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Get Four
|  | JUNE 24, 2005
By Mara Der Hovanesian Citi Gets a Legg UpA $3.7 billion asset swap with Legg Mason may be the first sign that banks are turning their backs on the mutual-funds businessAre big investment and commercial banks about to sell their mutual-fund units en masse? The long-standing theory that banks -- and even some mutual-fund complexes -- would eventually rethink and exit the money-management business gained traction June 24, when Citigroup (C ) announced it would trade almost all of that operation to Baltimore's Legg Mason (LM ) in a a $3.7 deal. The deal will make Citi, the world's largest financial-services outfit, the No. 2 brokerage behind Merrill Lynch (MER ), with its 14,100 employees. Citi's asset-management group, which oversees $460 billion, will double Legg Mason's assets under management overnight, making it the fifth-largest U.S. money manager. STRATEGIC SHIFT. The deal rekindles the debate among analysts and consultants over whether the multibillion dollar mutual-fund enterprises of big banks are worth the trouble of keeping -- and if not, whether mergers and acquisitions will begin to pick up. The initial market reaction was tinged with skepticism. Punk, Ziegel & Co. analyst Richard Bove wrote in a recent report that such a deal would hurt Citi and be a bonanza for Legg Mason: "Selling a business that has an attractive long-term outlook to obtain a business that has a clouded future would be simply wrong." GimmieCredit's Kathleen Bochman agrees. She was "surprised when I first heard the rumors, because asset management in general is such an attractive, low-capital business." Still, the asset-management business at Citi boasted only a 13% return on invested capital. While that figure may strike average investors as substantial, it remains "much lower than some of [Citi's] other businesses," Bochman explains, adding that the Legg deal would mesh with Citi's strategy "over the last year or so, as it has sold off low-return businesses." It wasn't so long ago that the decision to get into the asset-management and mutual-fund businesses was a no-brainer for banks -- in part because they build relationships in other corners of a bank's empire, such as retirement planning and retail banking. Also, a generation of aging baby boomers promised continued growth, and asset management provided a cushion for the up-and-down business cycles of investment and commercial banking. NO TAKERS. So banks invested heavily in building their asset-management infrastructures and talent. During the market boom, banks and other big players displayed a voracious appetite for money management, with a record-breaking $1 trillion in assets under management in 2000, according to investment bank Freeman & Co. These days, the market's offerings have hardly drawn a nibble: Last year, Merrill Lynch put its asset-management unit on the block for a few months, but received no decent offers. While some think Morgan Stanley (MWD ) should shed its fund unit to get back to the basics of investment banking, it is holding on to it for now. Insurer Marsh & McLennan (MMC ) may consider unloading its Putnam fund unit to raise cash, but buyers may be hard to come by. There are a handful of reasons why asset-management deals have been so few and far between. For one thing, there is is the disincentive of regulatory compliance, now more onerous than ever. Virtually scandal-free until a few years ago, bank-run funds have been under attack for poor governance standards, for improperly fueling gains with IPOs, and for giving hedge funds preferential treatment by allowing them to trade afterhours. DIMINISHED EXPECTATIONS. Consider that Fleet, Bank of America (BAC ), Bank One (ONE ), and Citigroup bank funds were among those most often mentioned in the headlines during the timing and afterhours trading scandals. "Regulator scrutiny in the industry has brought about concerns about reputation and brand risk," says Kevin Quirk, principal of Casey, Quirk & Assoc., a financial-services consultancy. "Now you have to figure in those costs, which can be pretty dramatic. So you're nervous about owning this asset-management business." Bank executives also have discovered that, despite their initial expectations, mutual-fund fees don't have much of a stabilizing impact on earnings. Instead, they ebb and flow with assets and the fortunes of the stock market. Moreover, funds don't generate transaction fees like investment banking -- and unlike retail or commercial banking, there are few benefits to scale. The bigger funds get, the worse their performance often becomes. Since manager compensation rises in line with revenues, there is no margin expansion. For all these reasons, some banks may fast be coming to the conclusion that they're better off selling the investment-management products of others, rather than worrying about the care and feeding of a team of in-house asset managers. Indeed, Citi's strategy is to move towards more distribution of financial products, even though the brokerage business is inherently more volatile than asset management.
BW MALL
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