Magazine article American Banker

Mutual Funds: Key to Investment Management

Magazine article American Banker

Mutual Funds: Key to Investment Management

Article excerpt

As we near the midpoint of the decade, the trust investment area at most banking institutions is facing a critical juncture. The spotlight was first firmly focused on a department many once considered to be a "sleepy backwater" by the American Bankers Association-commissioned study conducted by Coopers & Lybrand; many read the conclusion of that report to be, "Grade up or get out."

In the ensuing period, the entry into trust facilities by mutual fund management companies, brokerage firms, and other financial institutions has shown that simply providing trust capabilities alone will no longer suffice. Lastly, the sharp decline in the percentage of major corporate pension assets managed by trust banks over the past ten years has forced those in a decision-making role to look at the future prospects for this area.

While many are taking defeatist attitude and saying that there is no way they can compete on an even footing in today's highly charged competitive atmosphere, perhaps hope exists. Some of the pieces for success are in place, while the others are easily acquirable.

Why does a fiduciary of a large pension plan, or for that matter an upscale individual investor, choose to have his assets managed by a bank? In the past, a large part of that decision centered around the "comfort" they enjoyed knowing that their monies were in the hands of a sound financial institution.

Today, while that comfort factor might yet bear some marketing strength, growing investor sophistication by both the bank's potential and existing audiences has dramatically shifted the emphasis towards relative and absolute investment performance. The Difficulties of "Grading Up"

This is where most of those with defeatiest tendencies find the "grade up or get out" choice so perplexing. Grading up at most institutions in a financial impossibility. In many cases, the very structure of that firm will not allow investment professionals functioning in that once sleepy backwater known as the trust department to earn a multiple of what senior management of the bank itself earns (base salaries for "all star" portfolio managers are now approaching -- or -- exceeding $1 million per year).

In others it is simply because cash flow, or any reasonable expectation thereof based on new business, does not warrant the type of budget which would be required to support a full-fledged research and portfolio management effort.

The alternative of closing down the trust investment area is not a palatable choice either. This function has traditionally been an integral part, even though most often not featured, of most of these institutions. Psychologically, it would be looked upon as ceding part of their raison d'etre to shut down this department, which is a hurdle few wish to face. What is the answer then? Is there any way for banking institutions to achieve competitive equality in a performance-sensitive enviroment?

Perhaps the answer is mutual funds. Mutual funds provide the necessary ingredients -- liquidity, flexibility, diversity -- for successful investing in the existing highly volatile and highly complex equity and debt markets. Yet they do not place any strain at all on the internal operating budgets of the department. If anything, as we will see later, they allow for much more compact budgets. Four Steps of Portfolio Management

Let's explore how mutual funds can efficiently be integrated into the typical trust department's investment role. For the sake of this discussion, let us look upon portfolio management as a four-step process.

Step one is the dialogue with the client to clearly define their investment objectives. Step two is the development of an asset allocation model combining client inputs with the firm's own projections of risk-reward forecasts for basic asset types. Step three is the creation of a more refined sector allocation schematic that precisely defines which sectors in the spectrum of investment alternatives will be captured in the client's portfolio at any point in time. …

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