NEW YORK -- Maybe mutual fund companies are right: the best thing you can do as an investor is put your money with them. Except rather than invest in their funds, the smartest decision over the past 25 years would have been to buy their stock.
With many fund companies reporting strong inflows of new money and rising profits, it's noticeable just how great a business model mutual-fund management is for fund companies, if not their shareholders.
Looking back from the latest quarter to the second quarter of 1986, shares of fund companies dramatically outperformed almost all other stocks as well as their own funds.
Leading the way: Eaton Vance Corp., which has seen its stock rise almost 7,000 percent cumulatively over that roughly 24-year span. Meanwhile, T. Rowe Price Group Inc.'s shares gained just under 5,000 percent, while Franklin Resources Inc. climbed about 3,700 percent.
Investors in those companies' best mutual funds didn't fare quite so well.
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The top-performing fund from each company over the same period was Eaton Vance Worldwide Health Sciences Fund, with a total cumulative return of about 1,500 percent. Franklin's Mutual Quest Fund rose almost 1,300 percent, and T. Rowe Price Capital Appreciation Fund gained close to 1,200 percent.
Those are impressive results, albeit from the finest funds out of hundreds that these three giants have offered over the past 24 years. By contrast, the Standard & Poor's 500 Index rose 366.2 percent in the period.
There are two main reasons for fund companies' outsized returns: the highly profitable nature of their industry, and explosion in assets delivered by the trend away from company pensions toward individual retirement accounts.
Money managers essentially make their income from one source: assets under management. A big part of fund companies' growth since 1986 is that rising markets has raised their asset levels regardless of any organic growth. But on top of that, money has flooded in from individuals due to companies moving away from guaranteed pensions in favor of self-directed 401(k) retirement plans.
That's seen assets in the fund industry grow to $11 trillion at the end of February from $645 billion in mid-1986, according to the Investment Company Institute.
On top of these growth trends, the nature of the business has worked in fund companies' favor. If a fund's management fees are 1 percent of assets, for example, then an additional $1 billion into a portfolio brings an additional $10 million in revenue -- excluding certain pricing discounts such as breakpoints. But since the fund company doesn't have to hire another portfolio manager or more research analysts to handle the new money, that additional revenue is quite profitable.
"The asset growth is all top-line growth," said Matt Snowling, analyst at FBR Capital Markets, who covers fund managers.
But this lucrative pipeline may be narrowing. Snowling said the past 20-plus years were turbocharged because the fund industry was growing rapidly. The outsized performance of these fund-company stocks reflects how a relatively tiny industry became such a core part of Americans' financial lives, he said.
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Nowadays, Snowling said, asset management is "a mature industry." The shift to 401(k)s has almost finished, he added, meaning the end of that particular boom for fund companies.
Moreover, fund firms face new challenges. The biggest hurdles: competition from cheaper, more tax-efficient index-linked mutual funds and exchange-traded funds, and the growth of direct investing through online discount brokers such as E-Trade Financial Corp. and Scottrade Inc.
"Twenty years ago if you wanted to invest in stocks, and you didn't have enough to open a Merrill Lynch account, you needed a mutual fund," said Snowling. "The emergence of direct investing has taken assets from mutual funds."
Going forward, the strongest asset managers will offer a diverse lineup of funds to capture new money. Snowling said.
And there's always the cautionary tale to ward off investors who might think all asset managers are a sure bet. Take Janus Capital Group Inc., once a darling of the stock market. The firm's assets under management peaked at $258 billion at the end of 2000, Snowling said. Last March, the Denver-based firm managed $165 billion. Janus went public in June 2000, closing its first day of trading at $38.38 a share. On Wednesday, the shares closed at $13.18.
Perhaps those top-performing funds aren't such a bad option, after all.
