Sunday, December 6, 2009

The Birth of a new Fund

Birth of a New Fund

Even the cynics in the mutual fund industry had to scratch their collective heads when the latest fund “solution” was unveiled by Invesco Trimark. It might be useful to stop a minute and walk through how the newest mutual fund came to be. New funds do not just appear without a thought to what the market either needs or will bear. It costs money to launch a fund and it costs money and time to wind down an unsuccessful fund. The industry is quite efficient at burying the dead within the living by merging the failed funds with other more successful funds to make them disappear. However, every new fund is somebody’s best idea and the fund industry needs to breed many more successes than failures if they are to continue to thrive.

The Winning Conditions: To be successful and receive support within a fund factory, a new idea has to hit two primary thresholds:
1- Can we market it successfully? Funds are “sold” not bought. As such, the fund must have sex appeal within the investing marketplace. A great example is creating a fund focused on Gold when the market is hysterical about either a crash or hyper inflation. The gold market has its moments, as all markets do, but buying a fund after the hysteria has occurred means getting in high and likely selling off shortly thereafter at a market low. Having said that, it is as easy as falling off a log to market a fund during the hysteria.

2- Can we incent Advisors/Salespeople to push our new fund off the shelf and into portfolios? Because funds are a “sold” product, you need to excite the sellers to be successful. If funds were “bought” and not sold products then you would need to excite the investor. Fortunately, while investors can be fickle, salespeople are not. The way to an advisor/salespersons heart is through their wallet. Salespeople sell to make commission.

The Birth: The latest fund to enter the investing world is PowerShares Fund which combines the efficiency of ETF investing with the (?) of Mutual Fund investing.

The Challenge: This is the point at which the marketing folks start to earn their dollars. We know that ETF Index funds are efficient, low cost, and highly diversified. We also know that investors are becoming keenly aware of the popularity of ETFs. Combine that with the knowledge that ETFs are the enemy of the high cost, inefficient salesperson sold funds and you understand the challenge. How do we meet the demand for “bought” ETFs with a “sold” mutual fund? An equal marketing hurdle is how do we get salespeople to even have a discussion about the feared and hated ETFs with a potential investor?
The Solution(s): The challenge requires two solutions. The first is to make the investor feel they are getting the latest hottest craze, these new fangled ETFs, without needing to actually investigate what makes then so efficient. For that we need a name that screams ETF and avoids any in-depth detail on what makes then work. The focus needs to be “look you can get ETFs without leaving your salesperson”! Knowing most investors are totally reliant on the salesperson to select the funds, this approach meets the criteria for a successful marketing campaign.

The second part of the solution is to position the new fund as lucrative and beneficial to the salesperson. First we commit to the old standby; a fat commission via lucrative trailer fees. When the trailer fee is sufficient the salesperson/advisor will be more than happy to ignore the investment paradox of a high fee, non-managed fund. The second part is to play on the advisor/salesperson fear of the growth in ETF investing worldwide. The salesperson/advisor is well aware the ETF trend is a threat. What better way to handle the challenge then by jumping on board with a fund product wrapped in the disguise of an ETF.

Advisor/Salesperson Pitch: The product sales pitch is a great one and easy to understand.....what, sorry? Oh, let me be clear, the sales pitch is to the salesperson not the investing client. Why would we pitch an investor who has no clue what the salesperson is about to sell them? It would be a counterproductive extra step, as well as a potential death blow to the fund launch. No, let’s stay focused on who really matters, the salesperson/advisor who butters the fund company’s bread!

Now, as I was saying, the sales pitch is easy. Say you have clients upset that the funds they own massively tanked during 2008/2009 and they are thinking of starting a couch potato low cost ETF approach. Rather than slandering the ETF approach you can now say “no problem, I can take care of that for you with no need for a messy discount broker account and all that reading and research you need for a couch potato portfolio”! A further side benefit for the salesperson/advisor is that the ETF, with a huge 500% or so increase in MER costs, may very well underperform some of the mutual funds the investor owns! You get to rake in the trailer and if the fund underperforms due to high fees, you just tell the client “that’s why I recommend the high fee active managed funds; you should have listened to me!”. Clearly a win-win for advisors.

Well, that brings us to the end of the process. For clear proof that funds are “sold” and not “bought”, keep a watchful eye on the volume of the new fund sold by advisors who, up to now, have railed against ETFs as an extremely poor investment choice for their clients.
If the advisor/salesperson truly believed the ETFs were a poor product, then the ETF fund should be a total flop! If the advisor/salesperson is motivated primarily by trailer fees, the fund should be a raving success. I know which way I am betting!

For a great article on this new fund launch visit Jonathon Chevreau’s blog, Wealthy Boomer . He raises all the relevant points and leaves no room for waffling! The follow up industry responses seem to be a hodge podge of whining and denial.

Your “still looking for the meat” blogger, SOISMIKE