"Why all the confusion about mutual funds?" asks Chip Roame, head of Tiburon Strategic Advisors, who recently hosted the group's CEO Summit XII, April 18-19, in San Francisco. Mutual funds remain the leading investment product with $10.8 trillion in assets under management, the consultant points out. But intense scrutiny and fiduciary responsibility are associated with that success, industry leaders acknowledge.
One reason for the dominance of mutual funds is that financial advisors continue to rely on them in their portfolio-management work, Roame explains: Commissionable mutual funds represent about 40 percent of investment products used by independent reps, for instance, while these advisors rely on no-load mutual funds and other products in fee-accounts for 16 percent of their portfolio work.
Paul Schott Stevens, president and CEO of the Investment Company Institute, or ICI, which represents the fund industry, says fund fees have shown a downward trend since 1980, with investors clustering their 401(k) assets in low-cost products. And a year ago, ICI research found that the cost of owning mutual fund shares was at its lowest levels in 25-plus years.
Still, industry leaders know their fees are under fire from those who want better disclosure, as well as from those who are under pressure to go through them with a fine-toothed comb. "Now, with nearly three decades of experience under our belts -- and with today's uses of 12b-1 fees barely recognizable in the light of the rule's original purpose -- it is high time for a thorough re-evaluation," says SEC Chairman Christopher Cox at a recent ICI gathering.
Retired T. Rowe Price Group vice chairman Jim Riepe, now on the boards of Nasdaq and Genworth Financial, believes, "The uncertainty of today, in contrast to the certainty of the past, is an opportunity for those insurers of retirement income. Our obligation is to educate savers... we must give investors a fair shot."
The financial-services industry, Riepe says, has a fiduciary responsibility it must live by and a high standard to meet in terms of client expectations. Organizations like the traditional wirehouse broker-dealers can benefit most from this situation by placing "financial advisors and clients on the same side of the table."
The field faces more intense competition and rising demand, he notes, which requires that participants be both highly introspective and innovative. "We are moving from a product-push to an investor-pull" mode of operation, Riepe explains, which is being supported by government and the media.
In this context, says Putnam Investments CEO Ed Haldeman, the company he leads is firmly focused on its sense of mission. "We take care of people's money," he explains. It's critical that the firm maintain this commitment, rather than defining itself on purely numeric business targets such as the latest quarter's mutual-fund sales, changes in assets under management, etc.
At Putnam, which is being bought for $3.9 billion by a unit of Power Financial of Canada, this mission is accomplished by the moniker of consistent, dependable and superior performance, or "CDS." Putnam expects its funds to be in the top 50 percent in terms of 12-month performance, not to ever be in the bottom 25 percent and as often as possible to stay in the top 25 percent to 33 percent.
Its decentralized organization, in which there are 27 "boutique" asset-class teams, is meant to encourage these results, according to Haldeman. Bonuses for portfolio managers embrace the CDS concept, and are based on how these results are met over one year (20 percent), three years (40 percent) and five years (40 percent).
Putnam has changed drastically in recent years, Haldeman explains, through cost cuts and improved efficiency. It now includes about 2,800 individuals vs. 5,700 about four years ago. "We changed the culture to get rid of the hierarchy and earlier decision-making [structure]. We even got rid of management's executive dining room and the executive offices."
Haldeman urges the industry to confront the current discrepancy of 300 to 500 basis points that exists between reported and actual shareholder performance. "How can it be and be tolerated? Are we repairing it?" he asks.
Part of the solution, he says, is to offer broader-based products, such as asset allocation funds rather than narrow-focused offerings. And advertising with a focus on long-term issues rather than one-year performance is also important. "This can help investors not hurt themselves so much," Haldeman shares. Rather than encouraging investors to consider buying the latest hot products, for instance, firms could stress ways to help them minimize their underperformance with broader allocations.
As for the market-timing scandal that hit Putnam in 2003, only about five people were involved, according to Haldeman. Putnam, as the first firm on the regulators' radar screen, worked to strike an agreement with the SEC as quickly as possible. That drew the ire of some Massachusetts officials and complicated its work with the SEC.
The future of Putnam, he says, is very promising. "We do not want to do acquisitions," Haldeman explains, though the fund group continues to pursue international distribution partnerships.
John DesPrez, CEO of John Hancock Financial Services (part of Manulife Financial), says financial advisors and planners must help clients confront the health and wealth challenges that come with longevity. This trend should lead to strong growth in annuity sales, which can positively impact mutual funds given their important role as an asset class that's well integrated within the annuity framework, he explains.
The industry leader notes that the life-insurance distribution world is "evolving as the captive, agency sales forces break up." "There's no shortage of intermediaries to replace them," DesPrez says. Likewise, annuity products are changing, with a trend toward hybrid products that combine insurance, principal protection and asset management. Planners, he shares, need to carve up a percent of assets for the "post-85" annuity that would pay if you lived passed this age.
Manulife -- with its strong base of traditional life insurance -- is well positioned to write guarantees for such policies, he notes. The company made such a point in May 2005, when it introduced a "lifetime guarantee," rather than a 20-year pledge. Eventually, though, the industry could find that there's "too much risk for us to absorb," and hence the formation of a government agency that would serve as a guarantor for part of future policies is being discussed.
The CEO also explains that the April 2004 merger of John Hancock and Canada's Manulife succeeded for several reasons. First, work on the deal started during the bad credit cycle of 2001-2003, and it was completed before the bottom of that cycle. Second, the deal involved companies that did not have overlapping business, making it "a revenue deal" and not a cost-cutting merger.
A final reason for its success, DesPrez explains, was that the merger was financially well structured and did not involve "flow back," or the selling of the acquirer's shares that then flow back to a foreign market in quantities that can't be absorbed, as with Prudential's attempt to buy American General. In the case of Manulife, regulators in Toronto waived the buyback limit in cash, so the company could protect its shares. Arbitragers stayed away, the CEO says. Plus, the deal was done 100 percent in stock, he adds.
With its AAA credit rating, historically important brand, continuing momentum in net flows and new product development, John Hancock is poised to further strengthen its leadership position in a rapidly changing industry, according to DesPrez.
Janet Levaux is the managing editor of Research; reach her at email@example.com.