In Mutual Fund Industry, Less Cash Funnels to Fewer Firms

A little more than halfway into the year, 1999 is already shaping up as an annus horribilis for the rapidly maturing mutual fund industry--perhaps its most disappointing year since the recession-racked start of the decade.

Nearly half of all funds and fund groups are bleeding assets. Net new investments into stock funds are down despite broad gains this year in global stock markets. In fact, virtually all categories of funds are attracting far less new money than they did in the first half of 1998.

And two big reasons may be linked to the Internet.

Thanks to the continuing allure of Internet stocks and competition from cut-rate online brokerages, many Americans are investing directly in individual stocks instead of mutual funds.

And thanks also, in part, to the Internet, and the speed and efficiency with which it dispenses information, the new money that is still flowing into funds is being concentrated in a small group of funds and fund groups, with worrisome implications for the fund industry as a whole.

“I’ve been selling funds since 1984, and I’ve never seen sales so concentrated,” said Keith Hartstein, senior vice president in charge of national sales for the John Hancock Funds, which experienced net redemptions in the first six months of the year. “It’s frustrating.”

“The Internet has made financial services much more transparent,” said Henry McVey, an analyst with Morgan Stanley Dean Witter in New York. “And that has had a dramatic impact on the direction of fund flows.

“Specifically, investors are much more conscious of a fund’s performance--and are able to allocate dollars toward leading fund companies in a much more efficient manner,” McVey added.

Jerry Potts, director of marketing for Boston-based MFS Investment Management, said that for years, investors have had access to magazines and newsletters that tout the so-called best funds to buy.

The difference today, thanks to the Internet, is that you have access to real-time information. And “if something interests you, you can point and click and do something about it” immediately, he said.

This has been especially true since the rise of mutual fund supermarkets--such as those run by Charles Schwab and Fidelity Investments--where you can buy and sell shares of thousands of different funds managed by hundreds of different fund families online.

This concentration of assets--expected to be reflected in midyear fund industry data reported today--poses a threat to dozens of small and medium-sized fund companies that can’t rely on huge inflows from 401(k) assets, for instance, to serve as a buffer when their funds are underperforming.

With the growth in demand for their products slowing--and an overpopulation of fund companies--industry officials recently have been predicting a major shakeout in the business.

Many have been predicting that large, entrenched companies will expand their domination of the marketplace, based on their breadth of services and offerings--and their control of precious 401(k) retirement assets.

At the same time, smaller niche companies offering just one or two specialty funds will survive based solely on their expertise and performance.

In between, however, dozens of medium-sized companies may struggle to survive.

The fund-flow figures for the first half of the year seem to foreshadow this new reality.

Overall, domestic stock funds took in $85.4 billion in the first half, down from $112 billion in the first half of 1998, according to figures from Financial Research Corp. of Boston. All stock and bond funds combined took in $99.3 billion versus $172 billion.

More striking, 47% of the nation’s mutual funds and fund complexes suffered net redemptions in the first half of the year, FRC said.

In other words, almost half of all funds are bleeding assets. By comparison, last year at this time, only 24% of all fund groups were having net redemptions.

At the same time, 66 cents of every net new dollar that investors plowed into stock and bond funds in the first six months of the year went to just three fund companies--Boston-based Fidelity, Valley Forge, Pa.-based Vanguard Group and Denver-based Janus.

The three firms, based on the performance of their U.S. diversified stock funds, have consistently ranked among the best in the industry in recent years, according to Kanon Bloch Carre, a mutual fund consultant based in Boston.

They also happen to manage 15 of the 20 most popular mutual funds in company-sponsored 401(k) retirement plans, according to Pensions and Investments, a trade publication.

This further concentration of money in large, successful funds and fund companies may be “a sign of things to come,” said Chris Brown, a mutual fund analyst with FRC in Boston.

“I totally agree,” said Bill Dougherty, an analyst with Kanon Bloch Carre. “This is a maturing industry. The big are getting bigger, and the small are struggling for attention.”

Should these fund-flow trends continue, there may be another round of consolidation in the asset management business, analysts say. “I would assume we’d see more mergers,” especially among mid-sized firms, said Geoff Bobroff, an industry consultant in East Greenwich, R.I.

Another outcome already being felt: Fund companies are creating fewer new funds and consolidating the funds they already run.

Year to date through Wednesday, only 106 new funds had been created, according to Rockville, Md.-based Weisenberger, a Thomson Financial company.

By this time last year, the industry had created 487 funds. And by this time in 1997, the industry had launched 751.

At the same time, 202 funds had been merged halfway into the year, according to Weisenberger’s count, versus 159 midway into 1998 and 127 by that time in 1997.

As for the total amount of money being invested into mutual funds, few expect the situation to improve soon, since investors tend not to invest as much during the summer months as they do at the beginning and end of each year.

Plus, there are fears over the year 2000 computer bug to worry about.

Indeed, some analysts believe that fund investments won’t pick up significantly until after the new year--barring a dramatic new rally in the stock market.

Vanguard Chairman John Brennan, who also chairs the Investment Company Institute, the fund industry’s chief trade group, says much too much is being read into the short-term fund-flow data.

He says the figures simply reflect the cyclical nature of the mutual fund business. After three phenomenal years in which investors poured ever-higher sums into stock mutual funds, they may simply be “catching their breath,” Brennan said.

“There’s not a limitless amount of cash to go into mutual funds,” he added.

Still, while Brennan says fund flows will eventually rebound, new investments may continue to be concentrated in the giants.

Though small niche companies with better-performing funds will thrive, “it is going to be tough to be really broad in scope and be mid-sized,” Brennan said. “Can you invest enough to be great in service with mid-sized financial resources? Can you be great at multiple investment strategies with mid-size financial resources?”

Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.

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Who’s Winning, Who’s Losing

Here are the top five mutual fund groups in terms of net cash inflows in the first half of 1999 along with five companies that saw the biggest outflows. Data cover the companies’ stock and bond funds, excluding short-term funds.

Cash Flow Winners

Fund company: Vanguard Group

Net cash flow, in billions, first half of year 1998: $26.9

Net cash flow, in billions, first half of year 1999: $31.9

Total assets at June 30, in billions: $447.8

*

Fund company: Janus

Net cash flow, in billions, first half of year 1998: $4.1

Net cash flow, in billions, first half of year 1999: $18.3

Total assets at June 30, in billions: $108.7

*

Fund company: Fidelity Investments

Net cash flow, in billions, first half of year 1998: $12.4

Net cash flow, in billions, first half of year 1999: $14.9

Total assets at June 30, in billions: $588.9

*

Fund company: Pimco Advisors

Net cash flow, in billions, first half of year 1998: $6.1

Net cash flow, in billions, first half of year 1999: $7.2

Total assets at June 30, in billions: $50.9

*

Fund company: Alliance

Net cash flow, in billions, first half of year 1998: $3.3

Net cash flow, in billions, first half of year 1999: $6.9

Total assets at June 30, in billions: $44.6

Cash Flow Losers

Fund company: Franklin

Net cash flow, in billions, first half of year 1998: $5.1

Net cash flow, in billions, first half of year 1999: -$10.1

Total assets at June 30, in billions: $162.8

*

Fund company: Merrill Lynch

Net cash flow, in billions, first half of year 1998: $0.4

Net cash flow, in billions, first half of year 1999: -$7.2

Total assets at June 30, in billions: $75.0

*

Fund company: Neuberger Berman

Net cash flow, in billions, first half of year 1998: $0.1

Net cash flow, in billions, first half of year 1999: -$2.4

Total assets at June 30, in billions: $15.2

*

Fund company: Oakmark Funds

Net cash flow, in billions, first half of year 1998: $0.9

Net cash flow, in billions, first half of year 1999: -$2.0

Total assets at June 30, in billions: $9.4

*

Fund company: Grantham Mayo Van Otterloo

Net cash flow, in billions, first half of year 1998: -$0.6

Net cash flow, in billions, first half of year 1999: -$1.6

Total assets at June 30, in billions: $12.5

Source: Financial Research Corp.