WALL STREET BROKERS’ FUNDS WERE A TOUGH SELL IN 1997: INDUSTRY’S NET FLOWS ROSE, BUT WIREHOUSES’ SUNK 80%

Big Wall Street brokerages were the wallflowers at 1997’s mutual fund industry ball. While U.S. stock and bond mutual funds as a whole enjoyed a 17.5% gain in net cash flows from 1996, in-house fund families of brokerages like Merrill Lynch & Co. and Salomon Smith Barney Holdings Inc. saw net cash flows plummet by 79.8%.

Meanwhile, Dean Witter Reynolds Inc. saw its inflows turn to outflows while Prudential Investments continued to suffer net redemptions, albeit far less than in 1996.

Industry players provided the annual brokerage sales figures, which exclude money market funds, to InvestmentNews. New York consulting firm Strategic Insight, which compiles the figures in its Quarterly Net New Flows report, declined to confirm the numbers.

The data suggest that the nation’s largest brokerages continue to struggle as they balance attempts to offer objective mutual fund advice to customers with the desire to draw assets into their own fund families. Like any fund company, brokerages want the ongoing revenue stream that comes from management fees.

Dean Witter had the toughest time attaining that goal in 1997. The New York-based firm, a unit of Morgan Stanley Dean Witter Discover & Co., saw $130 million leak out of its portfolios in 1997, compared with 1996 when it raked in nearly $1.5 billion, even though a recent industry study suggests its brokers are more likely to hawk its own funds over others.

Officials at Dean Witter InterCapital Inc., which manages the funds, declined to comment.

“Live by the sword, die by the sword,” says Burton Greenwald, a Philadelphia brokerage consultant.

According to the Strategic Insight data, others also were sliced. Merrill Lynch & Co. and Salomon Smith Barney Holdings saw far less cash flowing into their mutual funds — with 1997 declines of 87.7% and 80.7%, respectively.

But PaineWebber and Prudential, which had 1996 net redemptions, saw big ’97 turnarounds. PaineWebber attracted $522 million in net cash flows while Prudential’s net redemptions drop
ped to $294 million from a whopping $1.79 billion the prior year, when its parent, Prudential Insurance Co. of America, was embroiled in a scandal over its annuity sales practices.

Net cash flows for the mutual fund industry as a whole were $27.2 billion, up 17.5% from 1996, according to the Investment Company Institute in Washington, D.C., which does not release individual company data. Yet net cash flows into the brokerage houses were a mere $3.6 billion in 1997, according to the figures obtained by InvestmentNews.

There are many reasons brokerages have failed to capture new assets for their in-house funds. Dean Witter notwithstanding, brokerage houses increasingly are encouraging the use of funds of outside firms.

Performance also played a role. While brokerage house funds in general fared well, they couldn’t match the stellar returns of the year’s top no-load funds: American Heritage Fund, up 75%, or Munder Micro-cap Equity, up 72%, according to Lipper Analytical Services Inc.

the big picture

Spokesmen for PaineWebber and Prudential, which have $7.9 billion and $56.6 billion in long-term funds, respectively, attributed their fund families’ turnarounds to better performance and increased marketing. A spokeswoman for Merrill Lynch did not return calls.

Avi Nachmany, Strategic Insight’s president, would not confirm the data but agreed to speak in general terms. He says brokerage houses — with the exception of Merrill — lack a significant presence in the retirement plan market where big mutual fund companies like Vanguard and Fidelity are leaders. Brokerages also have nice stables of bond funds, but more limited selections of stock and international funds than others.

Mutual funds are only part of the profit picture, of course. Brokerages saw record sales in individual securities, initial public offerings and unit investment trusts in 1997. “When you look at one piece of the puzzle, the other parts are invisible,” says Mr. Nachmany.

Still, some of the cash flow drops are dramatic. Inv
estors were less bullish on Merrill funds last year, parking $404 million of net new cash there in 1997 vs. $3.29 billion in ’96.

flight to quality

One reason might be that Merrill’s largest fund is global, and was hard hit by the Asian crisis. The $9.88 billion Merrill Lynch Global Allocation Fund underperformed its peers as well as domestic equity funds.

Reuben G. Brewer, an analyst with mutual fund tracker Value Line Publishing Inc., says the fund family overall held up well, but global market volatility probably scared some Merrill Lynch brokers into recommending a lot more money market mutual funds. Indeed, the data show that Merrill Lynch’s net cash flows into mutual funds nearly doubled in 1997 from 1996 when money market funds are added to the mix.

“’97 saw a lot of things — a crash, the Asian crisis,” Mr. Brewer says. “Those things dragged down people’s willingness to invest.”

At Dean Witter, fund flows may have slipped because brokers were getting used to new share classes for in-house funds introduced in 1997. Until last year, Dean Witter funds only carried back-end loads, in which customers pay a load if they sell before a certain number of years.

As for Smith Barney, it may have been hampered by the defection last summer of mutual fund marketing head Jessica Bibliowicz. She was replaced in November by Laurie A. Hesslein, director of mutual funds.

But a Smith Barney spokeswoman says the bulk of the assets into the firm’s mutual funds come from its mutual fund wrap account program, which is overseen by a different executive and also includes others’ funds..

Meanwhile, PaineWebber is patting itself on the back. Since Margo Alexander, president and CEO of subsidiary Mitchell Hutchins Asset Management Inc., became head of the fund effort three years ago, performance has improved “across the board,” says a company spokesman.

At Prudential, a heavy marketing push helped stanch outflows. Also, Prudential drew as much as $300 million into Quantum Fund, a small
company stock fund that it opened in September and closed 17 days later when money flooded in.