Wachovia deal likely to heat competition

BOSTON — Wachovia Corp.’s planned $6.8 billion purchase of A.G. Edwards Inc. could make an already competitive sales game even tougher for U.S. mutual fund firms, some analysts said.
The deal between the two key mutual fund distributors, announced May 31, would create the nation’s second-largest retail brokerage firm by financial advisers with nearly 15,000 advisers and $1.1 trillion of client assets.
The acquisition also would increase the leverage big brokerage firms have over fund companies trying to get on their platforms to reach financial advisers, said Ben Phillips, a managing director at Putnam Lovell NBF Securities Inc., a New York-based investment bank.
“If there’s one less distributor, does that make the wirehouses more powerful when it comes to pricing? When it comes to dictating what fund companies need to do?” Mr. Phillips said. “The answer is yes. You took two 800-pound gorillas and put them together.”
The proposed acquisition is likely to hit some fund firms harder than others, Mr. Phillips said. “If you are a mid-sized fund company with not-so-hot performance, and you don’t have a reputation for sterling client service, things like this will make you stay up at night,” said Mr. Phillips, who declined to cite specific examples.
Big wirehouses — such as Merrill Lynch & Co. Inc., Smith Barney, a unit of Citigroup Inc., and Morgan Stanley, all of New York, as well as UBS AG of Zurich, Switzerland, and Wachovia in Charlotte, N.C. — would have more leverage over fund companies if the deal goes through, agrees Jeff Strange, a senior analyst at Cerulli Associates Inc. of Boston.
“It’s just one less avenue to go down,” he said.

The U.S. mutual fund industry already has such limited pricing power when it comes to dealing with distributors that a deal between Wachovia and A.G. Edwards of St. Louis would make little difference, said Lynette DeWitt, associate director of retail investment markets at Financial Research Corp., a Boston-based financial services consulting firm.
“With the exception of a few firms like American Funds, mutual fund companies don’t have much power to negotiate pricing,” Ms. DeWitt wrote in an e-mail. “So while the theory that fewer distributors would increase pricing pressure is a valid economic argument, the reality is that the parameters are already tight and unlikely to get much tighter based solely on the merger.”
Wachovia has 8,091 advisers, which makes it currently the third-largest wirehouse, behind Merrill Lynch and Smith Barney, according to FRC, which based its findings on company reports.
Among regional brokerages, A.G. Edwards has 6,618 advisers. That ranks it behind Minneapolis-based Ameriprise Financial Inc. at 12,342 and St. Louis-based Edward Jones at 10,532.

Wachovia’s brokerage arm, Wachovia Securities LLC, is based in Richmond, Va., and will be based in St. Louis, following the merger. Wachovia Corp. also operates the fourth-largest U.S. bank.
Pricing power decline
Trends that have added to the erosion of fund firms’ pricing power include due diligence groups at brokerage firms, which increasingly have taken over the role of fund selection, giving fund firms less leverage to influence sales to advisers. Regulatory scrutiny also has put high pressure on fee structures, Ms. DeWitt said.
Many big firms that sell other companies’ mutual funds have developed due diligence — or central research — groups that “vet” funds and negotiate for such perks as institutional-share-class pricing, Mr. Strange said.
For instance, American Funds, which has good performance and low expenses, is likely to make many recommended lists devised by such groups for advisers looking to pick funds for clients, he said.
“The central research groups, they’re the ones who select these funds,” Mr. Strange said. “If you are on those lists, then it’s Thanksgiving. If you are not, then you have a lot more work to do in terms of influencing the advisers.”
The term “recommended list” can be a touchy one, conjuring up images of commissioned-based selling “where they’re just shoving it down the adviser’s throat, because they’re getting more bang for their buck,” Mr. Strange said. Instead, the lists are intended to be objective. Expenses figure into the selection process, because they can erode performance, he said.
“Of course, these firms do have relationships with these fund complexes,” said Mr. Strange, adding that although bottom-half funds are unlikely to make the list, “there’s typically some type of revenue sharing on some level, or some type of sponsoring of events, or even if it’s just working with their advisers and giving their advisers more support.”
Deals like Wachovia’s planned acquisition mean that fund companies likely will have to be more competitive with expenses to make them more appealing to central research groups or will have to put more resources into supporting both those research groups and advisers in the field, he said.
Wachovia doesn’t maintain a formal recommended list of mutual funds for its advisers, spokesman Tony Mattera said. The firm offers some 4,000 funds from about 400 families, including Boston-based Evergreen Investments, which had $312.2 billion of managed assets as of March 31.