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Making A Buck As Banks Hook Up

Personal Business: SMART MONEY


Has merger mania among financial-services companies finally awakened your interest in the sector? Picking individual stocks at this stage is risky, since investors have bid up many banks, brokers, and insurers on expectations they'll be acquired. But consolidations should go on for years. So you may want to look at a financial-sector fund. It can offer access to an array of stocks that should benefit as industry players seek higher profits and greater efficiency by teaming up.

Of the 23 financial funds Morningstar tracks, nearly all have had market-beating returns over the past five years. The group's average return over the period is a tidy 26%, against the 23% for the Standard & Poor's 500-stock index. But not every financial fund is the same (table).

Given that much of the dealmaking has been among local lenders, you might want to pick a fund that focuses exclusively on regional banks. Fidelity Investments has one, as well as others that concentrate on home finance, insurance, consumer finance, and general financial services. An even better bet might be a diversified financial-sector fund. These funds offer the potential for higher returns, because they're likely to benefit from the next consolidation trend: mergers across industries, like Citicorp's pending marriage to Travelers Group. Regulations separating banks, brokers, and insurers are expected to break down over the next few years. "A financial-sector fund can give you a little more spice," says Tom Finucane, co-manager of John Hancock Financial Industries.

Davis Financial is another fund playing the broad consolidation theme. Three-quarters of its $800 million in assets are divided among banks, insurers, and diversified companies such as American Express and Travelers. The remainder is in stocks from other sectors, such as technology and retailing. The fund boasts a five-year average annual return of 27%. "It's nice to have a big shopping list from which to choose," says Ken Charles Feinberg, co-manager of the fund.

T. Rowe Price Financial Services and Invesco Strategic Financial Services rely more heavily on financial stocks but have different strategies. Invesco's fund features high turnover, with nearly half its assets in domestic banks and thrifts and the rest in other financial businesses. T. Rowe Price has fairly low turnover and only 28% of its assets in banks, according to Morningstar.

Diversified funds could turn out to be more volatile than pure banking funds. Commercial banking is a stable, slow-growth business with fairly predictable earnings. Brokers and fund companies, meanwhile, could take a big hit if the bull market ends. But with marriages taking place across industry lines, broader may be better in this arena.EDITED BY AMY DUNKINReturn to top


Bank Stocks Plus









*Through Apr. 27

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When it comes to financial-services funds, John Hancock is clearly the king. The firm's Regional Bank Fund (FRBAX) has returned an average of 29% a year over the past five years and accumulated $8 billion in assets, making it the largest sector fund in history. The bad news (for everyone except current investors): It's closed to new accounts.

The good news is that in March, 1996, John Hancock launched its Financial Industries Fund (FIDAX), which has a slightly broader mandate and is managed by the same team as Regional Bank. Like all Hancock funds, it is sold through a broker and has a 5% up-front sales load. Already the fund has nearly $4 billion in assets. Both financial funds have registered a stellar 52% gain in the past year.

Tom Finucane is co-manager of the Financial Services fund and works on the team that manages Regional Bank. Business Week Online Associate Editor Amey Stone recently interviewed him about the future of the financial services industry and where investors might get the best bang for their buck.Q: Does it make sense for investors to buy a financial services fund now, or is the big move in the sector already over?A: As long as an investor has a longer time horizon than a week, it certainly makes sense to invest in this sector now. I think a holding period of at least three to five years is prudent. I don't know what the next takeover will be or what the market is going to do tomorrow, but I do know in the next five years there will be more consolidation, which bodes well for the financial services industry.Q: How do the two funds differ (aside from the fact that Regional Bank is closed)?A: Brokers frequently ask me to compare the two funds. Regional Bank is a more concentrated play on consolidation between banks and thrifts. Financial Industries is a play on mergers going on across industries. A lot of the recent action out of Washington and in mergers has been across financial industries. The Financial Industries Fund includes a broad array of banks, insurance companies, brokers, REITs, and finance companies. I think a broader financial sector fund like ours can give investors a little more spice.Q: What about risk levels?A: Even though the bank fund is in a narrower sector, it has a lower beta [a measure of volatility]. Overall, it will be less volatile because bank earnings tend to be more boring and predictable than the earnings of some other financial industries. For example, if the market tanks, brokerage earnings will go down very quickly, but bank stocks won't go down as much.Q: Why are there so many mergers all of a sudden?A: Financial services mergers got started in earnest when the federal rules changed in March of '97 for how much business at bank holding companies could come from brokerage divisions. That rule change triggered the creation of BT Alex Brown, NationsBank Montgomery Securities, as well as other banks buying into the brokerage business. Now we will have more following the lead of Citicorp and Travelers, but perhaps not right way.Q: How has the deal between Citicorp and Travelers changed the landscape?A: A year ago I would have expected to see more insurance companies buying each other. This is a slow-growth industry that is ripe for consolidation.

Now that Citicorp and Travelers Group have broken the mold, I think other banks (after all, they are lemmings) will follow along. I don't think everyone is as bold and daring as John Reed and Sandy Weill in betting that the rules will change. Most will wait until they can see something happening in Washington.Q: Does that mean insurance stocks could be good buys?A: Insurance valuations in general are better than in banking. Insurance is behind banking in terms of consolidation. Of course, there are different variables and different regulations, but the insurance industry faces some of the same pressures to merge that banks face. They too have excess capacity (too many people selling insurance to too few buyers), high costs, and stiff competition. That has been good for consumers, but tough on the margins for industry. The major difference is that it is harder for insurers to cut costs than it is for banks. In insurance, a lot of costs are tied in to brokers commissions. There are a lot more fixed costs in banking that can be eliminated in a merger. With insurance, there is still going to be a commission expense.Q: What are some bank stocks that may be acquired?A: Don't ever buy a bank stock just because you think it is going to get taken over! Invest in a bank that has good fundamentals, is well run, and will do well next year, even if it doesn't get taken over.

That said, if you put up the map of the new BankAmerica (BAC), you'd see they have a few big holes to fill. Everybody is looking at banks they could buy to fill those holes so they could have coast-to-coast covered. AmSouth Bancorp (ASO), Zions Bancorp (ZION), Fleet Financial Group (FLT) all come up.

Then there is Wells Fargo (WFC). What are they going to do now that they are faced with a bigger, more formidable competitor? Everybody thinks US Bancorp (USB) would buy them. But anyone who does has an awfully steep price to pay. Right now, there are a lot of stocks with pretty big takeover premiums, which could slow the pace of mergers for a bit. There will be more deals, but I'm not so sure there are going to be more deals that will happen next week.Return to top

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