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Goldman Plans to Boost Fund Business Through Banks

Goldman Sachs Asset Management plans to expand its mutual fund business by acquiring small fund families from banks looking to quit the proprietary fund business.

The New York financial services company last year announced the purchase of one bank-owned fund family and a definitive agreement for another. James McNamara, a managing director and the head of third-party distribution at Goldman Sachs, said the firm is looking to buy "sub-scale" fund families, those with less than $5 billion of assets under management.

"There are a number of small banks that are carefully considering whether they want to be a proprietary mutual fund manager anymore or if they would rather go to an open architecture model," he said.

McNamara said that buying small bank-owned fund families serves two purposes for Goldman: increasing the size of its mutual fund business, which had $99.12 billion of assets under management at the end of last year, and developing distribution relationships with the small banks.

Since Goldman began this initiative a year ago, executives at the company have spoken with dozens of banks, McNamara said. In July, Goldman announced its first deal, for six of the seven Golden Oaks funds owned by Citizens Bank in Flint, Mich. About $400 million of the $465 million of assets in the Golden Oaks portfolios were merged into Goldman Sachs funds.

The company made its second deal in November when, through an SEC filing, it announced a purchase agreement for the Expedition Funds of Compass Bank of Philadelphia. The family had six portfolios, with $1.1 billion of assets under management as of Oct. 6, according to the filing.

Goldman merged the six Golden Oaks portfolios into comparable Goldman-managed funds after the deal closed in October. McNamara could not discuss whether the Compass Bank funds would be liquidated or merged because the company is in a quiet period pending closing of the deal this month.

McNamara said he is confident that increased regulatory scrutiny and the expense of running a fund family will prompt more small and midsize banks to leave the proprietary fund business this year. "We want to do more deals in 2005 than we did in 2004, and we intend to do so," he said. "It is hard to put a number on what we expect, but it is really a robust pipeline."

Jim Schmelter, president and chief executive officer of Citizens Bank Wealth Management, said it decided to sell the Golden Oaks portfolios because the fund family never reached a competitive critical mass. "We didn't have the distribution network necessary, and we knew we had to get out of the business," he said. "But what really made us get it done at this point in time was the increased regulatory rules coming into effect." New SEC regulations would have required additional infrastructure, Schmelter said, and the $7.7 billion-asset parent bank would have had to hire people, including a chief compliance officer, to fully comply.

Other financial service companies have also started gobbling up fund families from small and midsize banks. Federated Investors added $774 million of assets under management when it bought fund units during the past two years from FirstMerit of Akron, Ohio, and Riggs National of Washington, as well as the seventh fund portfolio of Citizens Bank. In August it made a deal for Banknorth Group's $265.5 million fund family.

J. Christopher Donahue, Federated's president and chief executive officer, has said his Pittsburgh company has more deals in the pipeline and that, like Goldman, it does them in part to maintain distribution relationships with banking companies that want to get out of proprietary fund management but remain in the wealth management business. "This is an accelerating trend," he said.

William W. Reid, Jr., president and chief executive officer of ICBA Financial Services, the investment management arm of Independent Community Bankers of America in Washington, said very few community banks run proprietary fund units and that rising costs will drive more midsize banks out of this business.

"With the new compliance requirements, many midsize banks will face profit pressures unless they have substantial assets in their fund complex," he said. "Midsize banks will have to weigh whether the profit is worth the expenditures of resources, personnel and dollars that are needed to meet the compliance requirements."

However, Reid added, the disappearance of smaller fund groups and the corresponding growth of the largest families could prompt concern about limiting the choices available. "With as many funds as there are out there, we have not reached that dangerous threshold yet, but if the current pace of regulatory change continues, then we may face that someday," he said.

Financial Research Corp. has forecast a 14% increase in costs at fund companies and a 10% decline in revenues due to tighter regulation. The Boston research company has said it expects profit margins to fall 17 percentage points, to 19% by Dec. 31, 2005, from their 36% level at the end of 2002.

Goldman's McNamara agreed that rising costs and lower revenues have driven small banks away from asset management. "These companies haven't seen the growth in these complexes the way that they expected," he said, noting that at Goldman, annual outflows from its mutual fund business has been 4.3% a year since 2002. Today, the firm has $99.12 billion in mutual fund assets under management.

However, Goldman believes that the improved stock market combined with the firm's new strategy of buying small fund complexes will stanch those outflows.

Matt Ackermann is a reporter for American Banker.