately allocate resources to functions that were previously downsized. Utilize metrics to allocate new staff.
• When trying new strategies, implement small-scale pilot programs to measure the potential business impact. The ability to illustrate some success with actual numbers will resonate with senior management, as you go through the budget/planning process for future allocations. In addition, there is far less business risk with a pilot program.

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The number 1,060 is where Goldman Sachs is predicting the S&P 500 will close 2009. It is a 15% increase from June 30 and would represent the best second half perfromance in more than 25 years. In addition, it would return the index back to October 2008 levels.

A bullish equity market would greatly accelerate money sitting in cash or cash-like vehicles back into equity products. We have seen consistent dollars flow from money market funds into fixed income products over the last 20 weeks. Over that period positive dollars have flowed into equity products but it appears much of that money is a reaction to near-term market results, as there is a correlation of inflows versus outflows and market conditions. A sustained period of positive performance will likely mitigate investor uncertainty, which would lead to a consistent period of postive flows for equity funds.

We are still a long way from returning to past AUM and revenue levels, as if Goldman is right about the direction of the S&P 500, the index would still be nearly 500 points behind its peak level of June to October 2007. But, market conditions do appear to be moving in our favor.

Whether from a financial engineering perspective, or simply a marketing angle, we hear a lot of discussion on the failing’s of asset allocation, or more precisely, the failings of someone else’s version of asset allocation. These are similar discussions to what we heard after the tech-bubble burst, while then it was a “lack of diversification” and now it is a “lack of proper diversification.” The result of the discussions last time was tremendous growth of asset allocation funds and other managed allocation portfolios, and the massive growth of international equity, REIT, and natural resources (some would say performance chasing disguised as an effort to diversify). This time around, there is the chance that some equally transformational trends take hold as a result of these discussions.

1. In terms of ownership of process, we have seen and heard evidence of advisors taking back control from the home office as in the case of full service B/D’s as well as RIAs moving portfolio construction duties in-house away from previously outsourced consultants or strategic asset allocation specialists. We believe that these trends will be relatively short-term in nature as the challenges associated with the asset allocation and due diligence processes will push a large segment of advisors to seek to completely outsource these functions over the longer term.
2. From a product perspective we expect a few trends to develop or accelerate. First, we expect a lasting effect on allocations to true diversifiers (stocks/bonds/cash) and a pull back from ‘diversification light’ (US Equity, International Equity, etc). Secondly, increased usage of core & explore and tactical asset allocation models, will facilitate a greater demand for both unconstrained funds as well as alternative strategies.

For asset managers, product knowledge strength in the sales and marketing areas is a powerful driver toward taking advantage of both the opportunistic short-term trends as well as aligning sales and service models for strategic long-term growth.

1) Columbia Sale May Complete in Days
    Mutual Fund Wire | 7/17/2009

Because ... it is another large transaction within the asset management space and we believe a precursur to more deals.

2) What's So Absolute about Absolute Return Funds
    Morningstar.com | 7/14/2009

Because ... it is a fairly scathing article about the inability of absolute return funds to perform as planned.

3) Advisers Rethinking Traditional Asset Allocation
    Money Management Executive | 7/14/2009

Because ... you need to know how advisors, consultants, and research groups are constructing portfolios in order to properly position your products as a part of those solutions.

Coming off of a week of solid upward movement for the S&P 500, net sales of equity products were once again positive with a net intake of $3.5 billion. Over the past five weeks, net sales of equity products have been highly correlated to the performance of the prior week. It is too short a time period to believe the trend is highly predictive, but it does illustrate how sensitive investors are to market conditions. Our guess is the correlation trend will continue, as a 5% drop in the S&P 500 is likely to result in a pullback in equity sales.
 

A recent run of underperformance has led to some press coverage of the CGM Focus Fund. The fund produced extraordinary results between 2000 and 2007; however, it badly underperformed in 2008 and continues to slump in '09. Compounding the issue, $2.6 billion was invested in the fund in 2008, which means a substantial percentage of shareholders participated only in the downside of the strategy.

So what is a firm to do? Despite being painful and difficult, we firmly believe in maintaining a consistent process and message. From a sales and marketing perspective, the firm needs to aggressively stay in front of clients and reinforce why the investment process works. For a fund like CGM Focus, it is inevitably going to produce periods of both excess performance (7400 bps above the S&P for 2007) and under performance (1100 bps below for 2008); but over the long term the process will deliver high levels of alpha.

When organizations run away from under performance or move to reengineer a fund too quickly, it can negatively impact the credibility and image of both the organization and the sales force. Therefore, firms need to proactively address the issue and stand behind an investment process they believe will deliver for clients.

MainStay has reached an agreement to adopt four funds from Epoch Investment Partners. In large part it is a typical fund adoption with a couple of notable exceptions including:

• It is atypical for a firm to "adopt out" funds with $750M in AUM.
• MainStay is also taking on the separate account distribution responsibilities for Epoch.

Of greater interest is the fact that adoption took place at all. Fund adoptions had slowed to a crawl, as those funds with good track records and a lack of scale were aggressively targeted and acquired. However, recent market conditions have resulted in a significant despreciation of assets and asset managers continue to navigate a challenging sales enviroment. Both of these factors will lead to the next phase of firms that must decide whether to continue their fund businesses or look to exit it through acquisition.

For example, there are currently 325 funds with 3- and 5-year relative performance in the top third of their respective category, but manage less than $75M. And while many of these funds are not adoption candidates, that is a significant volume of funds that lack critical scale yet have a highly saleable track record.

One of the challenges facing asset management organizations today is institutional uncertainty. We have heard rumor after rumor about senior management changes, organizations for sale, and reorgs at firms. A recent Ignites article included a survey by KPMG, in which 65% of investment executives indicated that senior management lacked vision. That number jumped to 90% among US respondents. While both numbers seem high, particularly the US number, it is an indictment of the lack of innovation within our industry but also a lack of communication.

It is imperative that firms obtain strategy buy-in across the organization or execution will fall flat. One of the biggest mistakes that asset managers can make when working with a distributor is when a firm “goes into hiding" following a negative event at the organization (i.e. performance issue, PM turnover, etc.). Well, the same can be said internally when an asset manager experiences a highly challenging environment, like the one we have experienced for the last 12 months, and changes need to be made (or are made) but the flow of information is closed.

Today it is more important than ever for senior management to focus on open lines of communication to both their internal and external constituencies, as this will help minimize any institutional uncertainty.

1) Less Than Half of Adults Think Financial Services Firms Put Investors First
    Money Management Executive | 7/7/2009

Because ... Trust is the biggest driver of share of wallet, and while most providers think they are trustworthy, this research as well as our own show clearly that investors have doubts.

2) Russell Seeks to Launch ETFs
    IndexUniverse | 7/9/2009

Because ... The next generation of ETF providers are not niche startups and it's time to figure out if the market is an opportunity or a misadventure for you.

3) Lower Profits, More Mergers Seen for Mutual-fund Firms
    MarketWatch | 7/9/2009

Because ... Whether or not our industry has truly been permanently transformed or not, there are a number of long term issues stemming from the credit crisis and working toward understanding them is important in taking tactical and strategic actions to get back on track.

Net sales were highly positive during the week ending July 1; however, equity products suffered modest net outflows for the second consecutive week. The net redemptions from equity products followed two consecutive weeks of negative returns (-3.0%, -1.1%). Since the S&P 500 peaked in 2009 (946 on June 12), the market has dropped nearly 7%. This does not bode well for near-term flows of equity funds, as investors appear to be hypersensitive to market conditions.

As a follow up to our blog yesterday on potential job changers post recession, we thought we would revisit a survey we conducted on how job attrition would impact different functions at asset managers. The chart below illustrates which business functions you felt would be most affected by staff reductions. There were two standouts: product/marketing and sales. As a general rule, the survey results coincide with what has happened in the last nine to 12 months. However, while firms have realigned their headcount to coincide with revenue numbers, functional responsiblities have either stayed the same or potentially increased. Therefore, the strain on existing staff has grown. 

As of today, most firms have completed the internal review of their operations and have turned their focus on growing their business. This will eventually lead to hiring incremental staff, as the business environment improves. We feel that firms should take this opportunity to assess their organization and resource allocation, as there are opportunities to gain efficiencies and obtain a greater ROI on their sales and marketing outlays.

A recent survey by Adecco Group in the Atlanta Journal Constitution had some very interesting statistics about the impact of the economy on employee retention and retirement.

• 54% of US workers said they are likely to look for a job once the economy rebounds
• Nearly three in four of the youngest workers (ages 18-29) are likely to job hunt when the recession ends
• 44% of workers older than 60 have been forced to delay their retirement
• About 20% of Americans say they are saving money in case of a layoff

Our industry has been one of the hardest hit by the recession. Universally, there has been attrition in headcount and many retained employees are constantly concerned about the stability of their job. Salaries, bonuses, and commissions are all down compared to previous years. Many of the statistics that are quoted from the Adecco study are likely to translate to our industry.

Therefore, it is important for senior management to maintain their commitment to employee development. We believe training and education is an invaluable tool for building employee loyalty. This commitment will also resonate externally, as the firm's image and identity will take on the personality and culture of its staff.  

Today's Journal had an article (click here for the article) on investors pouring money into both ends of the risk spectrum - core bonds and "high octane vehicles like emerging market companies, commodities, and junk bonds." A look at the top ten selling categories through May illustrates the author's point, as six core bond categories ranked in the top 10, while High Yield, Emerging Market Equity, and Natural Resource products are also amongst the ten best sellers.

However, dig a little further and we see the great majority of money flowing into an isolated group of managers and categories. Intermediate-Term Bond funds have captured net inflows of $41 billion, which more than tripled the #2 ranked category (Short-Term Bond). Of the $100B in net inflows for 2009, Intermediate-Term Bond and Short-Term Bond accounted for 55% of net sales. At the firm level, Vanguard and PIMCO accounted for 66% of net sales through May.

Overall, we are seeing some dollars transitioning into higher risk categories; however, in large part money is flowing out of cash and into conservative fixed income products. We do anticipate the market share of equity flows to pick up, but we are at least months away from high alpha vehicles outselling core fixed income.

Following a two week drop in the equity markets of nearly 5%, sales of equity and hybrid funds have once again turned negative with $611 million in net outflows. Sales of fixed income products were solid, but the $3.3 billion dollar net intake represented a 15-week low. Despite the dip in long-term flows, retail money market funds assets were down another $6 billion during the week of June 24. Overall, the sales environment has stabilized; although there is still some sensitivity to near-term market results.

There is talk today about the lukewarm bids that Bank of America has received for Columbia. There are many challenges associated with M&A activity in the asset management space because of the unique nature of the business. Integration is difficult, and at an organization like Columbia, it is even more complicated because the firm itself has undertaken multiple acquisitions throughout the years. According to Jeffries Putnam Lovell, transactions were down by more than a third in the first quarter compared to 1Q08, with divestitures accounting for 51% of the transactions in 1Q09.

We do believe transactions can work; but here are some questions to consider:

1. Deal Structure/Cultural Fit - will integration be possible or will the new organization be complementary and need to maintain its independence? Also, what are the ultimate goals of the acquiree - do they want to stay in the business or is this purely a strategy to monetize their company? Often the value of the organization is in the senior management and a lot of equity, institutional knowledge, and relationships will walk out the door with the senior management team. 
2. Fundamental Value Proposition - as a general rule firms are acquiring a revenue stream via AUM and investment management capabilities via a defined, repeatable investment process. Do these processes and capabilities fit with the near- and more importantly long-term strategy of the acquiring firm? It is imperative that product and sales be in synch; therefore, the new firm's capabilities must fit your distribution strategy.
3. Secondary Value Proposition - outside of asset management capabilities and AUM, are there sales, marketing, operational capabilities, etc. that can be leveraged and potentially provide economies of scale? For a new entrant in the space, the secondary value prop may be as important as the investment management piece.

According to a survey by PricewaterhouseCoopers of 238 wealth managers, client attrition was between 6% and 10% during 1Q09. We anticipated significant client movement amongst the advisor ranks and the survey reinforces this notion. We are in the process of recovering from a prolonged bear market, which did not spare any equity asset class. And the bear market has resulted in many clients reassessing their financial situation and potentially making major lifestyle changes.

Our research indicates that near retirees begin to assess their financial needs in retirement following a life event, which may be as simple as a birthday or as impactful as a death or illness. What typically follows is a consolidation of providers. We believe the recent market was a life event for a large percentage of investors including the core workforce, pre-retirees, and retirees; and those relationships which are lacking in trust or service are likely to be lost to another provider.

Seems about right. Unfortunately, it will not result in any more money being returned to the victims of the Madoff scandal, many of whom had invested their entire life savings either directly or indirectly with him. From an industry perspective, it is imperative for client service personnel - advisors, call centers, internal reps, etc. - to be prepared to answer questions about the integrity of their business. Firms need to proactively promote their organizational principles and values, because the industry has been marred with a series of transgressions in the past decade.

Trust is an overriding factor in capturing and retaining client assets. Our research indicates that those individuals and/or firms with the highest level of trust capture as much as 20 percentage points more in wallet share compared to those with just average trust ratings.

Now more than ever, clients are going to question their investment relationships. Many have seen their asset base drop by more than a third and the industry has been hit with a series of negative pieces - Madoff, performance of target date funds, Stanford Financial to name three - therefore, trust has been shaken to its core. Increased client contacts through multiple touch points (phone, email, web, in-person) should be a strategy of every firm in the next 18 months.

1.)    Survey: Ranks of the Rich Thinned in 2008
        Investment News - 6/24/2009

Because ... the number of high-net-worth individuals in the United States with net assets of at least $1 million, excluding their primary residence, fell 18.5% in 2008 to 2.5 million, from 3 million in 2007, according to the annual World Wealth Report. Click here for the report. Clients of our Market Intelligence Platform will see the report in our synthesis of HNW and other topics.


2.)    Institutional Managers Coming Cautiously Back to Equities
        Plan Sponsor - 6/19/2009

Because ... institutional trends are usually a good leading indicator for the retail space.


3.)    Big Apple Shop Converts HF to Mutual Fund
        Fund Action - 6/22/2009

Because ... you should know Bull Path Capital Management is about to convert one of its long/short hedge funds into a long/short equity mutual fund.

The mutual fund industry continues to see movements from cash into long-term products. While fixed income has captured the majority of the money, equity products have also experienced solid net flows. In the past 14 weeks, net flows into equity products have totaled nearly $50 billion. In addition, in nine of those 14 weekly periods, net sales of equity/hybrid funds have exceeded $3B.

During that same period fixed income funds captured in excess of $100B in net sales. Therefore, two out of every three dollar is being allocated to bonds. We anticipate greater balance between fixed and equity products as the weeks proceed due to increased confidence in the equity markets and a concerted by advisors and research groups to reallocate large cash positions back into equity strategies.

 

Merrill Lynch and Capgemini released their annual World Weath Report (2009) and as would be expected the numbers are jarring. Wealth declined to 2005 levels, as the number of HNW investors ($1 million in investable assets excluding primary home) fell by nearly 15% and the ultra-HNW ($30 million plus) dropped by nearly 25%. What is clear is that those in the top one percent of wealth were not immune to the global economic conditions despite being privvy to the most sophisticated financial advice and investment solutions. The chart from our Retirement Income study (click here for more info) below segements investable assets using public sources and our projections (FUSE and Mast Hill Consulting) predict it will take years to return to mid 2008 levels. 

According to Lipper 208 funds have been eliminated in 2009, which is well ahead of 2008 when 282 funds were either merged into another product or liquidated. We anticipate the pace of fund mergers/liquidations to pick up over the next several years as firms eliminate products which are unprofitable, non-core to the organization, or are redundant to another fund in the lineup. According to Morningstar there are currently 7,700 mutual fund portfolios. Some stats to consider:

• 771 funds have less than $10 million in AUM
• 394 funds have less than $10 million in AUM and a 3-year track record
• 1,483 funds have less than $50 million in AUM and a 3-year track record

 
It is very difficult to create and market unique products, as the industry is satiated with product strategies. Firms need to deliver their core capabilities and provide meaningful value to their distribution partners. If strategies are not doing this, organizations need to understand the potential implications to the overall brand of the firm. We believe fund eliminations will significantly outpace product creations as we move forward.

We've seen reports that indicate that passive investing and/or the growth of ETFs will subside as the economy stabilizes. That bear market demand for ETFs must be separated from a fundamental shift in tastes. We firmly believe that there has been a transformation in portfolio construction at the retail level, which includes a greater allocation to passive strategies. ETFs have been the beneficiary of this shift. In addition, we believe this transition is not temporary and is likely to accelerate over the next decade.

Advisors and research groups have become increasingly sensitive to fees. They have increased their allocation to passive strategies in a defensive measure in order bring down the overall cost of the portfolio without compromising their fee levels. In addition, asset classes which offer greater market efficiencies and are therefore more difficult to achieve alpha will receive greater allocations to passive strategies. It is not purely altruistic motivations that are driving this shift; instead it is a combination of a true belief in a core/satellite approach and a defensive strategy to maintain the advisory fees of the distributor.

1) Obama's Financial Reform Plan: The Condensed Version
    The Wall Street Journal - 6/17/2009

Because...a "sweeping overhaul of the financial regulatory system" is going to affect us all, but few among us will read all 89 pages.

2) Frustrated by Losses, Americans Re-Assess Advisors
    Bank Investment Consultant - 6/17/2009

Because...23% of American investors considering changing firms or advisors is a big number and you will be tasked with 1) staunchly attempting to hold onto what you have, and 2) aggressively acquiring new business.

3) Mutual Funds Rake in Cash for 13th Straight Week
    Money Management Executive - 6/18/2009

Because...it's the weekend and it should be approached with a positive mental attitude!

Thirteen weeks and counting. During that period, $139 billion dollars has gone into equity and fixed income mutual funds, while $124 billion has flowed out of retail money market funds. We believe, in large part, the movement out of the retail cash products has directly contributed to the flows into long-term funds. Another encouraging sign for the industry has been the uptick in equity flows over the past two weeks. Net sales into equity funds (domestic, international, and hybrid) exceeded $5 billion in each of the past two weeks.

Barring a steep drop in the market or a highly negative reaction to the potential financial reforms, we think the industry has turned the corner and long-term sales will continue to accelerate. 

We are constantly probing our clients and industry experts for their thoughts on different trends in the industry. Our recent survey asked about the percentage of intermediary sales that will be derived through models. About two-thirds of the respondents felt that in five years models would account for 50% or more of intermediary sales. We are firmly in the camp of the majority because: 

• Distributors want consistency in portfolio construction, manager selection, and risk-profiling and the only way to obtain this is through models built by research groups
• Many advisors are focusing their efforts on non-investment services particularly for their HNW clients
• Distributors continue to build out their research capabilities in order to recruit reps from competitors

Near-term, we have seen some movement away from models. Some advisors have taken back the investment decision process from the research group, but we think this is in large part due to the economy and it is not a long term trend.

For asset managers, the growth in models should lead to a change in sales strategy. A scaled effort at the home office/research group of distributors with CFA-quality client service personnel will provide significant value to an organization. We also believe firms need to target research groups at bank trust departments and within a large team at a wire or an indepenent RIA. In order to do this, firms need to commit to training their sales personnel on the investment philosophy and process of their organization. The next generation of wholesaler needs to be deep in the organization's investment philosophy and investment process is going to be at the core of most sales and marketing activities.

An interesting article today in the WSJ Blogs (link here) discusses the disconnect between advisors and their HNW clients. The article noted that 80% of advisors feel they are doing a good or very good job amid the financial crisis for their clients, while only 30% of their clients agree and another 30% actually feel they are doing a poor or very poor job. For us, the satisfaction with handling the financial crisis in many ways is a secondary factor for how financial advisor should manage a HNW client relationships. The needs of the ultra wealthy go far beyond managing an investment portfolio. Advisors who help their clients with issues like:

• Security services
• Art collections
• Automobile collections
• Estate needs and planning
• Emergency services
• Travel needs

will build so much goodwill that in many ways the success of their investment portfolio will become ancillary in all but the worst conditions. It is a service business and advisors that embrace the needs of their client will build goodwill, trust, and ultimately incremental wallet share.

$2.7 trillion is the combined AUM of BlackRock and BGI. It will be the largest asset management organization in the world once the transaction closes. It has been estimated that more than $500 billion of the assets are retail in nature including about half of iShare's $300 billion in AUM. A number of questions come to mind following the announcement:

1. How complicated will the integration process be? (our guess, highly)
2. Are the product capabilities complementary? (on the surface, it seems like they are)
3. Will this afford BlackRock further penetration in the Merrill Lynch system? (remains to be seen)
4. How will the passive, quantitative, and active strategies be packaged? (remains to be seen)

Overall, the BlackRock/BGI combined entity will have huge scale advantages over all but a handful of competitors. We believe it will be a long and complicated integration process; but once it gains momentum, the combined organization will be amongst the most powerful asset managers in the world.

Once again we had positive week of flows. Fixed income products continue to account for the majority of net sales, but we did see an uptick in equity flows over the previous week. Coinciding with the positive momentum is a continued upward movement in the equity markets. Industry sentiment is improving due to an increase in consumer confidence. As a result, we believe advisors will start to rebalance client portfolios away from cash into equity products in the next six to 12 months, which will further boost momentum.

 

While the attention to fixed income investing has brought bond funds into the spotlight, it doesn’t take us long to find problems fund firms should address when presenting fund information.

 

A big issue is how to maintain web content consistency. As an example, we researched a fund and it is described in the Overview section as an investment targeting the 10 to 15 year maturity range; the Morningstar Style Box indicates the fund actually falls into the intermediate duration group. Furthermore, a quick check of the portfolio statistics reveals that the fund had almost half of its holdings in short term issues and less than 10% in long term issues. When we dug deeper into portfolio holdings, we also found many bond funds have recently loaded up on mortgage-backed securities even though they normally do not intend to invest heavily in this sector. While a fund manager can have the leeway to deviate from the stated strategy of the fund, an inconsistent message can severely challenge the sales process. For firms with less experience marketing fixed income products, an effective fix can be as simple as gaininga better understanding of the process ‘market-data-vendors’ utilize for collecting fixed income portfolio characteristics, which is much different than the process for equity products.

 

The inconsistency even exists within the same marketing documents. For example, a bond fund fact sheet shows the portfolio’s Morningstar Intermediate-Term category along with the Short-Term style box. Duration is one of the most important measures of a bond portfolio.

The problem with conflicting information seems widespread regardless of firm size. We suggest product managers conduct a thorough cross-check of their various marketing materials to make sure a fund is consistently presented. If any deviation is allowed, disclosures to clarify the divergence should be placed in a prominent position so that investors are not confused. More importantly, accurate information needs to get into the hands of the sales team, advisors, and due diligence teams.

Jing

The mutual fund industry has seen nearly $100 billion flow back into long-term funds over the past nine weeks. In the past two weeks (ended 5/13/2009), more than $30 billion dollars has flowed into long-term funds, including nearly $10 billion into equity products. Does this mean we have turned the corner? We believe the industry is poised for some sustained positive momentum. The S&P 500 bottomed-out on March 9th at 676 and it closed today just over 900, which represents price appreciation of nearly 34%. Investors have consistently seen positive movements in the market over the past 10 weeks, which has led to small pockets of money flowing back into equities. Safety continues to drive the bulk of flows into fixed income products; however, we anticipate an increased share of flows going into equity products, as advisors/research groups look to rebalance portfolios. There continues to be an uncertain sentiment hovering over the global economy, which is going to impact the pace at which money flows back into equity-oriented products, but we believe the worst is behind us.

Source: Investment Company Institute

Cash is taking a bigger role in household investable assets on two fronts. Short-term, and most prominently, we have seen a rapid flight to cash as a place to hide from the risks of the equity markets. To this end, money market fund assets held by U.S. households hit $1.5T at year end, a 17% increase over the 12 month period. This represents a 2% increase in the total household allocation to money market mutual funds from 4.2% to 6.2% of investable assets. Still, the temporary nature that many of these assets represents can be seen in the fact that while household money flowed to funds, their bank equivalents - money market deposit accounts - were relatively flat during 2008 experiencing about a 1.5% increase in assets. Longer term, household’s allocation to cash products has been growing slowly, but steadily, climbing above 20% at the end of 2007 and pushing 30% today reflecting the depreciation of equity. Even with low returns on cash and a more stable equity market, many are predicting investors will remember the pain of 4Q08 for a long time, and that allocations will remain over-weighted (relative to pre-crash levels) to cash and fixed-income products for an extended period. The macro implication is negative for manufacturers of equity products. Mitigating this somewhat, our analysis indicates that over 50% of this lowering of equity allocations will manifest itself in the form of decreased holdings of individual stocks. Still, it seems likely that when cash does start to move, the intermediate capital structure products (municipal bonds, limited- and intermediate-term fixed income look to be the winners in the short term.

Sam

We've long heard the arguments of active versus passive. Recently Standard & Poors published a report on the inability of active managers to outperform their benchmarks. And the percentage of underperforming products is fairly staggering; however, market cycles can affect the level of underperformance in these types of studies (although typically passive wins). This inability of active management to deliver is one of a number of factors that has led to passive products capturing incremental market share in the retail space. Two examples of increased usage are:

• Advisors utilizing passive products for a beta play, but to also lower the overall cost of the portfolio as a defensive measure in order to maintain their fees 
• Manager research teams increasingly implementing passive products in the portfolio construction process - particularly in a UMA-like environment.

So what is the meaning to active managers? We believe that those managers with sound investment processes, which produce meaningful alpha will always be in demand and have the ability to command a premium in the market. Those managers who are largely beta plays in a core category like large cap will not capture premium pricing and are likely to be unseated by passive strategies or low cost, low tracking enhanced products (i.e. quant). Packaged products like lifecycle are also going to increasingly utilize passive strategies because of increased fee pressure.

Therefore, long-term asset managers need to (1) refine their product offering to suit their distribution strategy and the demands of the marketplace, (2) adjust their fees as need be to be competitive, and (3) be able to articulate their value proposition as a manufacturer - and investment process will be at the foundation of that value prop.

Mike

Market instability continues to restrain sales of equity products. The near-term momentum of January was quickly overcome in February and the first two weeks of March, as more than $40B flowed out of equity products. However, the S&P 500 gained more than 10% between March 11 and March 18. Only one week later, weekly net flows of domestic equity products topped $2.6B. This was followed by weekly net intakes of $2.9B and $2.8B into domestic equity funds. Will this momentum continue?

Doubtful, as we've seen a move of nearly 30% up in the S&P 500 since the market bottomed out; yet we still see quick shifts of money in and out of the equity funds during that period, as advisors/investors react to near term market moves. The instability in the sales environment will continue, as there is still significant skepticism around the soundness of the global economies. 

Mike



 Source: Invesment Company Institute

There has been a lot of attention recently placed on social networking, websites, Web 2.0 technologies, and the generally low incidence of asset managers embracing these tools. As I have picked up anecdotes in conversation, it seems to me that these generalizations may be similar to the typical observations around advice offerings within DC plans. The statement goes something like “only 20% of participants access advice tools where they are available,” but in reality, it’s the solution that’s the problem, not the delivery of the solution. And if analyzed a bit deeper, it turns out that advice is reaching a high percentage of participants for whom advice tools are a viable solution, and further, it’s contributing to a positive outcome. The point from my perspective is that many firms are exploring and executing on a wide range of these activities, but that it’s focused on narrow and often unique processes/challenges/behaviors and thus not as easily identifiable. Further, I think the thesis that broad and rapid adoption by asset managers could reshape the competitive landscape is a bit dramatic. That being said, I do think there is something to the deaf-ears argument in that a heavily regulated industry and a high level of financial comfort with business-as-usual policies certainly doesn’t encourage asset managers to be early adopters in this space even in the face of valid arguments to the contrary.

Sam

We just met Jeff Margolis and felt an immediate connection given (1) his years of practical experience in distribution and (2) his views on what it will take to gain / sustain a competitive advantage…

Investment management firms are experiencing a period of upheaval and unprecedented events which are putting tremendous strains on their ability to operate successfully and profitably. This environment is putting a premium on efficient and effective execution. More firms fail from poor execution than from improper strategy and planning. The main cause for this poor execution is lack of involvement and ownership by senior management.

In order for investment firms to be successful, particularly in this challenging environment, they must link strategy and planning with execution in a continuous rather than linear process. Management must operate in the trenches with staff to understand execution hurdles each day. They will then be able to react in real time to adjust plans accordingly and quickly overcome hurdles. Integrated and communicative firms with strong cultures, rather than hierarchical and bureaucratic firms, typically operate in this way.

Jeffrey Margolis / www.margolisadvisory.com

Target-date funds, once hailed as being a major contributor to the improvement of the U.S. defined contribution market, have been getting drubbed in the media as well as in some regulatory circles for having failed miserably to deliver on their promises.  While the market correction may have pointed out some stark contrasts among providers, as well as highlighted some issues manufactures can work toward addressing, when taken in whole it serves to strongly suggest that as a product concept, target-date funds are indeed part of the solution.

A few things to consider: Pre-crash, according to Boston College’s Center for Retirement Research (CRR), the average 55-64 year old held $78k in 401(k) and IRA balances , which translates to around $56k  today, quite a hit. However, that same person should have balances totaling $230k post-correction based on CRR’s simulation. While components such as participation in a plan and the deferral level at which people participate account for some of this shortfall, poor investment decisions are also a key factor; something target-date products solve.

On the other hand, there is the argument that target-date funds exposed investors to too much equity risk, with the average 2010 fund experiencing a -26.2% return for the six month period ending February 28th and holding an average of 44% in equities. According to the ICI/EBRI, only in DC plans that offer stable value products and do not contain company stock (23% of DC assets) do we find an average equity allocation for participants in their 60’s that is lower than the equivalent target-date product. For all other combinations, equity allocations are in the low 50%’s for 60 year olds. Numbers from Vanguard (YE 2007) go even further showing that participants from 55-64 on average hold 67% equity (Average target-date equivalent equity exposure of 44% - 59%).

This is not to say there are not improvements to be made, but all else being equal, DC participants would be better off today if target-date funds had represented 60%-70% of DC assets opposed to the 6%-7% of DC assets (even less of older participants) pre-crash.

Sam

There has been significant criticism of the asset management industry during the recent economic crisis. People have questioned the suitability of lifecycle funds, asset allocation, fees, pricing, portfolio construction, and even the long-term viability of mutual funds. I've seen a report that indicates that the numbers of funds could drop by as much as 70% because investors were burned during the market decline and money will transition into other, more suitable vehicles like stable value, annuities, cash, bank deposits, fixed income, and exchange-traded funds. In addition, the report asserts that separately managed accounts (SMA) and unified managed accounts (UMA) are more suitable vehicles than lifecycle funds in a steep market decline. I have a number of problems with these conclusions including:

• Lifecycle funds will certainly come under criticism for an aggressive glide path; however, not long ago pundits were criticizing more conservative products which underperformed during a prolonged bull market. Lifecycle products certainly are not a perfect product but it is a better solution than 401(k) investors selecting their own portfolios. We do foresee changes in lifecycle products including customized managed accounts at the upper end of the market and the adoption of tactical asset allocation for at least a component of the portfolio.

• The structure or vehicle type has no impact on the suitability of a product in a down market. If a person is invested in an SMA or UMA, the only way they avoided the downturn would have been from a tactical move away from equities. An equity SMA is going to be fully invested and a UMA will provide a series of products but it would take a tactical move by either the research group, the advisor, or the end client to move out of equities. An investor in a lifecycle fund can move to cash at the close of any business day if they so choose or get the advice to make this move.

• According to the MMI, 80% of SMA assets resided in equity or balanced portfolios. I don't have the corresponding performance but my guess is that these portfolios produced negative performance that was highly correlated to respective mutual funds.

• ETFs are by-and-large an equity vehicle. More than 75% of ETF assets reside in equity products, so the real threat of ETFs comes from the active versus passive question, not mutual fund versus ETF.

We do believe active managers who are not able to produce, communicate, and repeat an investment process that provides meaningful alpha will be weeded out. There will be a survival of the fittest mentality. We also believe investors are going to become significantly more conservative in the next 12-24 months (illustrated by money pouring into cash products); however, we do not believe these circumstances will result in the “ice age” of mutual funds.

Mike

BlackRock, DWS, Legg Mason, JP Morgan, Schwab, JennisonDryden, Hartford, and ING are just a portion of the firms that have announced either the liquidation or the merging away of existing funds in 2009. One of the after affects of the market decline is marginally profitable mutual funds moving into the red as a result of asset depreciation. It is prudent for firms to assess the viability of all of their products by determining:

1. Is this fund currently profitable?
2. What are the near and long-term prospects of this fund category as it relates to
3. My ongoing and potentially shifting distribution effort

If the answer to all three of questions is no or does not fit, firms need to aggressively probe the viability of the product within their fund lineup. The shareholder proxy process is neither simple nor inexpensive; therefore, funds will move deliberately in terms of rationalizing product. However, we believe that post market correction is an ideal time to assess internal capabilities and eliminate any products that don't fit the long-term objectives of the organization.

Mike

The ICI reported $40 billion in net outflows during the weeks of February 25 and March 4, as a steep decline in the market precipitated dollars being taken off the table once again.

What does this mean? We believe 2009 will be marked with ebbs and flows. Investors do not like the near-term prospects of the equity markets and the stimulus package has failed to stabilize the economy to date or increase investor confidence. Despite a difficult market, we do feel there is opportunity to capture incremental dollars. Consistency of messaging and partnering with distributors to ease concerns of advisors and more to the point their clients is imperative. Sales and marketing cannot hide during a challenging environment. To the contrary, it is now when your distribution partners need the most help in positioning and selling their investment solutions and you should take center stage.

Mike

The barriers between institutional and retail asset management markets have diminished considerably in recent years, and with this, we have seen firms from both sides of the fence eagerly enjoying the others green grass. Still, these opportunities remain underexploited relative to the opportunity. It should be noted however that as the businesses have converged, the diversifying benefits have weakened as well.

As the fund business outside of the U.S. has grown to rival local industry, asset managers have recognized that international distribution is a powerful growth engine and business diversifier. While the recent market conditions have punished asset levels across borders, relative to European and U.S. markets, flows in Asia have been relatively robust.

All of this takes capital, so while we wouldn't expect the pace of diversifying transactions to equal the desire, we do expect capital to be deployed where it can be found.

Sam

Click here to be taken to a recording of the Webinar we conducted on our recent study Consumer Insights on Retirement Income: The Keys to a Competitive Advantage in Retirement Solutions.

Guest Blogger Laura Varas of Mast Hill Consulting

First and foremost, the core issue in the marketplace today is trust. Trustworthiness is scarce, and the traditional measures of trust - such as ratings and even long-term relationships - are being thrown into question. Managers who can prove years of reliability, and consistency in shareholder advocacy, are earning the highest flows. Managers should also make sure that their medium-term distribution plan relies on partners who are trusted by the end investor.

While trust is a reward for good past behavior and believable current policies, the second area of competitive advantage actually can be built up going forward. Capabilities to manage income-taking and minimize lifetime taxes, regardless of investment environment, will absolutely distinguish the winners from the pack. This is an area of intense competitive activity right now. No matter where the market heads, retired people tell us they need better support in this managing their withdrawals and keeping their plans on track.

Possibly, a third area may be outcome-oriented investment techniques. In addition to the classic principal protection concepts, firms are exploring hedging techniques that may be able to mimic the benefits of annuities. Economic common sense suggest that pooling mortality risk is hard to beat, though. These approaches, however appealing in concept, face steep cost-benefit trade offs, and skepticism about derivatives-heavy strategies.

• Models will act as a bellwether for massive industry share shifts as the velocity of manager additions/deletions reaches unprecedented levels in coming quarters.

• Manager Research Team (MRT) acceptance will deepen among advisors as the liability associated with using an "unvetted" manager grows.
• MRT fragmentation will accelerate as more wealth management teams and high-end RIAs deepen and develop localized due diligence capabilities.
• Demand for MRT model performance transparency will grow as the marketplace demands a level of transparency and comparability that doesn't currently exist.
• MRTs will increasingly incorporate passive investment strategies to help mitigate overall advisory costs to the client while protecting the advisor's fee revenue which has been severely dented by the market downturn.

        Owen Concannon

Guest Blogger Magnus Spence, founder of Spence Johnson

 

What are some of the main differences between the US and European asset management businesses?

 

I won’t try to track them all here, but here are five that often cause confusion:

1. There is no Separately Managed Account business in Europe, or very little.  In fact Europeans have no real understanding of this huge US business.  What is emerging in the UK and based not on the US but the Australian model are “Wrap” platforms run by insurers, mostly. 
2. There is very little 401K type business in Europe.  In the UK and a little bit elsewhere you get DC business emerging on a similar basis, but this is very rare elsewhere.
3. A very important role is played in Europe by many small Private Banks.  This type of institution is largely non-existent in the US and causes much confusion.
4. Fee-based advisers in the US sense are largely non-existent in Europe.  In the few markets where independent advisers do exist (UK and Germany for example) there is a shift happening towards fee-driven advisers, but it is early days.
5. There are no wire-houses in Europe as there were until recently in the US.  When Europeans (excluding the UK here) look for financial planning advice they tend to visit a retail bank, not a broker.

 

Now the game has changed and the new rules of business are steadily, if a bit slowly in my opinion, working their way across the system. Not only will there be a greater disparity among those receiving the market’s rewards…the speed at which firms are “punished” for poor performance has picked up considerably. The combination of natural evolutionary forces with the recent financial crisis are quickly reshaping the industry (e.g. tougher screening of investment products/process, evolution of FAs from broker to advisor, focus on retirement solutions vs. accumulation products) with the changes all ultimately linking back to a net benefit for the end client. Investment firms that have strong cultures, solid leadership and proven investment process obviously have the foundation for success. However, weaker competitors that have been able to “hang around” by making a series of relatively small incremental changes to their business…whether it be in new hires, new products or new marketing programs…are being exposed and will not survive. So…the silver lining in the crisis is to found in the fact that the best run firms that provide real benefit to distributors and their clients will emerge from the current turmoil with a significant competitive advantage over the rest of the pack.

Neil

As a piece of investment advice, diversification is perhaps the most espoused by asset managers. When applied to firm’s own business portfolios it similarly is thought of as highly desirable, yet strategies in place to achieve this goal very often lack urgency. The latest harsh reminder of the importance of diversification stands to serve as a powerful catalyst in accelerating a number of trends that underscore what asset managers have been doing to diversify their businesses.

Diversifying by asset class and investment strategy: There has been quite a bit of activity on two fronts. First, less bifurcation of traditional and alternative asset management as seen from both the perspective of traditionally focused firms moving in alternatives (i.e. Putnam launching market neutral products) as well as from alternative managers making forays toward the traditional (i.e. firms like AQR Capital entering the more traditional fund space). Secondly there is the more straight forward expansion of firm’s investment capabilities often through a multi-affiliate approach.

Next time we will look at some events and the outlook for firm’s diversifying their distribution focus as well as geographical reach.

Sam

The asset management industry is not one for change…and I think it is easy to understand why.  In the short-term, the marketplace does not precisely allocate its “rewards” to the best run groups.  Certainly groups like American Funds and T. Rowe have emerged at the top of the heap --  but there are literally dozens and dozens of investment shops whose core service offering (the investment performance of their funds) cannot be shown to deliver positive value relative to a comparable index/benchmark.  Yet, somehow, many these underachieving firms have been able to amass sufficient AUM to enjoy healthy profit margins on top of very attractive compensation levels.

 

The competitive dynamics of the industry are such that over the last 15-20 years small incremental adjustments to product, pricing and sales support have been sufficient to keep firms “in the game” as long as they had not blown up their investment performance (and even some of these blowups were overlooked).  The perceived payback for meaningful restructuring has rarely been sufficient to offset the comfort factor that came from continuing to do things the way they always have been done.  It is rare that a firm that is not embroiled in crisis to proactively alter its course in any substantive way. 

Neil

The vast majority of 2008’s memorable events from a financial perspective took place over the last few months. Further, while 2008 will certainly be remembered from a historical perspective, for many the freshness and the pain would be gladly forgotten. So let’s skip the review and instead offer a preview of 2009. From a sales perspective, the good news is that we expect a rebound to positive numbers from the harsh 4th quarter we are leaving behind. Be a bit wary however, as seasonal factors look to be more influential than a real change in short-term sentiment.

Sam

The asset management industry has stuck to the principle "if it's not broke, why fix it?" However, we believe the industry is poised to undergo a massive shift following the collapse of the market. No longer do firms have guaranteed margins in 20-40% range and difficult staffing decisions are being made every day.

Firms need to study their business practices, measure the ROI of their different functions, and consider overhauling how they do business. In the past, firms were not rewarded for being a first-mover in changing business practices (product development was another matter), as the downside risk outweighed the upside benefits. But now is the time to study every component of your business - investment management, sales, marketing, product, and operations - and embrace change.

Otherwise, margin pressure will continue and your business will be further marginalized.

Mike

Successfully or unsuccessfully managing a business through a recession largely falls to the astuteness of its management. Are costs being controlled effectively or is cutting being done in an indiscriminant manner? Are opportunities to make deeply discounted acquisitions being taken full advantage of? The answers to these strategic business questions have a profound ability to change the listings of winners and losers during severe market turmoil, but so can tactical actions taking place below the executive management level. A couple of best practices that everyone can employ in today’s environment in order to be best positioned to maintain momentum through the current downturn and accelerate quickly upon recovery include:

1. Keep your eye out for great people who would otherwise not been available.

2. Closely monitor the competition. Turmoil breeds mistakes and innovation, both of which can be capitalized on.

Sam