Banks Discover Money Management Again as Trading Declines
Global banks, forced by regulators to reduce their dependence on profits from high-risk trading, have rediscovered the appeal of the mundane business of managing money for clients.
Deutsche Bank AG (DBK) is now counting on the fund unit it failed to sell to help boost return on equity, a measure of profitability. UBS AG (UBSN) is paring investment banking as it focuses on overseeing assets for wealthy clients. Goldman Sachs Group Inc. (GS), JPMorgan Chase & Co. (JPM) and Wells Fargo & Co. (WFC), three of the five biggest U.S. banks, are considering expanding asset-management divisions as they seek to grab market share from fund companies such as Fidelity Investments.
“Asset management is a terrific business,” said Ralph Schlosstein, chief executive officer of Evercore Partners Inc., a New York-based boutique investment bank that last month agreed to buy wealth manager Mt. Eden Investment Advisors LLC. “Asset managers earn fees consistently without risking capital. Compare that to other businesses in the financial services.”
Banks will need to overcome the perception that they sometimes push their own funds and improve their middle-of-the-pack performance as money managers if they want to attract assets from investors. Goldman Sachs’s stock and bond mutual funds have trailed about 61 percent of their respective peers on average over the five years ended Sept. 30, and about 52 percent over the past three years, according to data from Morningstar Inc. in Chicago. JPMorgan’s mutual funds have been beaten by 42 percent of rivals over the past five years, while Wells Fargo’s have lagged behind 44 percent, the Morningstar data show.
Even if banks attract new clients, a renewed focus on asset management may not mitigate the full impact of Basel III capital requirements that will cut into profits firms made from leveraged trading. It probably won’t make up for revenue lost to the pending Volcker rule, which curbs lenders receiving federal support from trading for their own accounts.
Still, money management has advantages. It doesn’t require a lot of capital, and the investment risks are borne by clients. Unlike businesses such as trading, where results can be volatile, funds produce steady fees based on assets under management. The Standard & Poor’s index of asset managers and custody banks has a return on equity of 13.1 percent.
That compares with an average return on equity of 8.3 percent for the 24 firms in the KBW Bank Index (BKX), half of what it was in 2006 before the onset of the credit crisis, according to data compiled by Bloomberg.
“It’s not hard to see the appeal of asset management,” Neel Kashkari, a former Goldman Sachs investment banker who now heads global equities at Pacific Investment Management Co., said in an interview. “But some banks have struggled in the business because of a short-term view.”
As recently as 2000, brokers, banks and insurers dominated the rankings of global asset-management firms, accounting for six of the top 10 spots based on assets, according to data from trade publication Pensions & Investments. Today, they hold four of those positions as the balance shifted to BlackRock Inc. (BLK), Vanguard Group Inc. and Fidelity. The four banks and insurance companies on the list collectively have about $5.5 trillion in assets compared with more than $11 trillion for the rest.
The decline reflects a combination of poor performance, the rise of mutual-fund sales through fee-only independent advisers rather than bank-owned brokerages and the impact of a mutual-fund trading scandal uncovered by then-New York Attorney General Eliot Spitzer in 2003. The inquiries into improper trading led to increased regulation, raised operating costs and resulted in more than $4 billion in penalties to firms including Bank of America Corp. (BAC), Merrill Lynch & Co. and Citigroup Inc. (C)
“Culturally, asset managers have not been a good fit within banks,” said Jay Horgen, chief financial officer of Affiliated Managers Group Inc. (AMG), a Beverly, Massachusetts-based firm that holds stakes in more than two dozen money managers. “It’s a business model that requires an investment structure which recognizes value creation and operates across generations of existing and future partners, and banks just don’t have that in their tool kit.”
Citigroup got out of the money-management business in 2005 after selling its unit to Baltimore-based Legg Mason Inc. (LM), as former CEO Charles “Chuck” O. Prince changed the strategy put in place by his predecessor, Sanford “Sandy” I. Weill.
Merrill Lynch sold its money-management unit to BlackRock in 2006 as the bond shop founded by Laurence D. Fink diversified into stocks. BlackRock became the world’s largest asset manager three years later, when it acquired the investment unit of Barclays Plc (BARC) as the London-based bank sought to bolster capital after avoiding a government bailout during the credit crisis.
The 2007-to-2009 crisis, which froze credit and led to the bankruptcy of Lehman Brothers Holdings Inc., increased pressure on banks to raise capital by selling businesses.
Credit Suisse Group AG (CSGN), Switzerland’s second-biggest bank, agreed in 2008 to sell part of its traditional fund business to Aberdeen Asset Management Plc, while keeping its hedge-fund unit. The bank’s asset management division had 163.4 billion Swiss francs ($176.3 billion) in traditional investments at the end of last quarter, and 205.1 billion francs in alternative assets such as hedge funds, private equity, real estate, credit and index strategies.
In August, Societe Generale SA (GLE), France’s second-largest bank by market value, sold money manager TCW to its management and Carlyle Group LP in a deal valued at $700 million to $800 million, people familiar with the matter said at the time.
Amid the disposals, banks were coping with record-low interest rates in the U.S. and Europe, higher capital requirements under rules adopted by the Basel Committee on Banking Supervision and the 2010 Dodd-Frank overhaul of financial regulations, which limits income from trading.
The net interest margin, the difference between what the lenders pay for deposits and charge for loans, dropped to 3.26 percent in the third quarter of 2012, from 3.85 percent in the first three months of 2010 at U.S. banks with more than $15 billion in assets, Federal Reserve data show. Investment-banking and trading revenue at the 10 largest global investment banks fell at least 17 percent in each of the past two years and was up 3.3 percent in the first nine months of 2012, according to data from industry analytics firm Coalition Ltd.
As trading and investment banking slumped, managing investor money accounted for a greater percentage of fees. The median share of net revenue generated by asset and wealth management for a group of banks increased to 28 percent in 2012 from 23 percent five years ago, according to Johnson Associates Inc., a New York-based consultant. The share contributed by trading declined to 43 percent from 49 percent over the period, and investment banking fell to 14 percent from 15 percent.
Asset managers typically manage money for clients in comingled pools such as mutual funds, exchange-traded funds and private portfolios. Wealth management caters to rich individuals and involves a range of services including asset allocation, tax planning and estate planning.
Companies that operate networks of financial advisers, such as banks and brokerages, have run afoul of regulators in the past over conflicts of interest related to the sales of some mutual funds. While these advisers, unlike registered investment advisers, don’t have a legal duty to act in the best interest of their clients, regulators have punished companies for pushing the sales of proprietary funds, or funds that generate more revenue for the firm.
Shareholders have rewarded banks that held onto money-management units while punishing firms that didn’t. JPMorgan and Goldman Sachs, which expanded its businesses, are the two best performers in the 10-member Bloomberg Industries Global Investment Banks index over the past five years. Citigroup and Bank of America, which agreed to sell Columbia Management Group in 2009, were among the worst.
“Having an asset-management division is a huge plus when I’m investing in a financial company,” said David Herro, the Chicago-based manager of the $10 billion Oakmark International Fund. (OAKIX) “This is a stable and steady cash-flow item.”
Oakmark International, which has beaten 98 percent of its peers over the past five years, holds shares of Credit Suisse and Allianz SE, the German insurer that owns Pimco.
Credit Suisse is seeking to expand in hedge funds and vehicles that invest money in liquid assets such as stocks and bonds while paring private equity.
Deutsche Bank co-CEO Anshu Jain initiated a review of asset management last year after Germany’s largest lender was told by the European Banking Authority that it needed to raise capital. In September, after negotiations to sell the unit to Guggenheim Partners LLC collapsed, Jain said it would make more sense to turn the business around. The bank seeks to double profit at the unit by 2015. Deutsche Bank, which combined asset and wealth management in June, named a senior leadership team for the division under Michele Faissola on Sept. 17.
“This is one of the toughest management challenges and largest turnarounds that we have,” Jain, 49, said in an interview in September. “Michele is very much being entrusted with a critical mission for us.”
In the U.S., where the pressure to sell assets has abated, the share of banks’ revenue generated by money management has increased. At Goldman Sachs, money management accounted for 14.9 percent of net revenue in the first nine months of 2012 compared with 11.5 percent in the same period two years ago, according to company filings. Trading revenue at the New York-based firm was 55 percent of net revenue, down from 59 percent.
“Being in the cyclical business we’re in, there will never be a normalized proportion between asset management, investment banking and sales and trading,” Goldman Sachs President Gary D. Cohn said at an industry conference in May. “We have continued to really allocate or over-allocate resources into the banking business, into the asset-management business, understanding that those are our businesses that take a lot less equity capital.”
In May, Goldman Sachs acquired Dwight Asset Management, a $17 billion stable-value fund manager. Last December it agreed to buy a dividend mutual fund from Dividend Growth Advisors LLC. The bank wants to grow assets by boosting fund performance, which is its priority, Eric Lane and Timothy O’Neill, co-heads of Goldman Sachs Asset Management, said in an interview.
“This is a business with consistent and recurring base fees,” O’Neill said. “We have a strong preference to grow organically, but we’ll look at bolt-on acquisitions where we can add opportunistically to our products.”
JPMorgan, which last year became the first bank to crack the list of 10 largest U.S. stock and bond mutual-fund managers after more than doubling long-term assets since 2008, planned to spend more money on sales and marketing this year. Mary Erdoes, head of the New York-based firm’s $1.4 trillion asset-management division, described it in February as a “real gem” and said JPMorgan has “heavily invested in this business in order to set ourselves up for much future growth in the years to come.”
Wells Fargo, which a year ago agreed to buy Everkey Global Partners, an institutional money manager, is considering filling gaps in its product offerings in alternative-investment funds, small-cap stocks and European equity, said Mike Niedermeyer, who oversees the $450 billion unit.
“Acquisitions are attractive not because we’re trying to get scale, but because we are trying to get a fit,” Niedermeyer said in an interview. “Our focus will be on adding product quality or product depth.”
Still, assets overseen by the industry globally have changed little over the past five years and are about $58.3 trillion, compared with $58.8 trillion in 2007, according to a September study by Boston Consulting Group. As investors have turned away from stock funds, they’ve deposited about $1 trillion into fixed income since 2007, according to data from the Investment Company Institute.
Most money is going to passively managed products, largely those that track indexes, and top-performing funds. That’s going to pose a challenge for banks seeking to expand.
“A great portion of our success will be through generating investment performance,” said Lane, the co-head of Goldman Sachs’s asset-management unit, which has amassed $856 billion.
The company’s performance has improved this year, with its mutual funds beating 62 percent of peers through Sept. 30, according to Morningstar data. About 80 percent of the bank’s total U.S. mutual-fund assets are in funds ranked by Morningstar in the top half through the first six months of the year, the firm said. The figure is 63 percent for performance over three years and 53 percent over five years.
Investors still pulled $1.6 billion from the Goldman Sachs mutual funds. That compares with $23 billion in deposits that they’ve given to JPMorgan in the same period, the data show.
JPMorgan, the largest U.S. bank by assets, has been the most successful of its peers in attracting money to its investment unit, despite returns lower than Goldman Sachs’s. That’s partly because New York-based JPMorgan has courted financial advisers and opened hedge-fund-like products that appealed to investors fleeing stock funds. The company also invested in the business as others pulled back.
JPMorgan’s mutual funds have beaten 53 percent of their respective peers this year, the Morningstar data show.
Wells Fargo’s mutual funds have attracted $4.8 billion this year through the end of September while beating about half of their peers, according to Morningstar. The San Francisco-based lender, owner of the biggest U.S. branch network, is adding foreign stock and bond strategies as part of a plan to double assets by 2020. The bank has added six funds in Luxembourg to the seven already there and is adding staff in the region, according to Niedermeyer.
“This is going to be among the most important growth areas as we see an aging demographic buying investment solutions,” Niedermeyer said.
In Europe, financial companies in a position to hold onto investment units are citing their importance to the total business. Sergio Ermotti, promoted to CEO of Zurich-based UBS last year, said he would focus on wealth management and rely on asset management as another “key element.”
The company, rescued by the Swiss government in 2008 after its investment bank racked up subprime losses, said it plans to improve performance to lure clients to its wealth-management business, now the biggest contributor to earnings.
Deutsche Bank also will need to boost performance at its money-management unit. The asset-management division had about 16 billion euros ($20.9 billion) in net withdrawals in the first half as it was unable to pitch for clients during the sale talks and as customers shied from investments amid the debt crisis.
The Frankfurt-based bank’s DWS mutual funds in the U.S. have trailed 63 percent of peers over the past five years and about 50 percent so far this year, according to Morningstar.
The asset and wealth-management unit had a combined pretax return on equity of 13 percent last year compared with 54 percent at UBS’s wealth-management unit and 17 percent at the Swiss bank’s global asset-management unit. Deutsche Bank can only reach a goal of generating an after-tax return on equity of 12 percent or more by 2015 if the asset-management, wealth-management and global transaction-banking businesses double profit, Jain told analysts Sept. 11.
“Deutsche’s asset and wealth-management business has historically underperformed and not added a lot to profit,” said Simon Adamson, an analyst with CreditSights Ltd. in London. “It won’t be easy to convince people that Deutsche now really has a long-term strategy for the business in place.”
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