The HHI takes into account the relative size and distribution of the firms in a market and approaches zero when a market consists of a large number of firms of relatively equal size. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases. Markets in which the HHI is between 1,000 and 1,800 points are considered to be moderately concentrated, and those in which the HHI is in excess of 1,800 points are considered to be concentrated. During the 1990s, the HHI for the U.S. Mutual fund industry saw a minor decrease from 396 to 352 based on assets under management,6 indicating that the industry was, and still is, fairly unconcentrated according to this statistical measure.

Another fairly unconcentrated financial industry—domestic commercial banks (including thrifts)—has an HHI of 338, based on deposits of $3.4 trillion as of December 31, 2000. A subset of that universe—domestic money center banks— is much more concentrated, with an HHI of 1,676, based on deposits of $1.5 trillion. In comparison, the U.S. airline carrier industry has an HHI of 1,330, based on 2000 revenues.

The mutual fund industry’s low concentration score reflects not only the large number of complexes that offer mutual funds, but also the relatively even distribution of market share across many different players. The complexes ranked from numbers 5 to 10 in 2000 had market shares of between 2.4% and 3.3%. The next 15 complexes (making up the remainder of the top 25) had market shares of between 1.2% and 2.4% in terms of assets, averaging 1.7%.A 1.7% share translated to $119 billion in assets under management in 2000, giving these fund groups substantial resources to wage competitive battles. Competition between fund groups in this range is intense, with only a few tenths of a percent of market share separating many competitors.

FundsMoreover, new entrants continue to start fund management businesses and expand rapidly, as the barriers to entering this business are quite low. To become a manager of a U.S. mutual fund, a firm must register as an investment adviser with the SEC and sponsor a fund that must also file a registration statement with the SEC. But the minimum seed Capital for a new mutual fund is only $100,000, and there is no minimum capital required to set up shop as a registered investment adviser.A new fund manager can easily lease offices, computers and trading connections. Similarly, a new fund manager can hire one of several large banks or other external providers to perform almost all of the processing functions needed to run a mutual fund complex, such as handling customer transactions and inquiries, fund accounting and daily pricing and sending reports to fund shareholders and regulators. Moreover, since the advent of fund supermarkets, new fund managers can obtain instant distribution by agreeing to pay the supermarket operator 25 by or 35 by on fund assets. The new entrant can attract investor attention by launching a new type of fund (e.g., Internet funds) or attaining outstanding performance in an existing fund type—without offering a full line of fund products.

However, once a fund manager gathers a substantial amount of assets, it typically reaches a critical decision point. Should the firm remain a profitable manager of moderate size focused on a few types of mutual funds? Or should it embark on a plan to become one of the top 25 managers with a full product line? In making this decision, the firm must consider the key attributes that have vaulted these fund managers into the top tier. The top-tier players have built extensive distribution systems, either directly or through intermediaries. They have invested heavily in technology to provide a broad range of support services to their customers and portfolio managers.They have created a broad line of fund offerings, including specialized products like sector and international funds. They have developed, either themselves or through alliances, the ancillary services (e.g., employee record keeping) and products (e.g., stable value pools) necessary to compete in the defined contribution field. Finally, most of the top-tier players have developed a recognized brand identity over a long period of time.

Thus, although starting a fund group takes a small capital outlay, there are formidable challenges to a firm that has the ambition to break into the top tier of the mutual fund business. Firms with such ambitions have two main choices: grow their own fund assets internally or expand fund assets through acquisitions. The three largest firms in the mutual fund industry—Fidelity,Vanguard and Capital Research (the manager of the American Funds)—have tended to build their capacity from within. They are all independent firms specializing in fund management, avoiding major acquisitions and shunning potential acquirers. Putnam has also remained relatively self-contained, although it is owned by an insurance conglomerate rather than being completely independent.

For the rest of the top 10 firms, by contrast, mergers and acquisitions have been an important corporate strategy. As mentioned above, AMVESCAP PLC (the parent of AIM and INVESCO funds) and Franklin Templeton represent conglomerations of two or more firms focused on asset management. MSDW Advisors and SSB Citibank are also the result of mergers, but involving asset managers and other types of financial institutions. Merrill Lynch has built much of its U.S. fund business internally but has expanded outside the United Staes through acquisitions. Finally, the Janus/Berger fund group has seen both sides of the restructuring game: the Janus and Berger fund groups were acquired by Kansas City Southern in 1984 and 1992, respectively, and then spun out as a separate firm under the Stilwell Financial name in 2000.

Faced with the challenges of becoming (or remaining) top-tier players, many fund managers of moderate size have decided to combine with another firm within the fund management industry or be acquired by a larger entity: a U.S. or foreign financial institution.

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