d and served through the various fund types capital growth, income, and balanced. More and innovations have included exchange stock nd dual investment funds. The savings characof mutual fund investing has been strengthened opment of contractual plans, automatic dividend nent, withdrawal accounts, and programming insurance. The strong, stable secular growth of equity prices. group the funds have done very well, as illus1 Table IV. Under the column headings, the s identified as follows: in I-The growth in the number of open-end nt companies has provided a wide choice of nt types. an II-The growth in the number of accounts extraordinary. It has been at an annual comte of 13.2%. in III-Total assets. Almost all the public funds O the Investment Company Institute, whose hold common stocks valued at about 5% of value of all stocks listed on the New York change. n IV - The annual increase in the industry's his increase is composed of, first, sales of new es net of redemptions (Column IX) and, secket appreciation of the portfolios. a V-Total new sales of fund shares. It reprepublic purchase of mutual fund shares. Column VI- Total redemptions or repurchases of fund shares. This is a measure of the customer satisfaction with product. Column VII-Redemptions as a percentage of sales have been relatively stable for the past three years. Column VIII-Redemptions as a percentage of net assets appear to show less variance than redemptions as a percentage of sales. Column IX-Net sales, i.e., new fund shares sales less redemptions show the cash flow into the mutual fund. (Column V minus Column VI). Column X-The effect of general security market fluctuations on total fund assets shows the impact of market prices solely on the assets under management (Column IV minus Column IX). It will be noted in Column V that the sales of new fund shares have grown fairly steadily although at a lesser rate during periods of market decline. There is evidence of higher redemptions relative to new sales following market declines, such as in 1962 and 1966. However, even in the "bad" periods shown in Table IV, new sales exceeded redemptions. Also, it seems quite evident that the trend of redemptions versus sales which began to rise in late 1962, declined sharply in mid-1964. Redemptions continued to decline toward the historical level of 35%-40% of sales in the 1954-1962 period. The increased popularity of systematic withdrawal plans is apparently leading to some increase in redemptions as well as sales. The Securities and Exchange Commission The Securities and Exchange Commission began studies of the "investment company" industry in 1958. The Wharton School of Finance and Commerce of the University of Pennsylvania prepared a report for Congress that was submitted in August of 1962. A year later the staff of the Commission released a Special Study of Securities Markets discussing sales practices and the front end commission among other factors. These reports sharply criticized the operating procedures of the mutual fund industry. Neither the Special Study nor the Wharton Report included recommendations by the SEC. The sole report by the SEC that included recommendations has been Public Policy Implications of Investment Company Growth, which was released in December 1966. The legislative proposals were submitted to Congress in May 1967. Following the issuance of the "Wharton School Report" in late 1962, and the "Special Study" in 1963, mutual fund management company stocks began to sell at lower price earnings multiples than before. The investor conclusions from these two reports were generally pessimistic. Some investors believed that the criticisms were so severe that the SEC could not recommend change without jeopardizing the structure of the whole securities industry. During late 1965 it became increas ingly apparent that there would be a report some time in 1966. The SEC report on the industry expected during 1966 resulted in further P/E attrition. The fouryear price earnings multiples for these stocks may have reflected the prospects of change in the fee structure (Table V). Proposed Management Fee Changes The legislative proposal includes a scope of "reasonableness" in determining the compensation for services to an investment company. The consideration would include: (A) The investment advisory and all other service fees would each be negotiated separately. (B) The quality of service would be considered. "Thus, superior investment performance in relation to a fund's objectives would be entitled to appropriate recognition".1 (C) Economies of size should be shared with fund shareholders. 1. Footnotes appear at end of article. The fee would be evaluated in light of all other s received by the investment advisor. The objective of the new provision would be to re service fees similar to those which would be able if the parties dealt "at arms length"." management fee structure of the industry does pear to be challenged by the proposed legislative s. The fee schedule has been changed since the 50's in many cases, and reflects the performance ation. A capital appreciation oriented fund has a fee schedule than one chiefly concerned with inr stability of principal. This reflects what security s have known for some time namely, that it is marder to predict capital appreciation than income, erefore, it requires more attention and skill to = this objective for investors. Table VI illustrates nagement fee yield for selected mutual funds. The = the management income/average assets under ement. NASD has proposed that the word "excessive" be uted for "reasonable". If this occurs, the burden of would be upon the party claiming that the fee =ssive". e the SEC report considered the conclusions of he "Wharton School Report", and the "Special the recommendations of this report did not folof the proposals made in the earlier studies. For e, internalization of investment management and on of the size of funds are not considered as lar problems that require legislation. The princias of proposed change are: (1) management fees, sic sales charges and (3) the front end comof contractual sales. Other proposed changes deal with administrative matters, such as limiting gains payments for shareholders to once a year, >jecting investment company persons to the same Industry Reviews disciplinary proceedings as other parts of the securities industry. The two challenges to the future profit potential appear to be the proposed change in management and fund share sales fees. Proposed Sales Charge Changes The proposed legislation would reduce the maximum sales charge to 5% and change the method of calculation to a mark-up. The current industry practice is to have the 8.5% sales load as a part of the total acquisition price. This legislative proposal would limit the sales mark-up to 5%. The 8.5% sales load is currently equal to a 9.3% mark-up. The impact of this potential change on the distribution of mutual fund shares is enormous. Assuming the current practice of management companies retaining about one-fifth of the sales charge as an underwriting and distribution fee, and that the current commission of 50% of the total sales charge is paid to the salesman continue, the commission income of an average $10,000 a year salesman would decline to $6,000. This sharp drop of income would most probably reduce the number and quality of sales personnel, unless subsidized from another profit center. Only the largest and most profitable management companies could exist under those conditions. This would probably require most companies to consider either a captive sales force (like IDS or Waddell & Reed) or limit sales to newspaper advertising. It can be assumed the 5% commission ceiling would weaken the existing sales distribution for many funds. Whether reduction of the entry cost to a consumer would increase his willingness to acquire fund shares or the lessened incentive to a salesman would decrease sales is a debatable point. Perhaps lower cost of entry would offset decreased selling effort by salesmen. Many people in the securities industry believe it would not. To support this, the British experience is cited as an example. The British unit investment trusts sell mostly through London Stock Exchange dealers, who are limited to a 5% markup. Newspaper and magazine advertising is used extensively for special offerings that are made periodically. The ability to reach minimum size for profitable management has caused some mergers and limited the growth of the industry. Many companies do not have direct selling and plan to use the insurance variable annuity sales route as a substitute method of distribution to charge a load greater than 5%.* The economies of this reduction have not been disclosed, and should be the subject of considerable discussion. While many management companies do not receive significant profits from the underwriting and distribution of fund shares, the proposals could reduce fee income. Because of the total industry resistance to this change, the Senate Banking Committee Chairman proposed that |