Others likely to follow lead of Fidelity, Vanguard

In its bid to win over retirees, the fund industry may finally have found its Holy Grail: mutual funds that offer shareholders a steady stream of income that will last well into their sunset years.

And now that the industry has figured out how to create open-ended managed-payout funds, in-vestors — and their advisers — should be prepared for an onslaught of launches, observers say.

Last Wednesday, Boston-based Fidelity Investments, the nation’s largest mutual fund company, launched 11 funds of funds that aim to produce a steady income for retirees. Fidelity’s move came one week after the nation’s No. 2 fund company, The Vanguard Group Inc. of Malvern, Pa., announced plans to launch three similar funds by the end of the year.

Now that the nation’s two biggest fund companies have made clear how they intend to hold on to the retirement assets that they have helped investors accumulate for decades, competitors will have little choice but to follow their lead.

“People need income,” said industry consultant Burton Greenwald, president of Philadelphia-based B.J. Greenwald Associates. “There’s no question [managed-payout funds] will gain in popularity both with investors and fund companies.”

It’s a no-brainer, Jeff Keil, president of Keil Fiduciary Strategies LLC, a Littleton, Colo.-based industry consulting firm, said of the prospect of other fund companies’ jumping into the fray.

Exactly which fund companies will be next out of the gate is something of a mystery as most are loath to discuss products on the drawing board. But industry experts predict that it will probably be those with a strong presence in the 401(k) plan market, such as Baltimore-based T. Rowe Price Group Inc., that next follow suit.

“I suspect T. Rowe Price will be right around the corner,” said Reuben Gregg Brewer, director of research at Value Line Inc. in New York.

T. Rowe Price representatives did not return calls seeking comment.

While no major fund companies would talk publicly about whether they intend to follow Fidelity and Vanguard’s lead, many were willing to concede that they are keeping a close eye on open-end managed-payout funds.

“While we currently don’t have any specific plans to launch open-ended funds with managed-payout structures, we are continually evaluating how best to service the retirement market,” said Heather McDonold, a spokeswoman for Legg Mason Inc. of Baltimore.

AIM Investments, a Houston subsidiary of London-based Invesco LLC, took a similar stance.

“AIM is actively looking at retirement income solutions in our product development efforts,” said a spokesman, Ivy McLemore, who declined to comment further on the prospect of the company offering managed-payout funds.

Financial advisers say it’s not hard to understand why market watchers expect managed-payout funds to catch on.

“The demand is there,” said Donald D. Duncan, president of D3 Design Develop Deploy Financial Counselors in Downers Grove, Ill. “You can see that just by the fact that so many people are buying annuity products.”

U.S. variable annuity net assets increased 4.6% to $1.5 trillion at the end of the second quarter, up 4.6% from the asset level in the previous quarter and up 15.3% from the level during the year-earlier period, according to the most recent data from Reston, Va.-based NAVA (formerly the National Association for Variable Annuities, it has retained the acronym but now calls itself the Association for Insured Retirement Solutions).

Of course, managed payouts have been a feature of many closed-end funds for some time, but closed-end funds still appeal to only a small segment of investors.

The combined net asset value of all closed-end funds at the end of August was $259.28 billion, according to Lipper Inc. of New York. To put that into perspective, the combined net assets of all open-end mutual funds was $11.49 trillion in August, according to the Investment Company Institute in Washington.

Closed-end funds have narrow appeal mainly because they are somewhat more complicated than their open-end counterparts. They can trade at a premium or discount to their net asset value, for example.

Advisers said they are excited by the possibility of more open-end funds with managed-payout features.

“Advisers … have been hoping for techniques to manage the spending risk that clients will have in retirement,” said Rick Shapiro, a managing member of Investment and Financial Counselors LLC in West Hartford, Conn.

The funds offered by Fidelity and the funds planned by Vanguard appear to have relatively low ex-pense ratios, making them even more attractive, said Andy Berg, chief executive at Homrich & Berg Inc. in Atlanta. “I could see us using [managed-payout funds] for a small portion of a client’s portfolio,” he said.

Not everyone, however, is convinced that open-end mutual funds with managed-payout features are all that great.

“These products are subject to huge fraudulent and abusive sales practices,” said Bob Frey, founder of Professional Financial Management Inc. in Bozeman, Mont. Brokers may sell the payout as a “free lunch,” not disclosing to the investor that the payouts may be made by dipping into the fund’s principal, he said.

Fidelity, however, makes it very clear that its new funds — if the investor chooses the managed-payout feature — will use principal to make payouts, said Boyce I. Greer, president of fixed income and asset allocation at Fidelity.

In fact, the funds — actually target date funds of funds — liquidate when they reach a set date, he said.

The Vanguard funds in registration will take a different approach. If approved as expected, they will aim to preserve principal while ensuring modest payouts.

David Hoffman can be reached at [email protected].