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Fund firms face cutbacks

The travails of the financial markets could hurt mutual fund investors in more ways than one.

In addition to slashing the value of your portfolio, the bear market also has taken a pound of flesh from the companies that manage your mutual funds.

That normally wouldn’t be a cause for you to be concerned, but it could become one if the industry’s troubles linger.

A protracted downturn, some experts say, could mean higher fees, fewer funds to choose from and possibly the downsizing of the companies’ investment research departments.

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“The market’s problems have become the fund industry’s problems, and that can blow back on investors,” said Russ Kinnel, research director at fund tracker Morningstar Inc.

Until 2008, the fund industry enjoyed years of steady growth thanks to ballooning stock prices and growing investment in 401(k) retirement accounts.

But the upheaval in the stock and bond markets has left fund companies grappling with sharply reduced revenue, record investor redemptions and a sudden apprehension among clients about the financial markets.

Through November, investors yanked a net $151 billion from mutual funds last year, the first year with a net outflow in the 11 years that Morningstar has compiled the data.

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Coupled with the plunge in stock values, the redemptions pushed the industry’s assets under management below $5 trillion in November from $8.2 trillion in October 1997, according to Morningstar.

Given that fund-company revenue is tied directly to assets, “the industry has just taken a 40% pay cut,” said Lou Harvey, president of research firm Dalbar Inc. “It’s pretty devastating.”

As a result, shares of asset management companies have been beaten up even more than the overall market.

Janus Capital Group Inc. is down 72% from its peak last year. Mario Gabelli’s Gamco Investors Inc. has slumped 56%. Even industry stalwart T. Rowe Price Group Inc. is off 51%.

Many companies, including Janus, Fidelity Investments and Franklin Resources Inc., have responded to shrinking revenue by cutting jobs.

Management firms are suffering most immediately with their money market funds, which have been hurt by falling interest rates -- especially funds that invest in U.S. government debt.

As rates have tumbled, some firms have been forced to reduce fees to prevent money-fund returns from turning negative.

Other companies have limited new investments in Treasury money funds.

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For the companies, fee cuts have thus far been offset by the tide of money rushing into money funds from investors fleeing riskier holdings, said Peter Crane, chief executive of research firm Crane Data.

But if rates stay low for a long time, fund managers could introduce monthly account fees similar to those at banks or charges for ancillary services such as wire transfers.

“After a while they’re either going to give you your money back or they’re going to charge you for it,” Crane said.

Fees could increase in other ways.

As assets shrink, fund companies are likely to reverse price breaks that they’ve given to investors in recent years, some experts say.

When a fund grows to a certain size, fund companies often lower management fees to reflect the operating efficiencies of a larger fund.

The price discounts typically kick in after a fund’s assets exceed certain levels -- known as break points -- such as $1 billion or $5 billion.

The growth of fund sizes in recent years helped lower management fees to an average of 1.24% of assets last year from 1.44% in 2003, according to Morningstar.

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But many discounts tied to break points could be reversed this year because fund assets fell so much last year.

“Fees are definitely going to rise,” Morningstar’s Kinnel said.

Still, management firms are likely to be extremely cautious about hiking fees, said Aaron Dorr, an investment banker at Jefferies Putnam Lovell who follows fund companies.

“I expect fees to, in the main, stay about where they are,” Dorr said. “I don’t think anyone has the fortitude to tell their investors after they just lost 40% in their equity product that they’re going to raise fees in the coming year.”

Even moderately higher charges could be like a slap in the face for investors who “feel like, if anything, they’re owed a cut,” Kinnel said.

Fund companies also could look to cut costs by eliminating smaller funds.

Last year 621 funds were liquidated or merged into other funds, more than in any other year except 2001, according to Morningstar.

That dynamic has been most prevalent among exchange-traded funds, which have exploded in popularity in recent years.

Only five ETFs were liquidated from 1993 to 2007, according to Ron Rowland, a newsletter writer and money manager who runs an investing website.

Last year, 58 ETFs and exchange-traded notes -- close cousins that invest in bonds -- went by the wayside, and Rowland has 135 more on his site’s “deathwatch.”

If a fund closes, investors get their money back, but it’s an inconvenience and can have negative tax consequences.

“It’s not like giving your money to [Bernard] Madoff, but if you were planning on holding it for the long term, it’s a pain on many fronts,” Rowland said.

Though fund companies have trimmed mostly administrative jobs as the markets have tumbled, a protracted downturn could spur layoffs among researchers and managers, potentially hurting the quality of investment analysis.

“What happens next if the market doesn’t rally from here?” said industry consultant Geoffrey Bobroff. “The answer is probably another round or two of cutbacks, this time deeper and probably more prominent positions.”

One of the biggest question marks for the fund industry is whether frazzled investors will maintain their commitment to investing -- and to mutual funds -- after the second bear market in stocks in this decade.

Fund investors don’t have to worry much about being swindled as Madoff’s investors allegedly were, but many are reevaluating what to do with their money.

“The mutual fund industry is in somewhat of a shock,” Bobroff said. “Because of this being such a broad-based market decline, the industry has to be somewhat concerned. . . . Without a quick reversal, what will it take to bring investors back into the market?”

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walter.hamilton@latimes.com


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