Banks have made significant headway in recent years-particularly over the last year-in the investment products area. Most large institutions can now offer brokerage services and mutual funds, as well as annuities and other life insurance products.

To their credit, banks have increased their share of total mutual fund assets to more than 12%. Seeking to replicate the results of Charles Schwab, NationsBank and others have rolled out mutual fund supermarkets, where they sell both proprietary and third-party funds.

Banks are also slowly building their capabilities in brokerage. Waterhouse Securities, owned by Toronto-Dominion Bank, has won awards for its discount brokerage program, and Fleet Financial Group has seen positive results from its Quick & Reilly and Suretrade units.

Several banks have acquired more full-service brokers-some as byproducts of their investment banking purchases. Is this a sign that banks are headed in the right direction?

They have certainly made some positive forays into managing investment assets, but it really has been on an insignificant scale over all. Other than J.P. Morgan's buying a stake in American Century and Mellon Bank's Dreyfus unit, no bank has any consequential capital deployed to asset management. This means customer investment assets are continuing to flow out of banks to companies like Merrill Lynch, Fidelity, Vanguard, Charles Schwab, and others.

On the other side, traditional investment management firms have been making numerous acquisitions in asset management, highlighted by Merrill's purchase of Mercury in the United Kingdom. These firms see asset management as a way to smooth out earnings volatility and add income earnings from managing money successfully.

What does all this mean for banks? They must step up and make a serious entry into the asset management business to be competitive with nonbanks.

Growing the assets under management will most likely mean making mutual fund acquisitions.

The first good reason for this is it takes three to five years to build up a track record in rate of return. This is the main factor in investor choice and is critical to establishing a brand.

Fidelity and Vanguard are two examples that built their reputations by providing solid returns year after year. Having a solid brand in asset management, along with the right distribution, provides some protection if the bull market subsides.

One of the ways investors seek above-average rates of return is by looking at the Morningstar fund ratings. By one estimate reported in Business Week, almost all new money being invested in mutual funds goes to companies with four- and five-star Morningstar ratings. Very few bank mutual funds have secured these high ratings.

Second, the top five mutual fund firms control about 34% of the industry's assets, indicating that a significant number of investors hold funds across just a few mutual fund families.

Because assets under management are a huge driver in profits per customer, banks that want to make inroads here may find it necessary to acquire one of the large fund companies that comes with strong brands.

This does not mean that a bank would need to move away from selling other firms' funds or even forcing its customers to choose its own funds. The idea is to give customers solid choices for their investment needs.

Buying a large asset management firm does guarantee that mutual fund assets could stay within the bank and generate management and other fund fees, which translate into roughly 1% of assets under management.

Mutual funds continue to grow-and profitably, with pretax profit margins averaging 30% to 35%. For each $100 billion a bank adds to its portfolio, these assets could add $300 million or more in earnings per year.

A bonus for acquiring a top firm would be not only access to the 401(k) market (about a third of mutual fund assets are held in defined- contribution plans) but also the additional brokerage capability it would likely bring, which customers are increasingly demanding.

Third, mutual fund companies are comparatively cheap for banks to buy.

With about 20 million customers before adding those of BankAmerica Corp., NationsBank's market value per customer is $4,300. With more than 25 million customers, Chase Manhattan's market value per customer is $2,500.

Franklin Resources-the largest publicly traded mutual fund company-has slightly more than seven million customers, with a valuation of $1,900 each.

T. Rowe Price's six million customers compute to a market value per customer of $780. Nuveen & Co.'s roughly one million customers have a value of $1,300 each.

Even if we gave Fidelity a market value of $30 billion and an implied P/E ratio of roughly 50 (versus 25 at Franklin and 27 at Price), its 12 million customers translate into a market value per customer of $2,500.

What does this simple measure really mean to a bank?

The market premium for asset management customers is reasonable compared with bank customers. Because the stock market values investment assets at higher multiples than bank assets, banks could end up with higher valuations if they acquired mutual fund companies.

Said another way, the payoff for banks in acquiring mutual fund customers is a dramatic increase in assets under management for a reasonable price. For $15 billion, NationsBank added three million Barnett customers in a very strategic acquisition. For $30 billion-if our valuation is in the ballpark-a bank or other financial services firm could get 12 million Fidelity customers and $600 billion of assets under management.

This could add nearly $2 billion in annual earnings.

With Franklin Resources, for $13.5 billion some firm could add seven million customers and $177 billion of assets under management.

We are not trying to downplay the difficulty and the cost of purchasing a mutual fund company, or even suggest that a purchase is a done deal. There is little likelihood at this point that Fidelity or Vanguard are for sale-though many people could not have imagined the Citicorp-Travelers merger this year.

But banks need to get more competitive very quickly in managing customers' investment assets. One strategy for accomplishing this is to acquire additional assets under management, and mutual fund companies are the best route to this end.

Understandably, many of the largest U.S. banks have not been able to focus in asset management, as many are in the midst of mergers. But banks need to be mindful that the investment management and insurance industries are looking at the same table in this exciting restaurant of financial services. It remains to be seen who will get to eat the dinner.

Without acquiring additional assets under management, banks are in danger of ceding this entire, essential sector to the nonbanks.

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