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Paper Suggests Mutual Funds Should Re-evaluate Service Providers

A new paper from TowerGroup says mutual-fund trustees need to take a closer look at their operations.

A new paper from TowerGroup says mutual-fund trustees need to take a closer look at their operations.

A research note from Mass.-based TowerGroup, a consultancy that studies the use of technology in financial services, suggests that mutual-fund trustees take a closer look at the service organizations that administer their funds, suggesting that often the structure and costs of administration are not put under a microscope.

The study, authored by Gavin Little-Gill, senior analyst with TowerGroup, suggests that trustees (those hired to oversee mutual funds) are currently focusing on hot topics like anti-money laundering and the Patriot Act, while taking for granted that their service organization are functioning in an efficient and cost-effective manner.

"There is tremendous cost and risk associated with mutual-fund service centers," says Little-Gill. "They essentially function like a canary in a coal mine -- when things are happening to your fund it will impact the service organization, and things that impact the service organization impact the asset-management organization."

Organizations which service mutual funds are either in-house or third party and handle operations like asset management, fund accounting, custody, distribution and transfer-agency functions -- including processing purchases and sales, address changes, sending statements and tax forms, etc.

While over 50 percent of mutual funds use proprietary accounting systems, providers Wilmington, Del.-based PFPC and Kansas City, Mo.-based DST Systems currently dominate the vendor side of the shareholder accounting-system marketplace. Additionally, image and workflow-management systems and e-mail management systems should be evaluated by trustees, says Little Gill.

Little-Gill says it's important to think critically about the amount of money mutual funds are pouring into their service centers because they now have less direct contact with the end investor. Today, intermediaries like broker/dealers, which sell mutual funds to the end consumer, take on more of the burden to service the shareholder on an ongoing basis, essentially cutting the mutual fund out of the loop. Thus, Little-Gill says, it's worthwhile to evaluate how much a mutual fund is actually tied to the end investor and what types of servicing that modified relationship requires.

"As a mutual fund you have to ask, 'Who am I spending this money to support,'" says Little-Gill.

Additionally, he says, mutual funds should look at their shareholders with a more critical eye. In the past, funds operated off the belief that almost any customer was worth acquiring, setting account minimums as low as $2,000. That makes little sense, he says, as only accounts with over $12,000 are usually profitable. Little-Gill says trustees have a few options for dealing with this untenable situation.

"You could do nothing, you can fire some of these customers or you can try and lower the cost of servicing these accounts," he says. Lower servicing costs could be achieved, for example, by segmenting customers according to balance and tailoring service levels to more appropriately match a customer's level of investment, suggests Little-Gill.

He adds, "The point with my 12 questions is for a mutual-fund trustee to walk through these issues with their service provider. It's a good conversation to have and it will refocus both parties on the core issues so that the service organization's strategy is consistent with the mutual fund's objectives."

For example, here are three of Little-Gill's questions:

1. What are average service costs per account by fund, fund class, and type of account? By extension, what is the asset break-even amount for a shareholder with one or multiple funds?

2. Depending on whether you use proprietary or third-party systems or an affiliated or third-party service company, should you outsource? Have you evaluated third-party shareholder accounting systems? How often are outsourcing systems and alternatives discussed and evaluated?

3. What is our process for firing shareholders with balances under account minimums and for addressing unprofitable accounts? Who pays for exceptions? (The answer should be the distributor for exceptions made to maintain relationships with intermediaries, and all other exceptions should be documented.)

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