MONEY MANAGEMENT - Who Says It Doesn’t Grow on Trees?
Vibrant market conditions and ample liquidity helped firms in the II300 ranking of America’s top money managers yield bountiful results.
Money may not grow on trees, but a little water — okay, liquidity — never hurts. With the world a wash in funds that investors are eager to put to work, few companies have benefited more or found it easier to pros-per than investment management firms. And no wonder: Assets under management at America’s 300 biggest money managers, the Institutional Investor 300, grew a smart 16.9 percent in 2006, to reach $31.1trillion. That was nearly twice the rate of growth in 2005 and marks an increase of two thirds from five years ago, when the II300 managed $18.6 trillion. The minimum required to make this elite group continued to climb sharply: The smallest firm on our list, NewYork hedge fund manager Eton Park, reported assets of $6.3 billion, an entry hurdle that is $1.1 billion higher than in the previous year.
Leading the way for a third straight year is Barclays Global Investors, powered by strong investor demand for the firm’s enhanced index products, its exchange-traded funds and, more broadly, its alternative-asset offerings. At year-end San Francisco–based BGI managed $1.8 trillion, up 19.9 percent from 2005. “Our business was strong in 2006, with net new asset growth of approximately $68billion,” says CEO Blake Grossman.
With market valuations buoyant, investors looked farther a field in their search for alpha, driving up net flows in every asset class, both domestic and foreign. Global investments, in particular, notched impressive gains. Non-U.S. equities surged 32.6 percent, to $5.5 trillion, while assets in non-U.S. fixed-income securities grew by 19.0 percent, to $1.6 trillion — nearly five times the growth rate in last year’s ranking.
“It was a terrific year for us and for others as well,”says William Hunt, CEO of Boston’s State Street Global Advisors, which retains its No.2 ranking, with more than $1.7 trillion in assets. Hunt ought to know: SSgA gained more money — $307.2 billion — than any other firm except New York–based BlackRock, which vaults up the ranking from No.16 to No.5 thanks to its acquisition of Merrill Lynch Investment Managers in September 2006.
Strong demand for alternative-investment vehicles, and their lucrative fees, continues to bolster firms’ bottom lines, even as many managers revisit their strategies and invest in new business lines. A recent study of 87 U.S.-based asset managers by McKinsey &Co. and II’s U.S. Institute showed an average pretax profit margin of 31 percent in 2006, on par with the results for 2005.
For all this prosperity, no one is standing pat. Financial supermarkets continue to examine their asset management holdings — American Express Co.,Citi and Merrill Lynch & Co.have all jettisoned their operations in recent years. Other firms are aggressively buying stakes instand-alone hedge funds or starting their own: In the course of just a couple of days last fall, for example, Morgan Stanley announced that it had bought into three hedge funds. And in recent weeks two publicly held managers have reclaimed their independence: Nuveen Investments, which is going private, and Marsico Capital Management, which is being bought back from Bank of America Corp. by founder Thomas Marsico.
The industry’s strength is quite a happy change from just a few years ago, when sour markets were savaging money managers. In 2002 assets under management in the II300 were shrinking as a perfect storm of declining stock markets and falling interest rates slammed retail and institutional investors alike. Then money managers had to contend with a near-crippling wave of scandals — from market-timing to accusations of pay-for-play sales agreements —and regulatory constraints. Worries still abound.
Worries still abound. The troubled subprime-mortgage market has many investors nervous, as do concerns about a sudden tightening of global liquidity. Booming economies worldwide could trigger inflation, some investors fear, leading to higher interest rates that might dampen consumer spending, cool business investment and hurt stock markets. Higher interest rates could put an end to the corporate buyout boom, which is also bolstering equities.
Although these are ebullient times for firms that show they can be farsighted and adaptable, assets do not just walk in the door, and funds are not flowing to firms simply because they have hung out a shingle. Because of low volatility and strong stock market returns, many active equity managers failed to beat their benchmarks last year; these firms, like perennial powerhouse Fidelity Investments, which falls to fourth, have felt the pain. Boston-based Fidelity ranked first for a decade before it was knocked off its perch in 2003 by SSgA, while the other major indexer, BGI, moved in to second. Now Fidelity has been supplanted as the biggest active manager by the better-performing Capital Group Cos., based in Los Angeles, which moves up one slot from fourth last year.
The biggest winners in the II300 were firms that could supply products at both ends of the spectrum: cheap beta offerings like exchange-traded funds and higher-priced, alpha-generating products like hedge funds and such short-extension strategies as 130-30 funds, which combine active management with short-selling.
BGI is profiting handsomely in the current environment. Its iShares ETFs were the top contributor to last year’s net new asset growth of $68 billion, says CEO Grossman. New offering shave been fast and furious. Since December 2005, BGI has launched 33 ETFs — with 17 debuting between January and May 2006 alone — ten of which were fixed-income products. As of May 31 of this year, the firm’s global ETF assets totaled $289.6 billion, up 69.8 percent from May 31, 2005. Today, BGI has a 59 percent share of the ETF market. “Everybody else is jumping into a growing market but not getting a lot oftraction,” says Paul Mazzilli, director of Morgan Stanley’s ETF research team in Purchase, New York.
All told, BGI’s pretax profits rose 32.2 percent in 2006, to $1.3billion, on a 26.3 percent increase in revenues. IShares, which earn about 30 basis points per dollar of assets under management, pulled in roughly $292 million of the firm’s impressive $3.1 billion in total management fees. That figure includes performance fees on single-manager hedge funds, which grew from $14.3 billion in assets in 2005 to $19.0 billion last year.
State Street also has plenty to celebrate. Since taking over two and a half years ago, CEO Hunt has encouraged research teams at SSgA’s 11 offices around the world to work more closely together. The effort is paying off. As recently as 2002, SSgA’s non-U.S. business barely broke even. But last year assets in Asia, Europe, Africa, the Middle East and Latin America grew by 28.3 percent, to $550.4 billion, and contributed about 40 percent to the bottom line.
Although SSgA is less profitable than BGI, which has nearly five times as much in hedge fund assets under management, market observers credit Hunt with making big strides in building higher-fee-generating business. Last year 72.0 percent of SSgA’s new revenues came from active and enhanced strategies, pushing management fees up 25.6 percent, to $943 million. Net inflows were $86 billion, up from $36 billion in 2005. And with total assets up by 21.4percent, to morethan $1.7trillion, pretax profits climbed 40 percent, to $427 million.
“It was a record year in every way — assets, returns, profitability— across the board,” beams Hunt.
That was not the case for everyone, however. Fidelity is about half way through a four- to five-year effort to sharpen the quality of its equity research — it has hired some 90 new analysts as part of its research overhaul — but the firm’s equity mutual fund performance remained decidedly mediocre in 2006. And that has hurt. In a year when the Standard & Poor’s 500 index delivered a total return of 15.8percent, the 198 Fidelity equity mutual funds tracked by Lipper returned an average of 14.2 percent and ranked in the 54th percentile, down from the 40th percentile the previous year, when the funds returned 13.1 percent.
Last year Fidelity grew its assets by 14.6 percent, to nearly $1.4 trillion, some 2.3 percentage points below the II300’s overall growth rate. Active-management rival Capital steamed ahead, growing assets by 20.4 percent, to more than $1.4 trillion, on the strength of improvedperformance at its American Funds unit, whichrepresents about 75 percent of the firm’s assets. The 26 equity mutual funds in the American Funds family returned 19.4 percent in 2006 and ranked in the 33rd percentile, according to Lipper. In 2005 the funds returned 11.7 percent andranked in the 43rd percentile. (Executives at Fidelity and Capital declined to comment.)
Investment Managers, BlackRock grew assets by 149.1 percent, to more than $1.1 trillion, the biggest dollar gain last year. (Pittsburgh’s PNC Financial Services Group, which no longer owns a majority stake in BlackRock and cannot count the firm’s assets as its own, plummets from No.16 to No.101, chalking up the biggest dollar loss.)The deal was transformative. Already one of the three biggest insti-tutional fixed-income managers in the U.S., BlackRock has become a huge, multi specialized firm. It swallowed $314.4 billion in equityassets from MLIM. It also gained a wider reach into international markets, nearly doubling institutional global bond mandates, to $38.0billion as of December 2006, with the addition of MLIM’s investmentteams in London, Sydney and Tokyo. Expanded capacity in high-yield and distressed debt helped BlackRock nearly double its alternatives, to $28.7 billion.
Another positive for leading bond houses like BlackRock is the move to new pension funding and accounting rules in the U.S. that are putting pressure on defined-benefit-plan sponsors to manage their assets and liabilities more carefully and to become fully funded in the coming years. That, in turn, is fueling demand for bonds, as liability-driven investment strategies gain traction in the marketplace.
Some money managers are tapping into this trend, including NewYork–based Goldman Sachs Group, which moves up one slot in our ranking, to No.13. Fixed-income assets at the firm’s investment man-agement division jumped 29 percent, to $198.0billion. An additional beneficiary is Lehman Brothers Holdings, which grew its domesticfixed-income assets by 11.4percent, to $60.1billion. Overall, Lehmanattracted about $35 billion in net flows, growing its assets by 27.5percent, to $228.8 billion, and climbing five spots to No. 34. “Somelarge clients have reduced their equity exposure to better match theirassets and liabilities,” says George Walker, global head of Lehman’sinvestment management division. “That has been a real opportunity.”
Nowhere is the buoyancy in the business more evident than in alternatives — the fastest-growing asset class in the II300, surging 39.8 percent, to $1.3 trillion. That is more than double the growth rate in 2005.This year 50 hedge fund firms make the ranking, compared with 43last year. (Five years ago only 32 made the list.) The biggest, D.E. Shaw Group, is No.123. Standalone hedge fund managers grew their assets at a similar rate as in 2005 — a formidable 44.8 percent — increasing assets by $170.3 billion.
The money is flowing not just to stand-alone hedge fund managers. Firms that were once considered long-only players are aggressively pushing into the space, either buyingstakes in hedge funds or starting their own. In fact, traditional firms in the II300 grew their alternative assets by36.3 percent last year, versus just 4.8percent the year before. All told, they added $211.1 billion across several alternative asset classes.
“With the larger firms there is a sense of security because they are more established,” contends Jes Staley, CEOof New York–based JP Morgan Asset Management, the biggest single-manager hedge fund firm, and No. 6 on our list. “This notion that you have to go small to generate excess returns is being disproved by the marketplace.”Demand for alternatives certainly helped drive results under Staley’s watch: Assets grew 19.6 percent last year, to $1.0 trillion, and net income rose 15.9 percent, to$1.4 billion. JPMAM had a total of $68.5 billion in all types of alternatives at the end of 2006, including $33.1 billion in single-manager multistrategy hedge fund assets, up an impressive 69.7 percent from $19.5 billion at the end of 2005. That figure includes $15.7 billion managed by Highbridge Capital Management, a hedge fund firm that JPMorgan Chase & Co.acquired for $1.5 billion in December 2004.
Much of JPMAM’s alternative asset base experienced strong growth outside the U.S. last year. A case in point is Highbridge’s Asia hedge fund, which opened in December 2005 and had pulled in$1.5 billion in assets by the end of the following year.
In their quest for absolute return, institutional investors warmed quickly to short-extension strategies. “Demand for 130-30 just cameout of nowhere,” says Jeff Gabrione, head of Americas manager research at Mercer Investment Consulting in Chicago.
With this strategy, a manager typically shorts 20 or 30 percent of a portfolio and uses the proceeds from that transaction to add further exposure to the long position. According to Gabrione, short-extension strategies had attracted upward of $50 billion by the end of last year, much of it from pension funds drawn by the lower fees and better transparency relative to hedge fund investments.
There is no shortage of capacity. BGI, GSAM, JPMAM, SSgA and ING Investment Management all rank among the biggest managers of short-extension funds, as do several quantitative boutiques, such as Analytic Investors and Acadian Asset Management, both of which are subsidiaries of Old Mutual Asset Management. The few big managers that do not already run 120-20 or 130-30 products are scrambling to develop them.
Strong growth in global markets provided a lift to a variety of money managers in the II300. A case in point is Mellon Financial Corp., whose merger with Bank of New York Co. closed this month, creating Bank of New York Mellon Corp. Pittsburgh-based Mellon Financial delivered strong results before its merger, ranking among the biggest dollar gainers in 2006 and holding on to its No.9 position. Its total assets grew by 24.3 percent, to $879.7 billion, but its non-U.S. assets — mostly equities — nearly doubled, to $201.9 billion, accounting for 23.0 percent of the firm’s total assets last year, up from 14.7 percent in 2005. Of the non-U.S. asset growth, 25.5 percent resulted from two deals: Mellon’s October 2 acquisition of Walter Scott & Partners, an Edinburgh–based firm with $30.8 billion in assets; and the creation of a 50-50 joint venture with WestLB of Germany in April 2006 that enabled Mellon to begin distributing its funds in that country.
“Last year was a fabulous year for us,” says Ronald O’Hanley, CEO of BNY Mellon Asset Management. “What powered that growth clearly was the market’s and the investment community’s continued move toward non-U.S. investments.”
AllianceBernstein, the New York–based subsidiary of France’s AXA Group, which ranks No. 8 on our list, also gained formidable traction overseas. Created in October 2000 from the merger of growth power-house Alliance Capital Management and value shop Sanford C. Bernstein & Co., the firm has separate teams in the U.S., Europe and Asia that manage money in both investment styles and that cross-sell globally. Total assets under management grew 23.9 percent, to $717.0 billion, last year. But non-U.S. assets grew more than twice as fast, reaching $385.9 billion. Last year 76 percent of net in flows were from non-U.S. accounts, up from 69 percent in 2005 and 61 percent in 2004.
“Our growth rate is heavily in global style blends,” says Alliance-Bernstein CEO Lewis Sanders.
As Sanders and his fellow money management CEOs can attest, the fundamentals of the industry look stellar. But there is no guarantee that investors will continue to have the wind at their backs. Potentially higher interest rates and slower corporate profit growth could create near-term trouble for U.S. stocks. Timothy Bond, an asset allocation strategist at Barclays Capital in London, figures that the S&P500 is poised to deliver negative results this year. “It’ll be a pretty shoddy and poor return from the stock market,” he predicts.
That may be true. But many of America’s largest money managers— particularly the giants atop the II300 that are pursuing specialization across multiple asset classes — look better prepared than ever to weather market turmoil and seek new sources of profit. Take Lehman’s asset management unit. In the first quarter of this year, the firm added about $9 billion in assets, and on March 13 it announced that it had bought a 20 percent stake in D.E. Shaw, which managed $27.3 billion in alternatives and $960 million in traditional assets at year-end 2006. “Really tough markets would certainly change the industry,” says Lehman’s Walker, who orchestrated the transaction. But tough markets, he adds, “wouldn’t stop it or unwind it.”
The rankings were compiled by Senior Associate Editor TuckerEwing.