Money Managers are Hot, Brokers are Not

by By Ann C. Logue

In the past week, two of the world’s largest financial services firms, Merrill Lynch & Co., Inc. (NYSE: MER) and Citigroup, Inc. (NYSE: C) have been hit with turmoil. The top executive at each has resigned amid concerns about exposure to subprime mortgages and their ability to manage huge financial conglomerates. The Dow Jones Industrial Average has been under a great deal of pressure, in part due to the lousy performance of the four financial stocks in the Dow: American Express Company (NYSE: AXP), American International Group, Inc. (NYSE: AIG), Citigroup and JPMorgan Chase & Co. (NYSE: JPM).  

Although these five companies are making for a soggy stock market, not all financial services companies are doing poorly. As of Nov. 7, shares in mutual fund company Janus Capital Group Inc. (NYSE: JNS) are up 68.1% for the year, while T. Rowe Price Group, Inc.’s (Nasdaq: TROW) stock is up 38.1%. Franklin Resources (NYSE: BEN) has posted weaker stock performance, up 6.1% for the year. These numbers all compare well to the Dow, up only 6.7% this year, and the S&P 500, up just 4%.  

The money managers are doing so well in large part because they are benefiting from basic, long-term investment fundamentals and their customers are basic, long-term investors. The typical mutual fund investor is looking to buy and hold a fund in order to reach a long-term goal, like retirement or a child’s college tuition. This investor is thus paying steady, predictable management fees for years. Given an aging population that needs to fund retirements and ever-rising tuition costs, there are plenty of these typical investors to go around, bringing assets and fees to the mutual fund. In financial services as in any type of investing, though, higher risk is associated with higher reward. The money management firms are operating in a sleepier corner of the investment world, collecting fees and not taking huge risks. Some years, that’s a turnoff to investors; this year, that’s hot stuff. 

Mutual fund companies rarely trade for their own accounts. Instead, the trading and investment activities take place within the funds, so the fund shareholders—not the fund management company shareholders—benefit or lose from the vagaries of the market. The fund management company will probably have greater assets and thus receive larger total fees when the market and the funds are doing well, but not always.  

Citigroup, Merrill Lynch, JPMorgan and other diversified financial companies have large money management divisions. Those firms rake in plenty of fees: $1.4 billion for Merrill Lynch in the third quarter of 2007 alone from its fee-based business lines, including its line of mutual funds. As hefty an amount as that is, it was no match for the $5.9 billion in losses generated from principal transactions, especially writedowns from investments and trading in subprime mortgages.  

Some mutual funds have losses from subprime debt, but that doesn’t translate into losses for the fund company. Lower fees and concerns about growth, certainly, but not losses. (Note that shares in Franklin Resources, known for the depth of its fixed-income offerings including mortgage bond funds, have had much lower appreciation this year than shares in Janus, best-known for its aggressive growth funds.)  

The subprime losses aren’t the only concern dogging the diversified financial companies. Merrill and Citi are both looking for new CEOs, and their boards are finding that there are few people qualified to fun such large and complex businesses. It could be that the financial supermarket model, once embraced as a way to deliver comprehensive services and control the assets of the aging population, may not be all that solid.  

Investors often want to diversify the companies that they deal with, in part to compare advice and fees and in part to prevent any one person from knowing how many assets they have in total. It’s entirely possible that these firms will start spinning out or selling divisions, but it’s unlikely they’ll get rid of their mutual funds, annuities and related groups. That’s because money management offers a relatively stable stream of profits, something these firms can ill afford to get rid of. They need that ongoing base of business to support the high risk (and potentially high reward) proprietary trading desks, especially as they rebuild.

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