This year marks the 75th anniversary of the Investment Company Act of 1940. When the legislation was put into place, no one envisioned where the mutual fund industry is today.  According to the 2015 ICI Fact Book, at the end of 2014, open-end and closed-end mutual funds exceeded $16 trillion and ETFs were approximately $2 trillion. But the big question is: where do we go from here?

In this second installment of the Institute’s discussion with Bob Dorsey, co-founder and managing director of Ultimus Fund Solutions, we discussed the trends and direction he expects for mutual funds and ETFs in the next five to 10 years. His perspective as one of the largest, independent mutual fund service providers for RIAs in the country provides a great vantage point

Mutual Funds —The Nature Of Things To Come

Bill Hortz: What do you see for innovation in the mutual fund space? What directions do you see this may take and what may we expect in the future?

Bob Dorsey: I think what has changed so dramatically is how the investor ultimately invests in mutual funds through professional financial advisors. I’m primarily referring to the RIAs, fee-based advisors or financial advisors who work at the wirehouses charging a fee for managing investments.  Now investors don’t necessarily want to buy investment products, they want to buy investment advice. So the products have had to change over the years to accommodate more of a money management approach. The liquid alternative funds, specialized sector funds and ETFs are all byproducts. They became really great tools for financial advisors to manage their clients’ portfolios, help them get more precise asset allocation and stronger diversification. 

I think you will continue to see fund sponsors building investment products that fill specific needs for the financial advisor community in managing client portfolios to address market volatility, more extensive diversification and their changing client needs and expectations. In other words, you will continue to see more liquid alternative funds; unconstrained or niche bond funds like catastrophe funds, business development companies (BDCs); newer or lesser used institutional strategies wrapped into fund structures; and other uniquely constructed or active ETF strategies.

Bill Hortz: What are the major obstacles towards being more innovative within the mutual funds space?

Bob Dorsey: As you know, the mutual fund space is a highly regulated industry not only from the SEC and Finra perspective, but also from the IRS perspective, so you can only innovate up to a certain point. You need rules or regulation changes that allow you to really do some innovation. For instance, the IRS used to have the short-short test and that kept a lot of very active money managers from running some of their strategies in a mutual fund format, because they couldn’t pass the short-short test. When the IRS did away with that in the 1990s that really started to allow some of these hedge fund managers to be able to utilize some of their investment strategies in mutual funds.

Much of the innovation that is taking place in the mutual fund space is coming from fund sponsors filing for exemptive relief with the SEC so that new kinds of products can be brought to market. That’s how ETFs really came about. Fund sponsors filed for exemptive relief of certain '40 Act requirements, and once the SEC granted the exemptive relief, then the industry was able to create the different types of ETFs that are now available today.

Over the last two years, the SEC has received over 300 applications per year for exemptive relief for many different types of matters. It is anticipated that number will continue in 2015 and is also projected for the following year as well. The largest portion of exemptive orders continues to be with active and index ETFs along with an increase in business development companies.

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