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What 21st-Century Mutual Fund Investors Want

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U.S. mutual fund investors remain a powerful client segment for the global asset management industry, with more than $100 billion a year in earnings.

They also represent a rapidly changing group of consumers who have complex needs and a heightened sensitivity to volatility following the 2008 financial crisis. Today's mutual fund buyers are focused on outcomes instead of on investments that just outperform a benchmark such as the S&P 500 Index.

Relative return is necessary but no longer sufficient; less correlated, more absolute, risk-adjusted performance increasingly is a vital part of a fund buyer's criteria. Investors and their advisors now design portfolios around objectives such as growth or liability management, rather than simply on equities or bonds.

A low-return environment compounds this challenge for asset managers seeking to attract mutual fund customers. Between 1998 and 2000, the average 60/40 balanced portfolio invested in a basket of stocks and bonds globally grew 10 percent compounded annually. Since 2000, thanks to low interest rates and volatile stock markets, a similar portfolio appreciates about half that. The mighty tailwind that propelled growth for asset managers and their customers is now sputtering.

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Increasingly, mutual fund investors and their advisors seek out funds that clearly add value to a portfolio and that support long-term investment plans and outcomes. Successful fund companies will offer at least one of four value propositions that resonate with shifting demand, not only in the U.S. but among retail investors worldwide:

High-return active management: Products that offer robust investment capabilities relatively uncorrelated to market benchmarks should provide sustainable outperformance in a low-growth environment, but that's a tougher objective to meet now. The ranks of successful mutual fund managers of the next decade may include new players from hedge funds and alternative investments, many of whom are familiar with the wider set of strategies and tools required to succeed.

Cost-efficient indexing: Those seeking exposure to broad market trends can find it easily and cheaply through exchange-traded funds and other passive vehicles. Indexing has spurred a 15 percent drop in traditional asset management fees industry-wide since 2006 and will play a greater role in the long-term portfolios of many mutual fund investors. Large index providers will continue to provide most of these products.

Asset allocation expertise: This is the value proposition investors most desire and an area in which the global asset management industry has spent little time innovating. Mutual fund investors are redeeming out of traditional stock-and-bond balanced funds in favor of products that have more dynamic approaches to allocation, are focused on specific outcomes, and are built on globally focused asset classes and strategies. A wide range of fund providers—old and new, both quantitatively and fundamentally driven—will compete to offer these skills.

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Solutions-led distribution: Investors also will turn to open-architecture, packaged, multiasset and total portfolios products that assemble best-of-breed third-party managers for most required investment components. Wealth managers and intermediaries likely will become increasingly active in creating these funds.

Mutual fund firms with offering these value propositions will have a far easier time attracting business and capturing customers from asset managers slow to adapt. Conversely, a broad array of existing asset managers—including many of the largest mutual fund providers—will struggle to meet investors' demands. Mutual fund shareholders' expectations are uncovering an oversupply of outmoded providers in the industry: mainly those focused on benchmark-hugging portfolios with high fees that consume most of their thin relative returns.

The changing needs and expectations of U.S. mutual fund investors and their counterparts worldwide will reshape the global asset management industry. Between now and 2017, the firms adapting successfully will attract 90% of new industry revenues—within U.S. mutual funds and across the entire industry.

Asset management economics will consolidate around skill, not necessarily scale. In as soon as five years, product discussions among mutual fund shareholders and their advisors will be substantially outcome-oriented and focused on different criteria. As a result, the leaders in the U.S. mutual fund marketplace will look very different than they do today.

Ben Phillips, a partner at Casey Quirk & Associates, has nearly 20 years of experience advising asset management firms, financial services companies and governments worldwide on strategic decisions in the fund management industry.

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