Mutual Funds Struggling to Keep Investors

To some extent, investors are also moving money out of U.S. stock funds into exchange-traded funds, which are more tax efficient and more liquid than mutual funds, Deluard says.

ETFs are baskets of stocks that trade on an exchange. Investors own the underlying securities that correspond to their shares. So they only incur taxes when they sell the shares at a profit.

By comparison, mutual funds are pooled investment vehicles, and investors can incur taxes whenever a manager sells stock in the underlying portfolio -- regardless of how long they have owned the fund shares.

Also, funds can only be bought or sold once a day at the closing market price, while ETFs can be bought and sold throughout the day.

The mutual-fund industry has responded by lobbying for changes that would help it compete better. The first piece of legislation, which was introduced in Congress this past summer, is the GROWTH Act. It would defer the taxation of automatically reinvested capital gains until fund shares are sold. The bill was referred to the House Committee on Ways and Means on June 20, where it is currently pending.

The fund industry is also lobbying Congress to change the tax treatment of exchange-traded notes, another kind of investment vehicle.

There are other changes in store for the fund industry. The Securities and Exchange Commission has proposed improvements in the way mutual funds disclose information to prospective shareholders. The proposed rules assume investors don't read the prospectus when they buy a fund. They would require funds to offer an easy-to-understand summary of key details at the front of the prospectus, including investment objectives, strategies, risks, costs, the top 10 holdings, portfolio managers, broker compensation and tax information.

The proposed rules would also require funds to make the full prospectus available on the Internet in a user-friendly format.

The SEC is currently seeking comments on this proposal.