Doing business with
, the nation's largest retail securities firm, is about to get more expensive for mutual fund companies.
In January, Merrill began advising fund companies that it is seeking 25 basis points on gross sales of funds and 10 basis points on new positions, such as additional cash infusions into already-established fund accounts, according to three people in the fund community. If the plan becomes policy, a mutual fund complex that takes in $100 million in new assets via Merrill brokers would have to cough up $250,000 to get the full level of sales support from the firm's 12,000 brokers.
While many full-service retail brokerages demand such fees from fund companies, Merrill hasn't officially asked for a uniform payment before, industry experts say. But the numbers being bandied about at this point show a new aggressive posture.
"Merrill's dropping the bomb on everyone," says the head of marketing at one major fund complex. "But it's a way for funds to keep access to the sales system of the firm."
Most experts say the move makes sense for Merrill. "This kind of agreement does two things: It helps Merrill defer some expenses, and more importantly, it provides some revenue," says Michael Flanagan of
Financial Services Analytics
in Washington, Pa. "Merrill has one of, if not the most, potent distribution forces in the industry, and it can move funds."
Merrill isn't detailing any numbers, but it confirmed it's looking for a new fund deal. "We plan to adjust fee arrangements with nonproprietary funds that we sell in a way that is fair and consistent to all fund companies," a Merrill spokeswoman says. "The new fee structure reflects the value of our distribution capacity and increasing expenses to support that distribution."
The move "indicates that deals are all over the place, and Merrill wants consistency," says fund consultant Burton Greenwald. "There's no real matrix out there."
Greenwald labels Merrill's plan "in the mainstream" as far as the price level the firm is seeking, but adds, "This is going to put real pressure on many of the fees retained by advisers because it's on top of the 12b-1 fees. It's a business where management companies are being squeezed because the distributors have the upper hand."
People close to Merrill say the firm, at this point, hasn't determined exactly what it will be able to obtain from the new fee arrangement. It is probable, however, that Merrill will be able to charge about as much as it likes from fund companies eager to get shelf space in the formidable Merrill network.
The firm would continue to distribute product for fund companies that don't agree to cough up the 25 basis points, but it would no longer support proactive sales and marketing efforts at the same levels of those funds that are part of the new arrangement, the spokeswoman says. In the past, Merrill hasn't had this "most favored nation" policy of giving more sales support to firms that pay higher distribution fees.
But executives at some major fund companies say that Merrill is using the proposal mainly to determine the reaction of the providers and how much it can actually charge them. That initial reaction, people familiar with the situation say, wasn't good for Mother Merrill. "There's a sense that people think the plan is just too rich," says one fund pro.
Flanagan says that when
increased its OneSource fund fee structure to 35 basis points from 25 basis points in the mid-1990s, several funds resisted before deciding to pay the higher fee.
Merrill may need the plan to be rich. Over the past decade, it has led the securities industry in the move from volatile commission-based revenues to a more stable environment in which revenues are increasingly derived from recurring fees on funds and other packaged products. Yet people familiar with Merrill say that the firm's proprietary fund sales have been under pressure and that the plan to charge fees to outside funds is a move to compensate for that.
Some of the firm's proprietary mutual funds have been less-than-stellar performers. The
Merrill Lynch Growth fund, for instance, has returned an average of 6.3% during the past five years on an annualized basis compared with a return of more than 24% for the
. Over the past year, the fund has actually lost 27% compared with a 20% increase in the S&P 500.
Merrill insiders, however, say the move was prompted more by the need to have a larger, more consistent revenue stream. The firm's private-client group already covers more than 100% of fixed expenses through fee-based businesses, but the dynamics of the retail brokerage business are changing and technology spending is taking a bigger bite of that pie.
And the burdensome cost of full-service brokerage is looking even higher these days as discount firms and online brokers continue to develop their businesses by adding wider product offerings to their bargain-basement commission schedules. As a result, Merrill and its full-service compatriots can't afford financially or philosophically to allow funds inexpensive access to their expensive broker networks.
For now, though, the firm is "profiting from the imbalance in supply and demand," says Flanagan of Financial Services Analytics. "There aren't many distribution forces similar to Merrill."