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It's out with the mutual fund, in with the un-mutual fund

Fed up with the typical mutual fund, a former securities regulator with an appetite for reform is selling "folios," which are customized baskets of stocks, over the Internet.

Bombarded with pitches for new and different ways to invest their savings, most people might conclude that the last thing the world needs is another twist on owning stocks. Steven Wallman is not one of those people.

Last week, while the leaders of the mutual fund industry munched shrimp and sipped chardonnay at their annual gathering in Washington, Wallman was 15 miles away in Vienna, Va., plotting to take the finger food out of their mouths. Wallman, a headstrong former securities regulator with an appetite for reform, increasingly is irritated by what he sees as the burdens the typical mutual fund puts on shareholders.

Most funds are not worth owning, Wallman says, because they cost too much, fail to beat the market and often stick shareholders with big tax bills.

Funds set up to track market indexes solve some problems, but they do not offer investors much choice or control of risk, he says.

Wallman says he has found a better and, in many cases, less expensive way for investors to create customized baskets of stocks, which he calls folios, and two months ago he started selling them over the Internet.

He is not alone in trying to harness Internet technology to provide investors an alternative to mutual funds and brokerage accounts. In San Francisco, fledgling eInvesting plans to introduce "build your own" funds by September. "There is an enormous opportunity, leveraging the Web, to combine the convenience and instant diversification of a mutual fund with the control and direct stock ownership of a brokerage account," said Ben Phillipps, eInvesting's vice president of marketing.

The fees that funds charge add up to, on average, 1.35 percent of assets. On the median mutual fund investment, about $32,000, that translates to annual fees of $432, Wallman said.

"If people realized it's costing them $500 a year, that's something they would be really shocked about," he said. "Why don't funds have to disclose the monthly cost?"

It is bad news for the fund industry that that question is being raised by Wallman, a man so persistent that he still is pushing for stocks to be traded in decimals instead of fractions 2{ years after he left his appointed position on the Securities and Exchange Commission. Wallman, 46, is an iconoclast who often butted heads with SEC chairman Arthur Levitt and members of the commission staff. He does not abandon a cause lightly, but he contends that his latest venture is no quixotic mission.

For $295 a year, Wallman's company, FOLIOfn, will let investors create three do-it-yourself stock funds containing as many as 50 stocks each and as much money as they choose. For no additional charge, they can make changes in their holdings as often as twice a day through what Wallman hopes will become an efficient internal trading system.

Whether the world will beat a path to Wallman's home page at is far from certain. He is not the first to try to tap into investors' growing discomfort with traditional funds, a restlessness that has spawned several variations.

Some fund companies have begun listing fund shares on the major exchanges where they can be priced and traded all day. The Vanguard Group, the leading purveyor of the index funds so popular with buy-and-hold investors, announced plans recently to list shares of several of its most popular funds, including the flagship Vanguard 500 Index fund.

Other companies have created funds that let small investors take high-risk chances on companies that have not yet been cleared to sell shares to the public. Merrill Lynch and other brokerage firms have created baskets of stocks in a given industry that can be bought at relatively low cost.

"There are a lot of new ideas out there, and some, like exchange-traded funds, are starting to catch on," said John Rekenthaler, research director for the fund tracking firm Morningstar Inc. in Chicago. The folio concept "is a pretty big idea that's going to stick in some form," he said.

Still, it will be a while before this new breed of investment product takes a measurable bite out of mutual funds, which have been the individual's investment of choice for more than a decade. The Investment Co. Institute, which is holding its annual trade show this week in Washington, estimates that Americans have more than $4.4-trillion invested in 4,432 all-stock funds, a tenfold increase since 1990.

Burton Greenwald, a mutual fund consultant in Philadelphia, is dubious about the staying power of individuals' interest in managing dozens of stocks. "Will these products be a threat to funds?" he said. "I don't think so. I suspect their popularity would fade quickly if you had a prolonged bear market."

FOLIOfn, whose quirky name, Wallman said, stands for financial innovation, is taking aim at the bulk of that money, which sits in funds whose managers are paid to try for a higher return than, say, the Standard & Poor's 500-stock index. Wallman and his colleagues say that type of investing is pure folly.

"Every study has shown that stock picking by mutual funds has not been overly successful," Wallman said. "Unless you think you can pick the manager who will outperform, why pay money to throw the dice?"

The standard disclaimer in fund marketing materials that past performance is no guarantee of future returns should be replaced, Wallman said, with a warning label that reads: "Past performance has absolutely nothing to do with future performance."

Point out that he sounds a lot like John Bogle, the founder of Vanguard, who has long been an outspoken proponent of low-cost index funds, and Wallman grins. Bogle is "one of my heroes," he said. "I would love to get Bogle working with us."

Wallman acknowledges that his folios are not for everybody. "If you've only got $10,000 or $20,000, then you ought to be in Vanguard 500," he said. "It's a very good buy."

But investors with $30,000 or more in folios would pay less than 1 percent of their assets annually and gain the flexibility to choose the stocks they own and to adjust their holdings frequently to match their tolerance for risk. To help them get started, FOLIOfn offers sample folios, like one that contains the 30 stocks in the Dow Jones Industrial Average.

With a few clicks of a mouse, an investor can order, say, $6,000 worth of the Dow 30, and get $200 worth of each stock _ fractional shares in many cases _ in one swoop. A week or two later, that investor could sell 10 stocks and replace them with 10 others, then ask FOLIOfn to rebalance the folio to keep the investment spread evenly.

Using a discount brokerage firm, those moves would count as 50 to 100 trades or more. Even at commissions as low as $8 a trade, that would cost $400 to $900.

FOLIOfn's pricing structure puzzles some people who have taken a look at its Web site. "How are they going to make any money doing that?" wondered one broker at Merrill Lynch, which last year started allowing customers to make unlimited trades for a minimum annual fee of $1,500.

Wallman and his financial backers say that FOLIOfn can be profitable because it is building a computerized trading system that will keep most trades in-house, matching customer purchases and sales of popular stocks without incurring the costs of a middleman.