Retention proves trickier than sales

Despite strong gross sales performance across the industry, many mutual fund manufacturers are facing an uphill struggle in retaining assets, according to the July edition of Investor Economics Insight.

In some years, strong sales have helped to mask the problem. While redemptions have been increasing in dollar terms, inflows have been growing at a faster pace. Conversely, when sales slow down redemption rates appear to soar. For example, in 2003, the industry chalked up a “return ratio” of 91%, meaning that for every $10 of new sales, there were $9.10 in “returned” funds, or redemptions.

Then again, 2003 marked a low point for new sales at a time. Investors were still nervous about losses the year before and sales slumped to just $4.6 billion, or 1.3% of initial assets. But there was also some pent-up demand for redemptions — if nothing else, investors appear to have cottoned on to the idea of not selling when the markets are in a trough.

However, in the 12-month period ending with May 2006, that ratio had fallen to 74%, as sales surged to $26.9 billion, or 5.5% of starting assets. Of course, not every fund complex is matching the industry average, and two of the firms that are excelling in the retention game are bank-based fund companies.

RBC has managed to hold its return ratio down to 45% ($4.50 in outflows for every $10 in new sales), while TD has posted a ratio of 55%. Among the independents, retention becomes more difficult, with even the best of the large firms seeing outflows above the industry average.

Franklin Templeton has posted a return ratio of 76%, followed by Mackenzie and Investors Group at 82% — all three above the industry average. Meanwhile, AIM Trimark and Fidelity saw net redemptions push the ratio to 143% and 104%, respectively.

For some investors, the remainder of a DSC schedule had been enough to hold them in place, but for those who really wanted out of their investment, this hurdle did not suffice.

One of the retention strategies employed in the past has been to facilitate transfers within the fund complex. Investors could exit a fund before the DSC schedule had expired without incurring the redemption penalty, so long as they reinvested the proceeds within the same fund family.

This helped in the short term, but as the DSC schedule expired on funds sold in the mid- to late-1990s, transfer privileges lost their advantage — and with no redemption fee, there was little incentive to stay with either an out-of-favour fund or its manufacturer.

Between 2000 and 2002, transfers accounted for at least 60% of gross outflows, peaking at 64% in 2002, on gross outflows of $133 billion. While outflows fell below $100 billion in 2003 and 2004, redemptions increased as a share of flows. In 2004, redemptions accounted for 59% of gross outflows, with transfers falling to 41%.

Factoring out the mergers of RSP clone funds with their underlying investments, transfers accounted for only 45% of fund outflows in 2005, with redemptions making up the remainder.

Fortunately for fund manufacturers, gross sales began to pick up steam in 2004 as well, in most cases offsetting the increasing redemptions.

Investor Economics suggests a large part of the redemptions were driven by a shift in asset preference, namely, the shift from growth equities to income investing. As investors clamoured for yield, advisors found themselves placing more assets with non-traditional players in their distribution channels — funds sponsored by deposit-taking institutions.

“Many of the traditional stalwarts — the large independent fund companies — found themselves out of favour, and it took time for them to adjust to the shift in asset class preference from the equity-centric culture of the ’90s to a more varied and income-oriented approach,” says Investor Economics.

Despite strong equity markets, fund companies have struggled to attract net inflows to the core equity categories of Canadian, U.S. and international equity funds. In 2000, at the peak of the stock market frenzy, net new sales in these three categories alone totaled nearly $25 billion.

In 2003, investors redeemed a net $4.7 billion in these in these categories, cashing in on the early days of the stock market recovery. In the 12 months ended May 2006, these core funds remained in net redemptions, to the tune of $1.6 billion.

“The good news is that equity fund manufacturers have been able to use hotter income-oriented funds to recapture more of the potential outflows,” Investor Economics says. “Now, slowly but surely the negative metrics are easing and moving into positive terrain as investors move back to core equity funds.”

“Consequently, many have faced a challenging redemption environment,” the report says. “This again stresses the importance of a well-planned retention strategy, covering all asset classes, products and distribution channels.”

Of the fund complexes in the Canadian market, 12% offer funds covering at least 20 different asset classes. That may not sound like much, but its up from 4% in 1997. Over the same period, the number of fund complexes has dropped from 140 to 109.

In general, large independent firms — those with more than $20 billion in assets — tend to excel at recapturing outflows, thanks to the breadth of their product lineup. Among the best at recapturing outflows is CI Investments, which is currently boasting a recapture ratio of 76%, for the 12 months ended May 2006.

Other retention strategies have also paid off. Among smaller independent firms — those with assets under $20 billion — MD Management has consistently posted high recapture ratios, most recently dipping to 69%, but having hit 84% in 2003 and 81% in 2000.

MD Management is a specialized firm offering focused on the financial needs of medical doctors who may appreciate the tailored service. The firm also owns Saxon Funds, which markets directly to investors, a strategy which could partially explain the “stickiness” of their assets.

Brandes investors also demonstrate strong brand loyalty. Considering the firm only offers 10 funds (not including its seven U.S. dollar denominated versions), it boasted a 64% recapture rate in the most recent 12-month period, which ranks it behind only CI, National Bank (70%), MD and Desjardins (66%). Brandes could simply be enjoying a honeymoon period, though, as the firm is only four years old as an independent in Canada.

Despite relatively large product shelves, some of the leading deposit-takers have posted the worst recapture rates, with TD seeing only 27% of outflows transferred within its shelf, and RBC achieving 39%. Of course, these two firms are among the most successful in terms of net sales, so there is not likely much cause for alarm.