When Mercantile Bankshares shook up the top ranks of its investment management subsidiary two years ago, industry observers speculated that it meant the end for the bank's aggressive hedge fund strategy.
But this week, having launched a hedge fund of funds built on three proprietary hedge fund portfolios, the president of the Baltimore banking company's investment and wealth management arm said it remains committed to offering alternative investments.
"We plan to continue to take a disciplined, asset-allocation approach with our high-net-worth and institutional clients," said Kevin McCreadie, the head of Mercantile Capital Advisors. "That means using real estate and private products and hedge funds. Diversification has worked well, and hedge funds are going to continue to be a big part of that."
Historically, Mercantile has focused on small and midsize businesses and high-net-worth individuals, but in the past two years, it has expanded its focus on retail customers in its Maryland- Northern Virginia-Delaware footprint - plus an office in York, Pa.
In March 2004, Mercantile fired two top wealth management executives, John Pileggi, the chief executive officer of investment and wealth management, and Michael Donnell, a senior vice president. Mr. Pileggi had been named chief executive of the division in September 2003 after Wallace Mathai-Davis stepped down in an apparent clash of views with Edward Kelly 3d, the parent company's CEO, and the board of directors.
Gary Townsend, an analyst at Friedman, Billings, Ramsey & Co., Inc. in Arlington, Va., who covers Mercantile, said its deposit growth in the past five years was affected significantly by its acquisitions of F&M Bancorp in Frederick, Md., in 2003 and Community Bank of Northern Virginia last year.
"These acquisitions have helped their growth of deposits. Otherwise, their deposit growth has been in line, generally, with what we are seeing in the market," he said.
Mr. Townsend said Mr. Kelly had faced "a strong headwind" because of declining interest rates since he took the helm at Mercantile.
"He has had some missteps with the hiring of Mr. Mathai-Davis, but he has made a success of some acquisitions like the one in Frederick, Md., that many didn't think would be strong," he said.
The current rising interest rate environment "could really help the next stage of his strategy," he said.
Since Mr. Kelly took charge at Mercantile in March 2003 he has twice reshaped its wealth management executive board, as well as its strategy. He succeeded a local legend - H. Furlong Baldwin - who had run the Baltimore bank since 1976 and built it into a regional player with $10.8 billion of assets and 200 branches in three states.
Mr. Kelly said in an interview after the March 2004 firings that wealth management would change its focus under Mr. McCreadie's leadership. Mr. Mathai-Davis had focused the group on developing hedge fund products that it could offer to other companies.
Another analyst at the time predicted that Mercantile would take a "much more vanilla" approach to asset management. In May 2004, the company introduced the Mercantile Dow Jones Portfolio Funds, a series of five risk-based portfolios. These funds, unlike Mercantile's hedge funds, were intended for retail investors and required a minimum investment of just $1,000, or monthly investments of $25.
By contrast, the Mercantile Alternative Investment Fund, the registered fund of hedge funds launched Monday, requires a minimum investment of $75,000 and is intended for institutional and high-net-worth investors. Mr. McCreadie, who is also the asset management division's chief investment officer, calls this a niche product, however. "Hedge funds continue to be a niche with a lot of potential," he said. "It always has been a nice niche."
Analysts said Mercantile, which has $16 billion of earning assets, may have altered its strategy when it began making executive changes nearly three years ago but that the bank never abandoned its alternative investment products.
"It is a matter of finding a middle ground," said Burton Greenwald, an analyst at BJ Greenwald Associates in Philadelphia. "Banks want to be able to offer an array of products that satisfy all of their customers."
Brett Lane, a senior vice president who runs Mercantile's alternative investment strategies, said he believes the bank's original strategy never changed.
"Most things that we do from an investment management standpoint are driven by asset allocation," he said. "We have always been firm believers that hedge funds can offer strong diversification and portfolio efficiency."
But hedge funds have never reached the position that Mr. Pileggi outlined, for example, in a February 2002 interview. Mercantile would use hedge funds to extend its footprint, he said then.
Analysts at the time, however, used the "niche" term to describe what they thought Mr. Pileggi had been hired to do. And hedge fund assets now total $150 million of Mercantile's $3.7 billion of mutual fund assets under management.
Mr. Lane said he expects Mercantile's hedge funds to develop steadily. "I don't want to be held to a specific number," he said.
Hedge funds continue to be a strong piece of a diversified portfolio, even after their growth rates moderated from the double-digit pace during the bear market early this decade. Despite declining 0.60% in June the Greenwich-Van Global Hedge Fund Index of portfolio values has grown 5.5% so far this year.
Mr. Lane said the new hedge fund of funds would be attractive to large institutional clients, endowments, foundations, small colleges, and registered investment advisers.
