Banks Stumble Into Mutual-Fund Profits

(MoneyWatch)  U.S. banks are becoming dominant in the highly profitable investment-management industry, almost in spite of themselves. Like Chauncey Gardiner in the novel Being There, many of these banks find themselves in this enviable position mostly out of sheer luck.

The credit crisis dumped billions in lucrative high-net worth, pension and retail mutual fund assets into the laps of U.S. depository institutions as broker/dealers collapsed under the weight of subprime and structured credit losses. As a result, some of the biggest and most profitable names in investment management are now owned by banks.

During the credit crisis that hobbled broker/dealers, we saw the following deals go down:

• Bank of America acquired Merrill Lynch Asset Management
• Wells Fargo was able to snap up A.G. Edwards as part of its acquisition of Wachovia
• J.P. Morgan Chase now owns Bear Sterns Asset Management
• U.K.-based Barclay's Bank purchasef the asset management business of Lehman Brothers in a bankruptcy fire sale.

First-quarter earnings from BofA released this week show that having a strong asset management operation can boost the bottom line, especially at a bank that traditionally made its money on razor-thin deposit and loan margins. BofA's asset management division saw its net-income skyrocket from $176 million last year to $565 in the current quarter, mostly due to the Merrill Lynch acquisition.

Essentially, the consolidation achieved in weeks what banks have attempted for decades: adding a steady stream of fee income to their balance sheets.

But even more luck is headed banks' way, as investors burned by equity mutual funds flock to fixed income and trust products -- both of which are considered "sweet spots" for banks' traditional conservative investment approach.

"Banks have always been good at fixed income and cash and consumers expect them to be good at it," says Alistair Jessiman, managing director of the bank consulting firm Novantas. "The investors' risk appetite is swinging back pretty dramatically and that can only help banks."
Even given the market rally of the past several weeks, with 18 percent of American's wealth wiped out in the market collapse, investors are expected to play it safe for years to come.

The most promising assets for banks to gain the advantage is in the retirement sector. In the early 1990s, banks and thrifts dominated products such as IRAs with a 42 percent market share. But the ballooning of the stock market and the rise of "star" fund managers like Fidelity Investment's Peter Lynch caused the banking share of IRA assets to dwindle to eight percent as of last year.

Now the more investors lose with the larger independent money mangers -- such as Fidelity, Vanguard and Schwab -- the better banks feel about their chances to regain market share.

"My bank clients are much more optimistic about the future of the proprietary funds than they were a year an half ago," says Jessiman. "This is at a time when everyone else is very pessimistic. It's somewhat bizarre."

But bankers can't coast into profitability in asset management. They need to learn from the mistakes that lead them to surrender dominance in the retirement asset management business in the first place, says Benjamin Poor, an analyst with Cerulli Associates in Boston.

Poor explains that banks -- especially small and regional institutions -- need to embrace an "open architecture" method of distributing mutual funds that offers both proprietary and externally managed funds to bank customers. For years banks prevented their branches from selling anything other than their own bank-sponsored mutual funds, and customers balked at the lack of choice.

Bankers will also need to become better salesman of mutual funds and other asset management products by devoting a bigger slice of their budgets to investment management. For example, many banks continue to use a single investment adviser to sell funds among several branches rather dedicating an adviser to every branch.

"Banks still have issues around marketing," Poor explains. "Many regional and community banks don't have the budget or bodies to put together a decent sales campaign and that stuff resonates with clients."

Still, if banks can take advantage of the American investor's new found conservatism they could have a shot at dominating the industry for years to come. "I think the preliminary prognosis [for banks] is very good," Poor adds. "Stuffy and stodgy is the new black."