With three mutual fund giants well on their way to capturing nearly 40% of all U.S. fund assets, thousands of smaller fund companies are left competing for the rest, and some even contemplate exiting the business.
At the end of September, American Funds,
Fidelity Investments and
The Vanguard Group Inc. held 37.5% of all U.S. fund assets, up from 30% at the end of 1997, according to FRC.
"It's a brutal marketplace," said Jeffrey Dunham, chief executive and president of San Diego-based Dunham & Associates Investment Counsel Inc. "It truly is a David and Goliath story. The market does favor these massive-scaled fund families. The vast amount of flows goes to the biggest funds. If you don't have a brand, you are telling David to fight Goliath for shelf space."
Year-to-date through September, American Funds, Malvern, Pa.-basedVanguard and Boston-based Fidelity took in nearly 33 cents of every new dollar going into the 50 biggest fund companies, according to Financial Research Corp. of Boston. Ten years ago, the three biggest fund companies — Fidelity, Vanguard and American, run by Los Angeles-based Capital Research and Management Co. — captured 31 cents of every new dollar, FRC said.
With Boston-based Grail Partners LLC reporting that mutual fund mergers and acquisitions are on the rise — with the number of deals more than doubling from eight in 2001 to 17 in 2006 — some fund shops are finding it difficult to stay afloat.
"There are a lot of small and midsize mutual fund companies trying to decide if it makes sense to stay in the mutual fund business," said Dan Sondhelm, vice president and partner at the financial-marketing firm SunStar of Alexandria, Va. "Some of it is because they're looking to merge with another company that has the scale to do the distribution."
Many small companies say that it is harder to absorb costs, said Christine Benz, director of mutual fund analysis at Chicago-based Morningstar Inc. "Since they have been required to have a chief compliance officer as a result of the industry's market-timing scandal, many small firms have complained it was an onerous cost for them," she said.
For small and even midsize fund shops, passing on those higher costs to investors in the form of higher expense ratios is just not an option. That is because funds with an expense ratio of more than 1.5% are often dismissed by investors, Mr. Sondhelm said.
Indeed, the expense ratio for the average U.S. stock fund is 1.4%, according to Morningstar.
"As a result, the bigger firms are getting bigger," Mr. Sondhelm added.
Even big fund companies are willing to acknowledge that the scales are tipped in their favor.
"We believe that there are economies of scale that favor large fund families," said Chuck Freadhoff, spokesman for American Funds.
"For example, if you had a global research network, as we do, that comes at a cost," he said. "When those costs are spread among more shareholders, the cost per shareholder declines."
Many smaller fund companies compete by playing up attributes unlikely to be found at big firms, such as independent ownership and accessibility to portfolio managers and other top executives.
"We have no voice mail," said Neil Hennessy, president and chief executive at the Hennessy Funds of Novato, Calif.
"We do our own shareholder servicing. Everybody answers the phone," he said.
Others maintain a sharp focus on one unique investing style.
"We have one investment philosophy," said Dave Mertens, principal, sales and marketing, for the Jensen Portfolio at Jensen Investment Management Inc. in Portland, Ore.
"I think the larger companies feel the need to generate the next product and follow those fads," he said. "Today, it's 130/30, and tomorrow, it's a different flavor of international fund; then they are off to produce that product."
Other tactics smaller fund companies can use to compete with the giants include doing roadshows, attending conferences and hiring public relations firms to help them raise their profiles. Working in their favor, of course, is the fact that some advisers prefer to do business with smaller fund companies.
"A speedboat can turn on a dime much faster than an ocean liner," said Lou Stanasolovich, president of Legend Financial Advisors Inc. of Pittsburgh.
"I like the fact that a manager at a smaller company can go in different directions," he said. "We try to find managers that we can talk to in order to understand their philosophy."
Also, the owners may be the portfolio managers and may have personal money invested in the fund. The result might be a more focused manager, Mr. Stanasolovich said.
"We love to find an undiscovered, well-managed, small mutual-fund shop for our clients," said Chad Smith, financial planner at Financial Symmetry Inc. of Raleigh, N.C. "If you can find it before the masses, you benefit nicely in terms of return because of the freedom the manager still has to move in and out of securities."
In the end, it all "comes down to performance," said Chuck Gibson, president of Financial Perspectives in Newark, Calif.
Sue Asci can be reached at [email protected].
