increases could be as high as 40per cent.

Regulation is a perennial chal-lenge for an industry whose tightoversight by the Securities andExchange Commission hasbecome one of its hallmarks. Yetthe fight between the industryand regulators over possiblereform measures to money mar-ket funds would seem to have alot riding on it.

The money market fund indus-try claims the regulations theSEC is considering would effec-tively wipe it out in its currentform, eliminating a key source ofshort-term financing for busi-nesses and local governments.The SEC and some members of

the Federal Reserve’s board ofgovernors have argued thatmoney funds hold the potential todestabilise the economy despite anumber of reforms adopted by theSEC last year.

The challenges facing the USmutual fund industry will be thetopic of discussion at the ICI’s54th annual general membershipmeeting, to be held this week inWashington. The event’s theme,“Lasting Values – ChallengingTimes” and many of the panel dis-cussions will cover the numerousissues confronting the industry.

For Chris Donahue, chief execu-tive of Federated Investors,money fund regulation poses thebiggest challenge and risk to hiscompany. By far the biggestthreat, he says, is “the onslaughtof regulation. I don’t think ourbusiness is unique in this, but itcertainly does impact us and all ofour shareholders.”

Federated has responded to thepossibility of new regulations byworking with regulators and fed-eral lawmakers to try to shapeand influence the outcome of thereform movement. It has deployed

its legal staff to offer legal com-mentaries in response to some ofthe ideas being weighed by regu-lators.

One of the biggest gripes thatFederated and others in the indus-try have with the looming addi-tional regulation on money mar-ket funds is the lack of a cost-benefit analysis to determine theeconomic impact of further regu-

The US mutual fund industry hasno shortage of challenges, bothnear-term and long-term.

On the competition front,exchange-traded funds and otherpassively managed products havesiphoned off a sizeable chunk ofassets from actively managedmutual funds. The shift into betaproducts – as well as the steadygrowth of fixed income assets –has put a squeeze on expenseratios. In fact, new data releasedby the Investment Company Insti-tute, the group that represents theindustry’s interests in Washing-ton, shows that equity funds’expenses have dropped 20 per centfrom the 1990 average of 99 basispoints.

Besides a wholesale shift intolower-cost products, the down-ward pressure on expenses is alsobeing felt in the retirement mar-ket. The US Department ofLabour is preparing to imposenew rules this summer that willgive companies and their employ-ees a much clearer view of theirnet costs in their retirementaccounts. It is expected that thenew rules will push 401(k) planproviders to compete much moreon price.

Meanwhile, fund groups arefinding the cost of doing businesscontinues to climb. The majorbrokerage houses that serve asone of the primary distributionchannels for mutual funds arebeginning to demand more in rev-enue sharing and other fees fromfund advisers.

On top of this, margin pressureon asset servicing firms is result-ing in higher expenses for assetcustody and other types of back-office services. BNY Mellon, forone, is raising fees on about 700 ofits smallest asset servicing cli-ents. For some clients, the

FTfmFINANCIAL TIMES SPECIAL REPORT THE US MUTUAL FUND INDUSTRY Monday May 7 2012

lation. In fact, Federated hasthreatened to file a lawsuitagainst the SEC if it does not con-duct a thorough cost-benefit anal-ysis that assesses the impact ofany proposed regulation.

“We’re dealing with tens of mil-lions of accounts on a very effi-cient business and the other sidehasn’t done a cost-benefit analy-sis,” Mr Donahue says.

As well as the threat of newregulations, Federated and allother money fund providers havebeen saddled with a low interestrate environment that is costingthe industry a lot of money in theform of fee waivers. Low rateshave pushed Federated to waivefees on its money market prod-ucts to the tune of $320.7m,$241.6m and $120.6m in 2011, 2010and 2009, respectively.

Federated is hardly alone. Datafrom the ICI and iMoneyNet showthat money funds waived some$5.2bn in fees last year while col-lecting only $4.7bn.

Of course, beyond money funds,there is the ever-present challengeof the US market itself. The assetmanagement industry has becomeso successful at penetrating themarket that further growth willbe tougher to come by.

At the end of 2010, 23 per cent ofUS households’ financial assetswere held in mutual funds, closed-end funds, exchange-traded fundsand unit investment trusts,according to data from the ICI.

Continued on Page 2

Markets andregulatorkeep industryon its toesOverviewAndrew Greene takesthe temperature asmutual fund leadersmeet for the ICI’s 54thannual general meeting

Regulation SEC reforms ‘will kill’money market funds Page 2

Registered products Platformspave retail path for hedge fundsPage 4

Compliance Gatekeepers fight forresources and support Page 4

Retirement costs Spotlight onfees could intensify competitionPage 5

Distribution costs Margins underpressure as partners lift chargesPage 6

Product profilePimco’s TotalReturn ETF,managed by BillGross, makesstrong startPage 6

Overseas business US firms rulethe roost in Europe Page 7

Marketing Funds find novel waysto drive message home Page 8

Social media Firms overcomefears of Facebook and TwitterPage 8

Contents

Battle lines drawn: the money market fund industry is fighting the SEC’s proposed reforms Bloomberg

Asset managers havebecome so successfulat market penetrationthat further growth willbe tougher to come by

2 FINANCIAL TIMES MONDAY MAY 7 2012 FINANCIAL TIMES MONDAY MAY 7 2012 3

The money market fundindustry is arming itself fora possible court battle withthe Securities andExchange Commission overnew reforms of the product.

The weapons chosen takea seemingly benign form –hundreds of pages of com-ment letters filed with theregulator. In them, theInvestment Company Insti-tute, Federated Investors,Fidelity Investments,Charles Schwab and otherspresent research that couldbuttress an eventual court

challenge to any new rules.The reforms the agency is

reportedly considering –either a floating net assetvalue or capital buffers inconjunction with redemp-tion restrictions – wouldkill the money fund indus-try, say the ICI and thelargest sponsors of thefunds. The industry hopesits comment letters willinfluence the regulator’spolicy decisions, or deterfurther rulemaking alto-gether. But the commentletters also serve the pur-pose of papering the file fora future legal challenge.

“We’re continuing thedialogue [with the SEC],but we’re doing it by filingcomments that we thinkprovide insights into thepotential impact of what weunderstand they’re consid-ering, in hopes it informstheir decision on the ulti-

mate rule proposal,” saysPeter Germain, generalcounsel at Federated. “If itdoesn’t, it creates a terrificbyproduct if it comes to liti-gation.”

Federated has threatenedto sue the SEC if it goesforward with reforms. Thefirm would make its claimsunder the AdministrativeProcedures Act on groundsthat the agency failed ade-quately to analyse therules’ impact.

Indeed, the cost-benefitanalysis required as part ofrulemaking has become theSEC’s Achilles heel. The USChamber of Commerce hassuccessfully sued to blockSEC rules on several occa-sions, most recently withits challenge of an SEC ruleaimed at expanding proxyaccess.

The ICI may have sig-nalled greater willingnessto sue the SEC when itbrought suit last month,joined by the Chamber,against the CommodityFutures Trading Commis-sion over a rule.

But the ICI says it initi-ated the lawsuit “with a lotof reluctance”, according togeneral counsel KarrieMcMillan. “We view law-suits as an absolute lastresort,” she says, notingthat the last such lawsuitthe trade group broughtwas in the late 1960sagainst banking regulatorsover the Glass-Steagall Act.

Showing that the SEC didnot adequately assess thefull scope of potential costsof imposing any new moneyfund reforms would bolstera legal challenge, as woulddemonstrating that thecosts of additional reforms

far outweigh the benefits.The ICI, Federated and

DST have all detailed intheir comment letters thehuge operational changesthat would be necessarywith new reforms.

Federated, for example,notes that automatedaccounting systemsbetween transfer agents,fund complexes, banks, bro-kers and commercial usersof money funds would haveto undergo costly repro-gramming to implementredemption restrictions.

DST, like others, high-lights the possibility thatadditional costs, productcomplexity and ultimatelyloss of clients will leadsome fund firms to exit thebusiness.

Fidelity found that if theNAV were permitted tofluctuate, 47 per cent of itsown retail investors thatthe firm surveyed wouldmove some or all of their

assets out of money funds,while 57 per cent of institu-tional clients would do so.Roughly 50 per cent of theretail investors Fidelity sur-veyed said they wouldeither stop or decrease theiruse of money funds if aholdback were imposed.

Stephen Keen, counsel atReed Smith, says that if theSEC cannot refute that itsproposal would result in a

substantial reduction in theamount of assets in moneyfunds, then the proposalwould entail a significantloss to investors, most ofwhom will have to accepteither lower yields orhigher risks (or possiblyboth) from their cashinvestments.

Even very large institu-tions capable of investingdirectly in the money mar-ket could not do so as effi-ciently as money marketfunds. The proposal mayalso impair capital forma-tion, he says.

“The SEC will have todemonstrate benefits fromthe proposal that would off-set these adverse conse-quences to money fundshareholders and to overallmarket efficiency,” says MrKeen, in an e-mail responseto questions.

The firms also havesought to show that theSEC’s 2010 reforms ofmoney funds have been

effective in lessening sys-temic risk and that no fur-ther regulation is neces-sary.

Schwab says in an Aprilcomment letter that datafrom its own funds showthe new liquidity require-ments “would allow[Schwab] funds to handleredemption requests nearlytwice as large as the largestsingle day of redemptionsand more than twice aslarge as the largest singleweek of redemptions duringthe most extreme financialcrisis since the GreatDepression.”

Comment letters from theindustry also have askedwhether there really was arun on money funds in 2008,or whether it was a run bymoney funds, says BarryBarbash, partner at WillkieFarr. Others have ques-tioned the idea that a float-ing net asset value wouldmitigate runs on moneyfunds, he says.

SEC reforms ‘will kill’money market fundsRegulationA gentlemanlybattle by lettercould end in court,writes BeaganWilcox Volz

Karrie McMillan: ICI lawsuit initiated with reluctance

‘The SEC will haveto demonstratebenefits that wouldoffset adverseconsequences’

That is up from a mere 3per cent in 1980.

The industry has also suc-cessfully entrenched itselfin the retirement market,where mutual funds hold 54per cent of all assets held indefined contribution plans.That is up from 1990, whenmutual funds held just 8per cent of DC assets, ICIdata show.

“We’ve probably reachedthe maximum level ofhousehold participation,”says Gregory Johnson, chiefexecutive and president ofFranklin Templeton. “Andthen it becomes a marketshare battle and a cost bat-

tle and margins will drop abit.”

Still, Mr Johnson says theoutlook for the business isstrong, but says his firmhas focused on findinggrowth overseas. Alongthose lines, it last yearacquired UK-based managerRensberg Fund Manage-ment and Australian equitymanager Balanced EquityManagement.

Franklin’s global foot-print has helped it generatehigher fee revenue than itcould if it were focusedstrictly on the domesticmarket. The firm saw itseffective investment man-agement fee rate climb to65.3 basis points for fiscal

year 2011, up from 62.6 basispoints in 2010 and 58.3 basispoints for fiscal year 2009.The reason: higher levels ofinternational assets, whichearn greater fees than thoseearned on US products.

In fact, the US industry’sasset-weighted averagemanagement fee rate oninternational equity assetswas 63 basis points in the

third quarter of 2011,according to Lipper datacited in Franklin’s annualreport. That compares tomanagement fees of 47 basispoints for US assets.

For all the industry’schallenges, it still offersinvestors a strong valueproposition, says PaulHaaga Jr, chairman of Capi-tal Research & Manage-ment. Mr Haaga, who isretiring later this year, saysthe fund business today isnothing like it was in 1972when he got his start in thebusiness.

“Yes, it’s a very differentindustry than the one Ijoined when there wereonly 1 per cent of house-

holds” investing in mutualfunds, he says.

Today, the industry ishighly visible and has adirect impact on millions ofshareholders. What has notchanged, according to MrHaaga, is the fact that theindustry continues to oper-ate in a challenging envi-ronment.

“Every time I go to theICI [general membershipmeeting], each year there’sa different theme on whowill eat our lunch,” he says.“The truth is we alwayshave competition and thereis always a focus on ourexpenses and we alwaysneed to provide real valueto shareholders.”

Markets and regulator keep industry on its toes

Andrew GreeneManaging Editor, Ignites

Hannah GloverManaging Editor,GatekeeperIQ

Marianna LemannRetirement Reporter, Ignites

Chris NewlandsManaging Editor,Ignites Europe

Jackie Noblett,Peter OrtizReporters, Ignites

Danielle SottosantiReporter, Ignites andFundFire interactive team

Tom StabileAssociate Editor, FundFire

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Contributors

FTfm/Ignites – The US mutual fund industry

‘We’ve probablyreached themaximum level ofhouseholdparticipation’ Paul Haaga of Capital: ‘we

always have competition’

Continued from Page 1

4 FINANCIAL TIMES MONDAY MAY 7 2012 FINANCIAL TIMES MONDAY MAY 7 2012 5

Forthcoming rules from theUS Department of Laborthat will shine a brightlight on retirement planfees will drive costs downand reshape the plans,experts say.

Starting July 1, retire-ment plan service providerswill be required to discloseall fees charged to plansponsors and provide adescription of services ren-dered. Service providerswill also have to declarewhether or not they arefiduciaries to the plan.

Then, on August 30, aDoL rule requiring disclo-sure of plan fees charged toparticipants takes effect.Plan participants will beable to see exactly howmuch money their plansgained or lost and howmuch they paid in fees andother expenses.

The rules’ effects will befelt throughout the indus-try, which encompasses72m participants and nearly$3tn in assets, according toDoL estimates. By sheddinglight on fees, the disclo-sures are likely to drivemore fee competitionamong service providers,according to experts.

Indeed, using the DoL’sprojections, a recent reportby Dalbar, the Boston-basedanalysts, puts the rules’total cost to the industry at$16.9bn in lost revenuesfrom lower fees and addedcompliance expenses, basedon DoL projections.

Fees that are out of pro-portion to plan assets “willbe for all practical purposeseliminated”, says Lou Har-vey, Dalbar’s president.Meanwhile, proportionatefees won’t see much move-ment as long as service pro-viders convince plan spon-sors about the value of theirservices, he explains, add-

ing: “It’s the sort of thingthat’s going to take a longtime and they should bedoing today.”

Plan sponsors, mean-while, will not only want toexplain the disclosures toparticipants, but they mayneed to rethink their plans,according to Lori Lucas,defined contribution prac-tice leader at Callan Associ-ates.

The regulations andresulting push for lowerfees could affect 401(k) plandesign and benefit firmsthat provide less expensiveinvestment vehicles,experts say. That couldfavour more cost efficientsavings vehicles such aspassively managed productsand collective trusts.

“I think all of theincreased focus on transpar-ency and fees if any-thing . . . plays into ourstrong suit,” says KristiMitchem, senior managingdirector and head of globaldefined contribution forState Street Global Advi-sors, which primarily pro-vides collective trusts toretirement plans as opposedto mutual funds. Shebelieves that the biggestimpact the rules will haveis to increase the percent-age of indexed assets in the401(k) system.

Callan’s Ms Lucas notesthat focusing plan sponsorson how fees are paid “tendsto create broader discus-sions about plan design”,which can include “shifts toopen architecture in theinvestment fund line-up,and different fund struc-tures such as collectivetrusts and separateaccounts, which may beless expensive and whichtend not to have revenuesharing”.

The trend towards lowerprices also could createmore of a “one-size-fits-all”approach to plans, saysFred Barstein, founder andexecutive director of TheRetirement Advisor Univer-sity, a retirement planningcertification programmeoffered through the Univer-sity of California Los Ange-les.

“If record keepers areforced to lower the price oftheir services, it mightforce them to limit whatthey offer, including educa-tional meetings and custom-ised plan design, puttingthem into more standard-ised plans where profits aregreater,” he says.

However, the industry isnot likely to see the rules’real effect until 2013, whenplan sponsors make retire-ment plan decisions basedon the disclosures, accord-ing to Harvey. “Any serviceprovider that doesn’t have avalue proposition visible bythat time is going to losebusiness,” he says.

From a basic administra-tive standpoint, plan pro-viders generally are readyfor the regulations. “Manyproviders have completedtheir development work andare ready to comply withthe rules. Some havereported to us that theyhave already begun to rollout their new disclosuresand at least one companyhas already completed mak-

ing the . . . disclosures to itsplans,” says Larry Gold-brum, general counsel ofThe Spark Institute, a lob-byist for the retirementplan services industry.

SSgA spent the past 12months complying with theupcoming regulations, atask that primarily involvedputting information in theright format, according toMs Mitchem. The firm

already had been deliveringmuch of the required infor-mation to plan sponsors, socompliance was “moreabout format and form than… content”, she explains.

The approaching spot-light on fees comes asretirement plan providersare already feeling asqueeze from within theindustry, experts say.

“During the last five

years there has been atrend towards more fee dis-closure and transparencyand that has caused pricesto go down,” Mr Barsteinsays. By driving fees evenlower, the rules eventuallywill exacerbate consolida-tion among record keepersas they strive for scale, hepredicts. “It’s another pres-sure point.”

Spotlight on fees could spur competitionRetirement costsThe effects of newrules will be feltthroughout theindustry, writesDanielle Sottosanti

As they cope with uncer-tain markets, fund outflowsand the spectre of a moreaggressive regulator,mutual fund companies areleaning heavily on theirchief compliance officers.But compliance chiefs saythat while their jobs haveexpanded, they are oftensidelined in other ways,leaving them feeling over-worked and undervalued.

Compliance experts saythat if a company trulywants to improve its com-pliance programme, itshould make sure the CCOis not marginalised. Execu-tives should ensure, forexample, that the CCO hasenough resources and isasked to participate in dis-cussions about controver-sial matters, not just “inareas where we think he orshe will do little harm”, asJim Volk, chief complianceofficer at SEI, puts it.

“Firms need to be carefulof selective inclusion,” saysMr Volk. “I’ve seen that atother firms, where an exec-utive is worried what aCCO might say about a par-ticular issue, and as aresult, excludes them.That’s very damaging to aCCO’s credibility andmakes the CCO feel likethey’re not adding anythingpertinent.”

The satisfaction of chiefcompliance officers is anurgent matter now, afterthe US Securities andExchange Commissionannounced it would checkto make sure investmentcompanies are fully sup-porting those in such posi-tions.

The commission wants tomake sure “that there’s areal sense at the senior lev-els of the organisation thatadequate resources need tobe given to compliance, riskmanagement and controlfunctions and that inde-pendent standing andauthority are embedded inthe structure of those criti-cal functions,” said Carlo diFlorio, director of the SEC’soffice of compliance inspec-tions and examinations, atthe commission’s Compli-ance Outreach Program inFebruary.

“You can’t have a culturewhere a dominant individ-ual can say ‘bury it’ and it’sburied,” Mr di Florio said.“There need to be escala-tion channels.”

Intensifying the urgencyis the commission’s newwhistleblower office, whichwas created by the Dodd-Frank Act and offersawards of 10 per cent to 30per cent of any SEC sanc-tion greater than $1m forsecurities law violations.Compliance personnel mayqualify for awards in somecases, the commission said.While legal experts say it isunlikely a compliance chiefwould go to the SEC everytime he or she finds a prob-lem, they acknowledge thatit may be the only avenueavailable if fund companyexecutives are unresponsiveto problems or seek to sup-press them.

Compliance chiefs saythey face a host of frustra-tions. One told BoardIQ oncondition of anonymity thatin a previous job he endedup feeling beholden to thefund company because he

was paid by the firm, not bythe funds, a typical practicethroughout the industry.

“I got a tremendousamount of pressure frommanagement not to sayanything bad to the board,”he said. “I felt very con-flicted going to the boardand saying, ‘This smells,and you need to take a lookat it.’”

Another source of frustra-tion is a growing mandate,says SEI’s Mr Volk. In addi-tion to the duties set out bylaw, CCOs are also beingasked to lead risk manage-ment efforts and to act as“consensus builders orinfluencers of change”, hesays.

“[If a company] valuesthe CCO and is worriedabout the CCO moving on,they need to give the infra-structure he or she needs.That’s not just money, andit’s not just people. It’s psy-chological support.”

Donna Boehme, a princi-pal of Compliance Strate-gists and former CCO, notesthat such frustrations arenot just eroding the compli-ance programme, they arealso chipping away at theofficers themselves. TheSociety of Corporate Com-pliance and Ethics found ina recent survey thatincluded the financial sec-tor that 60 per cent of CCOs“were so stressed out thatthey lost sleep at night andthat they considered leav-ing their jobs in the lastyear because of this,” shesays.

“Just throwing the CCOout there with a badge anda title is not enough tomake a programme work.The business will not sim-ply ‘get in line’ just becausethe CCO asks it to do so,”Ms Boehme says. “Boardsand senior managementneed to take further actionto empower their CCOs andprogrammes, and part ofthat is realising that thebusiness ‘owns’ compliance,not the CCO.”

Gatekeepers fight forresources and supportComplianceWhitney CurryWimbish findssome CCOs worryabout ‘selectiveinclusion’ by firms

‘I got a tremendousamount of pressurefrom managementnot to say anythingbad to the board’

Lonely job:chiefcomplianceofficers donot want tofeelexcludedCorbis

In the swarm of new alter-native-style mutual fundshitting the US market,many entries are fromestablished retail businessplayers that know themoves to launch a regis-tered product.

That isn’t stopping long-time hedge fund managersaiming to elbow into thisbusy market, with someseeking to better theirodds by tapping into fundadministration platformsthat translate alternativeinvesting skill into a slick1940 Act package.

This year alone, hedgefund managers such asPalmer Square CapitalManagement, HaginInvestment Management,Rock Maple Services, andWhitebox Advisors havenew launches. They’re allchasing a sector whose$12.4bn in inflows in 2011made up 15.7 per cent ofthe US open-end, long-termmutual fund market’s$78.7bn in net new assetflows, according to Morn-ingstar data.

Already in the first quar-ter, $3.1bn in net flows hashelped the alternativemutual fund segmentreach $99bn in assets, orabout 1.1 per cent of Morn-ingstar’s US long-termfund market.

That momentum helpedattract 95 new alternativemutual funds last year,topping 2010’s 84 and morethan doubling 2009’s 46,according to data fromCerulli Associates andStrategic Insight/SIM-FUND. It also boosted thefortunes of Gemini Fund

Services, a New York-based platform that setsup mutual funds and isfinding a niche in alterna-tive strategies, saysAndrew Rogers, its presi-dent. Such products madeup more than half of the 60funds Gemini helpedlaunch in 2011, includingthe Altegris Futures Evo-lution Strategy Fund inOctober.

Mr Rogers says he seesmore hedge fund firmsmoving toward the 1940Investment Company Actstructure, a trend thatalready counts high-profilenames such as AQR Capi-tal Management and Per-mal Asset Management.

Such managers nowhave various platforms tochoose from in addition toGemini, including theNorthPoint service thatConvergEx Group rolledout last year, as well as

Cortland Fund Services,which Hagin used tounveil its new KeystoneMarket Neutral mutualfund this year.

These platforms havehealthy pipelines, saysAlec Papazian, senior ana-lyst at Cerulli. “One fundservicer told me her plat-form’s business with hedgefund managers has dou-bled in the last two years,”he adds.

Many recent productscome from smaller manag-ers, but larger players arelikely to capitalise on anew US law allowinghedge funds to advertise,says Patrick Morris,Hagin’s CEO.

“You’ll increasingly seeeven the largest hedgefunds realise their deeppockets give them a big[retail market] opportu-nity,” he says.

For hedge fund manag-ers, the ’40 Act option is asimple growth play – wid-ening distribution pastinstitutional and wealthyinvestors eligible for theirlimited partnership vehi-cles, Mr Papazian says.

A particularly under-served market are affluentretail investors who can-not allocate $500,000 in onechunk to a manager, saysJohn Kelley, president ofWilmington Funds Man-agement, which recentlystarted a multi-strategyalternatives fund withRock Maple, an $800mmanager with three lim-ited partnership products.

A recent survey fromCurian Capital also foundinterest from 1,000 smaller-book independent advisers,61 per cent of whom saythey plan to increase theuse of alternative assetclasses this year. Morethan 60 per cent said theyallocate less than 10 percent to such investments.

Alternative mutualfunds are not drawing inlarge institutional inves-tors for now, because mostcan secure better holdingstransparency and liquidityarrangements from hedgefund managers than theycould prior to the 2008crash, Mr Papazian says.

Still, even institutionsmight one day develop ataste for mutual fund for-mats, given the appetitefor Ucits alternative fundsbig investors have built inEurope, Hagin’s Mr Morrissays. “That’s a huge poten-tial market,” he adds.

Mutual funds may alsoappeal to smaller institu-tions whose charters barthem from standard hedgefunds, or to defined contri-bution platforms, saysDoug Fincher, RockMaple’s president andchief executive.

The trick still is forhedge managers to knowwhich products will andwon’t work in a ’40 Actconstruct. “Leverage andilliquidity are where youcan’t go,” Mr Fincher says.

That leaves plenty ofroom to roam, and a popu-lar flavour this year ismulti-manager alternativefunds, Gemini’s Mr Rogerssays. “The mutual fundmight have 10 differentsubadvisers each manag-ing sub-strategies – long/short, risk arbitrage, man-aged futures – all withinone ‘40 Act structure,” hesays.

Platforms pave retailpath for hedge fundsRegistered products

Tom Stabile looksat recent trends innew alternativemutual funds

Number of new alternative mutual funds by category

Category

Sources: Strategic Insight/Simfund; Cerulli Associates

2009 2010 20112120131387633100000

95

251277

107135400111

84

132

11144410401001

46

Other long/shortAbsolute returnAlternative allocationManaged futuresCommodityMarket neutralNatural resourcesCurrencyMaster limited partnershipsInfrastructure130/30Alternative energyInverse or bear marketInverse with leverageLeverageTotal

2009-2011

Hedge fundmanagers arechasing a sectorwith $12.4bn ininflows last year

The US mutual fund industry – FTfm/IgnitesFTfm/Ignites – The US mutual fund industry

Dalbar’s Lou Harvey

6 FINANCIAL TIMES MONDAY MAY 7 2012 FINANCIAL TIMES MONDAY MAY 7 2012 7

Demanding new distribu-tion agreements threaten tocrunch asset managers’margins, forcing fund fami-lies to rethink how theyapproach distribution andproduct development.

Fund companies, by andlarge, depend on intermedi-aries to sell their productsand help build their brandwith end-investors. Thisgrowing reliance on inter-mediaries comes as directchannel sales continue toshrivel; 81 per cent of non-retirement plan mutualfund sales came throughfinancial advisers, accord-ing to research publishedby the Investment Com-pany Institute last year.

Increasingly, major wire-houses and other broker-dealers are demanding to bepaid more for the role thatthey play. “They are forcinginvestment firms to look athow they run their busi-nesses and whether theycan be more efficient andproductive,” says T. NeilBathon, founder of FuseResearch Network.

Morgan Stanley Smith

Barney, for one, lastautumn began demandingbigger fees for space on itsfund platform. The wire-house, which employs morethan 17,000 advisers, toldasset managers that havinga presence on its platformwould cost at least $250,000per year, per fund family.The new rates representeda five- to 10-fold increaseover 2009 rates.

MSSB also raised revenuesharing to 0.16 per cent forboth fixed income andequity funds, up from 0.10per cent and 0.13 per cent,respectively, in 2010. Inaddition, it eliminatedbreakpoint discounts andincreased the annual cost ofholding “global partner”status, which allows greateraccess to advisers, amongother brand-boosting privi-leges, from $500,000 to$750,000.

In March, UBS followedsuit. The nearly 7,000 advis-er-strong wirehouse tripledthe amount it charges mostmanagers for new sales offunds held in commission-based accounts to 0.15 percent. UBS also began charg-ing 0.20 per cent annuallyon assets held in clientaccounts for equity andfixed-income funds. Previ-ously the charge had been0.075 per cent for fixedincome and 0.10 per cent forequity funds.

Other distributors are vir-tually guaranteed to follow,

analysts say, increasingfund companies’ cost ofdoing business.

Some firms have takensteps to insulate themselvesby using language in thefunds’ prospectus limitingthe amount they can paybroker-dealers.

The Franklin TempletonInternational Trust prospec-tus, for example, says: “Inthe case of any one dealer,marketing support pay-ments will not exceed thesum of 0.08 per cent of thatdealer’s current year’s totalsales of Franklin Templetonmutual funds, and 0.05 percent (or 0.03 per cent) of thetotal assets of equity (orfixed income) funds attrib-utable to that dealer, on an

annual basis.” AmericanFunds and Pimco have simi-lar language in their pro-spectuses.

But the demands of fundfirms’ distribution partnersoften go beyond pure reve-nue-sharing payments.“Asset managers are look-ing more at what is beingrequired non-financially,”says Roland Meerdter,

founder of consultancy Pro-pinquity Advisors.

Such efforts include con-ference and event sponsor-ships, dedicated wholesal-ers, or specific programmesto educate advisers in thefield. Distributors havebeen cutting costs and theyare looking to asset manag-ers to plug the gaps, hesays.

A look at the margins ofasset managers, comparedwith those of distributors,shows why. In the fourthquarter of 2011, operatingmargins for publicly-tradedasset managers averaged31.2 per cent, according toconsultancy kasina. Mean-while, those of major bro-ker-dealers were roughly 10per cent.

Propinquity’s Mr Meer-dter says that while assetmanagers are being askedto do more, they are alsoquestioning what they getin return – whether it ismore detailed intelligenceon product use, or greateraccess to branches andadvisers – prompting closerscrutiny of the profitabilityof each relationship.“Things are starting to geta little heated and they areasking: ‘What’s in it forus?’” he says.

Likewise, the boardsresponsible for looking aftermutual fund investors’ bestinterests keep a close eyeon costs. Revenue sharingis paid out of fund company

coffers, not shareholderexpenses. Climbing costs inall areas of the business,including distribution, haveboards on the lookout forwhether those pressureswill trickle down to inves-tors. They are asking morequestions on a range ofissues including revenuesharing, says SashaFranger, a research analystwith fiduciary services atLipper.

Fuse’s Mr Bathon sayspressure from distributorswill force shops to getsmarter about distributionand marketing. The tradi-tional wholesaling systemat most firms has changedlittle in the past 15 years,while the industry haschanged dramatically, hesays. “It’s old and it’s anti-quated.”

One problem is that, ingeneral, fund companiesstill pay their sales staffbased on sales, Mr Bathonsays. He believes fundwholesalers’ compensationshould be brought in linewith that of fee-based advis-ers, who are paid based onthe assets they retain.

Product developmentgroups must also thinkabout the profitabilitypotential of each fund theybring to market. Alterna-tive products are attractivebecause of adviser demand,but firms must be sure theyhave the investment talentto execute those strategies,even if it means lifting outa team or acquiring anotherasset manager.

“Distributors are lookingfor credible strategies,”says Mr Bathon.

Margins under pressureas partners lift chargesDistribution costsHannah Gloverexamines theimpact of agrowing relianceon intermediaries

Hand it over: intermediaries are raising rates Dreamstime

‘Things are startingto get a littleheated and [firms]are asking: “What’sin it for us?”’

Pimco’s much-hyped TotalReturn ETF is living up toits sponsor’s loftyexpectations so far, yet itis just one example ofwhat the industry says isgrowing adoption of activeETFs.

Many in the fundindustry looked to the BillGross-managed exchange-traded fund as a test casefor all actively managedETFs. Would investorsdesire an ETF version of apopular mutual fund?Would their interest notcome at the expense of theexisting fund? Could theactive ETF outperform itscounterpart despite havingto disclose all of its tradesand being barred fromusing derivatives?

While it is still early, theanswers to all of those

questions appear to be aresounding yes, at least byPimco executives’ accountof things.

“We’ve received verygood feedback on it. Peoplehave been pleased with theperformance, pleased withthe liquidity and tradingvolume. Our general senseis that we are reachingpeople where we haven’tbeen able to reach before,”says Natalie Zahradnik,senior vice-president andETF strategist at Pimco.She estimates the ETF hasadded a creation unit(100,000 shares) or two aday since its inception onMarch 1.

As of April 20, TotalReturn ETF had $466m inassets, placing it amongthe largest active ETFs onthe market. Pimco’sEnhanced Short MaturityStrategy ETF was thelargest as of March,followed by WisdomTree’s

Emerging Markets LocalDebt fund.

As for performance, inits first month out of thebox the Total Return ETFposted a return of 1.78 percent. That compares to 0.12per cent for its mutualfund counterpart.

Pimco has cranked upthe marketing push behindits actively managed ETFversion of Total Return.The firm embarked on asignificant advertisingcampaign featuring MrGross introducing the ETFand its strategy. MsZahradnik says thecampaign was partiallyintended to reach out toindividual investors whomits wholesaling force wouldotherwise be unable toreach, such as self-directedinvestors. Pimco alsochanged the ticker symbolfor Total Return to BONDfrom TRXT in early Aprilin an effort to make the

product easier to find byinvestors.

While some active ETFsponsors welcome theattention Pimco hasbrought to the category,the Total Return effect hasbeen muted, at best, forother firms. “I’m definitelyhappy Total Return hascome to the market . . . butI haven’t noticed a bigjump in assets in terms ofa rising tide floats allboats,” says NoahHamman, chief executiveof AdvisorShares.

Despite the boost ofTotal Return, active ETFs

made up just under $4bn ofthe $1.2tn in ETFs andETNs in the US, accordingto Strategic Insight. Manyattributes that make TotalReturn appealing toinvestors are uniquecompared with other activeETFs on the market, saysLoren Fox, senior researchanalyst at StrategicInsight. “The interest frominvestors is very fundspecific.”

Yet sponsors contendthat the demand for activeETFs is there. ForWisdomTree, the growth ofits actively managed ETFlineup is not seen asdifferent from the successof its self-indexed products,both driven by the overallmove toward ETFs as aninvestment vehicle.

“Some of it issemantics,” says JonathanSteinberg, chief executive,regarding the distinctionbetween non-index active

and rules-based activeindexes. “When I’m talkingto the end investor,performance isperformance whether it’srules-based or structuredactive.”

As other ETF sponsorsand traditional mutualfund firms begin to wadeinto active ETFs, successin the space may be just astied to the sales, marketingand operationsinfrastructure to supportthe product as the latter’sstrategy itself, sources say.

“Our goal is to createbroader access to thethings we do, whether theyare index funds or activelymanaged products, and it’sbeen somewhat gradual aswe’ve gained familiarityand comfort with the ETFstructure,” says DonaldSuskind, senior vice-president and head of ETFproduct management atPimco.

Pimco’s Total Return ETF makes strong startProduct profileJACKIE NOBLETT

A big advertisingcampaign featuresBill Grossintroducing the ETFand its strategy

The four best-selling fundfirms in Europe have morethan just a few things incommon.

Each boasts significantscale, a strong brand, andfar-reaching distribution.But perhaps the most recog-nisable trait of each of thefour firms is that they allhail from the US.

BlackRock, BNY Mellon,Franklin Templeton, and JPMorgan Asset Managementwere the top-selling invest-ment houses in Europe lastyear, according to 2011 fig-ures from Lipper.

BlackRock topped thecharts with some €23bn($30.5bn) of fund sales,while BNY Mellon, FranklinTempleton, and JP Morgannotched up €18.8bn, €12.8bnand €8.4bn, respectively.

If it was not for StandardLife’s €4.8bn haul, the topseven spots in Europewould have gone to USmanagers last year withGoldman Sachs finishing insixth place with sales of€3.8bn and Pimco in sev-enth with €3.5bn.

Apart from Standard Life,the only other Europeanfirms to appear in the top-10list were M&G in ninth with€3bn and Pictet in 10thwith €2.8bn.

But despite the domi-nance of US managers, com-mentators in Europe believethe apparent supremacy ofAmerican firms is littlemore than coincidental.

“The fact that we hadfour US managers in thetop five at the end of 2011 isprobably more down tochance than anything else,”says Shiv Taneja, managingdirector at Cerulli Associ-ates.

He says the top five play-ers from any one of the pastthree years are linked bythe fact they share a“strong brand and consider-

able scale” rather than thecountry where they areheadquartered.

Ed Moisson, head ofresearch at Lipper, agrees,although he adds that “tim-ing has been crucial for thestellar sales some USgroups have achieved”.Most recently, he adds, thiscan be seen with Templetonand Pimco, which he sayshave benefited from theirposition of being “well-es-tablished” fixed incomebrands at “exactly the timeinvestors were turning tobond funds”.

In terms of bond salesalone, the Lipper figuresshow that Franklin Temple-ton notched up sales of€11.9bn last year, whilePimco had sales of €7.5bn.

Diana Mackay, a formersenior executive at Lipperwho now heads fund mar-ket research company FundBuyer Focus, believes theinclusion of money marketfund sales within the Lipperdata distorts the figures,and is the reason a largenumber of US names appearin the list.

“The US houses have avery big offering of moneymarket funds that are dedi-cated to institutional cli-ents,” she says.

“This is a very differentpart of the business, whichcan distort the real retailtrends in Europe, and sowith the exception of Stand-ard Life and Franklin Tem-pleton, a considerable per-centage of net sales camefrom money market funds,”she says, adding that morethan three quarters of BNYMellon’s and JP Morgan’sinflows are attributable tomoney market funds.

On the fact that so fewEuropean firms appear inthe top-10 sales list, sheadds: “I think that the largebank-owned Europeangroups are in a period ofhuge structural change, outof which you will see newplayers or re-dressed firmsemerge.

“But of the Europeanbank-owned players – therewill be groups that retaintheir dominant positionbecause they have beenquick to adapt to the chang-ing market conditions.” Shecites DWS and Allianz asexamples of this.

Ms Mackay, however,believes that Europeanfirms do have something tolearn from their US peersand that “maintaining com-petitive strength involves

taking lessons from out-side”.

“The US is one of themost competitive marketson the planet, and it is alsothe largest. To the extentthat US players offer bestpractice models, these mod-els will be absorbed.

“However, the Europeanmarkets are very differentfrom the US, so the US mod-els have to be adapted.

Many of the big US namesthat have been successful inEurope have expendedenormous energy and costto adapt to local conditions,rather than imposing a US-centric approach to theindustry.”

A number, she adds, havealso benefited from acquisi-tions – pointing out thatBlackRock’s size is theresult of the acquisition of

Merrill Lynch InvestmentManagers and Barclays Glo-bal Investors, which itselfincluded the large GermanETF player, Indexchange.

“Such groups may be US-owned but they have verystrong European creden-tials.” In any case, she con-cludes, in 10 years’ time itwill be “much tougher tolook at success in terms ofnationality”.

US firms rule the roost in EuropeOverseas businessStrong brands andgood timing havebeen vital, writesChris Newlands

Best selling fund firmsin Europe

Mastergroup

Source: Lipper

BlackRock

BNY Mellon

Fr Templeton

JP Morgan

Standard Life

Goldman Sachs

Allianz/Pimco

Investec

Prudential/M&G

Pictet

Country

US

US

US

US

UK

US

Germany/US

South Africa

UK

Switzerland

€bn

23.1

18.8

12.8

8.4

4.8

3.8

3.5

3.3

3.0

2.9

2011

In 10 years’ time itwill be ‘muchtougher to look atsuccess in termsof nationality’

FTfm/Ignites – The US mutual fund industry The US mutual fund industry – FTfm /Ignites

Diana Mackay: money marketfunds ‘distort’ the figures

8 FINANCIAL TIMES MONDAY MAY 7 2012

FTfm

Mutual fund marketers arestarting to compete forretail investors’ attention insuch non-traditional venuesas cinemas, lifts, cabs andeven during coffee breaks.

It’s all part of an effort onthe part of mutual fundsalespeople to drive theirmessage home by linking itwith potential investors’experience. Vanguard andOppenheimerFunds are twofirms that have launchedso-called experiential mar-keting campaigns in recentmonths.

Industry marketing exec-utives and consultants sayexperiential campaigns areoften not only more effec-tive than a traditionalmedia blitz, they can beconsiderably cheaper.

OppenheimerFunds, forexample, hit the big screensat the Tribeca Film Festivalin New York City lastmonth, presenting its “Glo-balise Your Thinking” cam-paign, which was launchedin February 2011. The firmsponsored “Beyond the

Screens”, a programme fea-turing screenings of threefilms that addressed globalpolitical, cultural and socialissues followed by inter-views with the filmmakers.

Oppenheimer’s campaignat the film festival alsoincluded pre-show quizzesthat asked attendees ques-tions to test their knowl-edge of cinema trivia andinternational markets. Onequestion, for example,asked attendees whichcountry has the most fre-quent moviegoers in theworld. The answer: Iceland.

By picking movies withglobal themes, Oppenhe-imerFunds found a nice tiein to its marketing cam-paign, says Marty Willis,chief marketing officer.“This is a way of reachingpeople in non-traditionalways. It is not just buyingadvertising space.”

What’s more, the cam-paign helped stretch thefirm’s marketing dollars. “Idon’t have the marketingbudget that a lot of thedirect retail advertisershave,” says Mr Willis.“What we were trying to dowas to break through theclutter in the sea of same-ness.”

Last year, mutual fundand money market fundproviders spent $147.4bn intelevision, magazine, news-paper, radio and outdooradvertising, up from $98.6bn

in 2010, according toNielsen Media Researchdata.

“The tricky part aboutbuilding brands with theend-investor is that it isvery expensive,” says DavidSwanson, founder and man-aging partner at consultingfirm SwanDog Marketing.

“In experiential market-ing, the memories havemuch more impact than thethings that you see in printor on TV,” Mr Swansonsays. “Being part of things

becomes embedded in yourpsyche.” The challenge formarketers, particularly inthe asset managementspace, is to develop pro-grammes that compel peo-ple to spend time on them,he says.

For Vanguard it meanstrying to engage customersas they open their wallets.The idea is to show themhow “at-cost” investingrelates to their daily chores,says Mike Ma, head of retailadvertising and prospectmarketing at Vanguard.

“Experiential marketing

has a huge role in showingthe connection of investingto everyday lives,” he says.

Vanguard is using coffee,cab rides and petrol pumpsto try to establish that con-nection. Passengers ridingin cabs in cities such asNew York, Boston and Phil-adelphia are beingreminded by the firm howmuch more a cab ride coststhan other less expensivemeans of transportation. Bycomparison, the firm showspassengers how much morethey may be paying formutual funds.

The same concept isreaching people at petrolpumps. “Everyone is watch-ing gas prices and goes togreat lengths to save a fewcents a gallon,” Ma says.“We try to reach peoplewhen they are searching forsavings. Experiential mar-keting has a huge role inbuilding those connec-tions.”

Another way the firm hasused to connect everydaysavings to low cost invest-ing was by selling coffee atcost in four major cities.Vanguard-branded foodtrucks sold coffee to pas-sers-by at the unbeatableprice of 28 cents.

“If we can relate invest-ing concepts, which areabstract, to things that peo-ple can, smell, touch andfeel, like coffee, then we’vedone our jobs,” Mr Ma says.

The push follows the roll-out of a campaign focusedon the impact of low coststitled “5x Phenomenon”,which highlighted savingsobtained by investors whochose funds that cost fivetimes less than competingfunds.

Coffee was also a centralelement at Fidelity’s“Thinking Big” campaign,which launched in Febru-ary. One campaign piecesays that “It takes 35 gal-lons of water to make a cupof coffee.” In the ad Fidelitydisplays its knowledge onwater economics. In avideo, research analystAnna Davydova talks abouthow regional water short-

ages will become morewidespread.

“The campaign is a plat-form to showcase the intel-lectual capital insights andresearch of our 429 globalanalysts. It positions us onbeing forward thinking,innovative and provocative.We are seeing a significantlift on overall brand impres-sions of Fidelity,” says JimSperos, executive vice-presi-dent and chief marketingofficer.

“Our goal would be everycouple of months to intro-duce a new theme.” Earlierthis month, Fidelity rolledout the second iteration ofthe campaign which focuseson synthetic biology.

Funds find novel ways todrive their message homeMarketingCab rides andcheap coffee arebeing used to helpbuild brands, writesMariana Lemann

Making a connection: experiential marketing by Vanguard

‘What we weretrying to do was tobreak through theclutter in the seaof sameness’

Mixing business and pleas-ure took on a whole newmeaning when the chiefexecutive of US GlobalInvestors urged senior man-agement to open a Face-book account in 2009.

Susan McGee, presidentof the San Antonio-basedasset manager, along withthe firm’s chief complianceofficer soon realised theperils of having enthusias-tic senior leaders befriend-ing one other in cyberspace.

Chinese walls meant torestrict contact and preventconflicts of interest werenon-existent on the socialmedia platform, creating apotential nightmare in ahighly regulated industry.

“We learned the hardway,” Ms McGee says. She

notes that a lack of clearguidelines for what seniormanagers could – and couldnot – post on Facebook ledto “a written policy so eve-ryone is clear of the expec-tations with respect tosocial media”.

What once was a novelway of communicating hasevolved into a routine partof life. This is no less truefor fund firm employees,than for advisers and inves-tors who increasingly preferto interact on various socialmedia platforms.

But entering the socialmedia arena to build abrand, jumpstart an adver-tising campaign, foster loy-alty, to stand out or simplyremain relevant is a strug-gle for many financial fundsconcerned about compli-ance risks.

Some firms have over-come their initial socialmedia apprehensions.Larger fund groups useplatforms, such as Face-book and Twitter, to solid-ify their relationship with

customers and expand theirreach.

And social media has ena-bled smaller competitors toreach a broader audiencewithout the budgets tradi-tional print and TV adver-tising require.

The results are real forMs McGee’s firm. In justtwo years, Facebook movedto the fifth biggest source ofreferrals to its website from12th. Twitter is now thethird biggest driver of traf-fic to the firm’s website, upfrom 20th two years ago.

Asset managers need asocial media policy thatcovers supervision, testimo-nials, customer privacy anddata security and otherissues, says Rajib Chanda,partner at Ropes & Gray.

“It’s not like it can’t bedone,” says Mr Chanda,who is one of 18 attorneysin the firm’s social mediapractice group, which wasestablished in December.

While some firms remainoverly cautious, “there arethousands of examples of

firms and individuals tweet-ing on behalf of firms, pro-viding useful insight andnot committing fraud”, MrChanda says. And the con-sequences of doing nothingshould be equally worri-some.

“There will come a pointwhere not being on socialmedia will be similar to notbeing on the worldwideweb,” he says. “And if youare not on social media, youwill be a dinosaur.”

Research and consultingfirm Corporate Insight saysabout 70 per cent of thefunds and exchange tradedfund firms it tracked areusing social media in someway.

Twitter is the most popu-lar social media platform.This year, the industry hasaveraged 8,000 followers perTwitter page, according tothe report. But Vanguardand iShares account formore than half of these.

As giants AmericanFunds and T. Rowe Priceembraced social media, theoverall adoption rate amongfund firms has risen from80 per cent last year to 87per cent this year, accord-ing to consultancy kasina.

But few firms other thaniShares, Fidelity and Van-guard engage their audi-ence in a two-way conversa-tion with their audience,kasina says – missing outon one of social media’s big-gest benefits.

The Financial IndustryRegulatory Authority andthe Securities andExchange Commission wonpraise for issuing socialmedia guidance, that letsfirms learn which platformsand features work best forthem.

But to comply with regu-lations, firms need to adoptand implement a sound pol-icy.

Shayna Beck, Vanguard’shead of social media, saysthe medium fits well withthe firm’s “plain talk”approach to investing.

The virtual aspect alsomakes sense for the firm,which has a bricks-and-mor-tar presence in few citiesand towns, she says.

“We built our reputationby word of mouth,” MsBeck says.

For Ms McGee of US Glo-bal, it’s as simple as “keep-ing up with how our inves-tors are living their livesand how they are receivingtheir information”.

Cost and security issueshave to be part of the equa-tion, but firms should notbe bystanders.

“You may not have allthe bells and whistles that alarger company can afford,but you still can have asocial media presence,” shesays.

Firms overcome fears of Facebook and TwitterSocial mediaClear guidelinesprevent mishaps,says Peter Ortiz

‘Not being onsocial media will besimilar to notbeing on theworldwide web’

Rajib Chanda