More exotic products due from mutual funds

The mutual fund industry will let its hair down this year, introducing ever more exotic, hedge-fund-like products that make even greater use of complicated vehicles such as derivatives, according to some industry experts.
JAN 07, 2008
By  Bloomberg
The mutual fund industry will let its hair down this year, introducing ever more exotic, hedge-fund-like products that make even greater use of complicated vehicles such as derivatives, according to some industry experts. "I think you'll start to see the industry come out of its shell," said Don Phillips, a managing director of Morningstar Inc. of Chicago. Not everyone, however, believes that such a move is a good thing. "I would see that being fraught with risk," said Reuben Gregg Brewer, director of research at Value Line Inc. in New York. Investors may not fully understand how hedge-fund-like products actually work, he said. Nevertheless, such funds will proliferate. Mr. Phillips said. The mutual fund trading scandals that erupted in 2003 forced the fund industry to take a more conservative approach to product development, he said. The industry didn't want to be perceived as coming out with a product for which it later would have to "apologize," Mr. Phillips said. But as the scandals recede from memory and funds face increasing competition from other investments, expect innovation, he said. To some extent, the mutual fund industry started down that path last year. In December, The Vanguard Group Inc. of Malvern, Pa., announced the reorganization of the Laudus Rosenberg U.S. Large/Mid Capitalization Long/Short Equity Fund into the Vanguard Market Neutral Fund. The fund was advised by Charles Schwab Investment Management Inc., a unit of The Charles Schwab Corp. in San Francisco. Orinda, Calif.-based AXA Rosenberg Group LLC, remains subadviser under the reorganization.

FIRST BIG FORAY

The reorganization marks Vanguard's first major foray into long-short market-neutral strategies. Other big-name companies  introduced institutional-style strategies to their funds last year. Boston-based Fidelity Investments unveiled three "enhanced index funds" in May. The funds employ complicated quantitative strategies to deliver returns that are 1 or 2 percentage points higher than the benchmarks they mirror. And DWS Scudder, the U.S. retail division of Deutsche Asset Management Inc. of New York, a subsidiary of Deutsche Bank AG of Frankfurt, Germany, last month rolled out the DWS Alternative Asset Allocation Plus Fund, a fund of funds that employs a variety of alternative-investment strategies. Such funds are likely to continue to pop up this year, said Russel Kinnel, director of fund research at Morningstar. "There's room for more long-short, or market-neutral-type, funds," he said. If that's the case, however, the fund industry may be headed down a dead-end road, said Geoff Bobroff, a mutual fund consultant in East Greenwich, R.I. Apart from the perceived risks to the investors, "so much of the industry is driven by asset allocation models that unless it's a true, valid asset class, you are invariably going to get a limited allocation," he said concerning funds that employ alternative strategies. While there may be some development of such funds, Mr. Bobroff said, he finds it much more likely that fund companies will continue to develop life cycle, or target date, funds. Such funds have become a popular product offering as a result of the Pension Protection Act of 2006. The act amended the Employee Retirement Income Security Act of 1974, directing the secretary of labor to issue regulations identifying qualified default investments. Plan fiduciaries enrolling workers who don't give investment preferences would be protected from liability if they picked one of those options. Life cycle funds, which use a mix of fixed-income and equity securities and become more conservative as participants age, qualify as one of the options.

MANAGED-PAYOUT FUNDS

Of course, with millions of baby boomers nearing retirement, fund companies are obsessed with retaining their retirement plan assets when the boomers leave those plans. As a result, expect to see more "managed payout" funds, such as the 11 launched by Fidelity in October, Mr. Brewer said. These use principal to make payouts. In fact, the funds liquidate when they reach a set date. Vanguard and John Hancock Financial Services Inc. of Boston filed with the Securities and Exchange Commission last year to offer similar managed-payout funds that will try not to eat into principal. "It is actually a halfway decent idea," Mr. Brewer said of such funds. David Hoffman can be reached at [email protected].

Latest News

Advisor moves: LPL adds $425M Evermark Investment Partners, $300M Merril Lynch group hops to Ameriprise
Advisor moves: LPL adds $425M Evermark Investment Partners, $300M Merril Lynch group hops to Ameriprise

LPL's latest addition, a San Diego team defecting from RBC, represents a milestone for the broker-dealer giant's Strategic Wealth model for wirehouse breakaways.

Senate tax bill stalls as hardliners balk at changes
Senate tax bill stalls as hardliners balk at changes

The new legislative proposal, which includes more aggressive cuts to Medicaid and a lower SALT cap, threatens a goal of passing President Trump's tax-cut legislation by July 4.

Osaic snaps up $13.5B CW Advisors
Osaic snaps up $13.5B CW Advisors

The deal for the Audax-backed RIA based in Boston gives Osaic a strategic foothold to attract more advisors and clients across the wealth spectrum.

Senate wants changes to Trump’s tax bill; here’s what’s expected
Senate wants changes to Trump’s tax bill; here’s what’s expected

‘Revenge tax’ on foreign investors could be scrapped in new version.

CFTC’s regulatory pioneer Bagley dies aged 96
CFTC’s regulatory pioneer Bagley dies aged 96

Veteran legislator helped set the standard for derivatives regulation.

SPONSORED RILAs bring stability, growth during volatile markets

Barely a decade old, registered index-linked annuities have quickly surged in popularity, thanks to their unique blend of protection and growth potential—an appealing option for investors looking to chart a steadier course through today's choppy market waters, says Myles Lambert, Brighthouse Financial.

SPONSORED Beyond the dashboard: Making wealth tech human

How intelliflo aims to solve advisors' top tech headaches—without sacrificing the personal touch clients crave