The business world is a dynamic one, facing constantly changing demands and competitive pressures. Those insightful enough to foresee the next trend or shift in consumer preferences stand to profit handsomely from such foresight.
The investment world is no different. Those who can get in front of the curve and predict which direction the industry is headed have the opportunity to gain a first mover advantage. Over the years, countless new mutual funds have been born, and countless more have died a quiet death -- closed or merged out of existence. So where is the industry headed from here, and how can you tell if your fund faces the risk of becoming obsolete?
News from ICI
Recently, the Investment Company Institute, which is the trade organization for the mutual fund industry in the U.S., held its annual general membership meeting in Washington, D.C. Investment professionals from across the country gathered to discuss some of the most important issues facing the industry today. One particular message that caught my attention was from speaker Chris Anderson, author of the best-selling book, The Long Tail: Why the Future of Business is Selling Less of More.
Anderson's book documents an overall shift in the focus of business from selling big-name superstar products to more specialized, niche products. However, Anderson noted, he does not foresee this shift occurring in the mutual fund industry. He believes that investors are less experimental with their finances than they are with regular consumer goods like books and music. As a result, investor faith in a particular fund company or financial advisor should keep them loyal despite the availability of other options. Additionally, since scale is so important to mutual funds, smaller funds will have more difficulty staying afloat. All in all, Anderson predicts that the fund industry will remain focused on larger-scale, less-specialized investment products.
Why less is more
While I think Anderson is correct in the long run, I believe the short-term story is another matter. You only need to look at the influx of new exchange-traded funds coming onto the market to see that narrowly focused niche products are enjoying a tremendous boom right now. ETFs are definitely in their growth phase, and it seems that more and more of these funds that focus on narrow segments of the market are springing up every day. Like most booms, the next stops down the line are usually bubble and bust. It remains to be seen whether or not some of these smaller niche ETFs can survive. Many likely will not.
The thing to keep in mind is not to lose sight of the long term in spite of all of the hoopla surrounding the short term. Will an ETF focusing on health-care companies that seek to treat or cure cancer be around in 10 years? Perhaps not. Will a fund that focuses on a diversified portfolio of large-cap domestic stocks be around in 10 years? That's much more likely. Most investors are better served by thinking big picture and long term. Niche products may come and go in the fund world, and doubtlessly many investors will benefit from them, but many more will likely feel the adverse effects of investing too heavily in a temporary trend.
Safety in diversification
So what's the key to avoiding those funds that are most likely headed for extinction? Simply put: Avoid the trends.
Don't invest in narrow funds that focus on specific industries or sectors, or in country-specific foreign funds. Diversification is the key, so ensure you are getting exposure to large-cap stocks such as Cisco (NASDAQ:CSCO) and Altria (NYSE:MO), as well as small- and mid-cap winners such as Synopsys (NASDAQ:SNPS) and Lubrizol (NYSE:LZ). Don't forget about a diversified international fund that invests across multiple countries and regions. Stick to the tried and true, and leave the trends to the day traders.
While no one will be able to tell you with any real degree of precision where the mutual fund industry is heading, odds are good that over the long term, those investments that stay focused on sensible, broad mandates will be those with the greatest staying power. You still need to examine each individual fund carefully before buying and perform regular checkups after buying, but it's important that you start with the mind-set of buying broad and buying for the long term. Doing so will help ensure that your funds will be much less likely to go the way of the dinosaurs.
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Fool contributor Amanda Kish lives in Rochester, N.Y., and does not own shares of any of the companies or funds mentioned herein. The Fool has a disclosure policy.
