Mutual Funds, Watch Your Backs

Mutual funds industrywide gained nearly $1.5 trillion in assets in 2007, up from $1.3 trillion in 2006. However, during 2007 nearly half of all fund managers experienced net redemptions among their long-term funds, Cerulli said. While international/global equity funds garnered a record $177 billion in flows in 2007, aggregate flows into U.S. equity funds during the year (-$37 billion) were the lowest since 1988, according to the report.

The most popular of all mutual fund types in 2007 were funds of funds (FOFs), due to the continued demand for embedded-advice products. However, Cereulli pointed out the FOF segment is becoming crowded, and in order to survive, managers need compelling points of differentiation.

Cerulli expects more mutual funds with international investment objectives and those that promise income-at-retirement solutions in 2008. According to the report, there were 130 new international/global funds launched last year. Additionally, several mutual funds promising predictable distributions for investors in retirement were launched in 2007, but most of these offer little more than complex systematic withdrawal options. Retiring investors need income-generating vehicles and they are comfortable with mutual funds, so it is difficult for them to think about decumulation over a 20- to 30-year period, Cerulli contended.

In addition, the products can be frightening, as many reserve the right to alter future distribution rates and merge or liquidate the funds at a certain point.

Alternatives to Mutual Funds

According to the Cerulli report, solutions giving mutual funds a run for their money include exchange-traded funds (ETFs), total retirement outsourcing (TRO) programs, and unified managed accounts (UMAs).

Low fees, intraday pricing, access to atypical indexes, and potential tax savings have always made ETFs attractive, and now that the first actively managed ETFs have been introduced, the product presents an increased threat to mutual funds, Cerulli contended. For ETFs to make further inroads and take additional market share from mutual funds, they must succeed with products that fit neatly onto retirement platforms, well-placed actively managed products, or embedded-advice products, according to the report.

As the provision of retirement services is an extremely low-margin business and is often unprofitable on a stand-alone basis, asset managers active in the TRO space view the market as a way to capture and retain assets. The majority of retirement plan recordkeepers operate their TRO businesses as a complement to other, more profitable lines of business, Cerulli noted.

UMAs and overlay portfolio management have become the industry standard for managed account offerings. The report pointed out that intense technological development over the past three years has enabled advisers to provide clients with customized portfolios consisting of multiple investment product types that all work together under one investment policy statement. Cerulli suggested, as UMA programs (which are powered by overlay management) grow, so will assets directed toward model-driven separate accounts, so now is the time for asset managers to harness what that means to their future business.