Struggling Stein Roe Jumps Onto Slow-Moving Net Fund Bandwagon

Struggling to counter flat sales and faltering funds, Stein Roe is going where many other established mutual companies have feared to tread: Internet fund territory.

The no-load fund company intends to launch the Stein Roe Internet Leaders fund later this year. Its preliminary prospectus still has a lot of blank spaces, including what the fund's expense ratio will be. Among its managers will be Stein Roe's busiest young star, David Brady.

It's no secret in the mutual fund industry that most established firms have shunned pure Internet funds. Just last month, Robert Pozen, president of industry mammoth Fidelity Investments, publicly rejected the idea of an Internet fund even though he said such a fund would snare it $3 billion in its first month. He didn't want to add to "speculation" in Internet stocks, he said.

The four largest Internet funds now in operation have been able to amass more than $2.7 billion in assets, though none of the companies running them are among the heavyweights of the industry. And despite deep pullbacks in Internet stocks lately, these fund are still posting enviable -- though quickly declining -- year-to-date returns.

Meanwhile, Stein Roe's asset growth has plateaued in recent years, according to Financial Research Corp., even as investors have poured billions of dollars of new money into mutual funds. The company is in the midst of a restructuring that has seen two of its portfolio managers -- including onetime star Gloria Santella -- leave the firm. Stein Roe had intended to merge Santella's faltering (SRFCX Quote)Capital Opportunities fund out of existence, but those plans were foiled last week when the Securities and Exchange Commission nixed the proposed merger into the newer (and presumably better-performing) Growth Investor fund.

Given that backdrop, Stein Roe's move can be viewed in at least two ways -- as a bold leap by a daring innovator bucking off industry snobbishness, or as a desperate lunge by a fund company willing to do anything to hold onto its assets.

Dennis Gallant, a mutual fund consultant at Cerulli Associates in Boston, says it's probably a little bit of both.

"There have been a lot of fund companies sidelined on this effort, leaving money on the table," Gallant says. "This provides [Stein Roe] with an opportunity to garner more assets and to be [one of] the first into a marketplace that, despite all the criticism, has been a viable and growing segment."

Given its difficulties, Stein Roe faces less risk as far as its brand is concerned than would Fidelity. And a successful Internet fund would have a much bigger impact on Stein Roe, which has just over $6 billion in its mutual funds, than giant Fidelity with $820 billion in assets.

"Despite any issues Stein Roe has, I think you're going to see more mid-tier, direct players willing to make these bets on these new, emerging markets for their potential to bring in more assets," Gallant says.

But that's only if the timing is right. The recent selloff in Internet stocks -- TheStreet.com Internet Sector index is off 36.5% from April 12 through Monday's close -- may allow Stein Roe to get into these stocks when prices are low. On the other hand, the firm may be launching the fund after the party has ended.

Stein Roe spokeswoman Marilyn Morrison, citing the SEC-imposed quiet period required for all newly registered mutual funds, could not comment on the firm's reasons for launching the fund now.

In naming Brady to the fund's management team, Stein Roe is tapping some of its best talent. Brady has been piloting (SRYIX Quote)Young Investor fund to positive cash flows and returns. And he's done it with the kind of down-to-earth modesty -- mixed with money-running acumen -- that makes investors gladly open their wallets.

Only thing is, Brady already has another job -- actually four -- at Stein Roe. Besides the $1 billion, just-for-kids Young Investor fund, he runs its $7 million grown-up clone, Growth Investor, with Erik Gustafson. The pair also is teaming up on Santella's old $530 million Capital Opportunities fund. On top of that, Brady runs Stein Roe's $65 million (SRLFX Quote)Large Company Focus fund.

That gives Brady $1.6 billion to run. If the Internet Leaders fund attracts the kind of cash that other Internet funds have, he could be running a lot more.

Morrison cautions that Brady shouldn't be thought of as the lead portfolio manager of Internet Leaders. Instead, he, Eric S. Maddix and Steven M. Salopek will "all be looked upon as co-managers of the fund."

Last week, Brady told TheStreet.com that the Chicago-based firm was hiring additional staff and analysts to help him with his work load, and he was optimistic about taking on the extra responsibility.