MONEY MANAGEMENT - Columbia’s Challenge
Bank of America’s asset management arm was coming on strong. Then the subprime crisis hit and Marsico bid adieu. Can it regain its momentum?
After watching net income plunge 32 percent in the third quarter, Bank of America chairman and CEO Kenneth Lewis famously snapped, “I’ve had all the fun I can stand in investment banking.” He seemed, at the time, to be enjoying the investment management business a lot better. One sign: In October he turned to Brian Moynihan, head of the bank’s global wealth and investment management division, to take over the beleaguered capital markets operation.
Lately, Lewis’s investment business, Columbia Management Group, has been providing far fewer jollies. In November the bank announced that it would inject $600 million to prop up its money market funds and institutional cash investments because of their exposure to structured investment vehicles,whose holdings of complex and risky securities have been hit hard by problems in the mortgage market. The move was meant to ensure that its enhanced institutional cash fund — Columbia Strategic Cash Portfolio — remained stable and that its retail funds, housed under the bank’s Columbia Funds unit, did not “break the buck,” or drop below par value of $1 per share.
Such an occurrence might shatter investors’ confidence, with devastating consequences. Columbia is one of the country’s biggest managers of short-term money funds: $232 billion of its $710 billion in assets were in cash at the end of the third quarter, $146 billion of that in money market funds.
“You have to do it,” says Don Phillips, managing director of fund research firm Morningstar. “Breaking the buck puts the industry in a panic. It would mean you can’t trust BofA or Columbia.”
But BofA’s efforts didn’t quite do the job. Edgy corporate and institutional investors pulled money from the Columbia Strategic Cash Portfolio — $5 billion of its $40 billion in assets in August alone — and it continued to bleed thereafter. Last month BofA said that it was shutting down the fund and returning the money, partly in cash but mostly by giving investors their share of the underlying securities.
Bank of America was hardly alone in shoring up its cash management and money market funds. Credit Suisse Asset Management, U.S. Bancorp, SunTrust Banks and the Evergreen Investments unit of crosstown rival Wachovia Corp., among others, have arranged similar bailouts. But the episode is a black eye for BofA, which marketed its conservative approach to short-term investing to corporate treasurers and retail investors alike. And it marks the third time in a decade that the bank has been dinged by its adventures in managing money. In 1998 it took a $372 million write-down on a venture with New York hedge fund firm D.E. Shaw Group, which suffered heavy losses following that year’s Russian government bond default. And in 2005, BofA paid $675 million in fines and forgone fees to settle charges of market timing and trading abuses at its Banc of America Capital Management and Fleet Investment Advisors units.
Today’s troubles come at a critical juncture. After seven often testy years under BofA’s roof, famed growth manager Thomas Marsico agreed in June to buy back his firm, Marsico Capital Management. He completed the deal last month, paying close to $2.6 billion for the firm, which BofA bought for $1.1 billion. BofA executives insist privately that they are happy to see the talented but demanding stock picker go, but Marsico Capital accounted for 40 percent of Columbia’s profits and about 70 percent of its mutual fund net inflows through September.
“Losing Marsico will be a challenge for them,” says Geoffrey Bobroff, a bank and investment management consultant in East Greenwich, Rhode Island. “The real question is whether money management firms that are subsidiaries of public companies can retain talent.”
Ironically, these difficulties have surfaced just as Columbia rebounds strongly from years of poor performance that stemmed partly from misguided stock picking and partly from managerial confusion. Executives had their hands full integrating the almost 30 investment shops they acquired, almost inadvertently, as part of a decadelong spree of acquisitions that vaulted BofA to the summit of the U.S. banking industry. Returns are up: As of September, 92 percent of its $65.3 billion in equity mutual funds place in the top two quartiles over a three-year period, compared with 47 percent in 2003. That’s good enough to rank fourth among 82 fund families with at least ten active equity funds, according to Morningstar data.
And BofA’s appetite for the asset management business, shucked by such rivals as Citigroup, remains keen. In July it bought U.S. Trust Corp. from Charles Schwab Corp. for $3.3 billion. The move gives BofA’s high-net-worth business one of the nation’s premier brands, while the addition of U.S. Trust’s Excelsior mutual fund family should ease the pain of losing Marsico, say officials. Also in that busy month, BofA recruited the highly regarded Jeffrey Carney, president of Fidelity Retirement Services, to build a wide-ranging retirement business at the bank.
Buoyed by U.S. Trust, the first nine months of 2007 were the best in Columbia’s history, with net income soaring to $523 million from $381 million for the same period in 2006. Confident, management decided to shell out $6 million to run its first national brand campaign touting its performance record.
“Very few companies have seen the performance turnaround that we have,” asserts Keith Banks, who was president of Columbia until October, when he succeeded Moynihan as head of global wealth and investment management. Banks, who was running Columbia when BofA purchased its parent, FleetBoston Financial Corp., in 2004, adds, “Marsico is a loss, but Columbia is a very different company than [Banc of America Capital Management] was when it formed the relationship with Tom. We have $700 billion under management, yet we’re still a growth story.”
Banks’s agenda to build assets and improve profits at Columbia, No. 18 in the Institutional Investor ranking of the 300 biggest U.S. money managers, is certainly ambitious. His goal is to push into alternatives and to boost substantially the firm’s international presence. Bolstered by its much-improved equity performance, Columbia plans to expand its institutional business, which currently accounts for 29 percent of its assets, by cross-selling pension fund management services to the bank’s many thousands of corporate clients.
“BofA has relationships with 80 percent of companies with pension assets of $200 million or greater, and Columbia has relationships with only 3 percent of these,” says Michael Jones, the onetime co-head of Robeco Investment Management who joined Columbia in 2006 to oversee distribution and was named in October to succeed Banks as head of the unit. “That’s a huge opportunity.”
Expansion won’t be easy — competition is fierce. Plenty of rivals are pushing into the same spaces as BofA, lured by higher margins and greater growth opportunities. Cross-selling is a marketing executive’s dream, but execution is another matter. Nor is BofA well known in the institutional space. “It’s a blank slate, particularly when it comes to the perception of the institutional business,” Jones acknowledges.
Still, BofA brass remain confident. “Despite our size, we’re very early in the growth game. Our challenge is to execute on that. But the opportunity is inarguable,” sums up Banks.
Columbia Management Group was assembled in the seemingly improvised manner common among banks cobbled together through multiple mergers. Today’s Columbia is a streamlined version of the sprawling entity assembled during the two-decade reign of the kinetic Hugh McColl, who before his 2001 retirement turned pokey North Carolina National Bank into a national powerhouse. In the 1990s he bought, among others, St. Louis–based Boatmen’s Bancshares and Barnett Banks of Florida. The grand prize for what had become NationsBank Corp. was its 1998 merger with BankAmerica Corp. of San Francisco, whose name McColl happily adopted.
With each purchase McColl and his successor, Lewis, added a proprietary money management arm, each with its own, often tangled, history. BankAmerica brought with it a complex and ill-fated relationship with D.E. Shaw through which it had sought to build noncore revenues. In March 1997 the bank loaned the quantitative hedge fund manager $1.4 billion; in turn Shaw agreed to run various businesses, including a fixed-income arbitrage strategy, for the bank. When losses triggered by the 1998 Russian government bond default ended that venture, David Coulter, BankAmerica’s former CEO and pretender to McColl’s throne, was forced out. BofA also backed Marsico in 1997 when he left Janus Capital Group and bought 50 percent of his new firm for $150 million the following year.
Meantime, NationsBank tried to jump-start its Nations Funds operation, which had $28 billion in assets, hiring wholesalers and becoming one of the first banks to market funds through Charles Schwab. In 2000, after the merger with BankAmerica, overall assets under management reached $275 billion, with $100 billion in Nations Funds, then the 19th-biggest U.S. fund group. That June it bought the remainder of the then–$12 billion Marsico business for $950 million. In 2003 the bank found itself in hot water when then–New York attorney general Eliot Spitzer charged Banc of America Capital Management with allowing Canary Capital Partners, a hedge fund, to market-time and late-trade its mutual funds.
BofA’s purchase of FleetBoston in 2004 added a more diversified asset management firm with a convoluted history. Fleet started its Galaxy Funds in 1995 and two years later bought the $22 billion Columbia Management Co., a Portland, Oregon growth manager. It folded in the money management arms of Shawmut National Corp. and BankBoston.
By 2001, Banks, the newly installed CEO and CIO of money management, was proclaiming FleetBoston’s desire to rank among the top 20 managers in the world. That year the bank bought Liberty Financial, parent of Stein Roe & Farnham, Colonial Management Associates, Newport Pacific Management, Liberty Wanger Asset Management and other boutiques.
In 2002, Banks hired Colin Moore, then CIO of global and international value equities at Putnam Investments, to run equities and make sense of the diverse business lines. The business was a loose confederation of shops spread out across the country, whose managers rarely talked to one another. Multiple portfolio management teams oversaw similar investments and engaged in duplicate research efforts. Worse, there was no consistent and replicable investment process that could be conveyed to institutional consultants or distributors. Only about half of their equity funds were performing above the median.
To start, Banks and Moore decided to integrate the managers under the Columbia brand. Moore pulled together portfolio managers and analysts from the different shops and combined them into new value, growth, blend and quantitative teams. He instituted an investment process with clear risk-and-return targets and established a single compensation system that included bonuses for outperforming benchmarks. He also built independent research groups that portfolio managers could use for stock picks or to get unbiased opinions. Three weeks after the fund families were formally rebranded under the Columbia name in fall 2003, Bank of America agreed to buy FleetBoston, whose approximately $160 billion in assets under management were 45 percent in stocks, 40 percent in fixed income and 15 percent in money funds.
FleetBoston money management executives were big winners, not least because BofA had pushed out its senior fund management following the market-timing scandal. Banks took charge of the combined asset management arm — which took the Columbia name — with Moynihan as his boss as head of wealth management. Then in February 2004, FleetBoston was pulled into the widening mutual fund scandal, charged by Spitzer with market-timing abuses. Morningstar recommended that investors steer clear. In 2004, Columbia had a net outflow of $3.7 billion, not including money market funds; the previous year it had had net retail sales inflows of $4.3 billion. In 2005, as $7.2 billion flowed out of the institutional group, pretax income declined by $17 million, or 4 percent, on flat revenues.
Banks and his team hunkered down, focusing on combining Banc of America Capital Management and Columbia. Streamlining the product line, they reduced the number of retail mutual funds from 119 to 76 and money market funds from 24 to 12. They also consolidated back-office operations and technology for an estimated one-time savings of $200 million.
Banks turned his attention to the laggard fixed-income business as well. By March 2005 he had hired Stephen Peacher, CIO of Putnam Investment’s credit team, to run taxable fixed income. Peacher had plenty to do. “The consultants would come in and say, ‘Show us your performance versus the Lehman aggregate,’ and we had three sets of numbers to show them,” he says.
Peacher, now CIO of all fixed-income and cash businesses, eliminated duplication and, aligning managers by style, centralized research. Short term, the moves were costly; as redundant portfolio managers and analysts left and others took on new roles, some institutional investors balked.
Morningstar lifted its “Don’t send new money” warning after BofA reached a final settlement with regulators in April 2005. Performance picked up, as did business. In 2003 only 13 percent of Columbia’s equity funds had outperformed their benchmarks after fees and expenses; that figure rose to 77 percent by the end of the third quarter of 2007. Over the same period the percentage of equity funds in Morningstar’s top two quartiles climbed from 47 percent to 77 percent. The happy result: Through November 2007, retail net sales, excluding money market funds, rose to $7.6 billion from $3.1 billion for all of 2006.
Still, BofA remained heavily dependent on Marsico, whose shop, rare among other parts of the BofA empire, remained autonomous. Marsico never hesitated to go directly to Lewis with any issues. That irked Columbia’s management, but Marsico was in the catbird seat. In 2006, up to half of net income was attributable to Marsico’s funds, while approximately 85 percent of new inflows came from Marsico.
In December 2006, Marsico flew to Charlotte and told Lewis that he wanted to buy back his firm so he could bring his family into the business and spread equity among his employees. Marsico’s growth style had come back in favor — from $12 billion in 2000 the operation now has $110 billion under management — and he was able to tap into cheap credit markets to fund the buyback. Lewis, who insiders say was weary of dealing with Marsico, agreed to sell.
Banks insists that BofA will do just fine without Marsico. Columbia will retain $40 billion of institutional assets subadvised by Marsico and will continue to sell Marsico’s retail funds. Banks expects to make up the lost profits in about a year by putting the 250-strong Columbia sales force behind its own products. He contends that the U.S. Trust’s Excelsior Funds will more than offset the Marsico loss. Excelsior fills a number of gaps in Columbia’s lineup and adds capacity in such styles as small cap, value, growth and international, including emerging markets. It boasts some highly regarded managers, including David Williams, who has run the five-star Morningstar-rated Excelsior Value & Restructuring Fund since 1992, and Richard Bayles, who has run the five-star-rated Excelsior Equity Opportunities Fund since 2004.
Banks has a point. With U.S. Trust’s asset management business included, third-quarter 2007 revenues of $488 million, up from $406 million in the third quarter of 2006, were the best in Columbia’s history. Net income before taxes rose to $181 million from $145 million.
Marsico aside, Banks and his senior executives have a mess on their hands in their cash business, normally a stable and low-margin but steady profit provider. Like its rivals, Columbia bought the paper of structured investment vehicles to offer investors a better yield in its institutional cash and retail money market funds.
As the subprime mortgage debacle hammered the value of SIVs, Bank of America decided that to protect its reputation and its investors — some of whom were also big corporate customers of the bank — it would step in to back up two funds. It has pledged $200 million to support Columbia Cash Reserves, a money market fund with nearly $60 billion in assets, which, as of December, held $644 million in the London-based Cheyne SIV that defaulted on interest payments in October, and it was also holding $250 million of Axon Financial Funding, an SIV that had been downgraded and put on watch by Standard & Poor’s in September.
BofA also moved to defend its Columbia Strategic Cash Portfolio, whose assets had reached some $40 billion in August to rank among the biggest enhanced cash funds; these are designed to provide higher yields, with slightly higher risk, by holding longer-duration securities than money market funds.
A few big investors, including the Kuwait Investment Authority, wanted to redeem their shares, an action that would have left remaining shareholders with a loss. BofA approached these investors about keeping their money at Columbia to ride out the storm, but shifting their funds into separate accounts; it offered to waive fees as well. The investors agreed.
Columbia cashed out less than $1 billion for small investors who each had less than $1 million in the fund, and has shifted $27 billion into separate accounts, giving investors their pro rata shares of the underlying securities. That left $6 billion in the fund, which Columbia has begun to liquidate. On December 21, Columbia redeemed 9 percent of each investment remaining in the fund — and all accounts remaining under $1 million — at an average price of 0.9881 cents on the dollar. The firm expects to make biweekly cash distributions from the fund until 90 percent is liquidated by this fall. There is no specific plan for the separate accounts at this point, but Columbia continues to manage them.
Winding down the enhanced-cash institutional fund has come at a cost. BofA lost $300 million liquidating the fund when it initially redeemed investors at 100 cents on the dollar; it is also sitting on another $300 million unrealized loss resulting from having purchased SIV paper from the fund. Eliminating management fees on the separate accounts, as well as on the fund as it winds down, could cost Columbia another $30 million in forgone revenues.
The problems may also dim the image of Columbia, which boasted that by managing its cash business separate from fixed income, unlike its rivals, it was able to attract the best cash managers and provide more focused risk management. Certainly its returns were enviable: Ninety-two percent of Columbia’s cash investments outperformed those of its peers over the one- and three-year periods through the end of March 2007. And customers buy money funds for yields.
Since the subprime blowup, Columbia president Jones has revamped the cash business, folding money markets into fixed income — it now reports to Peacher — to give it access to credit analysts with more experience with structured products. CIO Moore has day-to-day oversight of equity, fixed income and cash.
This overhaul is crucial, because the cash business, which grew from $154 billion in assets in March 2005 to $208 billion in March 2007, has been a key driver for Columbia. It provides 33 to 40 percent of net income, and profits from the highly efficient unit, which has just 35 staffers, are often plowed into other initiatives. The cash business is important in other ways too: It accounts for 82 percent of Columbia’s institutional business, which the asset manager is relying on to power growth. And many of its clients are also customers of the corporate bank.
Columbia executives still have high-reaching growth plans. They want to get bigger in the highly competitive institutional business and think they can do so by selling strategies to clients that already have long-standing relationships with the parent bank.
“In the early 1980s you could cold-call the treasurer or controller of Eastman Kodak and get him on the phone. No way can you do that now,” says Jones, who is increasing his staff for this push.
In April 2007 he recruited Amanda Grant, head of global relationship management at Babson Capital Management, to run institutional client service. He is building a team, including Tucker Glavin, who ran the East Coast corporate pension plans business for Fidelity Investments’ institutional asset management group, to work directly with BofA bankers and is putting together a four-person consultant relations group to cultivate consulting firms, the gatekeepers to the pension funds and other institutions.
Some bank asset managers — and brokerage firms — that haven’t succeeded at cross-selling asset management to other clients have hived off their management arms: Merrill Lynch & Co. sold 51 percent of Merrill Lynch Investment Managers to BlackRock in 2006, and Citigroup swapped its asset management operations for Legg Mason’s brokerage a year earlier.
Why should Columbia succeed where others have failed? Jones says that compensation plans have been revised to reward cross-selling and notes that in 2007, bank referrals generated $20 billion in assets for the global wealth and investment management unit. Banks adds that cross-selling meets clients’ desires to reduce their number of service providers to get better pricing and service.
With much of the growth in asset management coming internationally, Columbia has added staff in London and Singapore to distribute U.S. domestic products overseas. Though Jones expects initially to build investment capabilities in Asia using in-house talent, he is also considering small acquisitions or liftouts of portfolio managers. He says only about $30 billion of the firm’s U.S. investments have been sold to non-U.S. investors, and Columbia is registering eight new funds in Dublin to increase its reach.
Like many traditional asset managers, Columbia also wants to hop on the alternatives bandwagon. It recently launched its first multistrategy fund, a research-driven long-short fund and a 130/30 fund. Even though Columbia has little experience in the sector, Banks is adamant that he doesn’t want to make an acquisition of an alternatives manager and that the firm can develop nontraditional products on its own.
“You’ll see more and more traditional managers getting into alternatives, and we’ll be no different,” he says.