Sign of the Times: Small Bank Bailing Out of Fund Business

When Sunburst Bank launched its bond mutual fund in the fall of 1993, it was following the lead of many other banks that had rushed into the booming fund market.

But the Grenada, Miss.-based community bank now wants out of the mutual fund business. It is seeking approval from shareholders to merge its only fund into an outside company's portfolio.

"Our timing could not have been worse. No one could have predicted what the bond market would do," said William H. Andrews, a senior vice president at Union Planters Corp., Sunburst's parent.

Sunburst is not alone. After more than a year of turbulent markets and sluggish mutual fund sales, many banks have begun reexamining whether managing mutual funds is a viable business to be in, especially in an increasingly competitive market.

A group of bank observers wonder aloud whether the small circle of banks that manage their own mutual funds may shrink further this year as some players bow out of the race by merging or selling off their funds.

"I think a third of these banks are revisiting the idea of whether they want to be in the mutual fund (management) business," Edward E. Furash, chairman of Furash & Co., Washington.

He added that more banks will follow Sunburst's example and vacate the fund business and "bank size doesn't have much to do with it."

The common problem facing many banks is an inability to generate enough fund sales to offset operating expenses. While experts disagree on the exact amount of assets a mutual fund needs to turn a profit, most say it takes at least $100 million.

Shortly after Sunburst began selling the Sunburst Intermediate Government Bond Fund, the bond market went into a tailspin and kept falling as the Federal Reserve hiked short-term interest rates seven times in less than 12 months. With performance of the fund tumbling, investors pulled out in droves leaving the fund with assets of $8.6 million as of the end of March - little more than what it started with in October 1993.

Performance aside, Sunburst's problems may have been fueled by a clash in management objectives. Sunburst had planned to use the bond fund as a stepping stone to launching a full family of mutual funds. That plan was scuttled, however, shortly after Sunburst was acquired by $10 billion-asset Union Planters, Memphis, last August.

"Union Planters didn't have plans at that point in time to build a family of funds," Mr. Andrews said.

Sunburst fund shareholders will vote June 29 to approve merging the bond fund with the U.S. Government Securities Fund managed by Federated Investors, a Pittsburgh-based mutual fund company that was the administrator to the Sunburst fund.

Sterling K. Jenson, president of First Security Investment Management, Salt Lake City, said banks often stumble if not enough seed money is used to launch a mutual fund.

"You need to have some size to get up to speed," Mr. Jenson said. "I think that $12 million is too small to start any fund."

Mr. Jenson said that First Security launched six mutual fund portfolios in December, seeding them with $338 million of converted trust assets.

But smaller banks - Sunburst had only $2 billion of assets before being acquired - will have a tougher time gaining the economies of scale necessary to manage mutual fund money, said Stephen A. Schoepke, a senior analyst at Moody's Investors Service, New York.

Small banks simply cannot transfer enough trust assets to effectively build on because typically "the revenue margins are so thin that they are not adequate to build any kind of retail market share," Mr. Schoepke said.

"This business is the chicken-and-the-egg business: People don't want to give you any money until you have a lot of it," said B. Anthony Weber, president of SMC Capital Inc., a Louisville, Ky.-based money management firm.

Even so, banks' marketing strategy makes them ill-prepared to compete for market share with established mutual fund companies like Janus Funds or Twentieth Century Funds.

"Banks think they can compete on service. Well, everyone expects service; service will only get you so far," Mr. Weber said.

A. Michael Lipper, president of Lipper Analytical Services, New York, said effective marketing of mutual funds is essential and banks should commit more resources to the marketing effort.

"In the end a bank should develop a proprietary fund only if it believes it can sell it effectively outside the bank," Mr. Lipper said.

Of the 118 banks that manage mutual funds, Mr. Lipper said, only a handful are actively trying to distribute outside the bank channel. "For those banks that aren't, it will be difficult but not impossible for them to get up to speed."

Some banks are considering an alternative to starting their own fund. Known as white-labeling, a bank markets a fund as its own, though the fund is actually managed by an outside company that incurs much of the liability.

Mr. Furash expects that many of the banks that drop out of managing their own mutual funds, and those considering adding mutual funds to their offerings, will turn to white-labeling as a remedy.

"None of them will abandon the sale of investments, but many will change the way they go about doing it," Mr. Furash said.

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