With the markets sagging and equity mutual funds leaking deposits like a worn tire, it's no wonder fund companies are swearing off the naughty ways of the bull market. Some of these moves are aimed at meaningful changes. Others might be as much an overreaction to the bear market as all those tech-heavy growth funds were to the bull.

On the plus side, some funds are now hiring outside stars to take over their in-house portfolios. Another approach is to de-emphasize direct marketing to individual investors (who are clearly not in the mood, anyway) and, instead, shift their focus to financial advisors by converting to load funds and hiring the salesforce to lavish attention on brokers and advisors.

“We are refocusing on business building, on helping reps market their own businesses,” says Martin Beaulieu, director of distribution for MFS Investment Management. “We're trying to know who the best brokers are.”

Another trend is the rise of so-called principal protection vehicles, which promise not to lose principal in down markets while also providing some participation in up ones. How big is this trend? Consider that as of year-end 2002, there were 20 principal protection funds with around $5 billion in assets; compare that to year-end 2000, when there were just 11 such funds with a mere $611 million in assets.

These vehicles are not universally admired. As one mutual fund executive says, they are really opportunistic products that bring in money by addressing a perceived need for special “safety” investments. “Sure, it raises assets in the short term, but it doesn't necessarily create long-term shareholder value,” he says. “Reps should be focusing their clients on the long term.” The better idea, he says, is to forget about the newest, coolest (and usually more expensive) option and concentrate on prudent asset allocation, using a mix of cash, bonds, and equities (and alternative investments, if the clients are qualified) to achieve largely the same result.

Picking the best managers helps a great deal also. And, in this department, there's the welcome trend of farming out management to top-notch subadvisors. Harbor Capital Advisors is famous for the practice, having picked Spiros Segalas to run its Harbor Capital Appreciation fund and Jakan Castegren to run its Harbor International. And many of Vanguard's equity funds are also subadvised.

There were 822 subadvised funds at the end of 2001, representing roughly one out of eight equity funds, according to Financial Research Corporation's most recent data. Subadvised funds were then attracting one out of five net dollars flowing into mutual funds, Financial Research estimates. After all, retail investors and reps alike prefer to invest with managers who have proven their skills.

In some cases, fund companies have assembled whole families of subadvisors, creating a cavalcade of stars that no single company could hope to employ full time. “It is a way to give clients the best of the best,” says Lawrence D. Urso, a senior vice president of Prudential Financial in Red Bank, N.J., who often steers clients to his company's subadvised line of funds.

American Express, which had some mediocre in-house funds, has revived its lineup with a selection of subadvised funds employing some of the brightest names in the business. Lord Abbett acts as a large-cap manager for AXP Strategic Partners fund. Davis Advisors oversees AXP Partners Fundamental Value, the large-cap value fund, while Gabelli runs AXP Partners Select Value, which seeks steady returns by focusing on small stocks and convertibles. In some cases, the company provides a unique product by teaming two managers with somewhat different styles. For example, the assets of AXP Partners Small Cap Core are divided between PBHG, an aggressive growth specialist, and Wellington, a more value-oriented shop. By combining the two styles, the company seeks to develop steadier results for shareholders.

But some companies hire managers and let them do things that they're prohibited from doing in their flagship fund. For example, Enterprise Funds recently began selling a bond fund managed by Bill Gross. But to differentiate from Gross's PIMCO Total Return Fund, Enterprise gave Gross the freedom to mix a sizable foreign stake in his predominantly domestic portfolio. It's worked: Helped by foreign bonds, Enterprise Total Return outdid Gross' flagship PIMCO Total Return in the fourth quarter of 2002. Enterprise has also signed Mario Gabelli for its Enterprise Mergers and Acquisitions Fund, based on a strategy that the manager had previously provided for institutions and hedge funds and for its Enterprise Small Company Value, a fund buying small and midcap stocks.

The next big step in mutual fund rehab has been the shift to advisor sales. This is a no-brainer, given the public's steady retreat from equities. Recent entrants offering A and B shares include Invesco, Strong, Columbia and Scudder. In some cases, the fund companies found that most of their sales were coming through advisors, despite their costly consumer marketing campaigns.

American Century, for example, has gradually been putting more emphasis on the advisor channel, by offering A and B shares. The company started introducing itself to advisors through wrap programs and variable annuities. Then two years ago, American Century introduced C shares, which charge no front-end loads and are aimed at fee-only advisors. In February 2003, the company announced the arrival of front-end loads and said that 10 of its funds would only be sold through financial intermediaries. The advisor choices include American Century Select, which started operating in the 1950s, and American Century Value, its flagship value selection. “We wanted products with longstanding histories,” says David Larrabee, a senior vice president of American Century. “The idea is to demonstrate our commitment and willingness to work with financial professionals.”

Advisor sales might be where the money is, but breaking into the new channel is not always easy. “It takes a lot of time and money to penetrate the advisor channels,” says Matthew McGinness, an analyst for Cerulli Associates. And the load market is still dominated by a handful of fund complexes, including American Funds, Putnam, Franklin and OppenheimerFunds — the same names that led a decade ago.

It's also a steep learning curve: MFS, one of the largest load companies, has invested heavily in its distribution system and remains a leader in supporting advisors, providing training materials and guidance on how to help clients with estate planning and other issues. Novices in the business may need to duplicate such intensive efforts in order to stand out from a field that is becoming increasingly competitive.

Where They Stand

Shares of full-service brokerage houses at a glance

Firm TKR Price TTM/PE P/Book FWD P/E 52-wk Low-Hi
Goldman Sachs GS 65.74 16.34 1.67 15.1 $58.57-$92.25
Merrill Lynch MER 33.15 12.30 1.31 12.1 $28.21-$56.60
Lehman Brothers LEH 51.50 14.88 1.50 12.3 $42.47-$67.33
Morgan Stanley MWD 36.05 13.35 1.84 12.0 $28.80-$58.27
Prudential Financial PRU 30.40 53.33 0.79 12.1 $25.25-$36.00
AG Edwards AGE 27.10 36.09 1.29 14.5 $26.50-$46.15
Charles Schwab SCH 8.44 29.10 2.66 28.1 $7.22-$15.80