The brokerage industry seized the opportunity to earn fee income by managing portfolios of securities for customers and charging a "wrap" fee for the service. This industry is now valued at $50 billion in assets.
Banks with brokerage subsidiaries are beginning to follow suit, with Chemical Bank taking a lead role.
But the newest, and strategically most intriguing, wrap trend is a program spearheaded by the bank's trust department.
Customized Portfolios
The trust department version creates mutual fund wrap portfolios for bank retail, commercial, and trust clients. The portfolios can be customized for each client or can be predetermined portfolios managed to achieve a certain investment objective.
Using a customer questionnaire and asset allocation modelling techniques, the trust department determines the appropriate portfolio of mutual fund investments to meet the customer's investment objective, timing horizon, and risk tolerance.
With changes in the market or changes in the customer's investment parameters, the trust officer will realign the portfolio appropriately.
The trust department performs these functions under an agency agreement with the customer that preapproves certain investment strategies under specified market situations. The agreement also details when consent must be gained before the trust department executes an investment transaction.
Within the boundaries of this agency agreement, the trust department may exercise its discretion over the investments, operating under the accepted "prudent man" fiduciary principle. Under this hat, the trust officer is not required to be licensed with a broker-dealer to sell investment products.
The exact number of banks with wrap mutual fund programs is not known, nor is it tracked. However, many leading third-party mutual fund vendors have developed turnkey wrap mutual fund programs and discuss them widely at industry conventions.
Federated Investors claims to have launched these programs in over 200 banks nationwide. SEI Corp. and Fidelity Investments have far fewer programs but are linked with key banks. Goldman Sachs has focused on the community bank market.
The programs consist of technology (asset allocation computer models), marketing and legal support, and, of course, access to the third-party vendor's funds.
For the third-party vendors, the wrap approach has been a way to lock in a distribution channel that funnels assets into the funds.
Key Benefits
For the bank, the trust department wrap has several key benefits financially and organizationally:
* Annuity income from the annual wrap fee, with an attractive fee schedule (typically 1% to 1.5%, half the fee charged on a brokerage wrap account).
* Operating efficiencies from the liquidity, convenience, and daily valuation of mutual funds. Mutual fund wrap portfolios tied to a dynamic asset-allocation model enable trust departments to handle the $50,000 account as efficiently as the $500,000 account.
* In approximately two-thirds of all banks, trust is a management locus for mutual fund programs. A trust wrap program is therefore spearheaded by the driving area behind most bank investment product programs.
* Trust is well seasoned in discussing investment alternatives and matching customer needs with appropriate investment vehicles. This expertise enables bank trust departments to compete effectively with the veteran fund vendors and brokerage houses. It also positions the bank as a source of professional investment services, rather than as a mere source of deposit-based transaction products.
* Trust departments typically possess the purchasing power to access institutionally priced mutual funds. As a result, the end yield to the consumer, net of the bank's wrap fee, is still competitive with retail-priced funds.
* The trust department's agency/fiduciary roles obviate the training and resource costs associated with registering retail bank employees as series 6 or 7 registered representatives of a licensed broker dealer.
* Selling investment products through a trust channel makes it easy to comply with Comptroller's Circular 274, which calls for clear separation in the marketing and sales of Federal Deposit Insurance Corp.-insured deposit products and investment products.
But perhaps the most intriguing, is the role mutual fund wrap programs can play in building the competitiveness and performance of a bank's own proprietary mutual fund program.
|A Viable Solution'
Particularly for the many banks that have recently launched proprietary programs, that have not yet achieved scale economies and are waiving management fees to compete on yield, the wrap program provides a viable solution.
Banks can design wrap portfolios that embed their own proprietary mutual funds in specific asset categories. These banks can then cherry-pick the highest-yielding third-party funds to fulfill other asset categories within the portfolio.
The blended rate of return on the wrap portfolio is still attractive to the customer, while the bank builds assets and scale in the proprietary fund or funds.
To achieve this final benefit, banks must use an asset-allocation program that is "vendor neutral" and flexible enough to allow the bank to substitute its proprietary funds for the third-party funds recommended by the model.
Most third-party vendor models are vendor specific by design. Goldman Sachs currently offers a sophisticated vendor neutral asset-allocation model, and Fidelity has one under development. Alternatively, the bank can develop its own asset-allocation model.
Although the above benefits are compelling, the execution of the program can be difficult, particularly with regard to building effective referral networks and referral incentive programs from the retail and commercial areas of the bank.
Most larger banks use the wrap program as just one of many distribution channels for investment products, and must integrate the wrap strategy with the investment product strategies residing in the brokerage, retail, and in some cases third-party-marketing areas of the bank.
In these instances, a concise "road map" segmentation strategy must be developed to direct the prospective investor to the right area of the bank to serve their needs.
Beyond simple dollar cutoff designations, this road map must incorporate cross-sell opportunities so that the customer is sent to the area of the bank that has the opportunity to establish the broadest cross-product relationship.
Though trust wrap programs are complex, the payoff to the bank can be significant.
Several regional banks project annual revenues of $100 million for their wrap programs, as well as 35% profit margins. For community banks, the trust wrap program is often the only viable way to offer investment products and remain competitive.
In all cases, mutual fund wrap programs are a strategic and highly profitable product to add to a bank's trust department aresenal.
Spectrem Group, a consulting firm with offices in Red Bank, N.J., and San Francisco, specializes in trust and investment product business lines. Ms. Errett is chairman and Ms. Figueredo a senior consultant.
