A changing landscape

The mutual fund industry has long been dominated by a handful of companies, but continuing fallout from the recent market downturn and other structural factors have created opportunities for nimbler, smaller companies to gain more business.

The mutual fund industry has long been dominated by a handful of companies, but continuing fallout from the recent market downturn and other structural factors have created opportunities for nimbler, smaller companies to gain more business.

No one is saying that The Vanguard Group Inc., Capital Research and Management Co.’s American Funds and Fidelity Investments — the three largest fund groups ranked by long-term mutual fund assets — will cease to be major players. But lingering investor discontent, the result of virtually universal poor fund performance during the recession, could allow smaller competitors to gain market share, fund executives said at an InvestmentNews round table on the fund industry held Feb. 9 in New York.

MARKET SHIFT

“I think there’s a big market shift going on right now,” said James A. Jessee, president of MFS Fund Distributors Inc. “Part of it is, you have a lot of assets with those companies where people are disappointed in the results, and they are looking for alternatives.”

But more than disappointing performance might be at work, said Frank Waltman, executive vice president of product management for Virtus Investment Partners Inc. It may be that some firms have gotten too big, he said, making it particularly hard for them to accumulate assets — especially in the wake of a recession.

“If you just look at the asset base and the normal redemption rate on that asset base, the amount of gross sales you have to generate just to overcome the natural pace of redemptions is huge,” Mr. Waltman said.

Structural changes in the marketplace might also help smaller asset managers gain business from the wirehouses.

“[The wirehouses] have enhanced their management. Their research people are really strong. They’ve taken some of the best from institutional firms,” said Stephen P. Fisher, president of New York Life Investment Management LLC’s MainStay Funds.

As a result, these wirehouses are more willing to consider funds that they may not have considered before, the fund executives said.

“What has been a great surprise for us is the acceptance among wirehouses to look at smaller firms,” said Russell M. Parker, chief marketing and distribution officer of FBR Asset Management Holdings Inc.

Of course, dealing with wirehouses is a double-edged sword for fund companies.

During the thick of the recession, many in the fund industry said that wirehouses were demanding more from fund firms in return for selling their products.

Mr. Parker, however, suggested that that is no longer the case.

“There was a time when the asset management side of the equation had maybe a lot of power at the harm of distributors, and then there was a time where the distribution had an awful lot of power at the peril of the asset managers,” he said. “I think the market has allowed the pendulum to come back closer to center.”

BALANCE OF POWER

That may be true, but it is still a struggle for smaller firms to negotiate with wirehouses and distributors generally, said Thomas R. Trala Jr., the chief financial officer and chief operating officer of one such small firm, Turner Investment Partners Inc.

“Where the pendulum stands for a firm the size of Turner, clearly, the advantage is still to the distributors,” he said. “In fact, the larger firms may be getting better deals than a firm our size that relies on that [distribution] relationship.”

That said, this is a pretty good time to be a boutique firm, Mr. Waltman said.

Another effect of the recession is that investors and financial advisers are demanding to know who is managing their money and how, he said. That gives an edge to boutique managers who provide more personal service, Mr. Waltman said.

It also helps that because of disappointing returns over the past two years, distributors are looking for successful firms to market to investors, Mr. Parker said.

“They are actually embracing the boutique, because if nothing else, it’s a new name at a time when people have had some of their appetite soured against the bigger players,” he said.

Midsize asset managers, however, are not being embraced. They are in a particularly difficult spot because “they’ve got a fairly expensive model in place, and they don’t have the scale, and their margins are coming down,” Mr. Jessee said.

That makes them attractive mergers-and-acquisitions targets, he said.

And now that the markets are a little less volatile, making it easier to agree on a sales price, M&A activity will likely increase, Mr. Parker said.

Not all the deals, however, will involve midsize companies, Mr. Waltman said.

There have been a number of big-name acquisitions in recent months, including Invesco Ltd.’s purchase of Morgan Stanley’s Van Kampen Funds Inc. in October for $1.5 billion.

Bank of America Corp. sold the long-term-asset-management business of its Columbia Management Group LLC subsidiary to Ameriprise Financial Inc. in late 2009.

Also last year, Barclays PLC sold its Barclays Global Investors unit, including its iShares exchange-traded-fund business, to BlackRock Inc. for $13.5 billion.

There may be more such deals ahead, Mr. Waltman said.

“I do think there will be some larger deals as you see insurance companies and banks looking at their book of business and really focusing on what their core business is,” he said. “In many cases, that may not be asset management.”

Insurance companies, however, are in a particularly good position to deliver the income-oriented products that retiring baby boomers want, Mr. Fisher said.

“Having an insurance company, New York Life, as a parent, [MainStay Funds] has the ability to offer some guaranteed product, and we’re seeing a lot of interest in immediate annuities,” he said.

GUARANTEES

Although income-oriented products will be winners in the years to come, Mr. Jessee said, he hasn’t seen much evidence that advisers are enthusiastic about selling guaranteed products.

“Clearly, the guaranteed-income or guaranteed type of solutions are something investors are going to seek out and want,” he said. “I’m just not sure advisers, for the most part, have gotten comfortable with that.”

One of the products that advisers will likely demand, Mr. Jessee predicted, will be “flexible funds” that allow the fund manager to invest across various sectors and styles.

E-mail David Hoffman at [email protected].