The mutual fund industry is facing waves of baby boomers who will retire and a volatile market that has scared many investors, but nothing has the potential to affect the industry more than a Securities and Exchange Commission review under way of Rule 12(b)-1.
Fund executives and financial advisers at an
InvestmentNews industry round table, however, said that they would be surprised if the SEC made major changes to the rule.
It is a complicated issue, said W. MacCarter Sims, head of intermediary distribution at Schroder Investment Management North America Inc., a New York subsidiary of Schroders PLC of London.
The 12(b)-1 issue is so complex, in fact, that Mr. Sims said he would be surprised if anything got done anytime soon.
"It just affects too many entities," he said. "It's got to be really well-thought-out before any kind of proposed ruling comes down on it."
The 12(b)-1 fees paid by shareholders through mutual funds rose from a few million dollars in the early 1980s to almost $12 billion in 2006, according to the Investment Company Institute, the Washington-based trade association for the fund industry.
Critics contend that the primary use of 12(b)-1 fees has shifted from paying for fund marketing to substituting for a sales load or fund servicing.
There is still debate, however, over whether there is anything wrong with Rule 12(b)-1.
"The system in my view is not broken," said Peter D. Jones, St. Petersburg, Fla.-based president of Franklin Templeton Distributors Inc., a unit of Franklin Templeton Investments of San Mateo, Calif.
There is confusion surrounding Rule 12(b)-1, but that could be handled by making it more transparent, he said.
"That's a change we would welcome," Mr. Jones said.
It may actually be a necessary change, said Ken Ziesenheim, Sebring, Fla.-based president of Thornburg Securities Corp., and a managing director with Thornburg Investment Management Inc. of Santa Fe, N.M.
"There's too much uncertainty," he said. "There's uncertainty from the [fund] directors' perspective in that they really don't know what they're supposed to be reviewing, they don't know what it's supposed to be legitimately used for, and that imposes some potential liability on them."
But Rule 12(b)-1 is part of a bigger issue, Mr. Ziesenheim said.
The Investment Company Act of 1940 — of which Rule 12(b)-1 is a part — needs to be revisited, he said.
"We are living in antiquated times as far as regulation goes," Mr. Ziesenheim said.
A specific problem for fund companies is the way fees are handled, he said.
"It is regulated and fixed by a prospectus," Mr. Ziesenheim said. As a result, it is difficult to adjust fees up or down, he said.
"Because of this anomaly, we have been forced over the years to create multiple share classes, which are totally inefficient, confusing and limiting," Mr. Ziesenheim said. It's time to "do away" with fixed pricing, he said.
There have been vocal calls recently from organizations such as the ICI and The American Enterprise Institute, a Washington-based think tank, for the introduction of a European fund model in the United States. That type of model isn't subject to oversight by an independent fund board, and it would give fund advisers greater ability to set fees as they saw fit.
But an overhaul of the act to allow such a structure would be an ambitious endeavor.
The chances for a thoughtful review of the act, however, are better than ever, Mr. Ziesenheim said. "There is a better probability in the next year or two than there was last year," he said.
Others — particularly financial advisers — are more skeptical.
"The [regulators] have their hands full," said Doug Kreps, principal and managing director of Fort Pitt Capital Group Inc., a Pittsburgh-based advisory firm with $1.25 billion under management. He is also co-manager of the $41 million Fort Pitt Capital Total Return Fund.
"It will probably take another 10 years ... to force change," said F. John Deyeso III, a financial planner and founder of financial filosophy, a three-year-old New York-based advisory firm with $3 million under management.
Until that time comes — if it comes — the industry is trying to address other challenges, the most immediate of which is how best to address the market's volatility.
One thing fund companies should avoid is unnecessary, inappropriate products that foster the investor tendency to chase returns, said R. Mark Pennington, a partner in charge of global relationship management at Lord Abbett & Co. LLC of Jersey City, N.J.
"We don't need to manufacture the next great solution," he said. The best way to deal with the market volatility is to educate investors, Mr. Pennington added.
"It's educating the clients on where we see the markets now, where they should be going forward, and being proactive, whether through conference calls or webcasts," Mr. Sims said.
Advisers, however, said that if fund managers want to help them, they shouldn't spend too much time trying to manage investor expectations.
"I want my asset managers to do what they do, which is manage assets," Mr. Deyeso said. Advisers are responsible for managing investor expectations, he said.
But mutual fund companies can make sure their funds are as transparent as possible, Mr. Deyeso said. Although it is always important, transparency is particularly important during volatile markets, he said.
Transparency helps make sure a fund manager isn't tempted to stray from his or her management mandate.
"The thing that will keep us up at night is style drift," Mr. Deyeso said. "I don't want to wake up tomorrow and find out my value manager is now really growth."
Mr. Deyoso couldn't say if he is seeing more style drift as a result of the turbulent market. But some fund groups do better than others when it comes to transparency, he said.
Baby boomers who will soon retire represent a less immediate challenge to the fund industry than the state of the current market, but one that could have a much greater effect on the industry's long-term prospects.
While fund executives said they are leery of coming out with new products aimed at helping investors though the current market, they are less opposed to developing products intended to meet the income needs of retirees.
"Our industry does need to create new products to service the people that need income," Mr. Ziesenheim said. But it needs to be careful not to promise too much, he said.
"I wouldn't want to see our industry compete on who can provide the greatest amount of income, because as you do that, you are starting to take greater risks," Mr. Ziesenheim said.
It's challenge for investment managers that want to hold on to retirement assets, he said.
The easy solution would be for the industry to figure out how to transfer fund shares directly to the shareholders' individual retirement accounts, Mr. Ziesenheim said.
"We aren't there yet, so we have to spend a lot of time selling and building our brand with the advisers, who we hope will be in a position to receive the cash from these employees who retire," he said.
E-mail David Hoffman at dhoffman@investmentnews.com.
For an edited transcript of the round-table discussion, go to
investmentnews.com/mutualfundtranscript.
