Money managers feeling a squeeze on fees are cutting costs and striving to become more efficient. The latest weapon in their ar-senal: a new form of pooled fund that goes beyond managing cash collectively in-house to doing the same for stocks and bonds.
“These new funds are a response to the pressures to drive costs down,” says Geoff Bobroff, president of Bobroff Consulting in East Greenwich, Rhode Island. “As the world hews more to
institutional benchmarks, eschewing Morningstar’s and Lipper’s retail standards, these pooled funds will reduce a battery of costs.”
To create a pooled fund, a mutual fund family collects all the assets in its publicly marketed funds that follow the same investment strategy -- small-cap growth, say -- even if those assets are lodged in a diversified portfolio with other asset classes. The monies are then combined into one pool that is managed by a specialist in that asset class. The bulk of the fund family’s cost savings come from reduced custody and accounting fees. Richard Davies, head of mutual fund marketing at Alliance Bernstein Investment Research and Management, estimates that his firm will save “north of 30 basis points” -- more than 40 percent of its custody costs -- with its new pooled funds.
All these new funds represent a variation on traditional pooling arrangements, which have been around for decades. Unlike retail mutual funds or their institutional counterparts, these pooled funds are not marketed; all are used strictly as an in-house management tool by fund families.
In an unusual approach, Alliance Bernstein first devised pool structures, then set out to gather the appropriate assets to pour into them. In March the firm registered 11 pooling structures with the Securities and Exchange Commission.
The new-style pooled funds trace their origins to 1996, when Fidelity Investments had the inspired idea of sweeping its retail mutual funds’ spare cash into a handful of centrally managed short-term pools. (The following year T. Rowe Price Group launched two in-house pooled funds for short-term cash, which it has operated ever since.) In time Fidelity had six cash pools, each with a relatively specific mandate: Treasury notes, commercial paper and so on.
By taking, for example, $1 million in commercial paper from each of 100 mutual funds and managing that $100 million separately, the mutual fund giant could have garnered incremental annual returns of more than 10 basis points, estimates consultant Bobroff. Today’s lower interest rates have whittled, but by no means eliminated, that extra-
return bonus.
Now Fidelity has extended the pooling concept out the yield curve. Last fall it added three longer-term fixed-income pools to its six cash management funds: one for high-yield bonds, another for tactical fixed-income instruments and a third for floating-rate notes. Fidelity managers cobble together these asset classes almost exclusively from retail mutual funds, with a smattering of money from collective trusts and separate accounts, and manage them in nine pools of specific asset classes.
Although all three of the new pools draw from a mix of retail and institutional sources, Fidelity is benchmarking them exclusively to institutional yardsticks: the Merrill Lynch High Yield Master II index or the Lehman Brothers aggregate bond index or the CSFB Leveraged Loan Index Plus. The firm figures that these standards will be more useful in managing the pools than the usual retail gauges that are geared to mutual fund sales.
Pooled funds provide several kinds of efficiencies. Because they can be laddered -- invested in similar securities with gradually longer maturities -- they earn straightforward, incremental returns. A $100 million pool can be divided into subpools, some with longer maturities, with an overnight subpool reserved to cover the day’s sales of mutual fund shares. The longer-maturity subpools yield perhaps a couple of basis points in additional return.
Moreover, pooled funds benefit from favorable custody, administrative and accounting rates because they offer economies of scale. Not least, their bulk gives them trading desk clout that can yield bargains. Bobroff says that a specialist manager “tends to run a pooled-fund portfolio in a more systematic fashion, minimizing the proclivity toward style drift.” The consultant adds, “It’s hard to put a number on it, but this centralization reduces variability of returns.”
Christopher Lynch, head of sales for the J.P. Morgan Chase & Co. unit that offers custody and other services to mutual funds, notes, “People are looking at pooling in various ways, to help manage complexity more efficiently.”
Alliance Bernstein recently introduced the first product to make use of its 11 structured pools: ten lifestyle funds intended for the defined contribution market. “By later this summer we plan to have 30 different products with different purposes -- ranging from college savings plans to retail mutual funds and institutional separate accounts -- all built from these 11 pooled vehicles,” says Davies. “There will be a common architecture, consistent investment management and significant operating efficiencies in the back office.” He adds, “We have spent two years building these new structures.”
The 11 pooled vehicles encompass a range of investment styles: U.S. value, U.S. large-cap growth, real estate investment trusts, international value, international growth, short-duration bonds, intermediate-duration bonds, inflation-protected securities, high-yield securities, small- and midcap value and small- and midcap growth.
Davies figures that for complex asset allocation strategies such as those of lifestyle funds, which rebalance toward more conservative investments as the holders near retirement, pooling can lead to a “dramatic reduction” in operating costs.
Alliance Bernstein will embed charges ranging from 7 to 22 basis points to use one of its pools. Robert Keith, who heads the firm’s institutional sales, says the fees will cover “operational expenses"; the investment management fees will continue to be collected out of fund assets.
Allianz Global Investors uses both Fidelity’s approach of collecting assets from multiple existing funds for its pools and Alliance Bernstein’s process of using those pools as building blocks for other products. AGI’s Fixed Income Shares, or FISH, pools make up 40 percent of the assets in the managed accounts of its high-net-worth clients with $250,000 to $5 million to invest.
“In a crowded marketplace, we developed these funds so that our clients could have access to all ten sectors of the bond market,” says Allianz managing director James Patrick, who heads managed accounts. The firm markets its managed accounts through wire houses and commercial banks. Allianz’s ten pools offer it more efficient and less costly management than mutual funds. They also give financial advisers the flexibility to allocate their clients’ assets themselves, rather than having to choose among the ten funds that are designed by Allianz.
“These funds let our financial advisers choose from a full tool belt,” says Patrick.
