by Cynthia Harrington
Thanks to recent changes in the tax law and new strategies to save, the $7 trillion currently under management by U.S. mutual fund companies is about to get bigger.
Among the products driving that projected growth among mutual fund concerns are Section 529 plans, according to Chuck Freadhoff, a representative at American Funds in Los Angeles.
Already 42 states offer 529s with mutual fund investment options, and the rest are bringing plans on soon. Last year’s tax act made the 529s much more attractive. Earnings on the plan are now tax free when withdrawn if used to pay education expenses.
Congress also granted retirement savers additional relief. Contribution limits were raised for defined contribution plans. Increased contribution amounts favor both plan participants and the mutual fund industry since almost half of the $1.7 trillion 401(k) assets are currently invested with mutual fund managers.
Despite the growing customer base, competition for assets is fierce. Dennis D. Foley, CLU, ChFC, CMFC, vice president, Investment Products, can take partial credit for TIAA-CREF’s award winning advertising campaign last year. The catchy television spots featured famous and not-so-famous educators who at one time or another had retirement funds entrusted to TIAA-CREF. One commercial ended with the question "Who wouldn’t want to invest the way Albert Einstein did?"
"We created the advertising campaign around our general marketing message," says Foley. "We want to educate investors to focus on the long term, diversify their assets and keep investment expenses down."
Foley says they were particularly pleased with the attention garnered from the campaign because he doesn’t have a huge advertising budget. The lion’s share of the ad dollars for the $272 billion in assets managed are focused on the core market of people within education. "We want to maintain the low expense ratios on the funds, so we have to be very creative to maintain our visibility with educators and still get the word out to other markets," he said.
An unlikely candidate won the new asset competition in 2001. Investors sought safe havens in value funds as growth investing tanked along with technology stock prices. The American Funds Growth Fund of America was the top selling mutual fund, gaining $5.3 billion in new assets last year. But there was no new or different marketing effort behind the list-topping growth. Freadhoff explained that the fund manager has the same old strategy of marketing through brokers and advisors. They did make some changes to in the compensation structure with the offering of B and C shares as well as F shares for fee-based planners. "Some people think we moved too slow to offer the different structures, but we finally recognized that we needed to match what the market wanted," said Freadhoff. "Ultimately the choice of types of shares and good performance returns are what advisors want."
"Marketing through experts is a core principle of the way we do business. We have always believed that investing is an activity that needs an expert."
The market could take another leap in size if Congress passes the Retirement Security Advice Act. Changing the ERISA laws to broaden access to advice for retirement savers is a major initiative of mutual fund trade association the Investment Company Institute. Julie Domenick, executive vice president and head of government affairs for the Washington-based ICI, thinks the chances are high of passing some form of advice legislation. The House of Representatives overwhelmingly voted "yes" on one version last fall. "Even before Enron dominated the front pages the House passed on this reform," said Domenick. "Now the President is saying that advice on retirement savings is important for plan participants."
Under the proposals advisors wanting to work for retirement plan participants would need to agree to increased fiduciary responsibility and provide uniform required disclosures about their firms and policies. Independent advisors, third-party providers and trade organizations like ICI, could all be qualified to provide direction and guidance to plan participants. "We now give advice to regular mutual fund shareholders," said Domenick. "It’s not logical that we can’t extend the same service to retirement plan investors."
Details of how advice would be accessed and paid for if necessary are still being worked out. One version of the bill requires the employer to hire an advisor. Another version, introduced by last year’s pension heroes representatives Rob Portman, R-Ohio and Benjamin Cardin, D-Md., allows the employer to create a flex-spending account for the employee to pay for independent advice.
Both Foley and Freadhoff prefer working through professionals. TIAA-CREF announced a major initiative to market to fee-based advisors last year. American Funds focuses all marketing efforts on advisors, not the public. "When an investor works with an advisor the money tends to stay longer," explained Freadhoff.
Changes for shareowners that keep their funds in taxable accounts might also bring more money under management. Now all mutual funds must report after-tax as well as pre-tax performance. This forces portfolio managers to keep a close eye on turnover.
Domenick also is working on legislation that would change the capital gains treatment for mutual funds. Taxing capital gains annually penalizes shareholders. The new plan would defer taxes on gains until the fund holder redeemed their shares. "Right now the required distributions present an illogical end result," she says. "Shareowners are saving for long-term goals, but have short-term liabilities on their investments."
Domenick conceded that her efforts to change the capital gains treatment have less support now than last year, given the demands of the slower economy. The proposal still has fans on the Hill, but will probably not see much action until the tax revenues increase when the economy begins growing again.
While mutual funds are benefiting from legislative changes, the market is challenging. Distributors are featuring their bond funds for the first time in a long time. "The biggest issue we face now is whether people will regain their faith in the equity markets as a place to put their money," said Freadhoff.
