Fidelity Investments, the king of mutual funds, is snacking daily on the lunch of most investment providers, banks included. But Fidelity also wants to share some of that lunch with banks.
Through its Fidelity Investments Institutional Services, or FIIS, Fidelity is actively partnering with banks in a variety of ways. Its Fidelity Advisor funds, a family sold exclusively in the financial institution channel, has been growing through a network that now numbers over 950 banks. Fidelity also is rolling out a new technology platform with software firm Broadway & Seymour that executives think will be compelling for institutions interested in improving their trust accounting. For all its size, Fidelity does have some catching up to do: Boston rival Putnam Financial Services remains the leader in mutual fund sales through banks.
William F. O'Grady, 48, is executive president of FIIS and heads Fidelity Distributor Services, which distributes the company's load funds through banks, broker/dealers, trust companies and insurance firms. The stocky, sandy-haired O'Grady came to Fidelity last March from Alliance Capital Management in New York, where he headed the bank sales operation. Prior to that, he worked as an executive at Chemical Bank and Citicorp. During a recent interview in Fidelity's downtown Boston offices, O'Grady talked about Fidelity's work with banks and the future direction of mutual fund sales. Some excerpts:
USB: Give me an assessment of the state of mutual fund sales through banks. 1994 was a terrible year, and very few people met their projections. How much better are things this year?
O'Grady: 1994 was a really challenging year. It was the proverbial cold bucket of water. As with most things in life, in the long term it will probably be a benefit, because I think it will facilitate a diversification of packaged product distribution in banks. Asset allocation will probably be embraced to a much broader degree. One of the reasons why 1994 was so painful for banks and their clients was the heavy investment in fixed-income products. So the lesson to be learned will be that diversification will be practiced by a lot more people, rather than just discussed.
I do think that 1995 has seen a very strong rebound. We've seen packaged product sales up about 20% year over year, and that shows the resiliency of the bank channel in the face of some adversity. And consumer confidence is certainly up.
USB: Being Fidelity, you have a retail presence that very few companies can approach. How does that help your people when they make sales calls?
O'Grady: What you're really talking about there is brand name recognition, and our retail distribution has enabled us to achieve very strong name recognition. That is very important to our strategy in the third-party distribution business.
To the inexperienced investor, the brand name recognition gives comfort to perhaps make that first investment, from a CD to mutual funds or annuities. For the experienced and the upscale investor, we have data that also shows that brand name recognition is extremely important. In fact, if you don't offer that brand name product, investors will adversely select away from you and go to someone who does have it.
USB: There could be other fund companies on the shelf, then, as long as you get your fair share of exposure.
O'Grady: That's exactly right. We're one of the few complexes that has pioneered that notion in our asset allocation strategy, which is non-proprietary in nature. By that I mean you can put bank proprietary product in it; you can put Fidelity product in it; you can put some of our competitors' product in it. That speaks to flexibility, supporting client needs and also the fact that we believe we can bring value added and get our fair share.
USB: Tell me about the sales force strategy. You have salespeople devoted specifically to large institutions, small institutions and broker/dealers. How does that break out, and how is that evolving? Broker/dealers traditionally were the biggest thing in the bank channel.
O'Grady: For a period of time, that was true, and they will continue to be very strong and very important. From an asset-gathering capability standpoint, I believe that the large trust market represents the largest opportunity both for banks and their mutual fund partners.
Why? The 401(k) business. This is the largest area of opportunity for the banks, and for us. And that in the largest measure will be done through large trusts. In 1995, two-thirds of the assets that we will gather with our bank partners will be done through large trust/community trust, one-third through bank broker/dealer-keeping in mind that our sales with broker/dealers will be up 20% year over year. So the denominator is growing in both cases, but the large trust 401(k) market is the largest opportunity out there.
USB: I saw a figure that you had about 950 bank partners and 2,000 broker/dealers. Is that an accurate number?
O'Grady: Those numbers are accurate. A bank-owned broker/dealer is managed by our bank division because we think that the bank broker/dealer is different from a regional (brokerage) or a wire house. They have different needs, and we call on them differently.
USB: Are there any thrifts represented? Is there a significant potential in that area?
O'Grady: There's a significant opportunity with thrifts, especially on the West Coast. We've increased our activity out there, not only in the savings and loans, but in commercial banks, keeping in mind that a negating factor is consolidation. You have to keep a watchful eye toward who your client is today and who the acquiror or acquiree is for tomorrow. We're trying to keep our oars, potentially, in both ponds. We do spend a fair amount of time thinking about and talking about what some of the implications of those changes might be.
USB: The bank trust department area sounds like an interesting one, and I gather you're attaching a lot of importance to it.
O'Grady: It's a very important area for us. We also have a very exciting initiative going with Broadway & Seymour Inc., of Charlotte, NC. What we believe we will offer to the marketplace through this initiative will be unique. It begins with a trust accounting system in the trust department, but it will be far more expansive than that. It will enable us to offer a total solution to the bank: trust accounting, as well as a brokerage platform.
USB: If I'm a larger bank, and I've already got that kind of a platform, is this system something I want to explore in a different way with you? It sounds like more of a turnkey solution for a smaller institution.
O'Grady: Actually, it's not. It's modular in nature; it has components. You can approach us any way you want. You can go a la carte, or you can go total solution. We're engineering it that way because you're right-different banks have different needs. They've made different investments in the past, and it's not a cookie-cutter approach.
USB: What stage is that program in terms of being rolled out?
O'Grady: Very early. We just announced the partnership a little over 30 days ago, and we're in discussion with some prototypes, so we're very early in generation one.
USB: What is the Broadway & Seymour contribution? Is it processing and settlement? What else do they do?
O'Grady: It's the technology platform that they bring to the table, particularly as it relates to the trust accounting system, exclusive of settlement. What Fidelity brings to the table are our technology solutions, along with particular knowledge in the brokerage back office.
USB: National Financial Services Corp. is helping you here. Could you talk a little bit about what it does, as opposed to what we've just been talking about?
O'Grady: National Financial is a sister company of ours here at Fidelity. They are the dominant player in the clearing area. They have more clients than any competitor, both in trust and in the broker/dealer area. Their primary business is that of acting as a clearing firm for banks and in broker/dealer. And we are able to partner with them, so we can leverage off the technology and the knowhow. When we sit down with one of our bank partners, if there's a joint solution that we're working on, we can cooperate very easily.
USB: We hear a lot about scale and critical mass in mutual funds. Lots of banks have started proprietary funds, but many of those will never make it past a couple of years. Is that a situation that will be advantageous to Fidelity, down the road? These are people who will be looking for solutions.
O'Grady: I believe that our bank partners will be looking for help in this area. As recently as a year ago, the conventional wisdom was that you had to achieve critical mass to make a fund profitable, and we're now hearing from people like Goldman, Sachs (& Co.) that this means $150 billion in a complex. And people were talking just a few short years ago about $100 million. So I think the ability to be a profitable fund in a surviving complex is going to change dramatically.
USB: That $150 billion number-I think I'd read that your Advisor funds had about $20 billion....
O'Grady: We've got about $80 billion under management here at FIIS, and we're north of $30 billion in the Advisor funds. But what I'm really talking about the overall complex (of funds at Fidelity).
USB: And that's somewhere around $450 billion or $500 billion?
O'Grady: Right. And the Goldman study talked about the need for a minimum of $150 billion. The economies of scale in the business are changing dramatically.
USB: Is that because of technology costs or the service costs?
O'Grady: This is a capital-intensive business on the technology side and the service side. That's where huge investments are going to need to be made. Not on the investment management side, but on the record-keeping and the 401(k) area. I think the surviving organizations are going to internalize record-keeping. It is expensive to do that. You need that to maintain service quality. And that's what I think large trust organizations, community trust organizations and commercial banks are going to be looking for when they evaluate a partner going forward.
Do you have the money management expertise? That's going to be a given, to get into the game. But do you have the resources? Those resources are going to be the result of having the critical mass in your complex.
USB: This whole area of asset allocation dovetails with financial planning. Is that a side of the business you're finding a lot of receptivity to?
O'Grady: Year to date across all markets, we've found about 5% to 6% of relevant total assets to be in asset allocation/wrap account products. We anticipate that by 1998, 10% of all relevant sales will be in asset allocation/wrap.
On a percentage basis, mutual fund wrap programs have grown significantly over the past 24 months. We haven't yet seen that same percentage growth in assets. There's been a tremendous growth of wrap product offerings, but I think there's going to be a lag before you start to see the asset-gathering capabilities materialize.
We do think that's a growing trend. We are in partnership today with a number of banks across the country where we're helping them design their wrap product, or our products are in their wrap offering or where we are even managing their proprietary wrap offering.
USB: You've added a couple of well-known bankers lately who've been involved in sales at a fairly high levels. Is it a big advantage in selling to the bank channel to come from a bank environment?
O'Grady: I believe it is an advantage. I think it is valuable to understand the culture, to understand the motivation, the regulation and to have some subject matter expertise around the bank marketplace, because it clearly has unique characteristics. But I will also say that it's important to have people who have strong sales and marketing experiences and qualities and blend that with the bank experience.
USB: You've combined your prospectuses for A and B shares. Was that to simplify things for the customer? And how has that been received?
O'Grady: We've taken a number of steps to simplify things for the shareholders and our bank partners-the whole issue of prospectuses and marketing materials. We believe that one prospectus for all shares only makes sense. You and I, as consumers, if we sat down at looked at a product and priced it, we'd have two decisions in front of us. Do I want to acquire this product or not? And once I've made that decision, what's the window of entry in terms of pricing? You wouldn't want to go to a totally different piece of material to make that decision. So we designed what we hope will be client-friendly materials for both the intermediary and the shareholders.
USB: What's been the reaction from the bank partners?
O'Grady: It's been excellent. Akin to that, we've come out with combined marketing materials and prospectus, and that's gotten outstanding reviews. That marketing material is in plain English, so people can really get their arms around precisely what this product is about.
USB: Do you have any overarching goal by the year 2000 for the Fidelity Advisor family, or do you just want to grow it as the market allows?
O'Grady: While we don't have a specific number in the mind over the next three years, directionally we have a very clear vision of a branded strategy that says that through FIIS clients-the third-party intermediaries-the Advisor product line will be the product line of choice. It's designed for the financial intermediary, it's priced for the financial intermediary.
USB: Is there an effort to add funds to that family, at this point?
O'Grady: Yes. Clearly, with the branded strategy and the migration from the reliance on retail funds to Advisor funds, we need to have a complete product offering. Today, the Advisor line has about 20 products, and we will probably add between two and six new products in 1996, both fixed-income and equity.
USB: Isn't there more of an appetite on the bank side for getting more equity funds? Traditionally, the client base has been in fixed-income funds.
O'Grady: Yes, and we think we have a very strong offering in that area already. But we do think there are a couple of areas where we can round out the product line. One of those areas is asset allocation. In addition to asset allocation as an investment practice, there is an appetite for asset allocation funds, and we plan to address that in 1996.
USB: Let me ask a little bit about the variable annuity side...
O'Grady: We're very excited about what is happening. 1995 is the year we rolled out our variable annuity, along with Nationwide Insurance. Our Fidelity Advisor wrap product (the insurance company provides the "wrapper" for a variable annuity) is now running about 27% of total sales, so we're very pleased with the welcome that offering has received. We went from a standing start in 1995 to that sort of contribution.
The growth in variable annuities has been pretty significant. Why? Because both investors and banks realize that in years like 1994, fixed annuities were simply driven by interest rate fluctuations and (sales) compensation. I think a lot of reasonable minds said, "This is not exactly in the spirit of asset allocation. We need to change some behavior here."
For those people looking for a tax-advantaged product, the variable annuity provides them with an alternative. So we've started to see some fairly significant flows, to the point where this year we'll do in excess of $200 million through the bank channel-again, from a standing start.
USB: Is there anything else you specifically wanted to talk about?
O'Grady: I think the envelope our whole discussion fits into and our overall value to our bank partners is that the differentiating factor for mutual fund complexes, going forward, is this: You need to provide the bank with a total solution. It can't be off of total return for my fund for the last three years, and here's my Morningstar (mutual fund rating). Bankers are looking for partners... They want knowledge increments.
That's what we're basing our business strategy on, going forward, coupled with what we believe is some of the best investment management expertise in the industry. But what we are hard at work on is the total offering, because we think that's what's enduring. Everybody's going to run into highs and lows and mediums on fund performance, but that's not what's going to be enduring.