Many banks are experimenting with ways to increase the growth of their proprietary mutual fund assets. One option often considered is improving the investment performance of the funds. We suggest that target marketing offers a better chance for success.

Among the factors leading to superior sales results, above-average investment performance is often cited as playing a material role. Banks with a focus on growing their proprietary funds could be tempted to try and capitalize on this assumption.

However, achieving consistently above-average investment performance is likely to be both difficult and costly-if it is possible at all.

Before investing, for example, in either highly paid portfolio managers or an expensive sub-adviser, it would certainly be prudent to review the empirical evidence for the relationship between investment returns and net sales.

We used Morningstar's data on 1995 equity mutual fund performance to conduct our analysis. The funds' reported total returns were standardized to account for differences in risk and plotted against their corresponding 1995 net sales. We adjusted for risk by dividing each reported return by its corresponding beta as reported by Morningstar.

Our analysis did not suggest a significant relationship between investment performance and net sales for this group of equity funds during 1995.

In fact, we could go so far as to suggest that on average at least, investors have paid little attention to risk-adjusted returns when making a mutual fund purchase decision.

Past analyses that we have performed on fixed-income funds suggest that this generalization is true, and that the lack of a causal relationship has remained essentially constant over time. Substituting 1-, 5-, or 10-year returns here does not change these results materially.

This seeming indifference to variations in investment returns is not altogether surprising. A sizable percentage of fund sales are still made through face-to-face channels, like those offered by banks. One possible explanation is that products distributed through face-to-face channels are sold, not bought.

This would be consistent with the behavior of the transitional customers, who typically account for the majority of mutual fund sales at many banks. Such customers are not self-directed investors and are therefore unlikely to make an independent assessment of risk/return trade- offs.

This permits other factors, such as fund availability, the favoring of house brands, or differences in compensation methods, for example, to have an impact upon sales results.

Finally, although there was no apparent strong relationship between investment performance and net sales for the universe of equity mutual funds we examined, we should not conclude that such a relationship does not exist for one or more individual market segments.

For example, we might reasonably speculate that self-directed investors would take a strong interest in risk-adjusted returns when making a mutual fund purchasing decision. Whether this is true, and relevant to achieving the growth objectives of any given bank, can be tested through market research.

Achieving above-average growth in proprietary fund assets under management will not, in general, be achieved by focusing on superior returns alone. If this is the case, what are the other growth levers that can be pulled to achieve that goal?

We suggest that target marketing may offer a more promising approach. The careful segmentation of a bank's customer base will likely reveal several sets of discrete mutual fund buying behaviors. Each behavior will be characterized by different preferences with respect to distribution, service, and investment product attributes.

Prospects for higher growth in net sales will be significantly improved by tuning the product portfolio, advertising, and channel availability to the needs of these individual market segments. In a few market segments, for example self-directed investors, enhanced returns could play an important part in such an optimized mix.

Ultimately, it is unlikely that a bank can provide an optimized solution for all market segments and still earn attractive profits. A relative cost/benefit analysis must be performed to support the selection of a subset of the market segments that will then become targets. The mix is then tuned to the target segments' needs.

Careful segmentation facilitates such an analysis and will place the benefit of enhanced performance in the appropriate context for sound decision-making.

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