Unscathed Fund Firms Stand to Gain
Among mutual fund companies, the rich may be about to get richer.
As the scandal over improper fund trading widens, Americans increasingly are channeling their dollars to fund firms that so far have been untouched by allegations of wrongdoing -- firms that in many cases already were favorites with investors.
Those companies include Vanguard Group, Los Angeles-based American Funds and Newport Beach-based Pimco Funds.
By contrast, some of the biggest firms implicated in the scandal -- including Putnam Investments and Janus Capital Group Inc. -- had been facing heavy cash outflows even before they were named as subjects of state or federal investigations in September.
For those firms and some others that have faced a torrent of bad publicity, keeping investors -- and luring new ones -- may be extremely difficult in an increasingly competitive fund market, said Geoff Bobroff, an independent fund consultant in East Greenwich, R.I.
“We are going to reorder the industry,” he said. “There will be the ‘haves,’ and then everyone else.”
Underscoring the severity of its challenge, Boston-based Putnam took out full-page ads in some major newspapers on Monday, promising that it would “lead the mutual fund industry in reform.”
On Oct. 28, Putnam became the first fund company formally charged with wrongdoing in the investigation of improper trading. Federal and state regulators said the company, the industry’s fifth-largest in assets, defrauded investors by allowing certain clients and two of its fund managers to engage in “market timing” trades that hurt average investors.
The industry probe has focused on whether fund companies in recent years permitted favored investors, as well as fund managers, to make excessive short-term trades that effectively skimmed profits from longer-term fund investors and drove up portfolio costs.
Most fund firms have official policies against such trading.
Putnam has said it tried to put a halt to timing trades but wasn’t totally successful. The company, which last week fired its chief executive, has maintained it didn’t commit fraud.
But investors haven’t been sympathetic: Putnam’s assets under management fell by $14 billion between Oct. 31 and Friday, to $263 billion, according to a filing that its parent company, Marsh & McLennan Cos., made with the Securities and Exchange Commission on Monday.
Some of that $14 billion was money controlled by state pension funds. But an estimated $3.9 billion was pulled by investors in Putnam’s stock mutual funds, according to AMG Data Services, an Arcata, Calif., firm that tracks fund purchases and sales.
Putnam’s problems holding on to investors’ dollars began before the scandal revelations. Dogged by poor performance in some of its stock and bond funds, the company saw a net $8.8 billion in outflows from those funds in the first nine months of this year, according to Boston-based fund tracker Financial Research Corp.
Fund cash flows measure new purchases minus redemptions.
A declining asset base hurts a fund company by slashing the money management fees it earns. Outflows from individual funds also can wreak havoc for portfolio managers by forcing them to sell stocks or bonds.
Denver-based Janus Capital, one of four fund firms named in the Sept. 3 court complaint in New York that broke open the fund trading investigation, also had been suffering from net cash outflows this year even before the scandal revelations.
Janus saw a net $7.7 billion leave its stock and bond funds in the first nine months, according to Financial Research.
A Janus spokeswoman said the company wouldn’t comment on recent patterns of investor purchases or sales. A Putnam spokeswoman did not return a phone call Monday.
Brokerage Morgan Stanley, which in September was fined $2 million by the NASD (formerly the National Assn. of Securities Dealer) for allegedly abusive practices in fund sales, also has seen net outflows this year, including $3.2 billion from its Morgan Stanley Investment Advisors unit through the first nine months, Financial Research data show.
On the other side of the ledger this year, American Funds, part of Capital Research & Management Co., saw a net inflow of $41.7 billion to its stock and bond funds in the first nine months, Financial Research said. That helped lift American’s total long-term fund assets to $413 billion as of Sept. 30.
Vanguard Group was second in the period, with a net inflow of $22.9 billion. Fidelity Investments was third with $18.2 billion, and Pimco was fourth with $16.7 billion.
In part, those companies have benefited from many Americans’ more risk-averse approach to investing after the three-year bear market in stocks, analysts say. All four firms have reputations for being more conservative in their investing styles.
And so far, none of the companies has been implicated in the fund scandal.
For American Funds and Fidelity, in particular, the cash inflows this year are in sharp contrast to 2000, when the companies lagged far behind Janus Funds, AIM Distributors and other companies that had been more aggressive in betting on highflying technology stocks.
Some experts say the biggest challenge faced by fund companies that have been named in the scandal is that intermediaries such as brokers and financial planners, who account for the majority of mutual fund sales, are likely to turn away from funds of tainted companies, rather than have to defend a company to a client.
“For a financial advisor, I can’t see a compelling reason to take on these issues,” said Robert McCarthy, president of fund research firm Kanon Bloch Carre in Boston.
Yet some fund companies that have been linked to the fund trading investigation say they have managed to slow or halt cash outflows in recent weeks.
The One Group funds, part of Bank One Corp. in Chicago, kept assets about level in October in its stock and bond funds overall, a spokeswoman said Monday. The firm had seen substantial cash inflows in the first nine months, according to Financial Research.
Bank One was one of the four firms named in the Sept. 3 complaint filed by New York Atty. Gen. Eliot Spitzer, though the firm itself has not been charged with wrongdoing. Spitzer has said his probe was continuing.
Kurt Brouwer, principal at financial advisory firm Brouwer & Janachowski in Tiburon, Calif., said he thought it would be “very hard” for implicated fund companies to spin a good story to retain or attract investors.
“This is America -- if we don’t like something, we can vote with our feet,” Brouwer said. “I think that’s going to continue to happen” in the fund industry.
