The mutual fund industry has been very profitable. In 1992 the 10 publicly traded mutual fund management companies averaged a 23% return on equity. But remember, these companies are well-established and large. In fact, only four families of bank-sponsored funds are larger than the smallest of these 10 publicly traded management companies.

And mutual fund industry profitability is highly dependent on economies of scale. The largest of these publicly traded companies posted a 31% return on equity; the smallest, just 17%.

A Different League

It is an industry increasingly dominated by a few giant national (international, in some cases) companies. The top five fund companies - Fidelity, Merrill, Vanguard, Franklin/Templeton, and Capital Research - account for over 30% of industry assets.

Another way to think about this: The top-ranked company manages more mutual fund assets than all bank-sponsored mutual funds combined.

The industry is beginning to show unmistakable signs of maturity - for example, price competition. There are many fund sponsors subsidizing expenses of their mutual funds to zero - actually paying all of a fund's expenses. In effect, the sponsor is "not only working for free, they are paying for the privilege."

Another sign of the maturing of the market is product proliferation. There are now more mutual funds - nearly 5,500 - than there are stocks listed on the New York Stock Exchange, and virtually every investment category is becoming increasingly crowded.

Too Late for |Unique' Products

In 1993, over 200 new bond funds have been introduced - about one each day. The proliferation of products has removed a major way for new entrants to compete - i.e., by introducing a "unique" new product.

Banks cannot be serious about competing without a full product line to diversify customers' investments.

Historically the mutual fund business did not require substantial capital - one of its great attractions. That is changing. In the broker-distributed channel, back-end load funds (so-called B-shares) are becoming increasingly popular.

These shares do not charge customers when they purchase the fund, but they do pay the broker for selling them. The sponsor "fronts" the money, then recovers it from the fund over time. This requires significant capital - every $100 million of sales requires $4 million to pay, commissions.

The No-Load Route

If a bank chooses to direct-market - i.e., compete as a no-load fund group - then there is a substantial investment in advertising, and the need for a very well-staffed and sophisticated customer service center.

The industry has developed a series of national brand names, supported by huge national advertising and promotional budgets. This is a significant challenge for the banks - despite their local strengths, there are no truly nationwide banks. There is very little evidence from the mutual fund industry that a regional mutual fund firm can be successful.

L. William Seidman, former chairman of the Federal Deposit Insurance Corp., says banks in mutual funds face formidable challenges. He outlined them in a recent speech at an American Banker conference in New York. Excerpts of his text follow.

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