DST strives to adapt to shifts in mutual fund industry
There’s a battle under way in the mutual fund industry. The prize is your account.</p><p>Millions of investors’ accounts already have been won and lost without the owners noticing. But a new skirmish could bring the fight into view.</p><p>At stake is the painstaking task of keeping track of your fund account and all the activity inside it. The work ensures that your account holds what is supposed to be in it.</p><p>For the owners of 113 million fund accounts, the job falls to DST Systems Inc. of Kansas City. For decades DST has been the big player in this behind-the-scenes business. It built a powerful client list of mutual fund companies and a solid workload for employees.</p><p>“Five or six years ago you would have said DST won the war,” said Peter Heckmann, an analyst who follows the data-processing industry for Avondale Partners LLC in Leawood.</p><p>Not anymore. </p><p>Mutual fund recordkeeping work is leaving DST — its total has fallen by more than 8 million accounts in two years — forcing management to dig in its heels. </p><p>The company has had recent setbacks in other businesses, too. Falling revenues were a key reason the company laid off 7 percent of its workforce last year.</p><p>DST hasn’t said how many of the layoffs hit Kansas City employees. But its local employment has declined over several years from more than 6,000 to 4,402 now. DST employs 11,200 globally.</p><p>Management has been seeking new kinds of processing work to do — for example, in the health care and insurance industries. And a small business acquisition last month was aimed at stemming the outflow of accounts.</p><p>DST executives declined to talk about their efforts but have told </p><p>analysts that they expect the shifting of accounts to subside after this year.</p><p>The company’s struggles mean its stock has done poorly. But</p><p> analysts say shares have gotten so cheap that DST itself might become a buyout target.</p><p><strong><span class="subhead">The shifting tide</span></strong></p><p>Mutual fund recordkeeping has been good for DST for a long time. CEO Tom McDonnell was among the first few employees when the company started inside Kansas City Southern in 1969.</p><p>Business blossomed as the mutual fund industry boomed in the 1980s and 1990s. There were more and more mutual funds and more and more fund accounts to keep track of. And fund companies looked increasingly to outside firms, such as DST, to do the recordkeeping for them.</p><p>One of those was American Century Investments, another homegrown Kansas City enterprise that boomed with the fund industry. In the last 10 years American Century has paid DST more than $223 million for its work. </p><p>But the mutual fund boom ended a decade ago. Investors grew skittish after the technology stock bubble triggered three years of falling stock prices. Then there were horrible losses in stocks during 2008, and last year’s May 6 “flash crash” added to concerns.</p><p>Mutual funds also face new challengers in their pursuit of investors’ dollars. Exchange-traded funds, for example, have become a $1 trillion business, but they don’t need DST’s recordkeeping.</p><p>And that means DST’s battle for business has changed. What had been a grab for the biggest share of the boom has become a tug-of-war with rivals over the slow-growing number of accounts.</p><p>Recently, the other side has been winning.</p><p>The other side is Bank of New York Mellon, which bought DST’s chief competitor in the fund servicing business from PNC Financial Services Group Inc.</p><p>BNY Mellon, as it’s known, says it keeps records on about 90 million U.S. mutual fund accounts.</p><p>But that’s about where the comparisons end. DST and BNY Mellon pursue fund account business differently.</p><p>At DST, the core business lies in working for the mutual fund companies and handling their registered customer accounts. Registered accounts represent 86 percent of all the U.S. mutual fund accounts DST keeps records on.</p><p>BNY Mellon handles registered accounts, too. But its core business lies in working with brokerage firms, and 86 percent of the fund accounts it handles come to it through brokers.</p><p>Geoff Bobroff, a fund industry consultant in East Greenwich, R.I., explains one key reason that BNY Mellon is winning the struggle for accounts these days.</p><p>“Mutual funds aren’t bought, they’re sold,” he said.</p><p>Investors have turned to brokers and advisers in the wake of bear markets. Relatively few buy directly from fund companies.</p><p>Brokerage firms, however, don’t run out and open a separate account with each fund for each of their customers that invest in it. They accumulate these fund choices and open one omnibus account to hold all its customers in that fund.</p><p>As far as the fund company knows, it has one customer with one account. </p><p>All the investor recordkeeping — tracking whose accounts hold how many shares of which funds, etc. — is done at the brokerage firm. In effect, investors own their fund shares through sub-accounts of the broker’s omnibus mutual fund account.</p><p><strong><span class="subhead">Sub-account king</span></strong></p><p>Keeping track of these individual sub-accounts is BNY Mellon’s core business. And as more and more fund shopping has happened through brokers, the sub-accounting recordkeeping business has ballooned.</p><p>DST is losing registered account business as some mutual fund companies switch over to sub-accounting relationships with brokers. Bobroff said there was not much the fund companies could do. After all, they like brokers that sell their mutual funds.</p><p>During the first three months of this year, DST shed 3 million registered accounts this way.</p><p>The good news was that 500,000 of them switched to DST’s sub-accounting system. DST earns less revenue on sub-accounts than registered accounts but recognizes that less revenue is better than none.</p><p>DST has been building up its sub-accounting business, handling 15.4 million sub-accounts at the end of March. That’s up 73 percent from the end of 2008.</p><p>And who is its biggest sub-account client? The BNY Mellon family of companies, with more than half the total at DST.</p><p>BNY Mellon didn’t buy PNC Financial’s recordkeeping business until last year. Two of its affiliates have naturally decided to move their 8.4 million sub-accounts that DST handles and a small number of registered accounts to the BNY Mellon shop. But account handoffs move slowly, and the BNY Mellon block remains in DST’s latest count.</p><p>McDonnell told analysts in April that — apart from losing the BNY Mellon business — DST’s sub-accounting work was improving. In May the company bought the assets of Baltimore-based Finix Business Strategies LLC and created DST Brokerage Solutions, bringing in Finix management’s expertise and knowledge of the brokerage industry in the deal.</p><p>McDonnell also has said that the registered accounts that DST is losing are among its lowest-revenue accounts, with the amount of revenue varying by the kind and amount of work involved with each fund company client.</p><p>DST also has argued that fund accounts with special tax status, such as individual retirement accounts and education-focused 529 plans, aren’t easily switched to sub-accounting. </p><p>One difference is that some tax-advantaged fund accounts can’t move without telling the investors, who can choose to opt out of the switch to sub-accounting. Employer plans such as 401(k) accounts would require the company’s approval to switch. And this paperwork adds to the cost of switching.</p><p>Registered accounts, in contrast, can switch to sub-accounting with simply the fund company’s approval.</p><p>Nevertheless, Heckmann figures that sub-accounting remains a “significant threat” to DST’s registered account business. He pressed management in an April conference call for an estimate of how much registered account business DST expected ultimately to retain.</p><p>McDonnell said the company hadn’t done the level of analysis that Heckmann wanted, which led the analyst to question executives’ “sense of urgency” on the matter.</p><p>“If we don’t sound emotional on the call, I mean, I think that your sense that there’s no sense of urgency around here is inaccurate,” McDonnell said.</p><p>DST has cut costs, including the big layoffs last year, to keep them in line with its revenues. McDonnell said in the call with analysts that the company had taken all the steps that seemed necessary for the rest of this year but would “continue to react to business conditions.”</p><p>No one predicts DST will lose all of its registered accounts. And DST estimates that this year’s losses will roughly equal last year’s 12.3 million but that then the losses will shrink. The company has been able to offset some of these losses with new registered accounts at the fund companies it serves.</p><p>BNY Mellon is trying to turn up the heat. This month it began to offer sub-accounting services to 529 plans. BNY Mellon also said automations created for those accounts would open up sub-accounting for other potential tax-advantaged accounts.</p><p>“It is a threat to their business,” said David Koning, an analyst who follows DST for Robert W. Baird & Co.</p><p>Despite the threat, Koning and Heckmann both recommend DST’s own stock to investors.</p><p>Koning said DST executives wanted the company to grow again, and he’s hesitant to dismiss their successful record. Their recent move to pursue work from the insurance industry could bring in significant new business, Koning said.</p><p>DST’s idea is that as more investors age, they’ll buy fewer mutual funds to build up nest eggs and more insurance company annuities that pay out money over their golden years. Insurance companies, meanwhile, need to develop new products for that demand. DST figures there’s work for it on both sides.</p><p>McDonnell told analysts each insurance account is likely to be more complex than a registered fund account and likely to generate more revenue.</p><p><strong><span class="subhead">A good buy</span></strong></p><p>Koning and Heckmann also like DST’s stock because of the many investments the company itself holds. There is nearly $1 billion worth of stock in publicly traded and privately held companies, real estate and other valuables in DST’s pockets, according to Koning’s estimates.</p><p>DST has amassed these gems through years of deal making, financed by the large amounts of cash its mutual fund business generates. Many have produced handsome gains. </p><p>In 2002, for example, DST bought a Prairie Village company that processed claims on cellphone replacement insurance. It was called lock\line LLC and cost DST $190 million, a relatively small amount for a buyer with more than $2 billion in revenue.</p><p>Three years later, DST agreed to merge lock\line into a large warranty management company, Asurion Corp. in Tennessee. DST ended up with 37 percent of Asurion’s privately held stock.</p><p>In 2007, DST sold all but 6 percent of its Asurion stake for $986 million in cash and $39 million in other consideration.</p><p>“A grand slam,” Heckmann said.</p><p>DST also bought EquiServe Inc., which keeps track of stockholder records for publicly traded companies. It sold EquiServe for a $120 million gain only six months after making the last payment to acquire it. McDonnell had said at the time that he can’t always pick when opportunities arise.</p><p>As yet, DST’s dealings haven’t produced a new core business to rival the long success that its fund services work has produced.</p><p>But that list of marketable holdings and DST’s ability to generate lots of cash make it potentially appealing to one group of buyers. </p><p>Private equity investors could borrow money to buy DST and use the cash and salable holdings to pay down the debt. </p><p>It’s called a leveraged buyout, which is different from a merger that would combine DST’s operations with that of a similar company.</p><p>“That would make a lot of sense,” Koning said of a possible leveraged buyout by private equity investors. “Wall Street often doesn’t like all the moving parts, all the investments and affiliates and all this stuff, while private equity is willing to pay for that sort of thing and split it up.”</p><p>Koning said he was not expecting a buyout. But would DST management entertain an offer?</p><p>“These guys strike me as willing to sell whatever at the right price,” Koning said.</p><p><hr class="infobox-hr-separator" /> <div class="infobox"> <strong><span class="infobox-head">DST’s dealbook </span></strong><br /> Here are most of the many business deals that DST Systems Inc. has struck over the years.</p><p><span style="line-height:0"><br clear="all" /></span><table border="0" class="story-table"> <tr class="story-table-even-row"><td><strong>Year</strong></td><td><strong>Deal</strong></td><td><strong>Amount</strong></td></tr> <tr class="story-table-odd-row"><td>1993</td><td>bought 60% of DBS Systems Corp. </td><td>$3 million</td></tr> <tr class="story-table-even-row"><td>1995</td><td>sold half interest in Investor’s Fiduciary Trust Co.</td><td>2,986,111 shares of State Street Corp. worth $98.2 million</td></tr> <tr class="story-table-odd-row"><td>1995</td><td>bought HiPortfolio Pty Ltd.</td><td>$16 million</td></tr> <tr class="story-table-even-row"><td>1995</td><td>bought Supervised Services Co.</td><td>$39.4 million</td></tr> <tr class="story-table-odd-row"><td>1995</td><td>sold Midland Data Systems Inc. and Midland Loan Services L.P.</td><td>$5.7 million</td></tr> <tr class="story-table-even-row"><td>1995</td><td>bought additional 20% of DBS Systems Corp.</td><td>$6 million</td></tr> <tr class="story-table-odd-row"><td>1996</td><td>acquired Xebec Imaging Services Inc.</td><td>$5.5 million</td></tr> <tr class="story-table-even-row"><td>1996</td><td>bought 15% of PSI Technologies Inc.</td><td>$2.9 million</td></tr> <tr class="story-table-odd-row"><td>1996</td><td>sold 23% stake in The Continuum Co. Inc.</td><td>4.3 million shares of Computer Sciences Corp. worth $295 million</td></tr> <tr class="story-table-even-row"><td>1997</td><td>bought additional 20% of PSI Technologies Inc.</td><td>$2 million</td></tr> <tr class="story-table-odd-row"><td>1997</td><td>sold First of Michigan Capital Corp.</td><td>$9.6 million</td></tr> <tr class="story-table-even-row"><td>1997</td><td>bought 81% of exchange firm to form DST Catalyst Inc.</td><td>unknown</td></tr> <tr class="story-table-odd-row"><td>1997</td><td>bought last 20% of DBS Systems Corp.</td><td>$13.2 million</td></tr> <tr class="story-table-even-row"><td>1998</td><td>acquired USCS International Inc.</td><td>13.8 mln shares of DST stock worth $825 million</td></tr> <tr class="story-table-odd-row"><td>2000</td><td>bought remaining half of Corporate Document Systems Inc.</td><td>DST shares worth $5.5 million</td></tr> <tr class="story-table-even-row"><td>2001</td><td>bought 6% of Wall Street Access LLC</td><td>$7 million</td></tr> <tr class="story-table-odd-row"><td>2001</td><td>bought 50% of exchange-america LLC</td><td>$15 million</td></tr> <tr class="story-table-even-row"><td>2001</td><td>bought 75% of EquiServe Inc.</td><td>$148.7 million</td></tr> <tr class="story-table-odd-row"><td>2001</td><td>sold Portfolio Accounting Systems</td><td>1.5 mln shares State Street Corp. and cash, combined value $75 million</td></tr> <tr class="story-table-even-row"><td>2001</td><td>bought remaining 25% of EquiServe Inc.</td><td>$38 million</td></tr> <tr class="story-table-odd-row"><td>2001</td><td>contributed DST Canada Inc. to joint venture</td><td>State Street contributed $43.5 million to joint venture</td></tr> <tr class="story-table-even-row"><td>2002</td><td>bought additional 14% of Wall Street Access LLC</td><td>$16 million</td></tr> <tr class="story-table-odd-row"><td>2002</td><td>bought lock\line LLC</td><td>$190 million</td></tr> <tr class="story-table-even-row"><td>2004</td><td>sold EquiServe Inc.</td><td>$216 mln cash and 29.6 mln shares Computershare Ltd. worth $91 million</td></tr> <tr class="story-table-odd-row"><td>2005</td><td>acquired Health Plan Solutions and $224.6 million in cash</td><td>swapped 7.1 million shares of Computer Sciences Corp. worth $323.26 million</td></tr> <tr class="story-table-even-row"><td>2005</td><td>sold DST Innovis Inc. and DST Interactive Inc.</td><td>$237.8 million</td></tr> <tr class="story-table-odd-row"><td>2006</td><td>sold lock\line LLC</td><td>37.4% of Asurion Corp., value unknown</td></tr> <tr class="story-table-even-row"><td>2006</td><td>bought Amisys Synertech Inc.</td><td>$136.5 million</td></tr> <tr class="story-table-odd-row"><td>2007</td><td>sold all but 6% of Asurion Corp. stake</td><td>$986.3 million cash and $39.2 million in other consideration</td></tr> <tr class="story-table-even-row"><td>2007</td><td>bought TASS LLC and Mosiki LLC</td><td>$14.9 million</td></tr> <tr class="story-table-odd-row"><td>2008</td><td>bought BlueDoor Technologies Pty Ltd.</td><td>$10.3 million and 85,006 shares of DST worth $3.1 million</td></tr> <tr class="story-table-even-row"><td>2008</td><td>bought remaining half of Broadway Realty Co. LLC</td><td>$13.3 million</td></tr> <tr class="story-table-odd-row"><td>2009</td><td>bought remaining half of Argus Health Systems Inc.</td><td>$57 million</td></tr> <tr class="story-table-even-row"><td>2010</td><td>acquired 70.5% of dsicmm Group Ltd.</td><td>$25.8 million in cash and stock of DST subsidiary</td></tr> <tr class="story-table-odd-row"><td>2011</td><td>bought assets of Finix Business Strategies LLC</td><td>undisclosed</td></tr> <tr class="story-table-even-row"><td>2011</td><td>bought Newkirk Products Inc.
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