Picture this: It's 1995, and you wander into your local bank branch. You're a first-time investor and keen on buying a mutual fund, an asset class that's getting a lot of attention.
The problem is that the branch's investment planner is in only one day a week and, well, the bank can't sell you that Fidelity U.S. equity fund you heard so much about anyway. Your question about asset allocation is greeted with a puzzled look from the teller. Wouldn't you rather just buy a guaranteed investment certificate?
It's hard to believe, but only 10 years ago the Big Six banks were on the sidelines of the mutual fund business, the hottest investment vehicle of the 1990s. While the banks stumbled along extolling the virtues of mortgage and money market funds, aggressive independent firms with more innovative funds such as Trimark Investment Management Inc. and AIC Ltd. grew exponentially and Investors Group found people are willing to pay a premium to get financial advice.
Ten years later, the shoe is on the other foot. The giants of Bay Street have transformed themselves and today oversee a staggering $200-billion in fund assets under management, up from about $36-billion nine years ago. The banks' market share has climbed to 36 per cent of the pie today from 24 per cent in 1996.
How did they do it? The big banks took their cues from the competition. First, they improved their fund offerings by finding good talent and broadening their product mix via partnerships and strategic acquisitions. Second, the banks realized funds were sold, not bought, and wider distribution was key to growth. The road to success was finding a way to sell to investment advisers and let them worry about selling to investors.
"It didn't happen overnight," said Karen Fisher, managing director and head of mutual funds and the managed asset group at Bank of Nova Scotia. The banking sector has undergone a "slow creep" to success built on fund performance, training and distribution, she said.
In 2005, it's the banks that are dictating the terms of engagement. In particular, the fund heavyweights among the banks -- Royal Bank of Canada, Toronto-Dominion Bank and Bank of Montreal -- have become the industry's leaders. Banks are flexing their muscles as never before and will be hard to dislodge from the winner's circle.
"We're not just about beating the other banks. It's about beating the whole industry," said Rob MacLellan, chairman of TD Asset Management Inc. and executive vice-president and chief investment officer of Toronto-Dominion Bank.
Banks were reluctant mutual fund sellers in the 1990s. There was a widely held view that funds cannibalized their historically strong trade in GICs. More importantly, banks were hesitant to enter the business of providing financial advice. Banks sold a limited number of "no-load" funds, an in-house managed fund sold to the customer with no additional fees or costs.
Distinct buying patterns emerged, with sales spiking during registered retirement savings plan season and then falling into redemptions for the rest of the year.
The problem was the banks' customers felt no loyalty to the no-load model. While banks assumed clients would embrace a lower fee, market trends showed investors were willing to pay more when financial advice was part of the package.
"We were selling a number of funds but we were also losing a fair number of customers because we had not developed the advice capability we have today," said Brenda Vince, president of RBC Asset Management Inc.
In contrast, Investors Group was the top-selling fund company year after year through the nineties. The achievement hinged on the Winnipeg company's industry-leading ability to retain clients because it had a dedicated team of financial planners.
Financial advice, good or bad, is an "umbilical cord that doesn't cut very easily . . . it's very captive money," one former bank executive said.
A long list of upstarts and niche players feasted on the banks' shortcomings. While the banks hocked plain-vanilla money market and equity funds, spry independents made the most of red-hot niche markets. AIC, Altamira Investment Services Inc. and Fidelity Investments Canada Ltd. saw their assets under management soar as they fed the market's appetite for mining, financial services, U.S. and foreign market mutual funds.
"I miss the time when banks were an easy target. It was so nice to steal their assets -- they had no idea what they were doing, but that's all changed," said Joe Canavan, chairman and chief executive officer of financial advice giant Assante Corp.
Just how much things have changed is well illustrated by the TD Canadian Bond Fund, a fund that had humble beginnings 17 years ago.
Fresh out of school, math whiz Satish Rai joined TD as a level one computer programmer in 1986. The University of Waterloo graduate had a flair for the markets and begged for a job in TD's investment group, a seven-member team sharing a single office.
Mr. Rai began working on the new bond fund, building a record of solid returns and earning a string of industry awards. The fund's following grew and its assets under management crept past the $100-million level in 1993 and by 1998, they had surpassed the $1-billion mark.
Two-thousand was the watershed year when a series of events transformed the bond fund, TD and the bank's role in the fund business.
First, TD sewed up its acquisition of Canada Trust, a deal that provided "a whole new level of distribution," Mr. Rai said. Fund assets under management swelled to $29.8-billion. BMO, National Bank of Canada and Canadian Imperial Bank of Commerce did strategic fund deals too, but none had the impact of the TD-Canada Trust merger.
Then, TD made a radical decision to overhaul its sales chain. In an ambitious move, TD became the first bank to begin courting sales channels beyond its 1,100-strong branch network, first through brokerage TD Waterhouse Group Inc. and then selling bank-branded funds through independent advice channels such as Assante, Berkshire Group of Cos. and Dundee Wealth Management.
The carrot for advisers was a higher management fee. In a bank branch, customers pay an annual management expense ratio of 1.07 per cent for Mr. Rai's TD bond fund; in 2000, the bank began marketing an adviser series with a bond fund MER of 1.39 per cent. The net result? Higher costs for the customer and a 32 basis point sweetener for advisers. Today, the TD bond fund has sales relationships with about 4,000 advisers from coast to coast.
"The banks are getting a lot of advisers on board." said Michael Morrow, a Thunder Bay financial adviser.
Meanwhile, TD and the rest of the bank sector began an intense training program. Thousands of bank employees received financial planning designations and now sell mutual funds. Combined, the banks' fund sales force is a staggering 36,000, about half the entire adviser membership of the Mutual Fund Dealers Association of Canada. The growth curve is stunning; several banks interviewed said it's hard to get a good count of their disparate sales teams of 10 years ago.
The chief tool in the banks' arsenal is the so-called "wrap" account, a blended pool of mutual funds that, paradoxically, provides a customized solution in a one-size-fits-all format. Wraps have become the success story of the business. Currently, more than $90-billion is invested in high-end and mass-market wrap accounts, up from about $52-billion five years ago, according to consulting firm Investor Economics. About 23 per cent of all funds sales last year were funds in wraps, market share that will leap to 43 per cent by 2014, IE forecasts.
While Franklin Templeton Investments Corp., AIM Funds Management Inc. and others have enjoyed some success selling proprietary wraps of their own, the cross-selling power of the banks has given them a commanding lead. For example, TD's FundSmart wrap comprised of TD funds oversees $7.2-billion in assets under management; in comparison, Franklin Templeton well-regarded Quotential wrap is $3.9-billion.
"There is no question that one of the things that has fuelled the strong success that the banks have had over the last couple of years has been . . . one-stop shopping fund of funds programs," said Dan Richards, a Toronto fund marketing consultant.
Mr. Rai's fund has ridden the wrap wave, too. The TD bond fund is a cornerstone of TD's FundSmart and two smaller wrap series that combined manage a total of $10.5-billion. The bond fund's assets under management have soared from $1.3-billion in 2000 to $6.3-billion today.
TD, along with its banking rivals, has expanded its in-house expertise from its fixed income base to include Canadian equities, balanced and income funds. It has hired a well-regarded list of external advisers to manage TD's foreign funds too, including Morgan Stanley and Oppenheimer & Co. Inc. The bank's investment team has outgrown its single-office digs; more than 100 investment professionals now occupy two floors in Toronto's BCE Place.
To say the banks' rise to power has put many independent and foreign-owned fund companies on the defensive would be understatement. When it comes to competition, banks have the bigger team, they own the ball and guess what? They get to set the rules too.
"It's harder and harder for people to compete with the banks . . . but you have to play ball," said the head of one independent fund company. Several fund companies contacted declined to comment on their relationships with the banking sector.
Independent and foreign firms covet what the industry calls "shelf space," that is, making a bank's recommended sales list and gaining access to the branch network and affiliated brokerage. The problem is that third-party fund sales make up a tiny piece of the sales pie, especially at RBC, BMO and TD. Banks have ramped up their fund management skills and, in many assets classes, can now offer a competitive alternative to a third-party fund.
As a result, many fund companies are focusing their energies on the wrap market. The banks each offer third-party wraps that include a mix of funds managed by Fidelity, Mackenzie Financial Corp. and others. The catch is that the fee structure for the outside firms is dramatically reduced. Banks pay the fund manufacturer an institutional rate, a closely guarded fee that can be as little as half the MER paid by a client to an adviser.
In fact, independent fund companies are "chasing" the banks for a bigger slice of the less lucrative wrap trade to secure market share, said Edgar Legzdins, president and CEO of BMO Investments Inc.
It's a profit squeeze for many mid-tier players struggling to end many months of redemptions in retail accounts, a list that includes Fidelity and AGF Management Ltd. Even juggernaut CI Fund Management Inc., Canada's third-largest fund firm, must cut deals to gain access to the bank's captive client base.
"The bank business we get is very good business. Would I like it to a be a higher-margin business? I'd like everything to be a higher-margin business," CI CEO Bill Holland said.
Industry-wide, however, there is some consensus. Banks, along with independent and foreign firms alike, believe further consolidation is inevitable. No one is betting the banks will be the sellers.
"We won't stand still," said Bill Hatanaka, executive vice-president of wealth management at TD. "We won't become complacent for even a short moment."
How the big banks got their fund game back
In the mid '90s, the banks were upstaged by independent mutual fund companies. Then they woke up and stole a page from their rivals' book. Nine years later, their assets under administration are up
and they have boosted market share by
52 per cent
The size of the Canadian mutual fund pie has grown sharply in nine years, but the banks' share has grown even faster
Total fund assets: $153.5-billion
Total fund assets: $554.5-billion
© 2007 The Globe and Mail. All rights reserved.
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