The Big Screen: Smaller-Than-Life Tech Funds
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It looks as if fund companies are going to start cutting back, but their loss stands to be your gain.
In the 1990s, folks had money in their pockets and a mind to invest for retirement and other goals. To sate rising demand, fund companies rolled stock funds off the assembly line by the dozen, many of them betting heavily on the then-sizzling tech sector. But the past year and a half has reversed the good fortune of stocks in general and tech in particular, starving funds of both assets and potential buyers.
Now fund companies are closing funds and merging them together to reduce costs. Though the idea of fewer funds might rattle you, it will probably add up to improved funds with more discipline and fewer gimmicks in the end.
"I absolutely think we'll see fewer funds, and that's good for investors," says Jim Folwell, a fund industry consultant with Boston-based Cerulli Associates. "It will be survival of the fittest."
Here are five reasons the stock-funds universe is due to shrink:
1. There are too many small funds with lousy track records.
In 1990 there were 1,100 stock funds; today, there are nearly 4,700, covering every style and sector you could name. In that time assets have jumped from $240 billion to $3 trillion, though that money hasn't been spread evenly. The 25 largest fund companies have 73% of the industry's assets, which means there are plenty of funds that aren't getting their share.
Of the nearly 3,200 U.S. stock funds in Morningstar's database, more than 1,300 have assets of less than $50 million, according to the Chicago-based fund tracker. Some 780 of those are more than three years old. And more than half of those have performed worse than their average peer over the past three years.
Given the drubbing funds have taken over the past year, the odds of these small, struggling funds getting bigger aren't good. Due to slackening inflows, the number of bond funds has basically flatlined at about 525 over the past four years; that's not a good sign for the thousands of stock funds out there.
2. There are too many tech-obsessed funds.
Stocks posted bigger gains between 1995 and the start of 2000 than in any previous five-year stretch, with tech stocks leading the way. Emboldened investors stuffed record billions into tech and tech-heavy growth funds, which fund companies slapped together as fast as possible.
At the end of 1995, there were 21 tech funds; today, there are a whopping 152. As we outline in this week's
Big Screen, the vast majority are losing money: Their average 50% loss over the past 12 months augurs a spate of mergers and liquidations. Some 20 have already vanished this year.
3. The mutual fund market is maturing.
Today, some 52% of U.S. households own funds, more than double the level 10 years ago. While this is widely held to be a good thing, it also indicates that fund industry growth can only slow.
"I think over the long term this is a limit to how many people are going to own funds," says Scott Cooley, a senior fund analyst at Morningstar. Cerulli's Folwell agrees. "It's hard to argue there's as much opportunity for growth in the fund industry as there was just a few years ago," he says.
4. Fund investors have lost some confidence in the stock market and in fund managers.
The past year's losses have been so steep that investors aren't putting as much money in stock funds as they used to.
Big-cap growth funds gobbled up the lion's share of the record $309 billion that gushed into funds last year. But their 25% fall over the past 12 months is worse than any calendar-year loss in the past 20 years. Many tech-light value funds are in the red, too, leaving investors befuddled.
This year, stock funds have taken in just $13.4 billion in net cash, according to the Investment Company Institute, the fund industry's largest trade group. And even that slim surplus may not hold through the end of 2001: In September, stock funds' net outflows
topped $29 billion, breaking a record set in March. Investors are putting some money in bond funds and putting the rest in the bank. While this trend often signals a bottom for stock prices, it probably also presages a growing line of cuff-linked fund managers at the unemployment office.
5. Funds aren't the only game in town anymore.
Traditional mutual funds face steep competition from exchange-traded funds and separately managed accounts.
Faced with slumping stock prices and sagging inflows a few years ago, you might have been tempted to say that money would return to stock funds whenever things started looking up again. But that might not be the case now. Unlike traditional mutual funds, exchange-traded funds, or ETFs, are priced throughout the day and trade on an exchange. They typically offer lower expenses than standard funds and are starting to get traction with individual and institutional investors. At the end of September, there were 92 stock ETFs with some $64 billion in assets, according to the ICI.
And separately managed accounts threaten to poach fat-cat fund investors. These accounts, which have steep minimums, are essentially personalized mutual funds. A manager uses your money to build a portfolio and trades according to your personalized goals and tax situation. With potentially lower expenses, these accounts will pose a serious threat to funds.
Of course, some good funds that can't get attention will probably disappear, but the bottom line for you is that things will get tougher in the fund business, but better for fund investors.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.