MarketWatch columnist Chuck Jaffe gazes into the future and sees the big mutual-fund stories of the coming year.
The big stories in the mutual-fund world are always taking shape, but the new year gives us a chance to gaze into the crystal ball to try to read future headlines.
Performance stories always rule the day — and I don’t make market forecasts, leaving that task to people willing to volunteer for the job of village idiot — so maybe it will be a good year if the economic crisis winds up serving as the backdrop for the developing stories, rather than continuing to dominate the news itself.
Here are the fund-world stories that could capture the headlines in the year ahead:
• A proposal to end money-market funds as we know them.
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In light of several money-market funds “breaking the buck” and losing shareholder money in ’08, the Investment Company Institute formed a money-market-funds working group to come up with solutions for improving the business and protecting consumers.
The industry proposal is likely to suggest that money funds scrap their constant $1 share value and move to a floating net-asset value roughly pegged to $10 per share. That means the fund would expect to be priced at $10 every day, but that the value could fluctuate based on the daily values of the underlying securities.
During the money-fund crisis in September, many fund firms paid millions to buy bad paper back from their funds to keep customers whole and avoid share prices below $1; allowing a floating net-asset value would ease the pressure that fund firms feel now to hold up their end, and would place that risk squarely on consumers.
Remove the stigma of breaking the buck and you can expect it to be broken a lot. Therefore, if the industry can push this through, it will be abdicating responsibility for the promises made over the last two decades.
It is hoped that consumers and regulators will recognize this idea for what it is, a shameless attempt to make sure money-fund operators never eat their bad cooking.
• Bond-fund investors accepting losses in exchange for safety.
Current Treasury yields are barely above the expenses incurred by an average bond fund. If yields can’t keep pace with costs, short-term bond funds are virtually guaranteed to lose money, at which point individual investors should be abandoning their short-duration bond funds (in favor of buying Treasurys directly or simply opening high-yielding bank accounts).
That exodus won’t happen, at least until late in the year; instead, investors will stick with government bond funds waiting for better days, favoring the perceived safety over having to find someplace else to put the money.
• Congress reconsidering target-date funds as a default choice.
When the Pension Protection Act was passed by Congress in 2006, it allowed employers to offer target-date funds as the ideal default choice for employees who might not otherwise invest. Indeed, through September, nearly one-third of all money flowing into funds had gone into these funds.
But performance for the average target-date funds was scarcely better than the average all-equity fund in 2008, so there’s a real question whether the funds offered the kind of diversification and safety that made them look like a good choice. While I doubt Congress will act on this, it will revisit the question, prompting fund companies to scramble to come up with another “better idea.”
• No change in the 12b-1 fee.
Regulators have discussed everything from limiting to eliminating this “sales and marketing fee.” The issue slipped through the cracks in ’08 despite promises that it would be on the front burner. In other words, this issue is dead.
• Renewed popularity of mutual funds as an investment vehicle.
During the market’s last upward run, the headlines were all about hedge funds and ETFs (exchange-traded funds, which track stock indexes but trade like a stock). The current market exposed hedge funds and ETFs for their risks as being most appropriate for traders only.
As a growing number of hedge funds suspend redemptions or suffer losses from events like the Madoff case, investors can once appreciate the simplicity of mutual funds, where investors always know how they are doing (daily performance updates), aren’t pushed to invest massive amounts and can diversify easily at a reasonable cost.
It won’t keep fund flows positive in a down economy, but it will show that traditional funds have a long way to go before meeting their purported demise.
• At least 1,500 funds calling it quits.
One surprise from 2008 was that there weren’t more liquidations. Still, the pace of closures picked up near year’s end and it’s going to be a constant in ’09.
Small fund firms are finding it increasingly difficult to remain profitable at a time when assets are shrinking and costs are rising. Regulators are responding to hedge-fund problems by increasing the paperwork burden on traditional funds. Big firms are consolidating funds that do roughly the same thing, and will kill off those funds with long-term track records that have been permanently impaired by ’08 results.
Operators of bond funds — particularly short-term government and money-market funds — will first close to new investors and then just close altogether as they recognize that they can’t run their business at current yields and cover costs.
And promoters of ETFs — who have been throwing funds out there to see what sticks for years — will see the time has come to pull the plug on investment premises that haven’t gained traction with investors. Any exchange-trade fund with a bad track record over a short history — and with less than $50 million in assets — is a candidate for liquidation.
Chuck Jaffe is a senior columnist at MarketWatch.
He can be reached at firstname.lastname@example.org or Box 70, Cohasset, MA 02025-0070.