Money Magnet: Mutual Funds

Last month, when an estimated $400 billion in certificates of deposit matured, banks were able to capture a significant portion of the funds that were not rolled over into new CDs. The reason? A newly successful product on the banking scene: mutual funds.

For the several thousand banks that offer them, mutual funds are hot, hot, hot. Since interest rates are falling, more customers are moving their investments to mutual funds, where returns are normally higher than on a savings or money market account.

In 1990, investments in all mutual funds broke the $1 trillion mark. It's too early to determine how much of the new money flowed into banks, but one thing is for sure. Banks would like to capture more.

Hopes Dim for New Powers

For now, it looks as though banks' hopes to get increased powers to underwrite and sell mutual funds directly are dashed. With the legislative clock ticking down, Congress is expected to pass a much narrower banking bill than the industry wanted, excluding power to run mutual funds.

Nevertheless, banks can and do act as investment advisers, meaning they can manage the funds and sell them through subsidiaries. These funds, known as proprietary bank funds, are offered by 112 U.S. banks, according to Lipper Analytical Securities Corp. Total assets of these funds currently stand at about $113.2 billion.

And many small and medium-sized banks have forged ties with third-party broker-dealers, through which banks can offer nonproprietary mutual fund products to their customers. Through third-party brokers, banks can get their customers into just about any mutual fund in the country.

Both Expected to Grow

Both proprietary and third-party mutual funds are expected to continue as a growth businesses for banks, primarily because customers want them. They know that investing for the long term through CDs alone just will not do. And that point is being driven home especially hard in this era of low interest rates.

"A bank must ask itself whether it is going to let a consumer walk across the street to a brokerage firm or do something about it," said D. Mark Olson, president and chief executive officer of Invest Financial Corp., Tampa, Fla. "Particularly now, with rates plummeting, the question is not whether funds are going to be [purchased] but where."

Banks, even without added legislative powers, are the envy of the securities industry, which has fought long and hard to keep them out of their business.

"Banks have an edge, in that they have hundreds of customers who don't trust securities brokers but do trust banks," said Joy Montgomery, executive vice president of New York-based SunAmerica Asset Management, and former managing partner of Money Marketing Initiative, a consulting firm specializing in bank mutual funds. "These customers want mutual funds, and they want to keep their money with a bank."

What's more, banks have an extensive retail network through which funds can be sold.

Barnett Banks Inc. of Jacksonville, Fla., rolled out its Emerald family of six mutual funds Nov. 1 through its 550-plus branch network.

"Not a whole lot of banks offer funds through their retail system," said Barnett spokesman Robert Stickler. "We're doing it as a way to enhance our service to our customers and, of course, to enhance our fee income."

Chase Manhattan Corp., which has offered its Vista family of mutual funds through bank trust operations since 1983, rolled out a new program in June through which it will sell the funds and other nontraditional investment services in about 300 branches.

While big banks like Barnett and Chase may have the where-withal to offer proprietary funds, it's not so easy for small and medium-sized banks.

"The big banks will all take a foray into manufacturing their own family of mutual funds," predicted Mr. Olson of Invest Financial. "But banks with $20 billion in size and down aren't likely to have enough capital or the appetite to run the funds."

To begin with, about $25 million in assets is needed "just to be able to open your doors," according to Miriam Allison, a former trust banker who founded Sunstone Financial Group, Inc., a Milwaukee-based consulting company.

Profit Threshold

Once open, the industry rule of thumb holds, a fund must hit $100 million in assets becoming profitable, although this varies depending on the type of fund and the fund family's structure.

Melanie L. Fein, a partner in the Washington law firm Arnold & Porter and a former senior counsel to the Board of Governors of the Federal Reserve System, suggested that banks cosider the followig three factors before they consider developing a proprietary mutual fund:

* A market analysis should determine whether the bank is indeed losing deposits to mutual funds.

* The bank should determine whether it has sufficient investment expertise among its staff to offer a competitive mutual fund.

* The bank must determine whether the mutual fund can ultimately generate enough fee income to justify it.

Typically, said Ms. Fein, banks don't cover expenses during the first year or so. "These days, many banks don't have the capital to invest in a start-up product," she said.

"Proprietary funds are not for every bank," agreed Ms. Allison. "Banks' ability to seed their mutual fund portfolios with sufficient assets to make them economically feasible in a short period of time is a necessity."

One way this can be done is to convert some or all of a bank's trust department assets into a proprietary mutual fund. Clearly, to earn substantial profits, banks must reach critical mass in terms of asset size.

"In this country, more is definitely better," she said. "As the assets of the funds grow, fixed costs are spread over a larger base, which allows the investment adviser to earn a greater amount for investment management while maintaining a competitive expense ratio."

PHOTO : Ten Biggest Funds

PHOTO : Best-Performing Money Market Funds [Tabular Data Omitted]

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