Consolidation was a hot topic at the annual mutual fund and investment management conference in Orlando last week, sponsored by the Federal Bar Association and the Investment Company Institute Education Foundation.
Barry P. Barbash, head of the Securities and Exchange Commission's division of investment management, set the tone for the event when he revealed that his unit gets merger-related applications at the rate of about one a week. The following is excerpted from Mr. Barbash's keynote address, in which he discussed the impact of consolidation and globalization on the mutual fund industry:
Investors pay for investment advice, whether it comes in the form of a mutual fund, a wrap fee program, or a broker. How much an investor pays for the services of a financial adviser or investment manager appears to be somewhat less of a concern, when she may do more comparison shopping for a VCR than for a mutual fund.
The observation that "most investors are blissfully unaware of how much they are paying for the privilege of owning a mutual fund" may not be an overstatement. A 1996 OCC/SEC survey concluded that fewer than one American in five knows how much her funds charge. It seems that, when economic times are good, investors think they can afford to be oblivious of these costs.
Investor attitudes toward fund fees are likely to change, however, should fund performance decline. At some point, a consolidating fund industry may be faced with a penny-pinching financial services consumer and will have to tailor fees and other aspects of its business to accommodate this change. I think that I can safely predict that a spotlight will be on expenses related to the distribution of fund shares. Distribution-related expenses always have been, and always will be, a sensitive issue.
One consequence of consolidation is that it may reduce the number of distribution channels available to funds, giving distributors greater market power, and potentially make fund access to investors, and investor access to funds, more expensive. The question then will be how much the industry needs to spend on distribution services and where it will find the necessary resources.
Will investment advisers, for example, find more of their financial and managerial resources being devoted to distribution and less being focused on basic portfolio management? How will investors react to these developments? Will their expectations concerning fund performance- expectations that have been raised by the greatest bull market in history- continue to be met?
We already have a preview in the 401(k) plan market of how the issue of fund fees may play out. A primary force behind recent mergers in the fund business has been the desire to gain access to this market, which includes 25 million participants investing about $1 trillion in the aggregate.
The issue of the day for almost every financial magazine is the fees charged by 401(k) plans and whether they are excessive. On the regulatory side, the Department of Labor held a hearing last fall to consider whether 401(k) plan sponsors and participants understand the fees they are paying and whether additional disclosure is needed.
Our division is beginning an updated study of mutual fund fees, including those associated with 401(k) plans. We will look at trends in the overall level of fees, the way fees are assessed, and whether fees continue to reflect the existence of economies of scale that are passed along to fund shareholders.
Raising investor awareness and understanding of fund expenses may, in turn, lead investors to demand greater clarity and accountability for fund fees, both in the context of 401(k) plans and otherwise. Preparing for these changes should be one of the top priorities for the industry.
Investor demands will take on an altogether different meaning as a result of the globalization of the financial services industry. Many recent international mergers likely will make it easier for the investment management business to enter foreign markets, efforts that at present appear to be in the pioneering stage. Having a universe of investors that includes those from other countries, however, has its own implications.
An issue that recently has come to the fore is the disparity in the type of fee disclosure that U.S. and foreign investors receive. Most funds based in Europe and Asia, for example, disclose only management fees, not expenses such as distribution costs paid by fund shareholders.
The stark contrast between the opaqueness of the information provided by these funds and the transparency of fee information relating to U.S.- registered funds has begun to be noticed. A recent study concluded that, for the year ended 1996, the fees paid by offshore funds based in Europe actually were $2 billion higher than the management fees disclosed to investors.
Criticizing this state of affairs, the study's author expressed support for the U.S. system of fee disclosure and urged European regulators to adopt a similar system. I can report that at least some of those regulators believe that measures to improve fee disclosure by European funds should be undertaken and soon.