Goldman Sachs Asset Management says it plans to expand its mutual fund business by acquiring small fund families from banks looking to quit the proprietary fund business.
The New York financial services company last year announced the purchase of one bank-owned fund family and a definitive agreement for another. James McNamara, a managing director and the head of third-party distribution at Goldman Sachs, said it is looking to buy "subscale" fund families, those with less than $5 billion of assets under management.
"There are a number of small banks that are carefully considering whether they want to be a proprietary mutual fund manager anymore or if they would rather go to an open architecture model," he said.
Mr. McNamara said that buying small bank-owned fund families serves two purposes for Goldman: increasing the size of its mutual fund business, which had $99.12 billion of assets under management at Dec. 31, and developing distribution relationships with the small banks.
Since Goldman began this initiative in the first quarter of last year, executives at the company have spoken with dozens of banks, Mr. McNamara said. In July, Goldman announced its first deal, for six of the seven Golden Oaks funds owned by Citizens Bank in Flint, Mich. About $400 million of the $465 million of assets in the Golden Oaks portfolios were merged into Goldman Sachs funds.
The company made its second deal in November when, in a filing with the Securities and Exchange Commission, it announced a purchase agreement for Compass Bank's Expedition Funds. The family had six portfolios, with $1.1 billion of assets under management at Oct. 6, according to the filing.
Goldman merged the six Golden Oaks portfolios into comparable Goldman-managed funds after the deal closed in October. Mr. McNamara could not discuss whether the Compass Bank funds would be liquidated or merged because the company is in a quiet period pending closing of the deal this month or early in February.
Mr. McNamara said he is confident that increased regulatory scrutiny and the expense of running a fund family will prompt more small and midsize banks to leave the proprietary fund business this year.
"We want to do more deals in 2005 than we did in 2004, and we intend to do so," he said. "It is hard to put a number on what we expect, but it is really a robust pipeline."
Jim Schmelter, the president and chief executive officer of Citizens Bank Wealth Management, said it decided to sell the Golden Oaks portfolios because the fund family never reached a competitive critical mass.
"We didn't have the distribution network necessary, and we knew we had to get out of the business," he said. "But what really made us get it done at this point in time was the increased regulatory rules coming into effect."
New SEC regulations would have required additional infrastructure, Mr. Schmelter said, and the $7.7 billion-asset parent bank would have had to hire people, including a chief compliance officer, to fully comply.
Other financial services companies have also started gobbling up fund families from small and midsize banks. Federated Investors Inc. added $774 million of assets under management when it bought fund units during the past two years from FirstMerit Corp. in Akron, Ohio, and Riggs National Corp. in Washington, as well as the seventh fund portfolio of Citizens Banking Corp. in Flint. And in August it made a deal for Banknorth Group's $265.5 million-asset fund family.
J. Christopher Donahue, Federated's president and chief executive officer, has said his Pittsburgh company has more deals in the pipeline and that it does them in part to maintain distribution relationships with banking companies that want to get out of proprietary fund management but remain in the wealth management business.
"This is an accelerating trend," he said.
William W. Reid Jr., the president and chief executive officer of ICBA Financial Services, the investment management arm of Independent Community Bankers of America, said very few community banks run proprietary fund units and that rising costs will drive more midsize banks out of this business.
"With the new compliance requirements, many midsize banks will face profit pressures unless they have substantial assets in their fund complex," he said. "Midsize banks will have to weigh whether the profit is worth the expenditures of resources, personnel, and dollars that are needed to meet the compliance requirements."
Mr. Reid said the disappearance of smaller fund groups and the corresponding growth of the largest families could prompt concern about limiting the choices available.
"With as many funds as are out there, we have not reached that dangerous threshold yet, but if the current pace of regulatory change continues, then we may face that someday," he said. "But there are plenty of choices still for consumers today."
Financial Research Corp. has forecast a 14% increase in costs industrywide and a 10% decline in revenues due to tighter fund regulation. The Boston research company has said it expects profit margins to fall 17 percentage points, to 19% by Dec. 31, 2005, from their level at the end of 2002.
Goldman's Mr. McNamara agreed that rising costs and lower revenues have driven small banks away from asset management. "These companies haven't seen the growth in these complexes the way that they expected," he said. "They haven't seen the growth that they had hoped for, and given the current environment and the expectation from investors, they want to offer best-in-class products and services to their investors."
Mr. McNamara said Goldman is interested in making these deals in order to develop scale in its mutual fund business. Since yearend 2002, the asset management unit has been reporting outflows - 4.3% of mutual fund assets, to $99.12 billion.
Mr. McNamara said that an improving market and the strategy of buying small fund complexes make him confident that Goldman's fund assets under management will grow this year.
"This trend and this growth will accelerate in 2005," he said. "We are looking at opportunities to acquire across the board. We are interested in acquiring any fund family from a firm that is interested in changing its strategy to go to open architecture."
