Regardless of whether the stock and bond markets can sustain their momentum in 2010, the mutual fund industry -- and fund investors -- appear destined for a year of bad news.
That's the only conclusion I can draw after looking into my crystal ball to see what lies ahead for the fund business. In all the years I have been doing this -- and it's about 15, during which time I typically have gotten about three-quarters of my forecasts right -- there have never been so many dark events looming on the horizon. These aren't necessarily events on the scale of the financial crisis of 2008, but they are the big stories for the fund business.
My selections may not be the fund world's only hot news -- I'm hoping there are some more positives that I have failed to foresee -- but I expect to see the following events in 2010:
1. Money market funds closing
If interest rates don't go up soon, a flood of fund companies will shut down their money-fund businesses because there's no profit in it. Industry watchers say fee waivers to keep money funds profitable are costing Charles Schwab about $100 million in earnings per quarter, for example. Corporate boards aren't willing to allow that forever.Already, several money funds have shut down or stopped accepting new money, but if rates don't rise soon, that will become a bigger trend. When rates do rise, the financial companies will reduce their waivers and keep virtually all of the increase for themselves, at least initially.
2. Money market funds failing
It may seem odd that rates could rise and a money fund could fail, because rising rates would obviously help their backers make a profit. But consider institutional money funds: Corporate treasurers and big power players could decide to capture the rate hike immediately by dumping the fund and moving directly to commercial paper. If that happened, the fund would hold paper that had become less attractive.If a rate hike is big enough, some institutional fund will bite the big one.
3. Bond fund investors in a panic
Bond fund yields right now are well below traditional norms, but that hasn't stopped investors from flocking to safety and security. Industry researcher Strategic Insight estimates a record $400 billion moved into bond funds during 2009. When rates rise -- and they will go up, in small steps, in 2010 -- bond fund prices fall, and bond fund investors suffer. With 10-year Treasurys at abnormally low historical rates, the next move up in rates will mean that bond fund investors will suffer more than usual.
When fund investors see their bond funds take a rate hit, many of them won't be able to stomach the ride. They had moved to bonds for yield and safety, and they'll be queasy watching bonds readjust to a market where rates are on the rise.
4. Bad news from commodity, real-return and absolute-return funds
Historically, the fund industry has always followed the trend. When an area of the market gets frothy and looks good, fund companies pile in. Once the fund companies have all plowed ahead, the hot sector or investment style falters.It's a time-tested story, and it's happening right now with commodity, real-return and absolute-return funds. They've been hot for a while now, but that will come to a halt in 2010.
5. The closing of smaller companies' target-date funds
In about 95% of all retirement plans, the target-date funds offered are the ones run by the company running the plan. As a result, the biggest fund companies dominate the life-cycle and target-date market. In 2010, smaller players -- those without a big business in putting together corporate retirement programs -- will call it quits.When that happens, innovation and the evolution of these funds will stop, and consumers will be stuck with what's out there, a path that leads to mediocrity.
