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].
