Until the mid-'70s banks were home to the majority of the average American's assets. No more.
Starting in the late '70s, mutual fund families began draining those assets by offering investors a chance at returns that easily topped those of traditional savings accounts.
Banks, to their credit, fought back. The largest bought or built, managed and marketed funds. Midsize institutions, lacking similar resources, formed distribution relationships with third-party fund families to share depositor assets.
And progress was made. In 1998 bank mutual fund sales accounted for 23%, or $104 billion, of all new fund sales.
Yet many small and midsize institutions don't offer funds. It's not because they don't want to, but rather they're overwhelmed by the 13,342 funds in existence and don't know how to decide which ones to offer. Though that number is intimidating, finding funds that will best serve depositors isn't impossible. It just takes a little research.
Begin with the premise that your bank's offering will center around what I call "core funds," the building blocks of any portfolio:
U.S. large and small-cap growth and value funds.
U.S. and corporate investment-grade and non-investment-grade bond funds.
International and emerging market equity funds.
And a money market fund.
Eliminate volatile, speculative offerings like sector and emerging- market debt funds from your initial offering. You can always add these high-octane products later.
Next, consult a professional rating agency, such as Morningstar or Lipper. You'll need this service to obtain a true sense of past results and the potential.
Purchase a fund analysis software program and begin screening for funds in the categories outlined above. Eliminate funds that don't have at least a five-year track record.
Now dig down into the remaining funds, starting with performance.
How did it do relative to its benchmark and peer group? Look for consistent outperformance.
Just as important, how much risk did the fund take to achieve its returns? A standard deviation greater then 1.5 times that of the S&P 500 is usually reason to pass. The fund may have delivered good numbers, but it is probably too volatile to suit your clients' needs?
Next, was there any style drift, or - as I like to put it - did the manager "pull a Vinik?" As manager of the Fidelity Magellan Fund, Jeff Vinik made a huge and disastrous market timing bet on fixed-income. Magellan shareholders, who believed they owned a growth equity fund, ended up owning a bond fund delivering unsatisfactory returns.
Make sure the funds you're considering invest as advertised. The last thing you want are clients invested in a fund that "blows up" trying to time the market.
The next consideration is manager focus. Choose funds managed by experts in a specific category. Managers focused on one category of investing-and one fund-usually provide more value than managers who spread their time and energy across several different styles and portfolios.
Manager tenure is also key. If the fund has good long-term performance, make sure the manager or team in place produced it.
Consider compensation. Is the fund manager's compensation based on its performance relative to a benchmark or its peers? This isn't a make-or- break issue, but I believe it's extremely important that the manager's interests are aligned with shareholders', and performance-based compensation accomplishes that mission.
Since you've eliminated funds that don't meet your criteria, you should now have a limited list in each fund category. It's time to call the fund companies.
Explain you're considering offering their funds at your bank and want to interview the manager, analysts, and traders about approach, holdings, and performance. Interview these groups separately, because you're looking for inconsistencies in the explanation of the fund's investment process.
Ask them to explain how they decide to buy and sell stocks. Is there a decision-making process in place or is the fund dependent on the whims of a "guru?"
I recommend buying a well-thought-out, easily explained process. Demand to see the fund's holdings at several time periods over the past year. Are the holdings appropriate for a fund in its category? (This is where you uncover style drift.)
Also, how do the fund's holdings compare with its benchmark? You're looking to avoid funds that have taken concentrated, often risky bets, like a growth fund with most of its assets in Internet stocks. Another important issue is how the manager incorporates new information and technology to strengthen the decision-making process.
And learn how the professionals feel about working on the fund. How important is it to them? Why do they enjoy it? Is their own money invested in the fund?
Never underestimate the importance of being comfortable with the people running your clients' money. After all, money management, like banking, is a relationship-driven business.
Finally, this process is not just for screening funds, but monitoring them as well. Selecting your funds is only half the battle. Making sure they continue to deliver is the other. You should monitor performance, look for style drift, and keep abreast of changes in management. Any deviation from the norm is reason to consider replacing the fund.
If you follow these guidelines, you should have an impressive mutual fund offering, which satisfies your clients investment needs and helps your bank retain those critical assets under management.