Rising interest rates have led to meek performance in most investment portfolios, and disastrous losses in many.
But for banks aiming to grow their mutual funds, this isn't necessarily all bad news. The reason? Lagging returns can help banks transfer trust assets into mutual funds, which is a goal of many institutions.
Such transfers already have played a notable role in the growth of bank mutual fund complexes. For example, First Chicago Corp. over the next several months plans to transfer some $4 billion of trust money into mutual funds.
Comerica Inc., Detroit, added $1.3 billion to its mutual funds this year through such transfers, while Chicago's Northern Trust Co. added more than $1 billion. Other banks that have moved tens of millions to hundreds of millions of dollars this year include Bank of Hawaii, National City Corp. and NBD Bancorp.
Banks are portraying these moves as winners for both themselves and their trust customers. Banks benefit by converting portfolio management services provided to wealthy trusts into investing services they can sell to anyone through a mutual fund.
These so-called trust conversions can also build scale and breadth in banks' proprietary fund families.
The beneficiaries of a trust are supposed to gain by getting the daily share price valuations that mutual funds are required to perform, and that few trust portfolios provide.
Likewise, it is believed that mutual funds receive closer scrutiny by market researchers and securities regulators. At a minimum, mutual funds get more publicity.
But banks eager to make such conversions face a tax conundrum. That's because under current law, the transfer of assets from a trust fund into a mutual fund is a taxable event. This means unrealized gains on securities in trust portfolios are subjected to capital gains taxes when the transfer takes place.
This is despite the fact that in most of these conversions, the trusts' securities holdings are simply exchanged for mutual fund shares. The securities themselves are never sold on the open market. They end up in the mutual fund.
Trust funds consisting of employee benefit and pension assets don't have to pay these taxes, because of their tax-deferred status. But common trust funds - those set up by wealthy individuals or families - are taxed.
Banks that force their trust beneficiaries to incur such a tax just to build scale in a mutual fund can be seen as violating their fiduciary responsibility to act prudently.
For this reason, most of the trust conversions to date have been of employee benefit assets. The result? At the end of 1993, banks had some $152 million in common trust funds, according to the accounting firm KPMG Peat Marwick.
But some banks are taking advantage of this year's sluggish markets to chip away at that total. The reason is that portfolios which have been flat or down can be converted into mutual funds without a substantial capital gain, and thus without a significant tax penalty.
Among the banks to take advantage of this opportunity is Bank of Hawaii. This institution recently moved $400 million of common trust fund assets -half of its common trust funds - into four new mutual funds.
Deborah G. Patterson, a senior vice president of the bank, said interest in such moves among other banks is high.
Another incentive is that legislation many bankers had hoped would pass this year eliminating the tax penalty on conversions has died.
Rather than wait for new legislation next year, some banks are considering just charging ahead, said Kathy L. Anderson, a KPMG partner who heads the firm's mutual fund practice.
"I think quite a few banks are looking at conversions absent the enabling legislation," she said.
Ms. Anderson added that she knew of at least five banks that have done such conversions of common trust funds in the past two years.
