Many businesses spend small fortunes to establish and promote their brands. Last year, Merrill Lynch, for example, spent about a half-a-billion dollars on “marketing and business development.” Imagine Merrill's new challenge: Come April, Merrill Lynch will remove its famous name from the brokerage's own funds to relaunch them under a new (as yet to be determined) name.
Why? Merrill thinks its products are good enough to compete on their own — and be sold on all sorts of platforms. But, a Merrill Lynch spokesman says that competing firms haven't been willing to sell funds bearing a rival's name.
Merrill isn't the only broker struggling to sell its funds via third parties. While cash floods into companies like Vanguard Group and Franklin Templeton, investors have given the cold shoulder to proprietary funds run by major wirehouses like UBS and Morgan Stanley. All the big brokers have reported declines in their market shares of total fund assets. (That said, Merrill did report stronger sales of its own funds through third parties in the first nine months of 2005.)
Turning Around House Funds
Some advisors attribute the sales problems partly to mediocre performance records. In fact, many proprietary funds have produced below-average results. But brokerage companies have been fighting back, hiring new managers and striving to improve returns. Several wirehouses have acquired outside money management firms. The Van Kampen Investments unit of Morgan Stanley has been reporting healthy sales. Wachovia's Evergreen Investments has also been growing in recent years. “Many of the proprietary funds have weak records, but there are some real stars that are worth considering,” says Richard Bregman, chief executive of MJB Asset Management, a registered investment advisor in New York.
Advisors who have traditionally shunned in-house funds should take another look. In nearly every asset category there are proprietary portfolios with sterling records. Clients who want tame exposure to large-cap stocks should consider Van Kampen Equity and Income, a contrarian fund that buys unloved stocks that seem poised to rise. During the past decade the fund has returned 11.9 percent annually, outdoing the S&P 500 by 2.5 percentage points per year. Van Kampen has achieved that stellar record while delivering a smooth ride, recording standard deviation and beta scores that are much lower than the S&P's.
Another resilient choice is UBS U.S. Large Cap Equity. When stocks cratered in 2000 and 2001, UBS actually made money. Careful attention to prices caused the fund to underweight technology stocks and avoid the worst damage. The portfolio managers estimate the value of future cash flows and only buy shares selling at bargain prices. The discipline keeps the fund away from hot stocks and results in a portfolio of reliable blue chips, including Microsoft and Johnson & Johnson.
Small-cap investors seeking some downside protection should consider Jennison Small Company, which is operated by Prudential Securities. Staying broadly diversified, the fund has avoided big losses and finished in the top half of the small growth category for the past five consecutive years. Portfolio manager John Mullman insists on holding stocks in every sector, as defined by the Russell 2000. That forces the portfolio to own a sizable stake of value stocks. Because of the wide mix of growth and value stocks, the fund can thrive in a variety of market climates.
Jennison buys some turnaround candidates, but most holdings are steady performers. “The bulk of the companies have good returns on capital and annual earnings growth of 15 percent or so,” says Mullman. He particularly likes reliable business service companies that can deliver growing earnings year after year. A top holding is Iron Mountain, a document-storage specialist that serves a variety of large and small companies.
Over There Funds
Investors seeking an alternative to a foreign index fund should try Evergreen International Equity A, which has bested its benchmark, the Morgan Stanley Capital International EAFE index, during the past five years. The fund holds a wide mix of stocks, including small and large issues, growth and value. Portfolio manager Gilman Gunn likes to find stocks with high returns on equity and growing earnings. A favorite holding is Anglo Irish Bank, which has grown steadily by lending to underserved markets like small businesses. Gunn likes to track down complicated conglomerates that are often bargains because analysts can't spot the valuable assets. One such holding is Brascan, a Canadian company that owns real estate and produces hydropower.
Gunn says he stays out of trouble by following a careful selling discipline, getting rid of any stock that is down 20 percent. “The 20 percent rule limits losses and forces you to be honest about your mistakes,” says Gunn.
By avoiding blow-ups and spotting bargains, Goldman Sachs High Yield has managed to finish in the top half of the high-yield bond category for seven consecutive years. Portfolio managers Andrew Jessop and Rachel Golder range widely in search of higher yields, often buying European bonds and focusing on issues that others shun. When wireless stocks collapsed after the market downturn of 2000, Goldman Sachs scooped up bonds from companies like Crown Castle, which provides towers for cellular networks. The bonds rebounded later along with the rest of the wireless industry. “People said that the tower companies had hit a wall and wouldn't be able to grow,” says Golder. “We thought that the bonds had value because the wireless business was not going away.”
In the staid world of tax-free funds, Merrill Lynch Municipal National stays ahead of the crowd by posting a higher yield than most of its competitors. While some funds aim to score capital gains with nimble trading, Merrill portfolio manager Walter O'Connor buys and holds high-yielding bonds that can't be called for years. The fund currently owns some bonds that it bought a decade ago. Such issues have much higher coupons than current issues, which gives the fund an advantage over younger competitors. O'Connor has gained some extra yield recently by keeping 20 percent of assets in bonds ranked below investment grade. Such issues come with default risk, but they tend to be resilient when interest rates rise and most bonds fall. The high-yield issues help diversify the fund and enable it to rank as a low-volatility choice.
Losing the Race
All the major wirehouses have struggled to sell their proprietary mutual funds.
|% share of total mutual fund assets|
|UBS Global Asset||0.32||0.23||0.20||0.20||0.21||0.24|
| Source: Financial Research Corporation. |
Proprietary Funds That Stand Out From the Pack
|Fund||Ticker||Category||Category % |
|Evergreen International Equity A||EKZAX||Foreign Large Blend||11%||19.8%||19.1%||4.9%||5.75%|
|Goldman Sachs High Yield A||GSHAX||High yield Bond||11||5.1||16.5||8.6||4.50|
|Jennison Small Company A||PGOAX||Small Growth||9||21.3||24.4||9.5||5.50|
|Merrill Lynch Municipal National A||MDNLX||Municipal National Long||6||3.9||5.5||6.4||4.00|
|UBS U.S. Large Cap Equity A||BNEQX||Large Blend||3||13.0||15.9||5.6||5.50|
|Van Kampen Equity and Income A||ACEIX||Moderate Allocation||8||12.7||13.7||5.6||5.75|
|Source: Morningstar. Returns through 10/31/05.|