As money fund profits fall with interest rates, banks with smaller money fund complexes are increasingly considering outsourcing their management to larger fund companies.

And some of these fund companies, such as Reserve Funds, Federated Investors, and Nations Funds, are gearing up to grab a share of this subadvising business in 2002.

The current low-yield money fund environment — early January’s 1.54% annual yield average is the lowest in the product’s 30-year history — puts tremendous profit pressure on smaller money fund complexes, said Peter Crane, an analyst at Boston’s Imoneynet, which watches the money fund industry.

Banks want to outsource, letting bigger fund companies take over the management, administration, and custody of their money funds. The banks keep their name on the funds, market them to their customers, and watch their profits rise, Mr. Crane said.

Stephen Franz, chief investment officer at First Focus Funds, the mutual fund subsidiary of First National Bank of Omaha, said the bank is considering outsourcing the management of its $300 million of money funds.

Many other banks are considering the same thing, Mr. Franz said. "Anyone who hasn’t thought about it before is thinking about it right now," he said.

In fact, were it not for the bank’s equity and bond funds — which spread the cost burden of running money funds — First Omaha would have sold its money market assets by now, Mr. Franz said. "If we were just offering money market funds, it would be a no-brainer," he said.

If First Omaha chooses to outsource — which it has not yet decided on — it would probably keep the assets outside the bank even when interest rates rise, Mr. Franz said. "My sense is, what we’d find is that we like the format and the profitability so much that it wouldn’t make sense to bring it back in," he said. It might make sense to take the funds back in-house if their asset total grew substantially, he added.

Imoneynet’s Mr. Crane said it usually takes at least $1 billion of assets under management for a money fund complex to be significantly profitable. Slightly fewer than 100 of the hundreds of money market fund complexes are that large, he said.

Even larger banking companies are outsourcing their money funds. Today, Citizens Financial Group said that it had hired the Mellon Financial Corp. subsidiary Dreyfus to manage and administer $1 billion of money fund assets.

Fund companies like Reserve Funds. are targeting money funds with assets of less than $1 billion, said Bruce Bent, president of the New York company.

In addition to yield pressure, many banks are also realizing that managing money funds is riskier than they had thought, Mr. Bent said. The collapse of the energy trading giant Enron and defaults by Pacific Gas and Electric and Southern California Edison showed money fund managers that trading even short-term corporate debt can be risky, he said.

Mr. Bent said that several small and midsize banks are talking to Reserve Funds about outsourcing a number of other services as well, including cash sweeps and insured deposit programs.

At least one fund company sees subadvising money funds as a stepping stone to other business.

Tim Pillion, senior vice president of bank marketing and sales at Federated, which manages at least $13.5 billion of money funds for other institutions, said he is also hoping that managing banks’ money market funds will lead to business such as subadvising fixed-income funds.

Many banks lack the resources to adequately assess the risk of the short-term securities that money funds buy, he said. "Running a money market fund is not a no-brainer," he said. "If you’re not in the top 10 [in assets], you have to seriously consider why you’re doing this."

Federated already manages money market funds business for financial services companies like SunTrust Banks, Lehman Brothers Inc., and State Street Corp., and it is in talks with other banks and brokers, he said. Reserve Funds recently signed a deal with American Express, among others.

Some banks insist on managing their money funds themselves, however.

Robert Bannon, chief investment officer for Eureka Funds, part of United California Bank, said it has no plan to outsource the management of its $600 million money market fund complex. These funds’ profits, though lower than usual, help the bank develop its fixed-income and equity funds, which hold assets longer and are more profitable, he said.

Managing the funds itself lets the bank tailor products specifically to its customers, who are mostly middle-market California corporate executives, he said.

Eureka’s money funds have also had strong growth in the past six months, regardless of their yields, Mr. Bannon said. By applying management techniques to the money funds similar to those for its equity and bond funds, Eureka can hold down costs and keep the money funds fairly profitable, he said.

Brian Placzek, head of fixed-income research and portfolio manager at WM Funds, an affiliate of Washington Mutual, the Seattle thrift company, said the increased risk of money fund management is actually an argument for keeping it in-house. "One reason banks may want to keep it in-house is because they have more oversight of the fund," Mr. Placzek said.

The WM Funds, which oversee about $770 million of money market funds, would remain profitable even with a further drop in interest rates, Mr. Placzek said. Fund shareholders may suffer a bit, but most are looking for safety rather than yield in money market funds, he said.

"If you combine liquidity and safety, you have to sacrifice on yield," Mr. Placzek said. "For [a few extra] basis points, does anyone really want to toss and turn at night?"

Even Mr. Franz acknowledged the downside to outsourcing money funds: a loss of the personal touch — which is especially important in dealing with the wealthy. "If you outsource completely," he said, "you lose the ability to serve the high-touch relationships."

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