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Pozen: Much Change for Fund Industry in Last Decade

Bridget B. Hughes, CFA

Bridget Hughes: Hi, my name is Bridget Hughes. I am one of the fund analysts here at Morningstar. I am here today with Bob Pozen, who is the chairman emeritus of MFS Investment Management. He is also the co-author of a new book called "The Fund Industry: How Your Money is Managed."

Bob, thanks so much for being with us today.

Robert Pozen: Glad to be here.

Hughes: So, you have written a book on the fund industry before, nine years ago. This time you have included a few chapters specifically geared toward individual investors. Why did you think that was important to do?

Pozen: I think that the individual investor is, obviously, a big component of the industry, there are millions of them, and I guess I believe that a lot of those investors need something more than Mutual Fund for Dummies. That they actually want to know how their funds are managed and what's happening behind the scenes. Of course, they can just look and see, "well what was the return last year?" But I think that there is a growing appetite for a fuller understanding.

In particular, one thing that I noticed was that lots of investors feel overwhelmed by all the information they get, there are so many prospectuses, annual reports etc. And one of the things we've tried to do in this book is tell investors, here are all the documents you get, but here are the ones to look at, and within those documents, here are the specific things that are really going to be important to you. So, don't feel overwhelmed. Here is a guide map to what to look for.

Another thing is, lots of investors are confused about all the different measurement systems. Morningstar has an excellent system as do others, but they don't really know what they mean, how do you use them. So we try to explain to investors what are the tools that are available to them, and how they can use those tools. So, I think that's another big service that we are doing for investors, and hopefully they'll like it.

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Hughes: And then keep this as a reference right on their desk as they are going through those documents.

Pozen: I think, actually, it was one of the people who reviewed the book said, this is going to be the new bible of the mutual fund industry, people will just keep it right on their desk, and I hope he is right.

Hughes: So, you have been in the industry for a long time. You spent your career at a couple of different mutual fund shops. And since you wrote the book nine years ago, can you talk about some of the more substantive changes that you have seen?

Pozen: There have been a lot of changes in the last nine years. Let me just identify a few of them. First is, there has been a much bigger move toward international investing. We see a lot of U.S. investors who now are much more interested in emerging-market funds, international funds, and those things, and similarly, we see lots of fund managers who have now expanded big time into Europe and China, Asia etc. So, that's something we now devote three chapters to, and I think that's really important.

The second thing is, we know that, as competitors to mutual funds, we have ETFs, we have hedge funds, and they have gathered considerable assets. So, we have a specific chapter that deals with hedge funds and that deals with ETFs and tries to explain to people what are the similarities, what are the differences, what are the pros and the cons.

I guess the other thing that I would say is, there has been a significant change in the companies that are running mutual funds. Last time we wrote this, which was about 2001, there was actually a crescendo of what I call outsiders coming into the industry. Lots of Europeans were buying fund managers in the U.S., lots of banks, lots of insurers, lots of brokerage. That whole trend has pretty much reversed. Now, we are going back to what you might think of as "the oldies but goodies" sort of fund manager, where that's their main business. This whole idea of a financial supermarket, we just sell everything to everybody, has not really worked out that well, and I think in an open architecture environment it won't.

So, we have the dedicated managers as the ones who have been most successful. We saw people like Citigroup and Merrill sell their fund managers on a strategic basis to become more distributors, and then more recently in the financial crisis, we saw lot of large finance institutions who needed capital sell their fund managers. So, all these managers have come back to the fund industry, and it's sort of like back to the future.

Hughes: So, the asset managers are the corporate managers as well?

Pozen: That's correct; the asset managers control their own destiny. They're the ones who are running the show. They're less and less part of these large diversified conglomerates.

Hughes: One area of interest for a lot of mutual fund investors has been trading. With new participants in the market and time horizons changing all the time, can you talk about how the trading function at a mutual fund firm has changed over time and what the state of it is today?

Pozen: So, that's a good question. There has surely been a huge change. I guess, if we look back 10 years ago, you mainly had the New York Stock Exchange and Nasdaq. There were two venues and the New York Stock Exchange had the specialist and Nasdaq had these dealers. Well, now, we have a virtual proliferation of all types of electronic trading, and I think that on any fund trading desk that they start by looking at all these electronic possibilities.

If we're talking about a 1,000 share order in Microsoft, you can execute that electronically in a lot of places, and then we have other sorts of electronic trading venues in which large institutions can indicate on an anonymous basis that they have a big block to sell, and they can sort of be matched up with other institutions. So, I think that we just have so many more trading venues that now a desk really has to view itself as having like almost multiple computers each of which is tied into these different types of trading mechanisms.

The other thing that's a big difference is, we used to have trading done in 1/4 or maybe 1/16, so that was a spread and that was built in. Now, we're down to decimal points, so it's much smaller. So, the cost of trading has come way down. That spread, that one quarter of a point really provided a lot of cushion and most of that cushion has gone away with decimalization. So, I think it's a much more efficient operation, but it's much more challenging, because there are so many different alternatives that you have to look at.

Hughes: So, best execution may be harder to define?

Pozen: Yes, you can – best execution is in part getting a lower commission rate and you can get lower commission rates electronically, but if you're trying to execute a large block, you're more interested not so much in whether you're saving a penny on the commission, but what's your price. You don't want to be sort of short-sighted here and get a lower commission and wind up paying a bigger spread, because someone saw your block coming.

So, I think the whole notion of best execution now means that you've got to look carefully at each type of order, understand the stock, understand the size of the order, and then really fit that order to the most appropriate trading venue, and there are a lot of different ones. So, you might very well for a certain type of block in an illiquid OTC stock, use a very different venue than you would even for a 100,000 share order of a high-volume stock like General Electric. So, this is what I think.

So, the trading has got a lot more to do, and of course, now we have more and more stocks done internationally. We see more fund companies having desks in places like London and Tokyo, and of course, those systems aren't quite as electronic as the U.S., the U.S. is much more advanced, but gradually those systems are changing.

Hughes: Well, thank you so much Bob for being with us.

Pozen: Great, glad to be with you, Bridget.