By Chuck Jaffe
Dow Jones Columnist 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-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 economic crisis of 2008, but they are the big stories for the fund business. I fear they will be much bigger news than that.

My selections may not be the fund world's only hot news-I'm hoping there are some more positives that I just fail 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 firms will shut down their money-fund business because there's currently no profit in it. Industry watchers say that fee waivers to keep money funds profitable are costing Charles Schwab Corp. some $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 firms 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 will 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. They leave the fund, which is holding paper that is now less attractive, while trying to get the new rate. 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 that a record $400 billion moved into bond funds during 2009.

When rates rise-and it says here that they will go up again, in small steps, in 2010-bond fund prices fall, and bond fund investors suffer. With 10-year Treasurys at abnormally low historic rates, the next move up in rates will mean that bond fund investors 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 moved to bonds for yield and safety, and they will be queasy watching bonds readjust to a market where rates are on the rise.

4. Bad news for investors in commodities, 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 firms pile in. Once the fund firms have all plowed ahead, the hot sector or investment style falters. It is a time-tested story, and it is happening right now with commodities, real-return and absolute-return funds; they have been hot for a while now, but that comes to a halt in 2010.

5. The closing of target-date funds run by all but the biggest companies: In about 95% of all retirement plans, the target-date funds offered are the ones run by the firm 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 is out there, a path that leads to mediocrity.

6. A clearer picture of "what's next" for exchange-traded funds: Some of the biggest investment firms-including Goldman Sachs Group Inc. and T. Rowe Price Group Inc.-want to make a splash in the ETF market in 2010. If they can gain traction, then competition and innovation will follow. If they find that the top five providers have a stranglehold on gathering ETF assets, that is bad news for the continuing development of competition and content in the ETF arena.

7. The Securities and Exchange Commission failing to improve the 12b-1fee situation...again: The SEC has recognized that 12b-1 fees--sales and marketing charges that are added to a fund's base expense ratio--are confusing and problematic. Regulators have vowed changes, but done nothing. They tabled the issue in the middle of the financial crisis, promising to get back to it when other matters were not so pressing. Even if the economy and markets improve in 2010, the agency won't get this job done.

8. Hungry, and stupid, investors: The market's strong recovery has a lot of investors hoping for more of the same. Alas, most observers see something more like a return to normal, where equity gains will be in the 6% to 10% range. For some investors, that is insufficient. Despite warnings from consumer and regulatory groups, they will dive into leveraged exchange-traded funds and other risky plays, because if they are confident of a 6% gain, they should be equally confident that a leveraged fund can go even further. It is a recipe that will lead some of those investors to ruin.

9. The rise of the summary prospectus...and its failure to achieve anything: The summary prospectus is a short-form document that offers investors a few pages of key data before they buy a fund. It trickled into the fund world in 2009, and will become the document of choice in the new year, saving fund companies millions of dollars in paper, production and mailing costs. Alas, it won't make a difference; investors aren't going to pay attention to a four-page prospectus any more than the 40 pages they get now. And don't expect fund firms to pass along those savings as a fee reduction either.

 

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