Banks, both large and small, are exiting the fund business.
Responding to considerably more stringent regulatory constraints, difficult market conditions and stiff competition for shelf space, an increasing number of banks have been forced to refocus their efforts away from failing money management businesses to more worthwhile ventures.
In a span of five days, investment banking giant Citigroup and two small regional banks sold off a huge chunk of their mutual fund assets to focus more on their core competencies and streamline their businesses, further underscoring the continuing trend of astute consolidation in the $8.1 trillion fund industry.
Citigroup recently put the finishing touches on a long-anticipated agreement to unload a bulk of its asset management business in exchange for Legg Mason's brokerage operations, a move that beefs up the bank's brokerage presence while recasting Legg Mason as one of the biggest pure-play asset managers. The move signals a blatant admission from Citigroup management that its mutual fund unit was either beyond repair or not worth fixing.
"Most of the bank proprietary fund families have had a difficult time growing their long-term assets," said Geoff Bobroff, a mutual fund consultant in East Greenwich, R.I.
"And the prospects of growing them in a slow-growth environment are even worse," Bobroff continued, adding that performance "tends to be a problem" at many bank-operated fund families because it is outside their core competency.
Essentially, banks are faced with the question of whether or not money management is an area of growth. They might be better served becoming a best-of-breed provider instead of trying to convince their customers or their internal people that selling proprietary makes sense, Bobroff said.
In transferring the brokerage operations of Legg Mason, Citigroup tacks on more than 1,300 brokers to raise its total to 13,800, enabling it to nip at the heels of rival Merrill Lynch, which itself houses 14,100 brokers. The deal came in line with CEO Charles Prince's campaign of unloading less-profitable parts of the company and followed the sale of Citigroup's insurance business Travelers Life & Annuity in January.
Under the terms of the deal, Citigroup will retain its Mexican asset management business, the Latin America retirement services business and its interest in its CitiStreet joint venture with State Street Corp. The transaction also includes a provision that locks in Citigroup as the primary provider of Legg Mason funds for a three-year period, essentially supplanting Legg Mason's private client group as exclusive provider. This now allows certain Legg Mason funds to be much more widely distributed.
According to Financial Research Corp. of Boston, Legg Mason now has $166.8 billion in mutual fund assets, making it the sixth-largest mutual fund complex. Stripping out money market funds, it ranks seventh overall. All told, Legg Mason will now manage $830 billion in assets.
While there are many positive synergies for both companies, there are some significant risks given the hefty amount of assets involved coupled with the level of integration required. Still, Legg Mason has a proven track record as a successful acquirer, best illustrated by two of its top-performing subsidiaries, fixed-income shop Western Asset Management and the value-oriented Royce Funds.
The swap enables both firms to avoid the conflicts of interest inherent in selling proprietary financial products and providing advice to clients on suitability, issues that have drawn the ire of regulators in recent years. Indeed, Citigroup paid $208 million in fines to the Securities and Exchange Commission for alleged fund sales abuses.
"Changes in the regulatory environment are forcing management to look at these businesses," said David Haas, an equity analyst who covers asset managers at Fox-Pitt Kelton. "In some cases, they come to the conclusion that the client would be better served if these funds were under another roof."
Haas noted that the deal benefits Legg Mason greatly by creating "scale, breadth and depth of product, both geographically and by style mix [as well as] cost savings. The only risk really is making sure assets don't walk out the door."
Meanwhile, Birmingham, Ala.-based AmSouth Bancorp. last Monday inked a $65 million deal to sell its $5.5 billion mutual fund management business comprised of 23 funds to Pioneer Investments because "it has become more difficult and more expensive for small mutual fund families to compete effectively," the company said.
The sale is part of a larger four-year effort by AmSouth to optimize its allocation of capital and generate high returns on its equity businesses. In addition, it stopped making indirect auto loans and sold its credit card business in the fourth quarter of 2004. AmSouth's biggest problem managing money was that it didn't have an efficient model. Having $5.5 billion in assets spread across 23 funds doesn't make a heck of a lot of sense.
"The money management industry is going to follow the way of the credit card industry, and we're going to see significant consolidation," said Jefferson Harralson, a banking analyst at Keefe, Bruyette & Woods who tracks AmSouth. "Banks are going to continue to attract wealth management clients, but it's going to be more of a fund-of-funds or an advisory capacity." Harralson noted that while AmSouth is shying away from one inefficient piece of the product chain, it still plans to go after wealthy individuals, perhaps placing more emphasis on separately managed accounts.
Elsewhere, AMCORE Financial, headquartered in Rockford, Ill., sold off three of its Vintage Funds totaling $163.8 million in assets to Federated Investors, citing the need to move toward open architecture and offer its clients a broader array of investment choices. Frankly, Amcore just doesn't have the economies of scale to be successful.
When viewed as a whole, these acquisitions signal a ramp-up in consolidation activity across the fund industry, in which companies are reining in corporate ego, reevaluating their business models and looking to withdraw from businesses that just don't make sense.
In short, many participants are realizing firsthand, as has been predicted since the beginning of the bear market, that they can't be all things to all people, particularly when faced with a sideways market and stiffer regulation in the wake of scandal.
"Brokerages, funds and banks are all trying to grow at above above-market rates," said Don Cassidy, senior analyst at fund tracking firm Lipper. With that as a backdrop, the market is poised for a period of consolidation or rationalization, during which, firms will look to focus more readily on their strengths and avoid trouble spots, he said.
"With the recent trading scandal and the public's appetite for safety, some banks may decide to concentrate on their primary roles and drop their Wall Street sides, " Cassidy said.
"Deals such as Legg/Citi and AmSouth/Pioneer thus accelerate the funds-business merger trend."
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