Once merely a resource for cheap stock trading, discount brokerage firms are gaining a foothold in the mutual fund business.
This month DLJdirect Inc., a unit of Donaldson, Lufkin & Jenrette Inc., became the latest discount operation to offer its customers proprietary mutual funds. TD Waterhouse Group Inc., the brokerage arm of TD Bank Financial Group, also plans to beef up its proprietary fund lineup. Others such as Datek Online have considered it but say it is not a top priority.
The fund industry, which had $5.98 trillion of assets on Sept. 30, has more than doubled in the past five years and grown fivefold since September 1989, according to the Investment Company Institute.
Given that growth - and the revenue potential fund management promises - it's easy to see why discount brokerages are eager to participate actively rather than share fees with third-party firms.
"They're grabbing some low-hanging fruit here," said Bill Doyle, director of on-line financial services research at Forrester Research Inc. of Cambridge, Mass.
So far only a handful of on-line firms, including Charles Schwab & Co. of San Francisco and E-Trade Group Inc. of Menlo Park, Calif., have established a presence in the proprietary fund business. Schwab has made the bigger inroads, with more than $100 billion of actively managed assets; E-Trade is sticking to index funds subadvised by Barclays Global Investors.
Gregory Smith, an analyst at Hambrecht & Quist LLC of San Francisco, said other brokerage firms will probably follow their lead.
"As these firms gather assets, it's one of the logical areas they look to get into," Mr. Smith said.
Charles Schwab, one of the more established discount operations, launched its family with four funds in 1991. It surpassed the $100 billion-asset mark in September, an impressive 50% increase from 1997. It now has 44 funds, a spokesman said. E-Trade started two index funds this month, bringing its total to six.
But discount firms must amass a large customer asset pool before establishing their own funds, Mr. Smith said.
Proprietary funds are being targeted to convenience-oriented investors, Mr. Doyle said, and though the fund management business is profitable, it will probably never be a major business line for the discount firms. That is because most investors will continue to be drawn to firms whose core business is asset management, he said.
Fidelity Investments has trod the same path in reverse. The Boston fund giant already had a huge mutual fund presence when it stepped into the discount brokerage business in 1996.
Most discount brokerage firms looking to create proprietary funds have favored index funds, which are less costly because they are not actively managed. To sell index funds, firms just need the ability to attract assets since they already have the clientele and the asset base, said Ramy Shaalan, a mutual fund analyst at Wiesenberger in Rockville, Md.
What's more, index funds have become extremely popular in recent years since they are tax-efficient and less costly for investors, said Karl Schulz, managing director of TD Asset Management, which subadvises the Dow 30 index fund for TD Waterhouse.
Mr. Schulz said TD Waterhouse plans to start five index funds - an Extended Market Index portfolio, European and Asian funds, a bond fund, and a portfolio tracking the Standard & Poor's 500 index - by February.
TD Waterhouse is also venturing into active management, with a technology fund and a tax-managed growth fund.
Mr. Schulz said the executives consider these two portfolios, which will be subadvised by T. Rowe Price of Baltimore, important asset classes.
DLJdirect has also entered the active management world with the launching of a growth fund and a technology fund on Nov. 19. Because its parent has an asset management arm, it is cost-effective to actively manage the funds, a spokeswoman said.
DLJdirect expects to expand its offerings, though it has no definite plan, she added.