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After they figured out how to do it, they still had to convince the fund companies that it made sense to market mutual funds in this fashion. To compile information for the team's marketing plan, John McGonigle made some reconnaisance visits to various fund companies. What he found was that in many cases he was the first person from Schwab ever to visit, in person, these companies. Expecting the red carpet treatment, he instead found himself being lectured to by his prospective clients.
The fund companies had tremendous concerns about the "hot money" being invested in their funds by existing Mutual Fund Marketplace investors. Fund companies wanted an opportunity to say "no" to certain investors. In short, the fund companies were very reluctant to take part in this new supermarket experiment. It might have even been an impossible sell job for McGonigle, except for one important factor. At the time, Charles Schwab was developing a vast network of independent registered investment advisors who were parking their client monies at Schwab and investing these funds in mutual funds. The fund companies wanted to get a piece of that business!
Schwab's financial advisor business was growing like crazy, and they owned that market. Fund companies were picking up on the idea that money was migrating out of the brokerage houses and into the hands of fee-only Registered Investment Advisors. The fund companies also realized that those Registered Investment Advisors could sell lots of investors on funds. Moreover, Schwab was the most effective route into the financial advisor market. The financial advisor industry was booming. Assets were growing at a 40% annual clip. They knew that McGonigle's new-fangled OneSource product would give them access to those clients.
Indeed, it is ironic that the financial innovation which makes it possible for individual investors to fire their financial advisor might never have come about without the fund companies' interest in attracting money from those very same advisors!
When it was finally time to begin signing up fund companies, Schwab knew that the small funds would be the first in line. The natural reaction of the large companies would be to sit back and wait to see how the supermarket fared. The risk was that the effort could lose momentum from the start. McGonigle was determined not to let that happen. Instead, Schwab started out by looking at the largest 60-70 fund companies and decided to invite the top twenty firms, exclusively.
Those firms that decided to join as charter NTF (no transaction fee) members would be able to enjoy lower costs than later participants. Charter members would pay a 25 basis point fee (0.25%) instead of the higher fee that funds which joined later would be required to pay. In the end, Schwab signed up eight of these companies. There were four Denver firms (Janus, Invesco, Berger, Founders), two New York firms (Neuberger & Berman, Dreyfus), Stein Roe (in Chicago) and Federated (in Pittsburgh).
Charles Brady, then President of Invesco's U.S. subsidiary and Chairman of the company until 2006, was an early proponent of the new OneSource supermarket concept. In San Francisco on other business, he had lunch with Charles Schwab who told him, "you should know about what we're doing in the mutual fund area."
"That sounds awesome," Brady said, "we're in." Invesco made history by being the first company to join the nation's first fund supermarket by signing a contract in April, 1992. Back at Schwab headquarters, McGonigle had set a "drop dead" date of June 10, in order to facilitate a public announcement of the product launch on July 20. The "drop dead" date passed with no one else signing. As of July 3, still only Invesco had signed on.
Although McGonigle had succeeded in persuading the marketing guys that the OneSource product would help them out, the lawyers remained an obstacle (there’s a surprise!). They were developing a new standard contract, from scratch, for a product that had never before been sold. John McGonigle's day started in the mornings with negotiations with east coast lawyers, and continued throughout the day, working his way west, until late in the night with his own San Francisco legal staff.
With only Invesco had committed, McGonigle saw that they were not going to make their deadline so he shifted gears and asked the fund companies to sign letters of intent instead of contracts. On July 10, the rest of the Charter NTF OneSource members signed the letters.
Jack Thompson, Janus Fund's chief administrative officer, had been an early OneSource enthusiast. Janus founder, Tom Bailey, was more skeptical. Schwab President, David Pottruck, begged and pleaded with Bailey who remained unconvinced. Negotiations bogged down after the firm's attorney got sick. In May 1993, almost a year after the first "drop dead" date, Janus still hadn't signed a contract with Schwab. Nearly $1 billion of Janus Funds were sitting in the OneSource omnibus account, yet no contract had been signed. Finally, after months of negotiations, McGonigle succeeded in getting eight of the largest mutual fund companies in America to launch an ambitious new product that revolutionized the world of mutual funds. Five years after it launched there was $80 billion invested in the Mutual Fund Marketplace. By 2007 the assets in the Marketplace had soared to nearly $500 billion, with over $200 billion of that in Schwab’s “OneSource” no-transaction fee supermarket.
Next post: Retail versus Institutional Investing
To start at the beginning of the Investment Heresies eMag, click here
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.
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