Nobody could fault the mutual fund industry for failing to give investors enough choices. At last count, 13,779 funds were clamoring for our attention. Even with all those options, however, plenty of exceptional mutual funds always have been off limits to just about everybody.
Historically, institutional funds were truly untouchables. These funds focused exclusively on managing the money of endowments, corporate pension funds and the filthy rich. A fund usually would be interested in you only if you could write a check for at least $1 million.
This haven of financial snobbery, however, is starting to disappear. Officially, institutional funds still maintain extremely high investment minimums, but sometimes there is a way to sneak in through the back door. Discount brokerage firms can hook you up with some of these funds for a modest amount of cash.
For example, the
MAS High-Yield Institutional bond fund requires a $5 million minimum investment from institutional investors. But you can buy shares through
for $1,000 to $2,500, depending on the brokerage firm. MAS High-Yield Institutional returned 3.17% in 1998, compared with an average loss of 0.42% for all high-yield funds, according to
Pragmatic reasons have prompted well-respected money-management firms like
Miller Anderson & Sherrerd
, or MAS, to welcome the rest of us. After witnessing the phenomenal amounts of money gushing into retail funds during the 1990s, they simply wanted to grab some of that cash for themselves.
Why should you care about this institutional change of heart? In a word, performance.
studies done in recent years suggest that overall, institutional funds enjoy a slight edge over their retail competitors. During the three years ended August 1998, for example, the average institutional domestic stock fund returned 13%, while the typical retail domestic stock fund lagged behind at 11.5%. It was the same story with bonds. The average institutional taxable bond fund gained 7.4%, while its retail counterpart increased 6.9%.
A 1996 study uncovered similar parallels. In that study, Morningstar analysts examined the total returns of institutional equity funds and retail funds during a 5 1/2-year period. The average institutional fund beat its retail competitor by eight percentage points.
The explanation for this performance advantage is easily explainable, says Olivia Barbee, managing editor of
Morningstar Fund Investor
. "It's a cost story," she concludes. "Institutional shares are cheaper than retail shares."
Institutional funds, just like the penny-pinching
, keep their expenses rock bottom. Obviously, it's easier for the institutional players to do this since they aren't saddled with the high costs of customer services operations, mass-marketing campaigns and consumer literature. The expense ratio of the typical institutional stock fund is 1.02% vs. the average domestic stock fund's 1.66%. Meanwhile, the average institutional bond fund charges 0.66% in expenses vs. 1.17% for retail funds.
In addition to
prices, institutional funds can provide a refuge from market timing and style drift. If you own shares in a large-cap domestic stock fund, you probably assume the portfolio is stuffed with huge corporations like
Johnson & Johnson
. But sometimes a manager, in trying to outwit the market, shifts a sizable portion of money into bonds or cash. You might think you own a piece of a growth fund, but it's transformed itself into a balanced fund or something else entirely.
Last year, Foster Friess, the highly respected manager of the
Brandywine fund, fell into this trap and was bitterly criticized. At one point, Friess raised the fund's cash stake as high as 78%. Not surprisingly, his fund missed out on the market's run-up and many shareholders took to the exits.
Abrupt U-turns in investment strategies would never happen at an institutional shop. Pension funds and other high-powered clients would not tolerate such a radical departure from a fund's mission. "You know what you are getting when you buy an institutional fund," says Tom Digenan, vice president of the
, an institutional asset manager in Chicago. "There is no style drift."
Digenan also suggests that institutional players are immune from marketing gimmicks. "The typical mutual fund family is a distribution factory," he insists. "The people who run those things are in product development. We are an investment factory. It's really the investments that drive everything we do. We aren't pumping out Internet funds or other funds of the day that you will see on the retail side."
Several Brinson funds with million-dollar minimum investment requirements, including
Global Equity Institutional and
U.S. Equity Institutional, are available for as little as $1,000 through Charles Schwab, Jack White,
Institutional funds also aren't known for attracting a lot of trigger-happy shareholders, which can be a plus during volatile markets. "Institutional money doesn't tend to move around as much as retail money," observes Stephanie Kendall, editor of
CDA Wiesenberger Mutual Funds Update
. "In times of trouble on Wall Street, institutional managers don't have to worry about a lot of redemptions."
Unfortunately, it's not easy finding institutional gems. Remember, these institutional players aren't buying air time to advertise their track records. One way to track down solid prospects is by checking Morningstar's publications, which do cover institutional funds. If you find a fund that looks promising, call your favorite discount broker and ask whether it's offered. You can also find some of these funds mentioned in discount brokers' fund network listings on the Web.
Beware of institutional funds that let in small investors but consign them to a different class of shares. These shares can carry higher expense ratios than those paid by institutions. If that's the case, investing in these share classes may not be such a good deal.
Don't get discouraged if one discount broker doesn't carry an institutional fund that you'd like. The discounters don't offer the same ones. It pays to shop around. But keep in mind that not all institutional funds are worth owning. "Make sure it's a fund that meets your needs," Kendall advises. "Don't just buy shares because it's an institutional fund."
Lynn O'Shaughnessy writes frequently about personal finance and mutual funds and is the author of
The Unofficial Guide to Investing.