blog

It Takes a Village

by Lee

Last week, Barron's wrote about Trader Mark -- a.k.a. Mark Smith -- whose blog, Fund My Mutual Fund, has helped him raise $3 million towards a $7 million goal and the potential launch of a mutual fund. The article has all the juicy details about Mark's Rising Tide Growth portfolio, but what I found most interesting was one of the social networking sites mentioned: Marketocracy.

Using community input to guide investment decisions and providing higher levels of transparency are nothing new -- Metamarkets comes to mind from the late '90s -- but Marketocracy takes this to another level. The firm boasts over 55,000 people managing over 65,000 model portfolios. Based on the 100 best investors each month, Marketocracy creates the m100 Index, which is in turn used as input for Marketocracy Capital Management's investment decisions in their mutual fund. They have even signed research contracts with about 500 members of their community.

Listening to individual investors' ideas about individual securities is not going to be the right research approach for every portfolio manager, but I do think that every firm can learn from Marketocracy and from Mark Smith: in the never-ending quest for alpha, firms must get creative in their investment approaches. Online communities are only one piece, but they can be a valuable tool in identifying product or investment trends and in identifying and recruiting investment talent.

Funds Cannot Get Sued Over Sudan

by Steven

The investment situation in Darfur illustrates why it's good business for mutual funds to be more socially conscious.

When I go to the grocery store, I look for three things: quality of produce (taste and health benefits), cost, and the environmental impact of the produce.

Should fund firms let social awareness determine which companies they work with, or should they just focus on getting the maximum return for their investors?

A recent SEC ruling provides a "Safe Harbor" for mutual funds that divest from Sudan. This ruling provides certain legal protections to funds that divest from companies (PetroChina, Sinopec, India's Oil and Natural Gas Corporation Ltd., Petronas, Schlumberger, and Tatneft) doing business with the Sudanese government. Under these legal protections, the fund firms cannot be sued for making investment decisions based on divestment criteria.

Divesting in companies that do business with the Sudanese government is a choice--there are other, alternative, socially responsible funds companies can select instead.

Additionally, it's simply good business to avoid companies that engage in "bad" corporate citizenship. Engaging with the Sudanese government, for example, puts companies at risk. Not only are they risking exposure to negative public opinion, but they are also linking themselves to a highly unstable government.

Consumers are very powerful, and their demand has made organic products a huge category within stores. Similarly, investors, specifically institutional investors, are becoming more socially aware. No doubt, we will see more fund managers adopt some of the social screens that the SRI sector has utilized for years.

Mirror, Mirror on the Wall: Self-Reflect Before Going Global

by Corianna

Are you an asset manager looking to break into a foreign market? If so, I suggest that rather than simply going after hot markets, or basing operations in regions where you already have pre-existing investments you take a good long look in the mirror. Ask yourself, does your brand or areas of expertise make you particularly well suited to serve a particular region?

In follow-up conversations after the Future of Distribution study we have begun to see some patterns emerging amongst our clients who are pursuing international expansion.

One common approach is:

• Step 1: Push to the EU through the institutional channel.
• Step 2: Layer on retail in Europe and push institutional eastward through Middle East.
• Step 3: Arriving in Japan.

Granted, to the extent that questions of market entry are about market size, international compliance rules and savings, all firms will come up with similar answers--access to data, government regulatory information, an excel document, and some simple equations are all that's needed to figure out which regions will be most friendly to asset managers in general.

However this does not mean that all asset managers should pursue the same markets. Rather than following the herd, why not pay attention to what makes your firm unique? Perhaps you are a company whose brand hinges on reliability and low-cost. Maybe your best bet is to start in Japan, where investors are particularly risk-averse, and go to Europe later. By focusing on what makes you different you may be able to throw the conventional expansion model on its head, and carve out your own unique empire.

A Return to the Age of Conservative Investing?

by Lindsay

While investors' quest for alpha, and subsequent interest in alternative investments, has been widely chronicled, there is another opposing force that will likely drive innovation in product development over the next several years: concerns about inflation and longevity risk pushing investors toward more conservative long-term investment strategies.

As reported by the Bureau of Labor Statistics last week, the Consumer Price Index rose at an astounding 7.9% seasonally-adjusted annual rate (SAAR) in 2Q08, and a 5.0% unadjusted rate for the 12 months ended June 2008.

The typical investor response to rising inflation, more aggressive investing, has also become a dangerous proposition, at least in the short term, as the Dow Jones Industrial Average has continued to bounce around over the past year, peaking at 14,279 in October 2007 and then plummeting to 10,731 just last week.

As reported by Ignites, several firms are taking a cue from the DB space and developing target date funds that use the principles of liability-driven investing (LDI). Essentially, these funds place greater emphasis on protecting investors against longevity, inflation, and currency risk to protect retirement income -- often at the expense of higher potential returns.

Is this trend enough to shift firms' focus from chasing alpha by developing the most obscure alternative investment vehicles to touting their safest, most-likely-to-protect-your-initial-investment funds? Will we all eventually go back to investing in utilities, like our grandparents did? It's hard to believe, but we might be going down that road...

How Big Will 130/30 Be?

by Mike Trapanese

Today, around $100 billion in assets are held in 130/30 strategies. Merrill Lynch envisions the worldwide market for 130/30 funds at $1 trillion in just five years time. More ambitious, the TABB Group doubles the estimate to $2 trillion and claims that 2 years should do the trick. Looking at recent growth, neither of these figures sounds outright unrealistic.

Research from Macquarie Capital Markets (Empirical Analysis on Active Extension Strategies, April 2008) shows that relaxing the long-only restriction can raise the transfer coefficient of a fund, thus increasing its information ratio and boosting excess returns. In an alpha-crazed environment, this helps to explain the 130/30 hype. As mainstream investors pour into long/short strategies, however, the cost profile of short trading is bound to change.

Short positions require borrowed securities. For an asset manager, a prime broker will locate lenders and facilitate an exchange. There is a natural limit to the number of shares on short offer, however, and this quantity is necessarily far less than the number of long shares on the market. Growth in 130/30, along with other long/short hedge fund strategies, will increase demand for borrowed shares and drive up the cost of borrowing them. Scarcity will enable both lenders and prime brokers to increase fees, eating away net returns.

At a recent NICSA conference, I heard a prime broker put a great deal of faith in his firm's ability to rehypothecate shares, effectively stretching the number of short shares currently available. When he was asked if $1 trillion was realistic, his answer was telling: "maybe."

Short trading will undoubtedly play a role in future fund innovations. In estimating the future market, however, we must be cognizant of the limitations of our current one.

Morningstar Takeaways

by Tricia

Back from the Morningstar conference in Chicago: The consensus from veterans of the Asian market is that Asian markets have re-priced themselves correctly following five years of unsustainable growth. Japan is interesting for the first time in a long time. Experienced managers continue to buy firms with long-term production capability, not short-term value, and advise others to hedge against Asian currency inflation. The main threat to global growth? Unredressed inflation. In other words, too much money chasing too few goods.

An interesting tactical note: In a room of about 150 financial advisors, about 2/3 held ETFs. Of those, one half said ETFs were a key part of their strategy. My question is, how can ETFs be so cutting-edge and innovative if so many people are already using them?

Overall, what I got out of the conference was this: The biggest challenge to globalizing your strategy is rarely operational; instead, the challenge usually lies in persuading people to see themselves as competitors in an increasingly complex global economy, and not to rest on their laurels -- a profound, and profoundly humbling, paradigm shift.

Wholesaling Darwinism

by Mike Mc

The lead story in Ignites from Monday, Wholesalers Face Scary Scenario as Advisor Ranks Fall (subscription), paints a grim, challenge-laden picture for today's sales organizations. The advisor population is shrinking; the average wholesaler lacks experience; the sky is falling.

It seems that rarely a day passes now where one wholesaling apocalypse or another isn't upon us. We sometimes dabble in it ourselves.

But lost amidst the constant rhetoric -- if I never read another article about product pushing externals, it'll be too soon -- is the fact that wholesaling is entrenched as part of distribution. It's here to stay.

What's more important (and more interesting) is how wholesaling is evolving. One such evolution, hybrid wholesaling, continues to be a dominant topic with our clients.

Like a fund reaching its 3-year anniversary, hybrid implementations industry-wide are finally establishing an identifiable track record. So, are hybrids here to stay, too?

We'll be releasing a full report on this later in the month, but early returns indicate that the answer is a resounding 'yes'. Based on our analysis, here are three key reasons why:

• Profits: for the vast majority of firms, hybrids have enhanced the profitability of their sales efforts, in some cases by more than 5%. In our research, no firms have indicated a decline in financial efficiency.
• Reach: where hybrids are placed and who they target varies dramatically across firms, but they are almost always focused on unexploited pockets of advisors (by channel, by geography, by behavior). With 300,000 advisors out there, wholesaling has elements of a numbers game, making it increasingly critical to find those shadowy corners of the advisor universe.
• Lifestyle: as hybrid positions have become established, they have become an important alternative for individuals who want middle ground when it comes to travel, and for firms who want to offer careers to salespeople that do not require endless time on the road. With field time ranging anywhere from 20% up to 70%, a hybrid role can provide a range of lifestyle options.

Given costs that are roughly 1/3 as much as a traditional external, hybrids will continue to play a key role in wholesaling evolution.

The landscape is changing, but the sky is staying right where it is.

The U.S. as a "Dying Proposition"

by Johanna

At a presentation on global trends in the mutual fund market I recently attended, I heard an interesting statement made about the U.S. asset management industry:

"The U.S. is a dying proposition."

Indeed, the U.S. financial markets are suffering a crisis, but the U.S. still has far and away the largest share of the global mutual fund pie. For example, in Q407 the Americas had 51% of worldwide mutual fund assets, whereas Europe had 34% and Africa/Asia Pacific had 14%. However, one of the factors mentioned got me thinking that such a morbid statement might have some truth to it. The idea centered on product innovation, and how it has moved overseas.

It's no surprise that the amount of regulatory hurdles in the US, which makes it difficult to bring innovative products to the market, puts this country at a disadvantage, so it's also no surprise that today many new product types are introduced abroad and then appear in a 40 Act version in the states a few years later. One recent trend that began overseas and is making its way to the U.S. marketplace is thematic investing -- such as funds centered on agriculture, climate change and anti-global warming, and financial global infrastructure.

Missing out on product innovation is one sign that the U.S. is falling behind other countries in the asset management market. Despite regulatory constraints and hassles, U.S. product providers must break from style boxes to remain competitive. The first step is to rethink product development processes and move further towards a "market needs" approach. As kasina posited in the report "Rethinking Product Development," instead of getting most product concepts from wholesalers or creating line extensions of current products, firms should do due diligence with advisors and investors to understand true market needs. The firms that succeed in translating those needs into new products (that likely won't fall in the style boxes) will have a chance of staying in the global fund game.

The Global Outlook: What to Watch For

by Tricia

Here in Chicago at the Morningstar Conference, the watchword is complexity. If I had to pick the most important thing to talk over with our clients, it would be the convulsive global environment.

The operating environment is almost completely reversed from what anybody would have dared to say even a year ago. The emerging markets are net creditors, and the US is a net debtor. The $350 billion dollars of market recapitalization came from the Asian central banks, not from the G-7. So did 60% of all global growth. Brazil's sovereign debt rating is higher than that of Citi's. The expectation is that the next massive recapitalization need will be that of the American consumer, whose resilience carried the global economy through the 1997-98 contagion.

That's nerve-racking. Consumer spending is about 70% of the American economy, and the American economy is about 1/3 the global output. In the last twenty years, Americans have had most of their equity stored in the value of their homes. We are right on top of the point where it will make sense for some people to drop off their keys and walk away from their mortgages. Certainly, for the first time in American history, homeowners are falling behind on their mortgage payments before they fall behind on other payments.

As we said in "Future of Distribution," the ongoing erosion to investible assets as well as to margins, makes a more compelling argument for global diversification (as if you needed another one) -- not just geographically, into the BRICs or "developing" (we're going to have to come up with a different nomenclature soon) Asia, but across commodities and industries as well.

Redemptions a Problem? Internals, the Cure

by Mike Ma

"We are beating benchmark by 1300 bps and we are suffering net outflows!"
"How do we stem redemptions from products that have good performance?"

This first statement was said by a good friend of mine I am vacationing with who happens to be a portfolio analyst of a high-profile asset management firm. The second question was also brought up in a call today with the head of marketing from one of the top 10 asset managers in the industry (I am on a working vacation ... lovely!) -- Two similar questions in 12 hours, so I figured a post was in order. My answer to both --

The internals.

Get the internals out there more, but do it with more intelligence. Two quick tips and thoughts, in order of preference and effectiveness:

1. If you own their own transfer agent ... - One of our clients has used the internal desk to call an advisor when a redemption order came through. You have T+3 before settlement and I'd bet you will be surprised at how many advisors you can talk off the ledge.
2. Or else ... use the Web reports - If you know which products are on your watch list make sure traffic reports or downloads of information about those products are promptly and delicately followed up on with by your internal desk on a daily basis. I'd like to reiterate the word *delicately.* You don't want your internals to come off as big brotheresque; rather, have these advisors be put into a regular call pattern with regular leading questions.

This is a situation best handled by people who can readily get to wherever they are needed. Who better than the internal wholesaler?

We just have to give them better tools.

Recapturing Margins through Measurement

by Lindsay

The asset management industry has reached a critical point in its evolution. The fat margins once enjoyed by not only the industry titans, but also the smaller, niche players, are slowly diminishing due to heightened competition, while top-line revenues at many firms are also being hit by asset outflows. So what's an asset manager to do?

The usual drivers of investors' and advisors' decision making, fund performance and product line-up, are difficult to change in the short term, and are largely out of distribution executives' control.

Distribution strategies and tactical implementations, however, are flexible, adaptable, and, most importantly, within the control of distribution executives. The asset management industry currently spends about 40% of incoming fees on distribution efforts, but most firms do not disaggregate the impact of individual initiatives and processes, preferring instead to look at aggregate sales figures.

One of things that really struck us while we were writing our latest report, Quantifying Distribution Strategies, was how much and how fast the asset management industry is changing. Not only do firms have to think of new products, new services, and new ways of doing business, but they must also re-evaluate, top to bottom, the metrics used to figure out how they're doing. Half of the executives we talked to said Sales is overvalued; the other half said Marketing is overvalued. The surprising part was that very few firms have mechanisms in place to find out, in any empirical way, who is driving what - so we outlined a few things the industry could be thinking about as it allocates valuable resources to different distribution functions.

It isn't accurate or useful anymore to treat distribution strategy as a monolithic entity; firms have to break it up into its component parts, and look at them individually. More than just the how-to of this is the 'have-to' of this: renovating business metrics is more important than it used to be. The money spent on distribution, and the lack of transparency around the results, exposes a compelling opportunity.

Investing in $ocial Networks

by Corianna

Cake Financial and SmartyPig are two social networking sites that have recently caught the attention of the press. The former is something along the lines of a huge online investment club allowing investors to track their portfolios, and the real time performance information of acquaintances and strangers alike. The latter lets individuals set savings goals and distribution plans and share them with friends, family, and loved ones.

On June 19th Cake Financial boasted the listing of over 5,000 new portfolios, and within two months of launching, SmartyPig had users in all 50 states. The success of these two sites suggests the turning of a new page in the story of online interaction. In particular, these sites:

• Excite competition between participants
• Allow people to learn from the experience of others
• Depend on people openly sharing financial information

The first two bullet points suggest that incorporating social networking capabilities into advisor sites might increase sales.

The third bullet point indicates that users are feeling more and more secure interacting and sharing personal information online. As users' comfort levels continue to increase, so will the demand for extensive online capabilities -- ranging from self-servicing tools, to ways to interact with others.

Where Have All the DB Players Gone? DCIO

by Sean

According to a recent study by Sway Research, "asset management firms are earning average margins of 25% on DCIO business versus roughly 18% in markets, such as mutual fund wrap and sub-advisory, and only 12% on the SMA business." As such, major defined benefit players such as BlackRock, Goldman Sachs, and PIMCO (among many others) are making a major push into the $1.7 trillion defined contribution investment-only business. In so doing, they'll be up against entrenched players like Capital Research, Fidelity, and Vanguard.

So what is it going to take for these firms to be successful? Here's the short list of things firms must consider:

• Establishing strong brand visibility among plan sponsors
• Gaining access to the large, open-architecture platforms
• Rolling out new products that meet plan participants' demands for income protection and generation over specific time horizons
• Increasing collaboration among historically channelized institutional and retail distribution and operations functions

In an environment where, according to kasina's "Future of Distribution: Stay the Course or Innovate," 90% firms are experiencing declining margins, firms with strong institutional investment management capabilities should take a hard look at the DCIO space.

The Growing Exchange Traded Product Buffet

by Johanna

Advisors are excited about ETFs. In a recent survey of over 800 advisors conducted by State Street Global Advisors and The Wharton School of Business, 67% of polled advisors said that the ETF is the "most innovative investment product in the past two decades."

Product providers are equally excited, and recognize the opportunity exchange traded products offer, demonstrated by the 300-400 ETF products awaiting approval with the SEC, and the prediction that 560 ETFs are going to be launched in 2008. Twenty-three products were launched last month alone.

With the mad dash to get a piece of the exchange traded product market, providers are in danger of overdoing it. In the survey, 21% of advisors listed "overwhelming choices" as the greatest disadvantage of ETFs. What does this mean for product providers?

Educational Support

Firms must support the growing market with value added content around the advantages of products like ETFs and ETNs, but also around the underlying indices and the various ways these products fit into an investor's portfolio. Clearly the Web comes to mind as a key lynchpin to supporting advisors and helping them choose between the myriad products on the market today and those soon to come. For example, advanced product selection tools and educational tutorials around less understood products (such as ETNs) will be increasingly critical in the upcoming months.

Differentiate

Furthermore, few firms do a great job of differentiating their exchange traded product offerings. ETF providers have differing philosophies on how to structure their ETF offerings. For example, WisdomTree uses core earnings or cash dividends to choose and weight companies in their ETF products, and Vanguard's ETFs are an additional share class of its existing mutual funds. Do advisors understand what this means when it comes to choosing products? Firms that are able to educate advisors around product fundamentals, but then also differentiate in this rapidly expanding space, are more likely to come out on top.

Product Development is Growing Up

by Anu

Recently, Paul Atkins, SEC Commissioner, spoke up for Asset Managers to develop a product czar. He specifies this role as a person with cross-divisional responsibilities. The czar would align ideas and trends from Investment Management, anecdotal input from Sales, market analysis from Marketing, fiscal concerns within Corporate Finance, flexibility and capacity within Trading and Markets, and other areas.

At kasina, we could not agree more. In our Rethinking Product Development research, few of the 20+ US and Canadian Product Development teams provide for this role.

Isn't this czar another step to improved enterprise-wide risk management? Instead of relying on alignment from water-cooler meetings and quarterly summits with over-packed agendas, a dedicated resource - with alignment goals - will reduce the expensive and potentially harmful launches of ill-conceived products. For a new product to have a chance at success, the firm needs alignment from numerous business units.

Additionally, the czar becomes the go-to resource on SEC regulations and processes for new registered products. And, over time, they would provides Sales, Marketing, and the Office of the CEO reliable and predictable dates for SEC approvals and therefore enabling properly timed sales training, on-time marketing development, and appropriate resource management. All this sounds like precise risk-management with an eye to lower overall new product launch cost, therefore saving the investor basis points.

Anyone have suggestions?

by Lindsay

Last week I played golf on a typical Florida course, wherein copious artfully placed, often hidden water hazards seemed to maliciously steal my perfectly executed (well, not quite) shots at every opportunity. As I was complaining bitterly about the clearly sadistic designer who had engineered this unforgiving course (forgetting, for a moment, that I was spending a long weekend in sunny Florida, while my colleagues were stuck in New York, staring at their computers), we drove across a long wooden bridge, traversing a large swamp between the 9th and 10th holes. In the midst of the reeds and about 15 feet from the bridge, was a box marked “Suggestions” perched on a tall wooden pole. It was clearly mocking us.

Golf analogies aside, the inaccessible "suggestions" box made me think about idea generation in the asset management industry, and how it differs from other industries. When executives at famously innovative companies, such as Apple's Steve Jobs, are interviewed, they often discuss the processes their companies have in place to encourage idea generation by employees at all levels. Tapping into the intellectual resources of all employees, rather than simply those employed in product development or creative capacities, they say, helps them continue to be thought leaders.

The asset management industry, on the other hand, often seems to employ a model more like the aforementioned golf course. Suggestions and ideas are nominally welcomed, but the effort that it would require to actually submit them (figuratively, swimming through the swamp and climbing the pole) doesn't seem worth it, so firms largely remain siloed, in this respect. I recently met with one firm that is taking small steps toward combating this issue. The firm has created a program through which its Product Marketing and e-Business teams actively solicit ideas from employees in call centers, and encourage participation by offering prizes for the best ideas. Anecdotal evidence suggests that the program has been successful, and that many ideas have been implemented since the program's inception.

Asset managers are often given a hard time for, with a few exceptions, playing follow-the-leader. For those who are not among the few industry leaders, tapping into the collective brain power of all employees could be a first step toward creating a creative, innovative culture and, ultimately, towared breaking from the pack.

Tangerines and the Art of Messaging

by Anu

This weekend, I took my four-year-old grocery shopping. We were looking at the fruit when I let out an exclamation: "Pixie Mandarins!" The Pixie is a relatively new tangerine -- it tastes like a jar of honey met freshly squeezed orange juice. My daughter was enthused, because I was enthused. The interesting thing about the Pixie is that it's exclusively grown in Ojai, a lovely farming community northwest of Los Angeles.

So I wanted to share my joy with fellow shoppers. To five people, I said, "Hey, these are delicious citrus fruits." And how many decided to purchase them? ZERO.

To another set of five people, I said, "Hey, have you had these? This is a Pixie Tangerine and I doubt you'll find it anywhere else in Brooklyn. It comes from this little, magical farming community called Ojai, just inland from Santa Barbara." And how many decided to purchase the citrus? FOUR.

What are we doing in our industry? Are we just telling advisors that there's "large-cap growth funds in aisle four" or are we describing the unknown value of a TIPS fund in volatile markets?

If you do nothing else, please look for those Pixies; they won't be around much longer.

Customized Search: Why Not?

by Johanna

In 2005, Google rolled out a customized search product. Basically, it's an engine that sits on top of the Google platform and allows the search provider (whoever is maintaining the Web site where the search is located) to restrict the domain. In short, the customized search engine cuts down the Web universe based on the search provider's specifications. Two examples include Green Maven's search of sustainable and environmentally friendly Web sites, and The Economic Search Engine, which searches over 10,000 economic-related sites.

Why don't asset management firms use this function? Firms could locate a customized search engine within news or commentary sections, and set that search engine to query both within the site as well as within selected financial services and news Web sites. The search could be product- or sector-specific, and labeled as the "Asset Management News" search, or the "Mutual Fund News and Research" search.

With the Google customized search tool, the search return pages would open in a separate window, but would display the firm's logo. While this option does commit the sin of sending advisors away from the firm's site, it provides a valuable service, and at least gives the firm a branding boost in the process.

Turning Services into Products

by Lee

A friend sent me a link to this video about Denmark's Jyske Bank. They have taken some impressive steps to turn their banking services into physical "products" that customers can explore in their branches. Customers can grab a box labeled, for example, "My First Car Loan," and pull out the brochures inside (as shown below). They can also take these product boxes to a "TestBar" counter and scan the barcode on the box, bringing up a video on a computer monitor showing a fun to watch presentation.

Jyske's results have been equally impressive -- they doubled their customer base within a year. It is a shame that more companies don't make it easier (and more fun) for customers to get to know their offerings.

No One Likes a Failure...

by Lee

Since many asset management firms do not offer closed-end funds ("CEFs"), you may not be following the mess that is going on with "failed" auctions in the municipal bond market. Here is my take:

Auction-rate securities have long been a way to offer borrowers a way to finance for the long term at short-term interest rates that are periodically reset at auction. Investors have recently soured on this part of the market, due to concerns about a lack of liquidity and questions about the bond issuers.

What is a failed auction?
When there are not enough buy orders to meet the quantity of sell orders, the auction fails. A failed auction doesn't necessarily mean a loss of capital will occur, but rather that a seller cannot sell in the auction.

So what?
When an auction fails, the issuer is typically required to pay a maximum (or penalty) rate. The maximum rate typically can be either a relatively high fixed rate, such as 10%, or a formula-based rate.

What does this mean?
As a result of failed auctions, the cost of leverage for common stock CEF shareholders has increased to the maximum rate until there is a successful auction. This can contribute to a reduction in net investment income available to fund shareholders and lead to fund dividend cuts. Additionally, the issuer sees their interest costs soar.

While the failed auctions do not directly affect the securities held in CEFs or the ability of the common stock shareholders to sell their stock, the higher cost of leverage is a serious problem and liquidity for preferred stock shareholders is impacted.

What's next?
Just today, the Securities Industry and Financial Markets Association asked the SEC to allow those who issue debt to buy it as a short-term fix. As the agency evaluates concerns about whether a borrower's participation in setting the clearing bid in an auction for its own debt would be market manipulation, CEF providers are scrambling for both short- and long-term solutions.

While the resolution is still foggy, it does seem like capital is harder to come by than it has been in a long time -- and this isn't likely to change in the near future. As this all sorts itself out, I wouldn't be surprised to see providers of CEFs take a variety of steps, some which may seem drastic today:

• Many firms are already looking to new partners for liquidity (banks, insurance firms, etc.)
• Some companies may delever funds and redeem preferred shares
• Some CEF providers may even be forced to liquidate some of their funds

BETA for cheap?

By Steven Miyao

In conducting research for our recent "The Future of Distribution" report, I found it interesting that none of the actively managed fund companies that we interviewed--23 of the top 50 firms by AUM--had any plans for getting in on the passively managed game.

New data from FRC shows that Vanguard surpassed American Funds in last year's fund flows. What is even more fascinating is that other beta players, such as Barclay's Global Investors and State Street Global Advisors, also did very well.

This has severe pricing implications. The distinction between alpha and beta performance is now more transparent than ever, and advisors are not willing to pay for actively managed products that are really just expensive closet beta funds. Instead, advisors are seeking cheap beta products such as ETFs. On the other hand, only true alpha players are able to command premium fees.

Surprisingly, our study shows how the firms in the industry are at the same time complacent and yet strangely confident in taking on competitors whose strategies, strengths, and weaknesses resemble their own. Their obsession with familiar rivals and products, however, has blinded them to threats from low-cost competitors such as Vanguard, BGI, and State Street.

Another Starbucks Question

by Corianna

In December, Lindsay wrote a blog piece inspired by Mark Penn's new book, Microtrends: The Small Forces Behind Tomorrow's Big Changes. Lindsay recounted Penn's comparison of "Starbucks economy" of today, to the "Ford economy" of the twentieth century. Penn argues that consumer attitudes have moved from the ideal of mass production to that off mass customization. Starbucks, with its crowded menu of caffeine, milk, and flavor combinations, is undoubtedly the poster-child of 21st century customization. Who, Lindsay asked, would be the Starbucks of the asset management world?

In some ways, the asset management industry, with its cornucopia of funds, already looks a lot like Starbucks' menu. Indeed, you might think that everyone should be able to find what he or she is looking for from the industry's innumerable offerings.

It's not that simple, though; offering many things is not synonymous with offering customization. Customization is about more than just options; it's about experience. I suspect that customers--advisors and investors alike--aren't exactly awash in waves of joy when they see long mutual fund product lists. They are, I imagine, rather overwhelmed. I think it's time to step away from the Starbucks analogy. It's time to ask what customization asset-management-style looks like. And there's an answer: customization, asset management style, looks like UMAs. So, I'd like to tag a line onto Lindsay's question: Who, I want to know, will be the first to make UMAs available to the average asset management customer?

Break Out the Box Cutter

by Mike Trapanese

In my life outside of distribution consulting, I play the saxophone. John Coltrane has been an inspiration for me. Generations of jazz musicians have tried to emulate his style of improv by applying music theory to his solos. As it always does in music, however, the theory eventually became a thing unto itself. I'll never forget watching a music teacher throw his finger onto the page of a transcribed Coltrane solo to point out a "wrong note." Since I've constantly got sax on my mind, I've come to realize that lumping mutual funds into style boxes is much like evaluating Coltrane based on music theory.

Morningstar style boxes have their merits. As a classification system, they are an effective way of grouping funds for reference. As a marketing tool, they present an intuitive way to describe funds to advisors. They are, however, an inductive overlay and can be limiting from a product development standpoint.

Research analysts at broker-dealers are a more savvy audience than their advisor colleagues. Increasingly, the responsibility of picking funds is being transferred to these analysts as more and more assets pass through discretionary platforms every year.

These gatekeepers are more discriminating in their selection processes. In contrast to many advisors, they understand pure alpha and actively seek it. To differentiate their products in the eyes of analysts, product developers should look to build products around successful strategies rather than style boxes.

Morningstar gives style drift a bad rap because it undermines the integrity of their peer groups. Quite often, however, "drift" drives returns as part of a manager's investment strategy. This "drift" is the wrong note in a Coltrane solo. Thus the problem is not style drift-- but it could be the style box itself. The omnipresence of these boxes has blurred the line between strategy and style box. Building products around style boxes is a reliable way to ensure beta, but at the same time it is a sure-fire way to undermine the benefits of a successful strategy.

Building a fund product from the strategy up, without consideration of the style box it will occupy, comes with consequences. Invariably, returns will deviate from their benchmark. To communicate this paradigm shift to research analysts, Athena has developed a classification platform that groups funds by common strategy elements rather than common holdings. Examples of these strategy buckets are Economic Position, Future Growth, and Profitability. We at kasina have already started to hear research analysts talking about Athena's SBI platform.

It's important to remember that style boxes are a limiting force, and trying to stick within their walls is bound to limit alpha and drag returns towards the benchmark. Similarly, John Coltrane didn't rip legendary solos by staying within the confines of music theory -- he first understood the theory, and then understood those instances in which he had to surpass it.

Just as Good, Just as Smart... but Cheaper!

by Mike Mc

The term "commoditization" gets thrown around liberally when it comes to asset management these days. And with 8,000+ domestic, open-ended funds out there, it's easy to see why. The concept gains further steam when up to 80% of actively-managed funds under-perform their benchmarks in a given year.

Of course, commoditization typically brings with it price implications. (Many products) + (similar attributes) + (low barriers to entry) = Competitive Pricing.

And yet the question nags at me... why don't active managers compete on price?

According to a study by Peter Wallison and Robert Litan, pricing differentials of up to 300% persist within the mutual fund industry in the U.S. Contrast that figure with the 50% differential seen in the UK, and you have the ingredients for a very interesting discussion.

Wallison and Litan present an analysis that is worth reading. However, I found it wanting on one point. They argue in part that fund managers have little incentive to cut costs because of the way in which fees are determined. Seems to me that, even with the surrounding regulation, managers would want to pursue lower fees for two fantastic reasons:

• It is in the best interests of the shareholder. (Isn't that what every mutual fund is supposed to be about?)
• It is, as of now, an unexploited avenue to potentially gain an advantage on the competition.

Obviously the decision to compete on price is a complex one. However, with so many firms looking for something - a message, a product, anything - to stand out from the pack, I'm hard-pressed to believe that competing on price isn't a viable alternative for certain firms.

Therefore, despite the best efforts of Wallison and Litan, my initial question stands. And I'll be restraining myself from attaching the word "commoditization" to our industry.

Understanding the Chords to the Closed-End Blues

By Mike T.

Closed-end funds have fallen out of favor after several years of strong asset growth. It's not that assets are shrinking, but more that growth rates have begun to show signs of fatigue. kasina had been keeping a close eye on this phenomenon as we work regularly with several managers of closed-end funds. For those of you who do not work directly with these vehicles, here is some high level commentary to bring you up to speed:

With closed-end bond funds subject to both the market implications of the credit crunch and investor confidence surrounding the crunch, any demand for CEFs in today's market would likely come via equity offerings.

The number of equity closed-end funds has risen sharply since 2001, but still only rings in at 221 (compared to 435 for closed-end bond funds). This rise has correlated strongly with the path of the DJIA, which is currently showing high volatility and downward movement since July. The perception that CEFs are less liquid and more volatile than open-ended vehicles may also contribute to investor hesitation. Deep discounts to NAV will most likely be interpreted by managers as a sign that investors are bearish on CEFs, if not on the entire market.

Lastly, closed-end funds typically rely on leveraging to drive returns. A direct implication of the credit crunch is that leveraging costs have risen significantly. With a leveraged portfolio, swings in interest rates can have huge consequences for performance. Today's interest rate climate is uncertain at best.

The next few months will be telling. As managers watch the markets and the Fed closely, the following question will be on their minds: Is this a hiccup in the strong growth of closed-end funds, or a longer-lasting downward adjustment in their popularity?

What comes after the GMWB?

By Steven

The GMWB has been extremely successful, and is the best selling living benefit for insurance carriers. Forward-thinking clients don't want to rely solely on GMWB's success and have begun to think about what the future holds for the industry - beyond the baby boomer generation. They are strategically exploring which riders need to be developed for those who were born after the baby boomers (born 1943-1960, now age 47-64).

kasina develops new products along with our clients by looking at the characteristics of a specific target audience. Each generation has a new set of goals, and faces fears that didn't affect previous generations. Gen X (born 1961-1981, now age 26-46), the next generation after the baby boomers, is moving quickly towards a future where they expect to face:

• Escalating health care costs in the face of increasing longevity
• Devaluation of the real estate market
• Massive inflationary pressures

This generation also:

• Gravitates toward highly customizable products
• Is committed to charity and philanthropy
• Has grown up with rewards programs

VA product innovations have to reflect these needs and preferences.

To market to GenX, annuities need to be customizable, while still addressing a diverse array of social concerns. Simple, intuitive solutions will be the most sought-after.

Variable annuities are too complex for the average investor and advisor. Generation Xers, more so than their predecessors, like to understand and be involved in their purchases.

The next generation of riders will have to:

• Address their specific interests and concerns
• Be customizable, with transparent pricing
• Offer various insurance ties
• Offer "rewards," such as a % of return given to charity, or cash back

The next generation is looming. It is now time to start thinking about their needs and retirement fears to build the rider for the future.

DC plans still do not offer SRI options

By Steven Miyao

Increasingly investors are putting their money towards socially responsible investment (SRI) funds. A survey by Mercer Investing Consulting, prepared for the Social Investment Forum (SIF), shows that less than 20% of defined contribution (DC) plans, such as 401(k)s and 403(b)s, at work, are currently offering one or more SRI funds. DC plans are starting to listen to investors and an additional 41% are planning to offer SRI options within three years.

Why would a DC plan not offer a SRI option when investors are increasingly demanding this as an investment option?

A Rolling Thunder

by Mike Mc

That drumbeat you hear far off in the distance? It's the ominous thunder from the coming storm around the fees asset managers collect on their products.

The signs are obvious and numerous:

• SEC Chairman Christopher Cox's ongoing mantra of data transparency and XBRL in the fund space.
• The ever-growing percentage of load-waived business being done in the intermediary channel.
• Proactive, blunt conversations between fund firms and their shareholders about fees, such as those seen on the Web sites for MFS and American Funds.

It's a bit of a running joke inside of kasina how fired up I get about fees. However, I get fired up because of the headstrong position of many firms within the industry. Comments like "we don't really want to have the conversation about fees with our clients" or "that is only going to make us look bad" are commonplace.

In fact, if I had a dollar for every time I heard something along those lines, I might be able to afford the loads on A shares. Of course I exaggerate for effect, but you get the idea.

The point is that our industry simply cannot afford to take a "don't ask, don't tell" approach to fees. As investors and advisors alike lend greater scrutiny to the value they are getting for their money, the only choice is greater candor and transparency.

Instead of hoping the topic goes away, firms need to tackle this head-on, especially as margin pressure continues to increase industry-wide. Wholesalers, Web sites, and marketing materials can all be used in this effort. There should be pride and justification in the fees firms are charging for their expertise, not a secret hope that nobody will notice. Firms leading the pack on this issue, such as Vanguard and American Funds, who have both publicly supported XBRL, will be able to position themselves as a champion of the shareholder and advisor and differentiate themselves from the competition.

Ultimately, this is a topic that isn't going away. Firms might as well embrace the discussion and attempt to make it a net positive. There is a 100% chance of rain; firms should start shopping for umbrellas now.

Reporting = Sales

By Anu

Recently, the kasina team researched different institutional reports from industry leaders. Asset Managers provide these reports (always quarterly, sometimes more frequent) to clients such as Endowments and Pension Funds. Each account may hold $1B; maybe more.

I was interested in one firm's discussion of their RFP reply process. That process included countless revisions of input from disparate teams across different geographies, followed by graphic design modifications. Why so much effort? Winning an RFP EQUALS revenue.

A thorough, high-quality client report also equals sales. Until recently, many firms viewed reporting as a back-office, low-importance task. That view is being replaced by the understanding that good reporting can be the deciding factor between continuing clients and those looking to exit.

Consequently, firms are beginning to investment more time and money into high-quality reports with process improvements and cutting-edge technology. As industry leaders separate from the pack, they'll continue to find that reporting equals sales.

Back to the Future: Involving Customers in Portfolio Management

by Lee Kowarski

At the ICI General Membership Meeting in Washington earlier this month, Chris Anderson (editor at Wired and author of "The Long Tail") spoke, among other things, about the increasing importance of providing customers with a voice (the "Web 2.0" movement).

In response to a question about the impact of this trend on our industry, Chris made a comment that stuck in my mind: "It clearly doesn't make sense for community management of a mutual fund."

Why not?

If Wikipedia can create an encyclopedia that is basically as accurate as Encyclopedia Britannica (and far more comprehensive and up-to-date), why can't a community make (or at least inform) investment decisions?

I think back to 2000 and the success (however short-lived) that MetaMarkets had with its OpenFund. While there was a portfolio management team ultimately making all investment decisions, the Fund disclosed all investment decisions in real-time on its Web site and encouraged open, two-way discussion via message boards. While the Fund imploded (due primarily to its focus on "New Economy" investments in 2000 and 2001), the approach is something that firms could learn from and apply to other types of investments.

Giving over full control of investment decisions to the masses is clearly a scary and challenging prospect, but firms could certainly benefit from building a closer relationship with their shareholders and advisors, and (as I'm sure Chris Anderson would agree) the masses have a wealth of information that could ultimately lead to better decisions.

Rethinking Fees: Pay for Performance

by Mike McLaughlin

Earlier this month, Fidelity announced its intention to add performance-fee adjustments to 19 more of its mutual funds. It's a simple concept: the more its fund managers trump (or lag) their benchmarks, the better (or worse) Fidelity will do.

According to Lipper, barely 200 funds (spanning 500+ share classes) use such performance-fee adjustments today. As a leader on this issue, Fidelity is effectively gambling on itself to the tune of tens of millions in profits.

Surprisingly, there is some hand-wringing over this move within the advisor community, with vague concerns about enhanced risk within the funds being the primary concern. I, on the other hand, am a huge fan.

Why? The primary reason is that such a structure directly aligns the interests of the:

• Firm
• Portfolio manager
• Financial advisors
• Fund shareholder

At the risk of simplifying things, everybody wins or everybody loses.

I also like that such an arrangement provides an avenue for differentiation for firms like Fidelity. Despite disclosure regulations, fees have long been a fuzzy part of the industry. However, competitive pressures and forces pushing for enhanced transparency, such as XBRL, are placing fees increasingly front-and-center in discussions about the industry and its products.

As a result, I see fees becoming a more important strategic weapon in the fight for assets. Outright price competition is one route, with pay-for-performance mechanisms another way for firms to take a potential liability and turn it into a strength.