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We can only hope that the contented smiles and mutual congratulations that the Bank Hapoalim and Markstone people exchanged on Thursday, when celebrating the bank's sale of the Lahak mutual funds company to Markstone's Prisma, won't shortly turn into mutual recriminations and mud-fests. Lahak's sale for the ridiculously low price of NIS 150 million was designed to assuage Markstone's pique after it bought the PKN mutual funds company from Hapoalim for NIS 850 million, only to find itself overpaying on royal scale.

But the way things are, the chance of the parties remaining friends doesn't look good, since the public is still busily withdrawing monies from mutuals. In fact, the withdrawals have only accelerated. Here's why.

PKN began to implode right after its sale, and the same thing has been happening to Lahak. Sources at Bank Hapoalim report that after the public learned of Lahak's sale two weeks ago, the withdrawals jumped in volume. It seems that during October 2006 alone, Lahak will have lost NIS 900 million in assets. Clearly, the investment advisers at Bank Hapoalim are losing no time in advising clients to go elsewhere.

In the past, investment advisers at the banks served as a sort of armed sentinel, whose job was less to advise, and more to keep the public's money inside the banks' mutual funds. But now that the banks have sold their mutual funds, their job description has changed; they've holstered their pistols and the money is roaring out. Naturally, the banks are channeling much of that money into other assets they run: deposits and structured deposits, assuring themselves of handsome income.

Catastrophic collapse

The banks find all sorts of amusing explanations for the gigantic outflow of money from the mutual funds: the increase in interest rates, the plunge in emerging markets, competition with ETFs, the war, Sharon's collapse, the instability created by the elections, the behavior of oil prices, and so on. We could add a few speculation of our own, such as the dismal performance of the mutual funds in the past and the fact that many of the funds the banks ran had become outmoded, unsuited to the modern marketplace. All that is well and good, but it seems that a much stronger explanation is required, to understand just why so many billions have leaped out of the mutual funds. After all, never before has the industry experienced such a dramatic collapse.

So: what happened to make NIS 33 billion seep, or roar rather, out of the financial statement in the space of just one year, though the market is booming?

There can be only one reason, and  it lies in the interests of the banks.

In the past, it was in the banks' interest to plug the mutual funds. They owned them. Now that they don't, they're plugging other products that make them profit. The workers at Bank Hapoalim earn more from selling structured deposits and bank deposits and ETF units than they would from selling units in mutual funds belonging to somebody else.

Here are the figures. On selling structured deposits they make 1% to 1.5% of the transaction volume. On selling bank deposits they make 1% and on ETFs, 0.5% a year plus 0.6% to 0.8% on a one-time basis (buy and sell commission). When they urge a client to buy an ETF that tracks real estate stocks, and after a month recommend that he dump the ET and get into some other red-hot certificate (broad-market stocks, for instance), they make in one month what they couldn't make on a mutual fund in a year.

What the banks make on distributing units in mutual funds is a distribution fee of 0.4%, on average.

The dowry that Lahak and PKN bring to Markstone is looking a bit grubby. No less than 94% of the clients of the two mutual fund companies are Bank Hapoalim customers (compare that with Ilanot Discount where only 85% of the customers are also customers of the parent bank).

The method

It appears that Bank Hapoalim is not a great partner for anybody hoping to keep the money inside his funds. Here is the sad story of two PKN funds that Prisma bought with its hard-earned lucre. Not just hard-earned lucre, but a lot of it: Prisma (a unit of Markstone) paid more than NIS 70 million for PKN Optimum Solid that had NIS 1.7 billion in assets.

When Prisma bought PKN Optimum Solid, the PKN group had NIS 20 billion in assets, meaning PKN Optimum Solid comprised 8.5% of its assets. A year later of hacking by the Bank Hapoalim advisers, and all PKN Optimum Solid has left is NIS 630 million. It lost NIS 1.1 billion in assets.  Based on the price Prisma is paying for Lahak, PKN Optimum Solid is worth maybe NIS 8 million.

PKN Optimum Solid was a 100% mirror of Bank Hapoalim's recommendations. It was created for one purpose and one purpose only: to raise money from the bank's clients.

This is how it worked. The bank's equity research department issues recommendations once a week (and monthly reviews too). PKN Optimum Solid would take the recommendations and implement them exactly, investing exactly the proportion of assets and for the terms that the analysts recommended.

The banks have computerized systems that the investment advisers at the branches operate. The systems are fed the client's assets and the risk that the client is prepared to accept, and tailors a specific portfolio based on the data and the equity analysts' recommendations.

When the client would meet with the adviser, the adviser would ask if he wants to accept the bank's recommendations (without mentioning PKN). The client would naturally say Yes. Then the adviser would turn on the system and start searching for an appropriate fund,

The system would troll through the mutual funds offered by say Mizrahi, Meitav, Leumi and even Analyst, but none precisely suited the recommendations. Then - Presto! like Cinderella's glass slipper, there it was: a mutual fund that precisely suited the foot, or the recommendations, and guess what, it was PKN Optimum Solid.

That is how PKN Optimum Solid raised NIS 1.7 billion from Bank Hapoalim's customers.

The fund's success induced Bank Hapoalim to launch six more Optimum funds of the sort, one in stocks, one investing abroad, and so on.

Don't get me wrong, Bank Hapoalim wasn't the only one doing this. Leumi had similar funds called "Best Invest Psagot" and " Best Invest Pia".

The funds would simply do what the bank advisers told them to do, so at any point in time, they precisely matched the advisers' description of the perfect portfolio (based on the client's choice of risk, asset types, and so on). And thus, after the computer had hummed a while, the client would find that the bank at which he sat offered exactly what he thought he wanted.

But now that the bank is not in the picture, and although PKN Optimum Solid was doing perfectly well, it is not the adviser's cup of tea any more. "We run by the room where Optimum's run as fast as we can, not to hear the money escaping," one cynical adviser joked. Ha, ha.

Fast boat to China

The second fund story we shall present is that of PKN Alternative Energy, which had been one of PKN's better performers, once upon a time: it raised hundreds of millions of shekels from the start of the year. Run by the brand-new investment firm of Shimon Alkabetz and Lenny Recanati, it succeeded where other PKN funds failed: in creativity, speed of reaction to trends and fads, and in performance.

So Prisma was purely astonished when mid-year 2006 arrived and they discovered that this lovely fund, PKN Alternative Energy, was also starting to suffer from withdrawals. Each month it was bleeding NIS 10 million to double that.

What happened? It turned out that Bank Hapoalim had started to sell its clients a structured deposit on the energy sector. To whom were they selling this deposit? Naturally, to people who wanted a holding in energy, including clients of PKN Alternative Energy.

"Inherent advantage. Potential for gain without risk. You have a unique investment product that combines a guaranteed principal with the potential for high returns. You can take advantage of investment opportunities, to diversify your portfolio and save costs," the bank adviser drones to the client (and who knows, maybe whispered something about that money just sitting there in that PKN Alternative Energy thingie). And so, PKN Alternative Energy remained with  only NIS 150 million.

You raise an eyebrow. But just yesterday, Leumi advised its clients via email that it's issuing a new structured deposit: linked to the FTSE/Xinhua indexes. One has to wonder what they think over there at Psagot and Pia about the new deposit, and its threat to their China funds.