Just when you thought performance could not get more mediocre, the fund industry has another surprise: They seem to be raising their expenses.
Even Morningstar's Fund Spy has taken note of this in an article which details the rising expense ratio.
The reason for the increase is that assets are down. That's not a solid reason since performance has also declined. But in the mutual fund world, the managers and fund distributors always seek to deflect the burden back to shareholders. That means shareholders will pay more (in the form of higher expense ratios) which will just add more time for shareholders to recover their fund's losses.
While this is an informative article, Morningstar falls flat when it comes to making any suggestions which could correct this persistent problem. Their suggestion is for shareholders to write a letter to their fund's board. That's it.
In reality, writing letters does nothing. Most fund boards are not concerned about shareholder reactions. Fund expenses are not a priority at the largest fund families . If expenses were such a major concern, boards would focus on 12b-1 fees and other wasted marketing dollars. Those are priorities and that determines overall expense ratios. Those ratios will not come down before other financial waste is controlled.
If a shareholder wanted to make a point, they would redeem their shares and move to another, cheaper fund. Redemptions are the only fund activity that fund boards acknowledge. That's the real power of redemption.
Monday, April 6, 2009
Sunday, April 5, 2009
American Fuinds Pays Over $2 bilion in 12b-1 Fees Alone in 2007
How much money do 12b-1 fees take from shareholders?
This article notes that American Funds in 2007 paid out over $2 billion in 12b-1 fees in 2007. This is a major reason why American Funds is consistently ranked as a leading fund family among investment reps. As a reminder, 12b-1 fees are shareholder money which is used to fund mutual fund marketing departments and compensate brokers for selling a specific fund family.
American Funds Hit With 12b-1 Lawsuit
The Street.com
Article published on July 2, 2008
By Kevin Burke
An investor in the $122 billion American Funds EuroPacific Growth Fund is suing the fund family and its parent for alleged misuse of 12b-1 fees.
The suit challenges a longstanding industry compensation structure crucial to fund companies' getting their funds distributed through different broker-dealers and ensuring that brokers who sell the funds get paid.
Rachelle Korland of Ohio filed a complaint in the Central District Court of California against Capital Research and Management Company and American Funds Distributor on behalf of all shareholders of the fund. The complaint accuses American Funds of violating its fiduciary duty under Section 36(b) of the Investment Company Act of 1940 by unlawfully financing activities that were not “primarily intended” to result in the sale of fund shares.
A spokeswoman for American Funds did not return phone calls seeking comment as of press time.
Attorneys for the plaintiff argue that American Funds’ 12b-1 fees were used to pay for ongoing shareholder services after the initial sale of fund shares, thereby making them “excessive and disproportionate.”
In 2007, over $2 billion in 12b-1 fees were paid by American Funds’ shareholders alone, according to the complaint.
The suit is seeking, among other things, a declaration that American Funds’ 12b-1 fees are “unreasonable, excessive and unlawful,” a removal of the 12b-1 fee adopted by the fund, removal of the fund’s independent trustees, undetermined compensatory damages in favor of the fund, and removal of American Funds Distributor and Capital Research as the fund’s distributor and advisor.
This article notes that American Funds in 2007 paid out over $2 billion in 12b-1 fees in 2007. This is a major reason why American Funds is consistently ranked as a leading fund family among investment reps. As a reminder, 12b-1 fees are shareholder money which is used to fund mutual fund marketing departments and compensate brokers for selling a specific fund family.
American Funds Hit With 12b-1 Lawsuit
The Street.com
Article published on July 2, 2008
By Kevin Burke
An investor in the $122 billion American Funds EuroPacific Growth Fund is suing the fund family and its parent for alleged misuse of 12b-1 fees.
The suit challenges a longstanding industry compensation structure crucial to fund companies' getting their funds distributed through different broker-dealers and ensuring that brokers who sell the funds get paid.
Rachelle Korland of Ohio filed a complaint in the Central District Court of California against Capital Research and Management Company and American Funds Distributor on behalf of all shareholders of the fund. The complaint accuses American Funds of violating its fiduciary duty under Section 36(b) of the Investment Company Act of 1940 by unlawfully financing activities that were not “primarily intended” to result in the sale of fund shares.
A spokeswoman for American Funds did not return phone calls seeking comment as of press time.
Attorneys for the plaintiff argue that American Funds’ 12b-1 fees were used to pay for ongoing shareholder services after the initial sale of fund shares, thereby making them “excessive and disproportionate.”
In 2007, over $2 billion in 12b-1 fees were paid by American Funds’ shareholders alone, according to the complaint.
The suit is seeking, among other things, a declaration that American Funds’ 12b-1 fees are “unreasonable, excessive and unlawful,” a removal of the 12b-1 fee adopted by the fund, removal of the fund’s independent trustees, undetermined compensatory damages in favor of the fund, and removal of American Funds Distributor and Capital Research as the fund’s distributor and advisor.
What the October 1987 Stock Market Crash Was All About
This American Public Media Marketplace commentary aired October 19, 2007 on the 20th anniversary of the Black Monday Crash. At the time, Chuck Epstein was managing director of marketing for the New York Futures Exchange and saw events unfold first-hand. This radio commentary notes that Wall Street prefers inertia to reform. It also points out that historic financial events, including the 2009 severe recession, indicate major transitions in financial power which affect how the investment business operates.
This broadcast aired October 19, 2007.
By Chuck Epstein
On the 20th Anniversary of the October 19, 1987 Stock market Crash --
Black Monday exposed battle of old, new
Commentator Chuck Epstein was working for the New York Stock Exchange 20 years ago on Black Monday -- when the Dow dropped 22%. He says that day highlighted a raging battle between the old guard and newer institutional traders.
TEXT OF STORY
TESS VIGELAND: If your main memories of October 1987 are Baby Jessica, the World Champion Minnesota Twins, and Whitesnake's "Here I Go Again". . . You weren't invested in the stock market. Today marks 20 years since Black Monday -- the Crash of October 19th, 1987. A 22 percent drop that rocked markets around the world.
The cause remains a matter of debate. The falling dollar coupled with a slumping bond market . . . Foreign investors fleeing the U.S. market . . . Commentator Chuck Epstein was the managing director of marketing for the New York Stock Exchange at the time. He says that day highlighted a raging battle between the old guard and newer institutional traders.
CHUCK EPSTEIN: Most market commentators who note today's anniversary of the 1987 stock-market crash will focus on statistics. But that's a mistake. The crash was much more than a stock market event.
It was really part of a landmark political battle over making long overdue changes to the New York Stock Exchange's 200-year old trading system. This system needed to accommodate new futures products and strategies, along with electronic trading. The crash also provided a rare public insight into how Wall Street copes with change.
Most investors familiar with Hollywood's versions of traders and investment bankers think that greed is the dominant force on Wall Street. They're wrong. The dominant force on Wall Street is inertia. Any major change creates a disproportionate shockwave.
The shockwave which hit Wall Street 20 years ago was about the increasing power of institutional traders. Their interests were not the same as the traders who owned the nation's futures and stock exchanges. Once exchange members saw that institutional trading meant greater risks and lower commissions, they had to devise an exit strategy. That meant going public, which helps explain why every major player in the 1987 crash, including the NYSE, Chicago Mercantile Exchange and Chicago Board of Trade, are all public companies today.
The crash also had a bright side. It helped individual investors by making lower-cost products, such as exchange-traded funds, stock-index futures and electronic trading, more accessible.
Most importantly, the Crash marked a time when innovation broke through the wall of tradition. But with the first baby boomers entering retirement, there is still a need for less expensive products. For instance, lower-cost annuities would mean more money in the hands of investors, providing boomers with greater retirement income and a more secure investment future. These are changes well worth making.
Innovation still has a critical role to play in today's financial markets. And we can achieve it without a crash.
VIGELAND: Chuck Epstein is now a financial writer in Folsom, Calif.
This broadcast aired October 19, 2007.
By Chuck Epstein
On the 20th Anniversary of the October 19, 1987 Stock market Crash --
Black Monday exposed battle of old, new
Commentator Chuck Epstein was working for the New York Stock Exchange 20 years ago on Black Monday -- when the Dow dropped 22%. He says that day highlighted a raging battle between the old guard and newer institutional traders.
TEXT OF STORY
TESS VIGELAND: If your main memories of October 1987 are Baby Jessica, the World Champion Minnesota Twins, and Whitesnake's "Here I Go Again". . . You weren't invested in the stock market. Today marks 20 years since Black Monday -- the Crash of October 19th, 1987. A 22 percent drop that rocked markets around the world.
The cause remains a matter of debate. The falling dollar coupled with a slumping bond market . . . Foreign investors fleeing the U.S. market . . . Commentator Chuck Epstein was the managing director of marketing for the New York Stock Exchange at the time. He says that day highlighted a raging battle between the old guard and newer institutional traders.
CHUCK EPSTEIN: Most market commentators who note today's anniversary of the 1987 stock-market crash will focus on statistics. But that's a mistake. The crash was much more than a stock market event.
It was really part of a landmark political battle over making long overdue changes to the New York Stock Exchange's 200-year old trading system. This system needed to accommodate new futures products and strategies, along with electronic trading. The crash also provided a rare public insight into how Wall Street copes with change.
Most investors familiar with Hollywood's versions of traders and investment bankers think that greed is the dominant force on Wall Street. They're wrong. The dominant force on Wall Street is inertia. Any major change creates a disproportionate shockwave.
The shockwave which hit Wall Street 20 years ago was about the increasing power of institutional traders. Their interests were not the same as the traders who owned the nation's futures and stock exchanges. Once exchange members saw that institutional trading meant greater risks and lower commissions, they had to devise an exit strategy. That meant going public, which helps explain why every major player in the 1987 crash, including the NYSE, Chicago Mercantile Exchange and Chicago Board of Trade, are all public companies today.
The crash also had a bright side. It helped individual investors by making lower-cost products, such as exchange-traded funds, stock-index futures and electronic trading, more accessible.
Most importantly, the Crash marked a time when innovation broke through the wall of tradition. But with the first baby boomers entering retirement, there is still a need for less expensive products. For instance, lower-cost annuities would mean more money in the hands of investors, providing boomers with greater retirement income and a more secure investment future. These are changes well worth making.
Innovation still has a critical role to play in today's financial markets. And we can achieve it without a crash.
VIGELAND: Chuck Epstein is now a financial writer in Folsom, Calif.
Friday, April 3, 2009
Fund Reform Should Be Part of the Bailout Package
Fund Reform Should Be Part of the Bailout Program
With all the media attention focused on the banks and mortgage companies, it’s odd that the financial sector which has the most contact with the investing public has remained entirely out of the spotlight. I’m talking about the mutual fund industry, which is the repository for trillions of dollars in retirement money.
This is unfortunate since the mutual fund industry has many things to account for. These problems are serious and cut at some of the fund industry’s basic business practices.
The list starts with poor due diligence. Funds make stated and implied promises to perform due diligence to root out bad investment ideas and bad people. The bad loans which became embedded into some bond, real estate, inflation protection, and money market funds should have been detected by more fund managers or analysts. They obviously were not. This helps explain why some money market funds fell below $1 per share.
Another failure stems from poor active management or at best, inactive management. Many shareholders pay for active management, and they did not get what they paid for. In too many cases, actively managed mutual funds declined by as much, or more, than passively-managed index funds.
Another serious problem is poor disclosure. Too many mutual funds are laden with hidden revenue sharing agreements, advisor paid fees, shelf-space fees, and other under-the-table payments which are paid to brokerage and independent investment firms. Ostensibly, these fees are disclosed in the fund’s prospectus, but as early as 1994, former SEC Chairman Arthur Levitt proposed that prospectuses be shortened and be written in plain English. That was 15 years ago, and the prospectuses still remain intentionally opaque.
All this matters because high fees in the form of the insidious 12b-1 which increases a fund’s expense ratio are often more important than the fund’s return, at least according to the fund distributor. When fees are recurring, they have a negative compound effect. This means investors lose even more money as time goes by.
So what should shareholders do?
Since investors have no control over their fund’s return, they must reduce expenses. Shareholders have to examine expense ratios and take action themselves because too many fund companies, especially the load-fund companies, don’t care about reducing fees. These recurring fees support the fund company’s marketing efforts. This puts too many load mutual funds at odds against their own shareholders. So if you want to make your mutual funds profitable again, reduce your expenses. You can be sure your mutual fund company won’t do it for you.
Chuck Epstein is a financial communications consultant who lives in Folsom, California.
With all the media attention focused on the banks and mortgage companies, it’s odd that the financial sector which has the most contact with the investing public has remained entirely out of the spotlight. I’m talking about the mutual fund industry, which is the repository for trillions of dollars in retirement money.
This is unfortunate since the mutual fund industry has many things to account for. These problems are serious and cut at some of the fund industry’s basic business practices.
The list starts with poor due diligence. Funds make stated and implied promises to perform due diligence to root out bad investment ideas and bad people. The bad loans which became embedded into some bond, real estate, inflation protection, and money market funds should have been detected by more fund managers or analysts. They obviously were not. This helps explain why some money market funds fell below $1 per share.
Another failure stems from poor active management or at best, inactive management. Many shareholders pay for active management, and they did not get what they paid for. In too many cases, actively managed mutual funds declined by as much, or more, than passively-managed index funds.
Another serious problem is poor disclosure. Too many mutual funds are laden with hidden revenue sharing agreements, advisor paid fees, shelf-space fees, and other under-the-table payments which are paid to brokerage and independent investment firms. Ostensibly, these fees are disclosed in the fund’s prospectus, but as early as 1994, former SEC Chairman Arthur Levitt proposed that prospectuses be shortened and be written in plain English. That was 15 years ago, and the prospectuses still remain intentionally opaque.
All this matters because high fees in the form of the insidious 12b-1 which increases a fund’s expense ratio are often more important than the fund’s return, at least according to the fund distributor. When fees are recurring, they have a negative compound effect. This means investors lose even more money as time goes by.
So what should shareholders do?
Since investors have no control over their fund’s return, they must reduce expenses. Shareholders have to examine expense ratios and take action themselves because too many fund companies, especially the load-fund companies, don’t care about reducing fees. These recurring fees support the fund company’s marketing efforts. This puts too many load mutual funds at odds against their own shareholders. So if you want to make your mutual funds profitable again, reduce your expenses. You can be sure your mutual fund company won’t do it for you.
Chuck Epstein is a financial communications consultant who lives in Folsom, California.
Thursday, April 2, 2009
Discover the Benefits of Managed Futures
Diversification is the tested method of reducing risk and increasing your odds of reducing losses. Most mutual funds offer stylistic variations of stocks and bonds, but they neglect the wider range of investment options, specifically funds which can sell short and have access to other asset classes and investment strategies, such as managed futures.
I wrote a book, Managed Futures in the Institutional Portfolio in 1992 which explains the benefits of managed futures and how they can benefit both institutions and individual investors. While it is over 15 years old, the techniques and benefits remain largely the same.
The one thing which has changed is the need for more financial advisors to expand their repertoire of investment alternatives to include ETFS, hedge funds and managed futures for qualified clients.
If an investment professional adopts a wider view of these readily available investment alternatives, they can better serve their clients by offering strategies which can post positive returns in advancing and declining markets, and in the case of ETFs, lower-cost and more tax efficient investments.
The managed futures book would also be a good place to become more familiar with what this strategy offers.
I wrote a book, Managed Futures in the Institutional Portfolio in 1992 which explains the benefits of managed futures and how they can benefit both institutions and individual investors. While it is over 15 years old, the techniques and benefits remain largely the same.
The one thing which has changed is the need for more financial advisors to expand their repertoire of investment alternatives to include ETFS, hedge funds and managed futures for qualified clients.
If an investment professional adopts a wider view of these readily available investment alternatives, they can better serve their clients by offering strategies which can post positive returns in advancing and declining markets, and in the case of ETFs, lower-cost and more tax efficient investments.
The managed futures book would also be a good place to become more familiar with what this strategy offers.
Why Mutual Fund Branding Efforts Fail
Most branding literature focuses on consumer products as opposed to financial services. Mutual fund branding studies are more rare and for good reason. The first is that mutual funds suffer from severe commoditization. There simply are too many similar funds which, unlike other industries, cannot compete on price. The second reason is that the business model for load-funds is inherently anti-shareholder.
This means the customer is not the prime focus of the branding effort. This explains why fund branding discussions often center around advertising, and not the whole arsenal of tools available to more comprehensive and effective branding programs found in the consumer sector. It also explains why social media are not appropriate for most funds since it would only be used by shareholders to explain their bad experiences.
The following article seeks to explain why fund branding efforts, especially among load funds, falls short of expectations.
Why Mutual Fund Branding Efforts Fail
By Chuck Epstein
Classic brand theory names trust and awareness as the primary determinants of brand value. The other key component of a brand’s power is the strong emotional connotation which the brand generates to supplement the consumer’s ego.
In today’s marketplace, consumers have begun focusing on brands which are exciting and have new features. These brands separate themselves from competitors and capture the public’s attention by being different and linking to a purpose which is larger than themselves. Some branding advocates have even coined the term “passion brands” to describe this exceptional emotional link.
Yet the vast majority of branding literature focuses on retail consumer products. With only a few exceptions, the financial services sector, specifically the $9.4 trillion mutual fund industry, has very little branding case histories and few major names ranked on the list of America’s most admired brands. Worse, while the mutual fund industry spends billions on advertising, too many of these funds have failed to produce the key characteristics which branding experts say constitutes brand excellence which, in turn, fosters customer loyalty.
I believe the core of the mutual fund industry’s branding problems, especially in the load-mutual fund sector, stem from the industry’s business model and its misplaced priority over exactly who they are serving. Looking at the two mutual fund business models—load funds versus no-load funds—it becomes evident that better branding is possible when there is a clear line between the mutual fund company and its shareholders. When that direct link between an investor and their fund company is broken, as it is in many load-mutual funds, it is impossible to reap the full benefits of brand building.
The specific problem is that too many large load mutual fund companies rely on a sales distribution network that works through independent financial advisors which ultimately interfaces with the end-investor. At each of these links, communications are broken and the load mutual fund company wastes too much money trying to create messages for each separate audience. Worse, at each interaction, the value of the ultimate customer, the end investor, is diminished.
In more successful consumer branding efforts, the link between customer and provider is more direct. But this was not always the case. While it is widely-accepted today, customers were not always the center of business marketing. It was only in 1960 that Theodore Levitt, a Harvard professor, wrote that marketing should focus on what customers want and that products should originate from their desires, not from what a company wanted to manufacture.
Branding literature contains numerous case studies of successful efforts from consumer product companies. This is where brand strength is measured by presence, relevance, performance, advantage, and customer bonding. Each of these variables can be readily deployed, tested and refined. But this same literature has noticeably few examples from load mutual funds. This raises the question of whether load mutual funds can reap the full benefits of branding if they cannot score high on each of these key attributes.
But mutual funds have a special set of challenges when it comes to building successful brands. First, most mutual fund companies do not evoke the all-important emotional connection with their shareholders which is critical to any brand’s success. Second, the mutual fund industry suffers from rampant commoditization which makes it almost impossible to claim any clear or special product benefit. The third problem stems from erratic mutual fund performance which dilutes any brand claim on product stability and durability. Fourth, load mutual fund companies are not focused on the end-investor, the actual person whose money is being invested in the fund itself.
Commoditization and Poor Performance
Here is a look at these problems in more detail:
The Investment Company Institute lists over 8,000 mutual funds, which includes 4,800 equity funds at year-end 2008. Of these funds, 1,809 were large cap growth funds of which only 34% beat the Russell 1000 Growth Index, while 33% outperformed the index over three years.
It’s difficult to explain how these funds differ from one another, so fund companies rely on revising quarterly data and touting their star ratings from the two major fund data companies, or creating carefully selected comparisons, or hypos, which compare funds against each other on some esoteric data or over a favorable time frame. But this sales message is used so frequently and by so many funds that it too has become commoditized. As a result, selling performance rankings based on fund rotations has become too familiar to veteran investment professionals.
In consumer marketing, product commoditization is countered by price reductions. While that provides more maneuvering room for consumer product marketers, load mutual funds have historically proved reluctant to reduce overall expense ratios, despite wide advances in computer processing productivity, the Internet, and increases in assets under management. One of the most controversial fees in today’s negative return environment is manager fees. Simply put, there is no reason for shareholders to pay management fees when the active manager produces index-like returns.
Fund marketers often try to break out of the commoditization trap through traditional tactics, such as advertising, trade-shows and premiums. But marketers often make the false connection between higher product and brand awareness with higher sales, when, in fact, there is no connection. People are aware of GM cars, but people still do not buy them. Similarly, advertising is no elixir. What advertisers forget is that they should be highlighting a product’s key differences, but with the rampant commoditization of mutual funds, there are few distinctions to tout.
Instead, the mutual fund industry’s standard approach is to play the fund performance rating game which changes quarterly, and only serves to highlight the constant rotation among mutual fund performance. Over time, the best performing funds and fund managers move along the cycle from top-performers to average-performance to-below average performance. It is a statistical certainty, yet the futile advertising persists.
What’s The Alternative?
Mutual fund marketers have an alternative, but it is part of a more complex process: changing the business model which, over time, will change shareholder’s minds. Both are very difficult, but given today’s reality, making these changes is a necessity if some intrepid funds want to thrive in a more competitive environment.
This choice will separate the load fund sector into two camps: those who want to be innovative versus those who want to keep the historical vertical relationship between the load fund company, its sales force and financial representatives who have actual face-to-face contact with investors. This is the model which puts customers last.
The alternative is to keep parts of the load fund structure intact, but add some new customer-centric features. This would include an alternative to fixed manager compensation which is currently awarded regardless of fund performance. Since manager expenses account for a large percentage of a fund’s overall expense ratio, managers should be compensated more if they beat a designated benchmark than if they only offer index-like returns. Alternately, load funds should make a concerted effort to cut overall expenses, especially in their marketing budgets.
The reality is the mutual fund industry is that the lower the expense ratio, the higher the client’s total returns. One the investment side, load funds can differentiate themselves by mixing active and passive investment strategies inside a single fund.
When it comes to changing consumer’s minds, market research has found that belief systems and attitudes can be altered only if you change the information on which the belief rests. This cannot be done in ads or commercials. Changing peoples’ minds can be done by altering their perceptions of the competition.
Successful campaigns outside of the financial services industry have succeeded since they highlight a competitor’s weaknesses. This changes customers’ perceptions which open them to consider new possibilities. But this approach will not work among fund companies due to the rampant commoditization. Initiating new business models is a first step for load fund companies which want to towards break away from the pack.
Correcting Brand Problems
While load mutual funds clearly have their own set of problems, they can learn about successful branding from the retail product marketing sector. Here are some of these new realities which are evident in retail product marketing which can be applied in the mutual fund industry:
• Brands are now controlled by consumers, not brand managers. Consumers can now create their own powerful messages about a brand based on their own experiences.
• There is no direct communication with consumers anymore. People get information from many sources, and people are more diffused. This means brand have to get consumers to come to them if they want to get their messages heard.
• Marketing today is a dialogue, not a monologue. This means marketers have to learn to listen in order to attract customers.
• Customers value personal experiences, yet they also want to be part of a community. They want to discover the key features about a brand, so marketers should encourage transparency.
• Market segmentation is dead, so marketers have to prepare messages which avoid class and background considerations. Marketers also have to be ready to deliver what consumers want when it is requested, otherwise the opportunity will vanish.
The Dilemma of Social Networking
While marketers are learning to listen to their customers, this has a different spin in the financial services sector. Social networking works well for companies which enjoy positive reputations and public images. However, companies which have skeletons in their closet and bad customer relations should not move into the electronic world of public social discussions without knowing the possible negative repercussions.
This negative online chatter could easily include discussions about fees, performance, and customer service, all of which are potentially incendiary. In too many social forums, there is more downside than upside potential for the mutual fund or financial company. Take the case of a Web site, PPSI, which hosted public complaints specifically about Northwestern Mutual. The online posts were signed and listed what policyholders and former employees contended were numerous poor sales practices. The forum became so popular and provocative that Northwestern Mutual, “which bills itself as “The Quiet Company,” took legal action which forced the Web site to close.
This may explain why only a few investment and financial companies, such as USAA, and the online investment firm, FOLIOfn, have initiated online discussion forums for customers to discuss trading ideas (FOLIOfn) and products (USAA has one of the best customer service reputations in the industry.)
These are some of the major reasons why social networking should never be applied to industries which do not want to invite transparency and have an open discussion about the merits of a brand’s promises. To become a true brand, with all the accompanying best brand characteristics, mutual funds will have to change their business model to focus on what they can consistently deliver to investors and shareholders. That will require lower expenses, more refined investment strategies, and elevating the role of the customer. If structural changes are not made, money spent on branding efforts will be largely wasted.
Chuck Epstein has extensive financial communications and marketing experience. He is now a financial communications consultant who lives in Folsom, California. He can be reached at cepstein@prodigy.net.
This means the customer is not the prime focus of the branding effort. This explains why fund branding discussions often center around advertising, and not the whole arsenal of tools available to more comprehensive and effective branding programs found in the consumer sector. It also explains why social media are not appropriate for most funds since it would only be used by shareholders to explain their bad experiences.
The following article seeks to explain why fund branding efforts, especially among load funds, falls short of expectations.
Why Mutual Fund Branding Efforts Fail
By Chuck Epstein
Classic brand theory names trust and awareness as the primary determinants of brand value. The other key component of a brand’s power is the strong emotional connotation which the brand generates to supplement the consumer’s ego.
In today’s marketplace, consumers have begun focusing on brands which are exciting and have new features. These brands separate themselves from competitors and capture the public’s attention by being different and linking to a purpose which is larger than themselves. Some branding advocates have even coined the term “passion brands” to describe this exceptional emotional link.
Yet the vast majority of branding literature focuses on retail consumer products. With only a few exceptions, the financial services sector, specifically the $9.4 trillion mutual fund industry, has very little branding case histories and few major names ranked on the list of America’s most admired brands. Worse, while the mutual fund industry spends billions on advertising, too many of these funds have failed to produce the key characteristics which branding experts say constitutes brand excellence which, in turn, fosters customer loyalty.
I believe the core of the mutual fund industry’s branding problems, especially in the load-mutual fund sector, stem from the industry’s business model and its misplaced priority over exactly who they are serving. Looking at the two mutual fund business models—load funds versus no-load funds—it becomes evident that better branding is possible when there is a clear line between the mutual fund company and its shareholders. When that direct link between an investor and their fund company is broken, as it is in many load-mutual funds, it is impossible to reap the full benefits of brand building.
The specific problem is that too many large load mutual fund companies rely on a sales distribution network that works through independent financial advisors which ultimately interfaces with the end-investor. At each of these links, communications are broken and the load mutual fund company wastes too much money trying to create messages for each separate audience. Worse, at each interaction, the value of the ultimate customer, the end investor, is diminished.
In more successful consumer branding efforts, the link between customer and provider is more direct. But this was not always the case. While it is widely-accepted today, customers were not always the center of business marketing. It was only in 1960 that Theodore Levitt, a Harvard professor, wrote that marketing should focus on what customers want and that products should originate from their desires, not from what a company wanted to manufacture.
Branding literature contains numerous case studies of successful efforts from consumer product companies. This is where brand strength is measured by presence, relevance, performance, advantage, and customer bonding. Each of these variables can be readily deployed, tested and refined. But this same literature has noticeably few examples from load mutual funds. This raises the question of whether load mutual funds can reap the full benefits of branding if they cannot score high on each of these key attributes.
But mutual funds have a special set of challenges when it comes to building successful brands. First, most mutual fund companies do not evoke the all-important emotional connection with their shareholders which is critical to any brand’s success. Second, the mutual fund industry suffers from rampant commoditization which makes it almost impossible to claim any clear or special product benefit. The third problem stems from erratic mutual fund performance which dilutes any brand claim on product stability and durability. Fourth, load mutual fund companies are not focused on the end-investor, the actual person whose money is being invested in the fund itself.
Commoditization and Poor Performance
Here is a look at these problems in more detail:
The Investment Company Institute lists over 8,000 mutual funds, which includes 4,800 equity funds at year-end 2008. Of these funds, 1,809 were large cap growth funds of which only 34% beat the Russell 1000 Growth Index, while 33% outperformed the index over three years.
It’s difficult to explain how these funds differ from one another, so fund companies rely on revising quarterly data and touting their star ratings from the two major fund data companies, or creating carefully selected comparisons, or hypos, which compare funds against each other on some esoteric data or over a favorable time frame. But this sales message is used so frequently and by so many funds that it too has become commoditized. As a result, selling performance rankings based on fund rotations has become too familiar to veteran investment professionals.
In consumer marketing, product commoditization is countered by price reductions. While that provides more maneuvering room for consumer product marketers, load mutual funds have historically proved reluctant to reduce overall expense ratios, despite wide advances in computer processing productivity, the Internet, and increases in assets under management. One of the most controversial fees in today’s negative return environment is manager fees. Simply put, there is no reason for shareholders to pay management fees when the active manager produces index-like returns.
Fund marketers often try to break out of the commoditization trap through traditional tactics, such as advertising, trade-shows and premiums. But marketers often make the false connection between higher product and brand awareness with higher sales, when, in fact, there is no connection. People are aware of GM cars, but people still do not buy them. Similarly, advertising is no elixir. What advertisers forget is that they should be highlighting a product’s key differences, but with the rampant commoditization of mutual funds, there are few distinctions to tout.
Instead, the mutual fund industry’s standard approach is to play the fund performance rating game which changes quarterly, and only serves to highlight the constant rotation among mutual fund performance. Over time, the best performing funds and fund managers move along the cycle from top-performers to average-performance to-below average performance. It is a statistical certainty, yet the futile advertising persists.
What’s The Alternative?
Mutual fund marketers have an alternative, but it is part of a more complex process: changing the business model which, over time, will change shareholder’s minds. Both are very difficult, but given today’s reality, making these changes is a necessity if some intrepid funds want to thrive in a more competitive environment.
This choice will separate the load fund sector into two camps: those who want to be innovative versus those who want to keep the historical vertical relationship between the load fund company, its sales force and financial representatives who have actual face-to-face contact with investors. This is the model which puts customers last.
The alternative is to keep parts of the load fund structure intact, but add some new customer-centric features. This would include an alternative to fixed manager compensation which is currently awarded regardless of fund performance. Since manager expenses account for a large percentage of a fund’s overall expense ratio, managers should be compensated more if they beat a designated benchmark than if they only offer index-like returns. Alternately, load funds should make a concerted effort to cut overall expenses, especially in their marketing budgets.
The reality is the mutual fund industry is that the lower the expense ratio, the higher the client’s total returns. One the investment side, load funds can differentiate themselves by mixing active and passive investment strategies inside a single fund.
When it comes to changing consumer’s minds, market research has found that belief systems and attitudes can be altered only if you change the information on which the belief rests. This cannot be done in ads or commercials. Changing peoples’ minds can be done by altering their perceptions of the competition.
Successful campaigns outside of the financial services industry have succeeded since they highlight a competitor’s weaknesses. This changes customers’ perceptions which open them to consider new possibilities. But this approach will not work among fund companies due to the rampant commoditization. Initiating new business models is a first step for load fund companies which want to towards break away from the pack.
Correcting Brand Problems
While load mutual funds clearly have their own set of problems, they can learn about successful branding from the retail product marketing sector. Here are some of these new realities which are evident in retail product marketing which can be applied in the mutual fund industry:
• Brands are now controlled by consumers, not brand managers. Consumers can now create their own powerful messages about a brand based on their own experiences.
• There is no direct communication with consumers anymore. People get information from many sources, and people are more diffused. This means brand have to get consumers to come to them if they want to get their messages heard.
• Marketing today is a dialogue, not a monologue. This means marketers have to learn to listen in order to attract customers.
• Customers value personal experiences, yet they also want to be part of a community. They want to discover the key features about a brand, so marketers should encourage transparency.
• Market segmentation is dead, so marketers have to prepare messages which avoid class and background considerations. Marketers also have to be ready to deliver what consumers want when it is requested, otherwise the opportunity will vanish.
The Dilemma of Social Networking
While marketers are learning to listen to their customers, this has a different spin in the financial services sector. Social networking works well for companies which enjoy positive reputations and public images. However, companies which have skeletons in their closet and bad customer relations should not move into the electronic world of public social discussions without knowing the possible negative repercussions.
This negative online chatter could easily include discussions about fees, performance, and customer service, all of which are potentially incendiary. In too many social forums, there is more downside than upside potential for the mutual fund or financial company. Take the case of a Web site, PPSI, which hosted public complaints specifically about Northwestern Mutual. The online posts were signed and listed what policyholders and former employees contended were numerous poor sales practices. The forum became so popular and provocative that Northwestern Mutual, “which bills itself as “The Quiet Company,” took legal action which forced the Web site to close.
This may explain why only a few investment and financial companies, such as USAA, and the online investment firm, FOLIOfn, have initiated online discussion forums for customers to discuss trading ideas (FOLIOfn) and products (USAA has one of the best customer service reputations in the industry.)
These are some of the major reasons why social networking should never be applied to industries which do not want to invite transparency and have an open discussion about the merits of a brand’s promises. To become a true brand, with all the accompanying best brand characteristics, mutual funds will have to change their business model to focus on what they can consistently deliver to investors and shareholders. That will require lower expenses, more refined investment strategies, and elevating the role of the customer. If structural changes are not made, money spent on branding efforts will be largely wasted.
Chuck Epstein has extensive financial communications and marketing experience. He is now a financial communications consultant who lives in Folsom, California. He can be reached at cepstein@prodigy.net.
Wednesday, April 1, 2009
Time is Not On Your Side: Recovering Fund Losses
Time Is Not On Your Side
Baby Boomers may recognize the old 1964 Rolling Stones’ song, “Time Is On My Side,” but when it comes to people who are approaching retirement, they should start humming another tune.
That’s because with the huge losses in both home prices and in their equity portfolios, anyone approaching retirement should be trying to recoup their losses as fast as possible. But the basic mathematics of finance is against that. Here are two examples using the decline in home prices and losses in an S&P 500 portfolio which show that recouping losses is primarily a matter of time.
If you paid $250,000 for a house and suffered a 20% loss, it would take you 15 years and two months to recover the loss. If that loss was 30%, you need a little more than 19 years to get back to even.
Aside from these losses, the other problem with housing is that there are so many houses on the market now, especially due foreclosures that the normal evolutionary real estate cycle of people becoming empty nesters or simply moving into bigger or smaller houses. All of this only adds to the inventory. One economic consulting firm has estimated that there is over an eight year backlog of housing stock in Florida.
Here is something else that that shows time is not on your side: If you had an S&P 500 index fund in 2008, that fund fell by 37.5%. To recoup this loss, it would take an investor over five years to recover this loss their assuming the traditionally-accepted 9.4% historical rate of return in the S&P 500 Index with dividends re-invested.
So that’s the one-two punch for the children of the Greatest Generation, significant losses in home prices and equity portfolios that only time can repair. Maybe this is what people meant when they said “time is money.” But for too many people approaching retirement, time is often an option that many people can count on.
Baby Boomers may recognize the old 1964 Rolling Stones’ song, “Time Is On My Side,” but when it comes to people who are approaching retirement, they should start humming another tune.
That’s because with the huge losses in both home prices and in their equity portfolios, anyone approaching retirement should be trying to recoup their losses as fast as possible. But the basic mathematics of finance is against that. Here are two examples using the decline in home prices and losses in an S&P 500 portfolio which show that recouping losses is primarily a matter of time.
If you paid $250,000 for a house and suffered a 20% loss, it would take you 15 years and two months to recover the loss. If that loss was 30%, you need a little more than 19 years to get back to even.
Aside from these losses, the other problem with housing is that there are so many houses on the market now, especially due foreclosures that the normal evolutionary real estate cycle of people becoming empty nesters or simply moving into bigger or smaller houses. All of this only adds to the inventory. One economic consulting firm has estimated that there is over an eight year backlog of housing stock in Florida.
Here is something else that that shows time is not on your side: If you had an S&P 500 index fund in 2008, that fund fell by 37.5%. To recoup this loss, it would take an investor over five years to recover this loss their assuming the traditionally-accepted 9.4% historical rate of return in the S&P 500 Index with dividends re-invested.
So that’s the one-two punch for the children of the Greatest Generation, significant losses in home prices and equity portfolios that only time can repair. Maybe this is what people meant when they said “time is money.” But for too many people approaching retirement, time is often an option that many people can count on.
Welcome to Mutual Fund Reform
Remembering the Role of Mutual Funds in Today’s Financial Crash
With all the media attention focused on the banks and mortgage companies, it’s odd that the financial sector which has the most contact with the investing public has remained entirely out of the spotlight. This critical omission is the mutual fund industry, which is the repository for about $3 trillion in retirement money.
This is an unfortunate omission because the mutual fund industry has many things to account for. These problems are serious and cut at some of the fund industry’s basic business practices.
They also have been known for years, yet many funds, especially load-funds which charge higher fees than no-load funds, have done little to address them. Now, with many shareholder accounts down by about one-third, many load funds should take steps to help their shareholders re-build their portfolios back to pre-recession levels.
The list starts with poor due diligence. Funds make stated and implied promises to perform due diligence to root out bad investment ideas and bad people. The bad loans which became embedded into some bond, real estate, inflation protection, and money market funds should have been detected by more fund managers or analysts. They obviously were not. This helps explain why some money market funds fell below $1 per share.
Then, there was the failure of active management. Shareholders pay for active management, yet in too many cases, actively managed mutual funds declined by as much, or more, than passively-managed index funds.
Another serious problem is poor disclosure. Too many mutual funds are laden with hidden revenue sharing agreements, advisor-paid fees, shelf-space fees, and other under-the-table payments which are paid to brokerage and independent investment firms. Ostensibly, these fees are disclosed in the fund’s prospectus, but as early as 1994, former SEC Chairman Arthur Levitt proposed that prospectuses be shortened and be written in plain English.
That was 15 years ago, and the prospectuses still remain intentionally opaque. In reality, financial advisers do not openly tell investors they will receive a trail on commissions for advocating certain funds over others for as long as the account remains open. This is a blatant conflict of interest, yet most shareholders remain in the dark about this practice, even when a fund delivers consistently poor performance.
All this matters because high fees in the form of the fund’s expense ratio are often more important than the fund’s return. When fees are recurring, they have a negative compound effect. This means shareholders lose more money as time goes by.
This blog will discuss the serious issues facing investors who want to recoup the losses they sustained in their mutual funds. I will also talk about how the losses in your home values have affected your retirement wealth.
Other serious topics we can talk about are the role of managed futures and other non-correlating types of strategies and funds, and how they can help your diversification.
All of this will be educational, not product promotional. We will also see why no-load funds, and ETFs help investors, as opposed to load funds which are sold through mutual fund wholesalers.
Watch this space for more.
Plus, your comments are always welcome.
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