Mutual funds evolve into more variety
STANLEY Egener, president of the No-Load Mutual Fund Association, recently talked with Monitor financial writer David Clark Scott about the avalanche of investor interest in mutual funds. The No-Load Association represents 95 management companies and 400 no-load mutual funds, which are funds offered to investors at net asset value and without the payment of a sales charge.
Mr. Egener started out with the Dreyfus Corporation in 1960, did a stint with Oppenheimer & Co., ran his own mutual fund company, and sold it before joining Neuberger & Berman Management in 1973. For 10 years he has been president of Neuberger & Berman in New York, which manages some $1.4 billion in assets invested in nine no-load mutual funds and one closed-end investment company. Here are his views:
Investors are plunging into mutual funds as never before. This individual retirement account season, many moved from low-interest certificate of deposits to mutual funds. The bull market has pumped sales to record highs. A similar boom, followed by a bust, occurred in the 1960s. Is that a precedent worth worrying about?
It was different. In the '60s the fund business was characterized by what they called ``go go'' funds. Remember? People ended up buying go-go funds with unrealistic expectations -- and ran into the 1968-69 market. They were so disenchanted that the fund industry got a good kick in the teeth.
The fund business today is different. You now have money funds. Lots of people use telephonic transfer now, which you didn't have then. You didn't have the wide spectrum of funds we have today.
If for some reason we ran into a long, persistent market decline -- which I personally do not foresee -- I think people would simply switch funds into something that would give them shelter. In the '60s they had no place to go. They just got out. So I don't think it's analogous. And I don't think investors are going to go back to banks. I think the shift away from CDs [certificates of deposit] is permanent.
Even if rates go back up?
If the rates go back up, there will be fund products that will equal or better the bank products -- with more conveniences and liquidity.
But if, or when, rates head up, isn't that going to cause some consternation among mutual fund shareholders?
Probably. Seventy percent of the sales volume in 1985 went into income funds. My concern is that some of those people felt what they were buying was analogous to the CDs that they just left. It's not the case. There can be variation in both the rate of interest they receive and in the initial value of their investment. I think lots of people are going to be unpleasantly surprised, and some may discover that the investment they made has a risk.
The high relative yields found in Ginnie Mae funds [which buy the mortgage bonds of the Government National Mortgage Association] have made these particulary attractive as rates have fallen. Are Ginnie Mae investors going to be ``unpleasantly surprised''?
Sure Ginnie Maes have risk. I think there are a lot riskier funds. I think junk-bond funds are far riskier. . . . But it's true a lot of people that bought Ginnie Maes were not aware of the interest-rate risk. They saw the fund investments were guaranteed by the government. I feel some interpreted that to mean the government guaranteed the rate of return. Not true. And it certainly doesn't guarantee the value of the fund.
I think people will be disconcerted in a rising rate environment. . . . A Ginnie Mae fund can drop 5 to 7 percent if interest rates rise a full point. Now you don't wake up one morning and find interest rates 1 percent higher. But [over time, rising rates are] going to disconcert people.
The public's love affair with mutual funds has been matched by a burst of new kinds of funds. Sector funds -- focusing on the chemical or leisure industry, for example -- have attracted a sizable following. What's happening here?
There's a wider spectrum of funds and a wider spectrum of risk. Most equity funds say to their shareholders, ``We will pick stocks from the industries we believe are going to outperform the rest of the market. . . .'' The whole portfolio assembly is designed to do well in up markets and afford some protection in down markets.
Then in the last year or so, you have a proliferation of sector funds. Sector funds are saying to investors, there are lots of industry groups; some of those industry groups will outperform the stock market. Here's a fully invested portfolio in a particular industry. Go get 'em.
They are appealing to the guy, in my view, who feels he has the ability to pick the correct sector. Probably the guy was someone who played the stock market and has found that playing sector funds can be as rewarding -- if he is right. And this is probably a lower-cost and more convenient way to do it. I think sector funds will continue to proliferate.
But their proliferation is going to cause problems, because there are some industries that have sector portfolios that are not large industries. There aren't enough stocks to accommodate hundreds and hundreds of millions of dollars of institutional money. And when the industry is no longer a hot industry, the exit door may be narrow. And with more people trying to get out of that exit door at the same time, it's going to greatly exaggerate the downside.
While sector-fund investors would not admit this, my guess is that the majority of people who buy a particular sector fund buy it after it has had a spectacular performance. They are attracted by its performance from the year before. That's not the time you want to be in a sector fund. You want to be in just before everybody discovers it.
But if the investor playing sector funds is one who picked individual stocks in the market, wouldn't he be savvy enough not to be chasing last year's winners?
If you charted sales in the mutual fund industry, you would see the peak of the sales in equity funds historically has occurred within three months of the market peak. So most investors who chase performance don't do as well as those who invest for the long term and don't try and pick the No. 1-performing fund by looking backwards. If you look at the top 10 funds each year, it differs. There's a reason for that.
International funds have been among the top performers of the past year or so. And they have attracted a lot of investors. Is this a fad, or are international funds going to continue to be popular?
I think international investing is here to stay. . . . Today, currencies are closely intertwined. There are many more multinational companies. The policies of one economy affect the policies of another. So I think that international investing will grow. Permanently.
I find it very difficult to imagine how an investor, by himself, could invest internationally. There are all kinds of problems besides currency: lack of information and liquidity, for example. I think it's a perfect fit for the fund industry.
What new developments do you see on the horizon for the fund industry?
There are so many diverse investment objectives, I'm hard pressed to think of something new. I think the next big impact in the fund area -- and I don't know when it can be because there are a lot of regulatory problems involved -- but I think index futures and index options are going to play a larger part in fund management.
I also think you will see a lot of funds wrapped in insurance wrappers. Variable life, universal variable life. I think you're going to see a lot of that around.
An insurance policy with a mutual fund kicker in the annuity portion?
That's right. You buy it from the insurance company; but a mutual fund management company, not the insurance company, will be running the money. There are lots of partnerships now. And we certainly are talking with a number of companies. You're going to see more of that.
I think you will also see more funds designed for people who want to make decisions for themselves. More sector funds. Narrower and narrower portfolios.