Charles Schwab Corp.'s agreement to buy U.S. Trust Corp. may be remembered as the first major crossover merger of the financial reform era, but its roots can be traced to another high-profile deal of two years ago.
In many ways that earlier pairing, a January 1998 deal that united the toniest of New York banks - J.P. Morgan & Co. - and the Kansas City, Mo., fund company American Century Investments, was a turning point for banking companies looking to compete on Wall Street with increasingly powerful asset management operations.
"The original goal was to be able to bring together for our clients the best of both worlds: a global institutional investment manager and the top U.S. retail mutual fund business," said Jeff M. Garrity, chairman of J.P. Morgan/American Century Retirement Plan Services. Mr. Garrity also co-heads the committee that oversees the partnership.
Though the firms have begun to cross-sell mutual funds, the main focus of the relationship to date has been retirement services. J.P. Morgan was strong in the defined benefit field but lacked the technology to keep up as more and more companies moved to defined contribution plans.
American Century's defined contribution record-keeping system, considered among the most advanced in the industry, gave J.P. Morgan access to "bundled" retirement plans, in which the plan's record-keeper also manages the majority of its assets, creating economies of scale.
That allowed J.P. Morgan to "go after larger plans and more profitable plans," Mr. Garrity said. At the beginning of 1998, he said, the average retirement plan J.P. Morgan managed had $31 million of assets. The average bundled plan taken on since then contains $111 million of assets, he said. (Mr. Garrity said current figures showing the average plan size overall were not available.)
At yearend 1999 J.P. Morgan had $2.5 billion of assets under management in bundled plans and $13.8 billion in unbundled plans. American Century had $8.8 billion in bundled plans and $5.4 billion in unbundled plans.
Also, the firms include each other's funds in their respective 401(k) plans, further boosting assets.
"We had a terrific platform, but had only gone so far up the food chain as far as size of plans," said W. Gordon Snyder, president of American Century Investment Services, the fund company's marketing and account service arm. "J.P. Morgan had size, but didn't have the record-keeping capability."
But, Mr. Snyder noted, "retirement plan service is not an end to itself. People have other needs," including advice and personal investments.
For instance, American Century could steer a retiring 401(k) client with significant assets to J.P. Morgan for mutual funds and private banking services, and the firms are working on setting up a systematic referral process.
On the mutual fund front, J.P. Morgan sells 20 of American Century's 72 funds to its high-net-worth clients, and at the end of this year American Century will begin offering a selection of J.P. Morgan's 22 funds to its 1.8 million retail clients.
Mutual fund assets under management in the J.P. Morgan funds have risen from $19 billion at yearend 1997 to $44 billion at yearend 1999. During the same period, the American Century Funds grew from $62 billion to roughly $109 billion under management.
From the outset, the companies' client bases intersected in a key area: the "emerging affluent" investor with roughly $1 million to $5 million of assets.
Indeed, J.P. Morgan's American Century gambit presaged the thinking U.S. Trust brought to the Schwab transaction, said Michael P. Kostoff, executive director of VIP Forum, a research firm in Washington that serves the investment management industry.
"As the market becomes more competitive, it's important to go after adjacent markets," Mr. Kostoff said. "Morgan's decision to go down-market is a smart move. They're leveraging their unique talent and position in the current market to improve value in the adjacent market."
Likewise, Morgan was a particularly attractive partner to American Century, which was looking for better ways to serve wealthy clients.
"What Schwab has done with U.S. Trust, we want to do with J.P. Morgan," Mr. Snyder said.
The fund groups complement each other in that J.P. Morgan has traditionally had a more conservative style of investing while American Century is better known for its aggressive growth portfolios.
According to American Century, J.P. Morgan clients have placed about $1 billion in its funds.
"We didn't anticipate such immediate response by Morgan's high-net-worth clients," Mr. Garrity said.
The firms are also looking for ways to work together overseas. American Century executives have met with J.P. Morgan's investment partners from France, Germany, and Japan - both overseas and in Kansas City - to discuss how to do business.
"As we look outside the U.S., we believe there are defined contribution opportunities in Japan and Europe," Mr. Garrity said. "We have the ability to take the best business practices in the U.S. and deploy them in those countries."
And, he added, in Japan and Europe "the vehicle of choice will be mutual funds."
While the two firms have acted as subadvisers for each other's funds for several years - American Century for one of J.P. Morgan's offshore funds and its real estate fund, Morgan for American Century's international bond fund - they will not integrate their asset management capabilities.
"We wanted to preserve the integrity of each firm, so we have purposely kept them apart," Mr. Garrity said. "We want to make sure both investment management firms focus on how they manage money."
In fact, Mr. Snyder said, a condition of the deal was to leave "redundancies" between the two fund groups, such as fixed income, in place.
On a practical note, he added, if the firms were to share research on a particular company, American Century and J.P. Morgan would be limited to a 5% stake in that firm's stock, pursuant to U.S. securities law.
The decision to make only a partial integration was an easier one for Morgan and American Century than perhaps it will be for Schwab and U.S. Trust, both of which plan to continue operating under their own names.
Making it simpler was the fact that Morgan purchased a 45% stake of American Century - sizable but short of majority. The deal allows J.P. Morgan to increase its stake to 49% in 2001, but Mr. Garrity said it has made no decision in the matter. Nor does he see it as a central issue. "We did not go into this partnership for financial return," he said. "We did it for strategic value."
The distance, Mr. Kostoff noted, also provides J.P. Morgan an entry point to the more pedestrian business of retail marketing without putting its high-net-worth brand name on the line.