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Asset Management

11:35 AM
Robert Hegarty, TowerGroup
Robert Hegarty, TowerGroup
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Ready for Cyber Investing: Buy Side Firms Move Online

TowerGroup's Robert Hegarty explains how buy-side firms soon will shift IT resources from industry-mandated efforts, like decimalization, to online efforts.

As the high-transaction sectors of investment services (brokerage, trading, etc.) gain significant online penetration, the more passive investment sectors like mutual funds and retirement plans are slowly following. Over the next two to three years, investment management firms will expand their Web presence, offering more capabilities such as transactions, personalization, and real-time valuation. Most of these services are already offered on the sites of the electronic brokerage firms, and all investors will come to expect this capability.

The demographics of mutual fund investors will help buy side firms move online more quickly. Mutual fund holders tend to be older than stock investors and slower to adopt the Internet. However, as they become comfortable with the Internet, and as certain concerns-most notably security and access-become less of an issue, mutual fund firms will be forced to provide more services online.

Securities Firms' Increase of Staff and IT Spending in Pursuit of IT Initiatives
Source: TowerGroup/SIA Survey, Technology Trends in the Securities Industry 1999: Transition to an Online World

Securities vs. Investment Management Online Presence
Recently published figures paint a bleak picture of the investment management industry: 48% of investment management firms do not have e-commerce capabilities; one-third of investment management firms have no plans to move their customers to the Web; only 6% of mutual fund investors bought funds online in 1999, down from 8% in 1997. In contrast, the securities industry has launched a blitz to move to the Internet. Securities firms plan to grow their Internet staff by more than 25% annually over the next three years. Likewise, their Internet budgets are expected to account for nearly 27% of the overall information technology budget, up from only 3% in 1996. Given the expected growth in assets gathered via the Internet, investment management firms will need to make similarly aggressive investments in Internet technologies in order to keep pace.

While mutual funds are not nearly as exciting (or even desirable) to trade online as stocks-largely due to the once-per-day pricing for mutual funds-investors will nonetheless soon demand the capability to buy or sell their fund shares over the Internet. This is a natural progression of investor behavior-frequent transaction products move online first, followed by the more passive investment vehicles.

Securities Firms' Increase of Staff and IT Spending in Pursuit of IT Initiatives
Source: TowerGroup/SIA Survey, Technology Trends in the Securities Industry 1999: Transition to an Online World

OpenFund: Taking Online Fund Management to the Extreme
While most investment management firms have been reluctant to move their business to the Web, MetaMarkets Investments (metamarkets.com) has climbed on with enthusiasm. With the launch of its OpenFund in August 1999, MetaMarkets has demonstrated how the Internet can shift power from provider to consumer by providing full disclosure about the fund management process. All visitors to the OpenFund Web site are allowed to view all holdings in real time as well as to see the trades as they are being placed.

OpenFund has returned its investors 86.6% (compared to 12% for the Standard & Poor's 500 and 35.7% for the NASDAQ) since its inception, albeit in a short time period during a significant rally. Presumably some of this performance is due to the fund's very nature. As OpenFund places a buy order for all to see, it is very easy for retail investors to piggyback-en masse-off those trades with some immediacy, adding to demand and thus driving up the prices of those securities.

Another advantage that OpenFund enjoys currently because it has only $39 million under management is that all of its trades are relatively small. A manager can trade essentially incognito, looking very much like a retail investor. If OpenFund continues to outperform the market as dramatically and begins attracting sizable money, it will be less able to move in and out of its positions quietly and without market impact, just like any large fund.

OpenFund's managers are not betting solely that their ability to move in and out of stocks like day traders will allow them to outperform the market. Rather, they are so convinced that the Internet will change the way business is done, they not only formed a company around it and its principles (that more information is better), but they also are buying the stock of the companies they believe will exploit this business model evolution most successfully.

In the short run, OpenFund is likely to succeed, as curious-and perhaps nave-investors will jump at the chance to mimic a fund's investments, thus helping to satisfy the self-fulfilling prophecy whereby holdings increase in value as a result of increased demand due to public sharing of all investment ideas. Whether OpenFund can sustain its performance over the longer term, or even beyond the curiosity phase, will depend on the prowess of its managers.

Strategies for Moving Online
Investment management firms pondering the many possibilities for moving their business and their customers online should adhere to these core tenets:

Define separate strategies for the multiple online opportunities. While they have multiple opportunities to take advantage of the Internet, firms should first address the most critical area to its business. For instance, if the firm has a particularly strong relationship with one of its institutional clients, it should partner with that firm to build a Web- or extranet-based e-commerce application.

Know your customer. If a firm serves several customer segments (e.g., institutional, retail, active, passive, etc.), a separate strategy must be devised before embarking on the technology initiatives required to build an effective Web site. Each customer type has very different needs and must be catered to differently online.

Get there first. Once online consumers become comfortable with a site, they are very difficult to move. As individual investors become more accustomed to the look-and-feel and capabilities of a particular trading-related site (Schwab, E*Trade, etc.), they become less likely to switch to an investment-related site for their investing needs. They are also more likely to tolerate a late entry into investment management by their current preferred online financial site.

Expect and allow for more frequent turnover. Just as online stock trading has turned many equity investors from long-term investors into short-term traders, the mutual fund investor's time horizons will also shorten. Once widely criticized by the industry for creating wild swings in mutual fund assets, "market timers" will no longer be the maligned rogues of mutual fund investing.

Provide direction for the customer. The top 15 investment management firms (as measured by assets) have widely varying home pages. This is primarily due to the different customer types they serve. Without determining what type of customer is entering the Web site, directing the individual customer to the appropriate set of products and services becomes nearly impossible.

Over the next two years, mutual fund investors buying and selling funds online will increase from the current 8% to almost 50% as the buy side shifts its IT project focus from industry-mandated efforts like the euro conversion, Y2K, and decimalization to providing their services via the Internet.

The combination of changing online demographics, definition and differentiation of sales channels, redeployment of technology resources to Internet technologies, and investor acceptance of online transactions increases the pace of investment firms' shift to the online world. Pushed by the online brokerage firms, financial planning sites, and other more Web-savvy sectors, mutual fund firms are now adjusting their strategic plans to embrace the Internet in an effort to avoid losing market share to the more nimble online firms.

Mutual fund firms will also become more consistent in the manner in which they interact with their customers. While the confusion generated by the rapid ubiquity of the Internet caused many firms to sputter onto the Web with a fractured Web site, these same firms are now formalizing their customer segmentation and message, allowing for more consistency among buy side firms in online services.

While most firms will not open their operations to the viewing public to the extent that OpenFund has, traditional investment management firms will take direction from this innovator to provide more information to their end customers, the individual investors. This model can also be used to provide value-added information to the high-end institutional customer.

As the Internet is adopted more broadly here in the United States and then overseas, retail consumers and institutional clients alike will demand access via the Internet, whether for fund performance data, financial planning tools, real-time transactions, or merely account information. In the end, as is the case with all Internet initiatives, the consumer will dictate what functionality and products will be offered online.

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