PITTSBURGH - J. Christopher Donahue, president and chief executive of Federated Investors, is not sure what banks will look like in several years. But he is sure his company's future, like its past, will be deeply rooted in them.
Banks are a compelling market "because they continue to have money," he said during a recent interview in Federated's offices. And "people trust banks. You say 'bank,' they say 'trust,' " he said.
Though some competitors have shrugged off banks as major distribution partners, Federated prides itself on helping banks grow instead of knocking them out of the competitive ring. It is a strategy that took shape three decades ago with Federated's successful pitch of money market funds to bank trust departments.
Indeed, Federated may have done its job too well; it is now trying to break out of its image as a money fund shop. Money market funds accounted for 66.74% of Federated's assets under management on Dec. 31; equity funds represented 16.78%; bond funds 12.7%; and separate accounts 3.78%.
"You chip away at that" perception of being purely a money fund manager, said Tim Pillion, who heads Federated's bank trust sales. "It just doesn't happen overnight."
To that end, Federated is shopping for an equity manager. And in March it plans to launch an exchange-traded fund consisting of stocks that make up the Standard & Poor's 500 index, said J. Thomas Madden, chief investment officer for domestic equities. Federated also plans to launch a mortgage-collateralized bond obligation during the first quarter and a high-yield fund in the next few months, Mr. Donahue said in a conference call with analysts and reporters last week.
And there are plans to offer separate accounts during the second half of the year for clients who invest $200,000 or more. The company currently offers separate accounts for customers who invest more than $1 million, said James F. Getz, who heads Federated's retail sales business.
Federated works with banks on many fronts. It sells funds through their brokerage units and capital markets groups, offers retirement products and plan servicing, and provides back-office support for banks' proprietary mutual funds.
Federated faces stiff competition from companies such as Fidelity Investments, Goldman Sachs Asset Management, SEI Investments, and Franklin Resources Inc., which are formidable contenders for banks' trust business. And on the brokerage side, Federated competes with the likes of Putnam Investments, Aim Management Group, Franklin, Fidelity, and Massachusetts Financial Services.
Nonetheless, observers said Federated's long history with banks will make it difficult for competitors to oust its funds from banks' shelves.
Federated's success in banks did not happen overnight. Its bank business did not begin to take shape until the mid- to late 1970s - two decades after the company was founded by three high school friends.
Victory on the banking front came only after Federated - frustrated by the failure of a U.S. government bond, a high-yield bond fund, and a small-cap fund to catch on with bank trust departments - decided to try its hand at selling banks a money market fund for cash management.
(At that time banks used passbook savings accounts to manage their trust customers' excess cash. One New Jersey bank used to wheel those passbooks to the savings and loan down the street in a shopping cart, Mr. Donahue recalled.)
As one of the first companies to launch a money market fund, Federated met with some skepticism from banks - about 100 rejected the pitch. But with a renewed marketing push and regulatory changes, the money fund, which maintains a stable price of $1 per share, ultimately caught on.
"They're really the only financial services firm out there that has a long history of working with bank trust departments," said J. Kenneth Alderman, director of the capital management group at Birmingham, Ala.-based Regions Financial Corp., a Federated client for some 25 years.
Part of Federated's success comes from the time and energy it has devoted to helping banks build their trust business, observers said.
Domenic P. Rocco Jr., president and chief executive of First Commonwealth Trust Co. in Indiana, Pa., said Federated helped his company get off the ground in 1991. Executives from Federated, which is about an hour away from the trust company, provided on-site technical assistance, sales training, and other help at least two days a week for the first two years, Mr. Rocco said.
Though roughly half of Federated's $124.8 billion of assets under management comes from bank trust departments, the fund company has also become one of the top 10 sellers through bank brokerages. It sold $2 billion of mutual funds through that channel last year, an 81.8% increase from 1998. Federated's business through bank and nonbank brokerages represented 33.6% of its assets on Dec. 31, the company said.
Another way Federated helps banks is by providing back-office services for their proprietary mutual funds. The fund servicing arm got its start in 1988 by launching fund families for Michigan National Corp. and Hibernia Corp. But it was reorganized in 1997 to focus on distribution, because most banks that wanted to had already launched fund families by that time, said Peter J. Germain, a senior vice president in charge of the proprietary fund servicing business.
Maitland Lammert, an analyst with Edward D. Jones in St. Louis, said there was some concern in the early 1990s about whether banks would continue selling Federated's funds once they had their own. But those concerns have not materialized, she said.
R. Edward Bowling, senior vice president and manager of proprietary funds at Wachovia Corp of Winston-Salem, N.C., said Federated - which distributes the banking company's funds - has always been receptive to promoting both families and has helped him flesh out the pros and cons of prospective products.
James C. McElroy, chief investment officer of Hibernia's trust division, added that it is nearly impossible to find fund companies that don't compete with a bank on one level or another. "We really have to deal with our enemies sometimes," he said.
Meanwhile, Federated has expanded beyond its bread-and-butter banking business. For example, it recently launched six offshore funds in Germany and bought a software developer from United Asset Management Corp. to boost its retirement plan business through third-party administrators.
Federated's theory is, "you've already built the factory, why only sell your product through one kind of store?" said Mark Constant, an analyst who covers the fund company for Lehman Brothers Inc.
The Pittsburgh fund company has made several attempts to shift its focus. It branched out into non-money-market funds in 1982, when laws were changed to allow banks to set their own interest rates and money funds were hit hard. Federated, which had grown to about $32 billion of assets under management, bled $6 billion of that in about four months, Mr. Donahue said.
The fund company turned to fixed-income funds as its savior, a strategy that helped it grow to $57.6 billion by the end of 1993. In February 1994, Federal Reserve Chairman Alan Greenspan raised rates, and Federated lost another $6 billion, Mr. Donahue said.
"That was a wake-up call to us," Mr. Getz said.
Federated shifted focus again and in 1995 opened Federated Global Research, a New York-based unit to develop global equity and fixed-income products. Since that time the company's equity assets under management have increased fourfold, to $20.9 billion on Dec. 31.
Another potential sticking point for the company's growth is the price of its shares, which have never traded more than $1 or so above their May 1998 debut price of $19. Despite his disappointment, Mr. Donahue said during last week's conference call, it is premature to consider taking the company private again.
Federated cannot "control the enthusiasm the market had with all the dot-coms," he said. For the time being, the fund company is content to buy back stock to boost its lagging share price, he said.
Besides, going public has its perks: It has given Federated a needed shot in the arm in terms of market recognition, Mr. Donahue said in a previous interview.
"There are some people who, when they think of Federated, think of us instead of clothes," he said, referring to Federated Department Stores, the owner of Macy's and Bloomingdales. "Not a lot, but it's happening more and more."
