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ICI Conference: Morningstar's Phillips Tells AdvisorOne Passive Strategies Attracting Assets

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Don Phillips, managing director of Morningstar, says that the mutual fund industry uses its annual gathering in Washington each year “to cheer itself up.” This year, the industry is trying to overcome the fact that the “wind has not been at the back” of its bread-and-butter strategy—active management. Rather, “passive strategies are where the flows have gone,” Phillips told AdvisorOne during the Investment Company Institute’s (ICI) annual conference on Thursday.

Because “actively managed funds as well as money market funds are under pressure,” Phillips says, the industry is turning toward more passive strategies like exchange-traded funds (ETFs). “The flows into passive [strategies] have been gaining momentum for the past several years,” he says. However, to “better showcase active management,” Phillips continues, the industry is using more alternative strategies and “go-anywhere” funds, which “allow [fund] managers to add value.”

While ETFs and target-date funds have been “growth areas” for the industry, Phillips says, only three fund firms—Fidelity, Vanguard, and T. Rowe Price—“have been beneficiaries of flows into target-date funds because [as] record keepers, they put their own target-date funds into their clients’ plans.” Fidelity and T. Rowe Price, he adds, are “not big players in ETFs, just target date” funds, while “Vanguard is a big player in both.”

While target date funds have rebounded since the 2008 market meltdown, the nation’s mutual fund managers must nonetheless ensure that investors understand what they are buying in a target-date fund, added Ronald O'Hanley, president of asset management and corporate services at Fidelity Investments, during a panel discussion at the ICI event. “We have to be very clear with shareholders exactly what they are investing in in these types of embedded solutions” like target-date funds, O'Hanley said.

Assets in target-date mutual funds continued to grow, ICI reports, due to “ongoing net inflows and investment returns.” As of December 31, 2010, target-date mutual fund assets totaled $340 billion, an increase of 11% in the fourth quarter and 33% higher than December 31, 2009, ICI says. Retirement accounts held the bulk of target-date mutual fund assets: 91% of target-date mutual fund assets were held through defined contribution plans and IRAs, ICI reports. The combined assets of the nation’s mutual funds increased by $49.4 billion, or 0.4%, to $12.171 trillion in March, according to ICI.

Target-date funds are also evolving. “We’ve already seen the move toward target-date index funds,” and “you will see more and more open architecture target-date funds,” Fidelity’s O'Hanley said.

Phillips said during the interview with AdvisorOne that while he believes "in time" there will be more open architecture target-date funds, the trend will really take hold when "investors demand it."

One of the challenges for the mutual fund industry moving forward, agreed both O'Hanley and William Glavin, president and CEO of OppenheimerFunds, is better communication with investors. For instance, the term “absolute return” can be confusing for investors, Glavin said. Investors “think there will always be a positive return” when they hear “absolute return.” O'Hanley agreed that investors must understand what’s inside “complex” products. “We shouldn’t limit innovation” in product design, O'Hanley continued, “but education” about those products must be delivered to shareholders.


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