The growing interest in the United States on the expense ratios of mutual funds, which has now spread to Capitol Hill, could be one of those bear market-induced changes which survives into the upturn – not least because fund managers that relied on a rising market to add assets by selling funds now have to find new ways of distributing funds and ensuring that those sales continue to make money.
TowerGroup today published a research showing that the growing domination of mutual fund sales in the United States by intermediaries – brokers, registered investment advisors and fund supermarkets – obliges mutual fund managers to change their business model. Intermediaries expect the fund managers whose products they sell to make them available on concessionary terms.
Yet TowerGroup says that the costs of servicing an account – and so, by extension, mutual fund expenses – are set to rise, unless mutual fund families develop strategies to control costs. “With the cost of servicing a mutual fund account now comprising close to one-third of a mutual fund’s expenses, it is critical that firms develop a more cost-effective savings plan to stay profitable,” says the Massachusetts-based research and advisory group.
TowerGroup says the technological infrastructure and business processes underpinning mutual fund services need to change. Unprofitable client accounts, the service role intermediaries play with respect to shareholders, and the ability to service client accounts and lower margins will all necessitate changes, says TowerGroup. Profitability models must be created and shareholders segmented, with unprofitable customers ultimately jettisoned.
The research discovered that larger fund families are finding economies of scale do not translate into cost savings, although larger funds are lowering their servicing expenses. Importantly, says TowerGroup, funds using affiliated service organizations are showing higher servicing expenses than those outsourcing those functions. “Trends toward the control of the shareholder relationships occurring at the advisor or intermediary, combined with data showing lower servicing costs by outsourced service providers, should reopen outsourcing discussions within mutual fund companies,” says TowerGroup.
The consultancy adds that the drift of sales to intermediaries makes world-class service delivery a questionable goal. “Firms selling through intermediaries need to resign themselves to competing as a commodity, or design a strategy to fight the commoditization trend,” says TowerGroup.
“While some mutual fund trustees will maintain the investment notion that ‘performance’ is the main factor in acquiring and retaining shareholders, the truth is that even the best investment product needs servicing,” says Gavin Little-Gill, TowerGroup analyst and author of the report. “The capabilities of a service company will define the capacity of a fund to support distribution channels in a profitable way, while higher costs of servicing funds have a direct impact on fund performance.”
To help mutual fund families lower operating costs, TowerGroup has drawn up a list of twelve “critical questions” that mutual fund trustees need to put to their service companies. Little-Gill says they need to act quickly. “When evaluating their service company they need to look at cost, risk and what is the effect on the investment product being distributed through intermediaries or other channels,” he says. The report, entitled Twelve Questions Mutual Fund Trustees Should Ask Their Service Company” is available free to independent mutual fund trustees.