MONEY MANAGEMENT - Trading Up?
Former star trader Kevin Parker is remaking Deutsche Asset Management with an aggressive push into alternative assets. Now can he make some money?
LEAPING TO PROMINENCE AS A FAST-RISING TRADER, Kevin Parker made a name for himself with his bold moves. His big bets arbitraging Japanese stocks in the early 1990s generated a big chunk of Morgan Stanley’s profits. Later that decade he traded his meteoric career at the investment bank for the chance to run Deutsche Bank’s fledgling equities trading business, which he turned into a global powerhouse.
Now head of Deutsche Asset Management, Parker, 48, is applying his hard-boiled trader’s instincts to the more genteel world of money management. Earlier this year, looking to bolster the fixed-income capability of the bank’s E561 billion ($815 billion)-in-assets money management arm, the American executive hired four senior fund managers from rival Invesco, including the chief investment officer of the firm’s $100 billion worldwide fixed-income group, along with 12 other professionals from that firm. In March, Parker flew from New York to Atlanta to inform Invesco CEO Martin Flanagan of the pending deal in an effort to prevent the incident from damaging Deutsche’s broader business relationship with Invesco. Not that he had any intention of backing down.
“I went down there as a professional courtesy in the hope of reaching a commercial solution,” the blunt-spoken investment banker tells Institutional Investor.
So much for Parker’s attempt at diplomacy. The meeting lasted just seven minutes, according to both men, and Invesco subsequently sued Deutsche for “scheming” to raid its staff. But Parker prevailed four months later, and the new Deutsche fund managers, based in Louisville, Kentucky, have already attracted about $5.5 billion in new assets. “We’re extremely excited about what these guys will be able to do,” Parker says in an interview from his office overlooking Park Avenue in midtown Manhattan.
The raid is only the latest example of the aggressive moves Parker has made during the past three years to turn around Deutsche’s sprawling but perennially underperforming asset management operation. Since being tapped for the post by Deutsche CEO Josef Ackermann in September 2004, Parker has dramatically restructured the subsidiary -- slashing head count by 27 percent, to roughly 3,300 worldwide, shucking an unprofitable U.K. institutional fund business and expanding Deutsche’s capabilities in high-margin alternative assets.
Deutsche’s activities in this area are already considerable, embracing RREEF Alternative Investments, an E83.4 billion outfit that runs mostly real estate assets, and DB Advisors, a hedge fund unit that Parker founded at the investment bank’s proprietary trading desk eight years ago.
But Parker is reaching for even more. He launched Deutsche’s first private equity fund of funds earlier this year after acquiring a stake in Dallas-based boutique Aldus Equity; he’s investing heavily in a quantitative group, which last year launched a global macro hedge fund; and he plans to use the former Invesco team to launch new long-short funds.
“Institutional investors are the 800-pound gorilla about to enter the alternatives investment market,” declares Parker. “We are beautifully positioned.”
Yet for all his wheeling and dealing, the results to date have been underwhelming, leading to questions about whether DeAm can meet the goal set by Ackermann, who wants a sizable and stable base of earnings from fund management to complement Deutsche’s bigger and more volatile investment bank.
Portfolio/fund management, which accounts for the bulk of DeAm’s revenues, dipped slightly, to E1.75 billion, in the first nine months of this year, from E1.77 billion a year earlier. The bank’s asset and wealth management division, which combines DeAm and Deutsche’s private banking businesses, generated pretax profits of E744 million in the first nine months, up 13 percent from a year earlier but representing only 10.2 percent of the group’s profits.
Parker insists he is on track to meet Ackermann’s goal, pointing out that DeAM generated net asset inflows of E27 billion in the first three quarters, up from just E6 billion in 2006 and outflows of E6 billion in 2005.
Many analysts have their doubts, though. “It’s too early to judge whether the business is turning around,” says Kian Abouhossein, a banking analyst at JPMorgan Securities in London. “I don’t see any material change in the business yet.”
“I’m skeptical about the turnaround of Deutsche Asset Management,” says Michael Beasley, managing director of Strategic Investment Solutions, a San Franciscobased investment consulting firm. “We’ve seen these kind of attempts before.”
Parker faces a number of challenges in seeking to rev up Deutsche’s fund management business, beginning with his big push into alternatives. He is looking to expand in this area just as the recent market turmoil emanating from the U.S. subprime mortgage crisis has knocked returns at many leading hedge funds, including Deutsche’s own quantitative long-short funds.
RREEF, which has been one of Deutsche’s bright spots in recent years, has suddenly lost some of its luster. The division’s flagship America REIT II investment trust, which has $10.6 billion in assets, has underperformed its benchmark over the past year after positioning itself too early for a downturn in the U.S. commercial property market. At the same time, a five-year incentive scheme put in place when Deutsche acquired RREEF in 2002 ended earlier this year, leading to the departure of ten senior executives, including Steven Steppe, former chairman of RREEF North America.
“Anytime there is a management shakeout, that’s cause for concern,” says Timothy Barrett, chief investment officer for the San Bernardino County Employees’ Retirement Association, which has $160 million in Deutsche’s real estate and infrastructure funds. He flew to San Francisco to meet with RREEF managers in September and returned satisfied that the “current team will stick around.”
Still, RREEF’s problems threaten Parker’s goal of increasing profits. Already RREEF is struggling to match last year’s high fees from some of its investments. Revenues in asset management fell 12 percent, or E82 million, in the second quarter from the same period a year earlier, as lower fees on real estate more than outweighed gains in the European retail business. RREEF head Chuck Leitner says real estate fees are inherently lumpy because they are paid when properties are sold. He insists the business remains strong with positive inflows this year in areas such as infrastructure and global real estate. ''There is clearly a trend among U.S. investors towards overseas real estate markets, he says.
Parker acknowledges the recent turmoil at RREEF but says that Deutsche always anticipated losing some talent when the incentives expired. He also insists that the market ructions won’t undermine the long-term shift toward alternative assets by pension funds, endowments and other institutions. “I was taught as a trader that the trend is your friend,” he says. “We see only a reinforcement of the trend toward alternatives.”
Another big problem is Deutsche’s long-underperforming U.S. mutual fund business, formerly known as Scudder Investments. The bank paid $2.5 billion to acquire Scudder from Zurich Financial Services in 2001, hoping to gain a U.S. retail fund presence to match its powerful DWS mutual fund unit back in Germany. But Scudder had been losing assets for three years before the acquisition, and the hemorrhaging has continued under Deutsche’s ownership. Parker rebranded the business as DWS Scudder and recruited Axel Schwarzer, previously head of marketing at the German fund unit, to run the business. Schwarzer has slowed the bleeding, but his efforts to boost performance and shift from direct sales to third-party distribution have yet to pay off.
The problems will make it hard for Parker to meet Ackermann’s aim of boosting predictable income from asset management to offset the volatility of investment banking. That ambition has become all the more urgent in the wake of the subprime crisis. Deutsche wrote down its exposure to mortgage-backed securities, leveraged loans and other products by E2.2 billion in the third quarter of this year, and reported a 20 percent drop in net revenue, to E5.1 billion. The bank did manage to increase net income by 31 percent, to E1.6 billion, through one-off tax savings and capital gains, including the sale and leaseback of its U.S. headquarters building.
Deutsche’s dependence on investment banking is weighing on its shares. The bank’s stock has dropped 12 percent so far this year, to E88.87 early this month, the same decline as that of rival Credit Suisse, but not as bad as those of UBS (down 20 percent) and Merrill Lynch (down 33 percent). Shares in Goldman Sachs Group, Deutsche’s biggest rival, were up 20 percent over the same period.
“Investors are concerned about the business mix in this environment,” says banking analyst Abouhossein. Asset and wealth management will account for just 15 percent of Deutsche’s expected E4.7 billion in net income next year, he estimates. By comparison, he forecasts that UBS will generate 53 percent of its estimated E11.3 billion in net income from asset and wealth management.
“This business is massively under the spotlight,” says Christopher Wheeler, an analyst at Bear, Stearns International in London. “My sense is that Parker is having a tough time.”
Parker expresses frustration with the low value that investors put on his business. “Analysts like to shoot us down because of lower real estate fees,” he says, “but alternatives is a lumpy business.” He remains confident about hitting his profit target, however, arguing that efforts to bolster performance -- such as requiring fund managers to invest some of their own money in the funds they run -- will generate steady inflows into Deutsche’s fixed-income, real estate, stock and infrastructure funds, as well as fuel the growth of its business of managing assets for insurance companies.
“We are building a performance-driven organization,” says Parker. “It requires courage, and you have to be willing to take tough decisions.”
Former colleagues attest to his ability to do just that. “Kevin is a proven and aggressive business builder,” says Ralph Reynolds, a Parker hire and former head of proprietary equity trading at Deutsche who is now co-head of Carlyle-Blue Wave, Carlyle Group’s new hedge fund.
ARKER WAS BORN IN BELMAR, New Jersey, a seaside town about 60 miles south of New York City with a winter population of just 7,000. His father worked as an electrical engineer for the U.S. government at the nearby radar installation of Fort Monmouth; his mother worked part-time as a real estate broker while raising six children. That modest upbringing forged a steely character. “I’m very secure in my career, in who I am and my family life,” he says. “I came from nothing -- the biggest salary my father made was $20,000 a year -- so I don’t worry about my future.”
In his youth, Parker says, he could see the beach from his bedroom, but the bright lights of the city called. He went to Manhattan for his studies, choosing management and finance because he “liked money.” He graduated with a bachelor of science degree from New York University in 1981.
Parker got his first taste of trading at E.F. Hutton & Co., then the second-largest retail brokerage in the U.S. behind Merrill Lynch & Co. and now part of Lehman Brothers. He joined a training program for proprietary traders and chose the equity derivatives desk. “Firms on the Street were still struggling with the demise of the commission-based model and were starting to deploy more of their own capital,” he recalls.
He left Hutton in February 1986 and joined Morgan Stanley, where his mentors included Rod Berens, former head of cash equities and now head of Berens Asset Management, and Sheldon Johnson, who was head of equity derivatives at the time. By October of that year, he had demonstrated sufficient trading skills to be picked to go to Tokyo to build an equities business for the firm. It was a stunning ascent for Parker, who didn’t have a passport and had never been on an airplane.
It was as a hotshot trader in Tokyo that Parker really made his name. Even as Japan’s stock market plunged and the country slid into recession, his aggressive stock arbitraging helped Morgan Stanley Japan post a pretax profit of ¥12.6 billion ($100 million) in the six months ended September 1992. Some in Japan blamed the firm’s trading for the market’s weakness, and Parker received anonymous faxes with death threats. “It was a crazy time,” he says. “People had lost a lot of money and were very emotional.”
The following year, John Mack took over as president of Morgan Stanley and shuffled his management team, making Parker, then 33, the youngest partner in Morgan Stanley’s history and head of the firm’s $1 billion technology budget. Mack had a habit of moving his stars around, but the shift left Parker with a bad taste in his mouth. “Within one year everyone forgot I had run a successful business and began treating me as a second-class citizen,” he says.
In 1997, Parker jumped to Deutsche Morgan Grenfell, as the investment bank was then called. In a newly created position of head of equities trading in New York, Parker became one of the bright young stars who remade Deutsche into a top-tier global investment bank, along with fixed-income supremo Anshu Jain and corporate finance chief Michael Cohrs.
Parker brought Ralph Reynolds and other former Morgan Stanley traders to Deutsche in 1998 when he oversaw the acquisition of the equity derivatives business of National Westminster Bank in Greenwich, Connecticut. He also set up derivatives trading divisions in Asia. By 2001, Parker had transformed Deutsche from an also-ran in equities into a major global player.
Parker also made the uncommon move at the time of opening up Deutsche Bank’s proprietary trading desk to outside investors through a division called DB Advisors. In 1999 he launched the first fund sold to Deutsche clients, called Noetic, a CTA fund that has since grown to more than $1 billion in assets.
The next launch, the DB Masters Fund, was a multistrategy hedge fund that invested in managers from Deutsche’s proprietary trading desk, such as QVT Financial, which was founded by Dan Gold with $1 billion in seed money from Deutsche Bank. The DB Masters Fund today has about $2 billion in assets; its underlying managers collectively run more than $20 billion.
When Ackermann shuffled his management team in the summer of 2004, Parker lost out to Jain and Cohrs, who were promoted to co-heads of investment banking. Parker says he was going to leave Deutsche to set up his own hedge fund but Ackermann persuaded him to stay and run asset management. Parker brought some managers from DB Advisors with him, giving DeAm the seeds it lacked to develop new single-manager hedge funds.
Parker is the latest in a line of investment bankers to lead Deutsche’s fund management arm. One of the first, Michael Dobson, came from investment bank Morgan Grenfell, which Deutsche acquired in 1989. Dobson took the reins of Morgan Grenfell Asset Management, as the business was then known, in 1998 in a management reshuffle after the firm was rocked by a scandal involving fund manager Peter Young. The manager was found to have made £2 million (then worth $3 million) through a fraudulent bond transaction but was judged unfit to stand trial; he was diagnosed with schizophrenia after allegedly attempting to castrate himself and appearing in court wearing a dress.
Deutsche’s 1999 acquisition of Bankers Trust for $9.9 billion pushed DeAM into the big time by adding $285 billion of assets -- Bankers Trust at the time was the seventh-largest money manager in the U.S., running mostly low-margin, passive index funds. But although the acquisition added assets and staff, profitability remained poor and Deutsche seemingly placed little value on the business. The bank even considered sacrificing its most profitable asset management arm, the domestic German mutual fund powerhouse DWS, in an unsuccessful bid to merge with rival Dresdner Bank. After arguing strongly against the proposed merger, Dobson resigned. He now heads London-based rival Schroders.
Dobson was replaced in June 2000 by Michael Philipp, then head of global equities. But hit by the downturn in global stock markets, DeAM’s profits fell 56 percent, to E293 million, in 2001.
Deutsche responded with the $2.5 billion acquisition of New Yorkbased Zurich Scudder Investments from Swiss insurance group Zurich Financial Services in September 2001. The deal added about $300 billion in mostly higher-fee-earning actively managed assets, including some $100 billion in U.S. mutual funds. But the acquisition also created more problems as the Zurich Scudder business suffered poor performance and significant outflows.
In 2002, Deutsche Bank thenchief executive Rolf Breuer and Ackermann, his designated successor, lost patience as profitability remained low. They decided to sell the index business acquired from Bankers Trust, which managed $150 billion, to Northern Trust Corp. Meanwhile, Philipp, who had been on leave to care for his sick wife, resigned and was replaced by the asset management division’s chief operating officer, Thomas Hughes.
Hughes set about boosting profitability with a cost-cutting drive that slashed 1,500 jobs. He also started a push into alternative investments with the March 2002 acquisition of RREEF for $490 million, adding $16 billion in property assets to Deutsche’s $20 billion and creating the biggest real estate fund manager in the world.
Yet asset management continued to suffer from poor performance, low morale and fund outflows. Hughes even entered talks with Invesco about selling the business, but Ackermann decided to keep it for the potential stable earnings, according to people familiar with the matter. In September 2004, Hughes left for family reasons, and Ackermann replaced him with Parker.
Parker is in many ways the typical investment banker. “He’s a no-bullshit type of guy,” says Richard Goldsmith, former head of the hedge fund unit at DeAM under Parker, who is now at Carlyle-Blue Wave. “He comes from trading rather than sales and is very direct.”
Parker lives in Manhattan with his two young sons and his half-German wife, a glamorous Cornell University graduate who frequently appears in the society pages. Dan’s Papers, a newspaper covering Long Island’s exclusive Hamptons area, carried a story recently in its online edition about an end-of-summer, white-themed party at the Parkers’ Southampton home. Guests included hedge fund managers Louis Bacon of Moore Capital Management and Steven Mnuchin of Dune Capital Management. Parker also is part-owner of Château Maris, a vineyard in Languedoc in southern France that produces highly rated wines with the La Livinière appellation.
His arrival as the head of DeAM produced some sour grapes, however. “There’s no way I would report to someone who had never been in the asset management business before,” says one employee who lost out in Parker’s shakeout. “He’s dismantled the business.”
Parker’s diagnosis was that Deutsche was suffering from unhealthy fiefdoms and competing brands. “Asia didn’t know whether it should market DWS or Scudder and did both; hedge funds didn’t want to share revenue; the German and U.K. institutional businesses fought it out,” he says. “Lack of revenue sharing, lack of cross-selling -- these were issues we had tackled and solved a decade ago in investment banking.”
His solution was to oust all three of DeAM’s top regional executives -- Paul Manduca in Europe, William Schiebler in the U.S. and James Goulding in Asia-Pacific -- and replace them with his own lieutenants. He reorganized the business along global product lines rather than according to geographical areas.
“Turning around the business was a huge and daunting task in September 2004,” says Roelfien Kuijpers, global head of institutional business. “But within two and a half months, Kevin had already announced the new management structure and the new management team.”
Parker also set out to improve distribution by hiring about 50 investment bankers, some from outside the bank, such as Robert Goodman, now co-head of DeAM’s insurance asset management business and a former investment banker from Lazard in New York. Investment bankers have “a problem-solving mentality that makes them more than just product pushers,” says Parker.
To bolster performance, Parker has taken a number of uncommon steps, such as shifting management of U.S. large-cap value stock funds from New York to Frankfurt in February. Clients worried about the change have withdrawn $2.5 billion in assets, but performance has improved significantly since Parker put Thomas Schuessler in charge of the $7 billion-in-assets portfolios. The DWS Large-Cap Value fund was up 14 percent for the year at the end of last month, putting it in the top 6 percent among its peers, according to Morningstar. The fund had languished in the bottom 25 percent from 2004 to 2006.
One of Parker’s most controversial moves was to sell the bulk of DeAm’s U.K. business in July 2005 to Aberdeen Asset Management for £265 million. The business had about £46 billion in assets and included the U.K.-based institutional equity, fixed-income, global equity, multiasset and DWS retail businesses as well as Deutsche’s Philadelphia-based active fixed-income business. The bank had inherited the business when it acquired Morgan Grenfell.
“The U.K. business duplicated what we had 500 miles away in Germany and operated in a market under tremendous fee pressure,” Parker says. The unit was losing E100 million a year, turning in a poor performance in equities and losing staff and mandates, he explains.
Deutsche Asset Management is divided into four divisions: the DWS retail business, with about E240 billion in assets; the institutional business, with roughly E159 billion in assets; the alternatives business, with some E68 billion in assets; and the insurance business, with about E94 billion in assets.
Retail and alternatives are the big money spinners. The retail business generated E1.36 billion in revenues for DeAM last year, followed by alternatives (E1.14 billion), institutional (E251 million) and insurance (E57 million). The alternatives business produced a return on average assets of 201 basis points, followed by retail with a return of 59 basis points, institutional with 19 basis points and insurance with just 5 basis points.
To boost alternatives, Parker has steered DeAM into private equity, first with the January acquisition of a minority holding in Dallas-based boutique Aldus Equity, which has about $3.5 billion in assets. Then he launched the $775 million DB Secondary Opportunities Private Equity Fund, which closed to investors in March, to buy secondary positions in existing partnerships and co-invest in companies alongside other private equity investors.
Parker hopes to add higher-margin core and core-plus products and absolute-return strategies with the addition of the team from Invesco. Those managers ran some $7 billion in absolute-return products that employed long-short strategies and credit derivatives, says Bart Grenier, global head of specialty fixed-income business. “I view these guys as cutting-edge.”
The business of running asset management portfolios for insurance companies like Switzerland’s Converium is where Parker expects to add the most assets, albeit at low margins. DeAM already ranks as the largest manager of insurance assets in the world, with $150 billion under management; division head Goodman hopes to reach $300 billion in assets within the next two to three years. “This is a scale business,” he says.
Elsewhere, Parker is investing heavily in the quantitative team run by Janet Campagna, doubling the staff to about 50 investment professionals, including 15 Ph.D.s. The quant group manages approximately $95 billion in assets, but like other managers using computer models, it was blindsided by the August market turmoil in some areas. DeAm’s large-cap 120/20 funds launched in November 2006 were down on average between 2 and 3 percentage points against their benchmarks from their inception to the end of August, according to DeAM.
Still, Campagna thinks she can double assets under management within the next two years, partly powered by growth in global tactical asset allocation, or GTAA funds. Deutsche manages about $21 billion in GTAA strategies at various risk levels. Its $200 million in assets in GTAA portfolios with annualized volatility of 20 percent -- dubbed the iGAP 20 percent -- have posted strong performance while much bigger rivals like the Goldman Sachs Global Alpha hedge fund have stumbled. The iGAP 20 percent fund produced a return of 23.3 percent net of fees last year, compared with a loss of 6 percent for Goldman’s Global Alpha. In the first three quarters of this year, Deutsche’s fund has returned 34.77 percent net of fees.
One of Parker’s greatest challenges is to turn around the performance of his U.S. mutual funds. Scudder’s poor performance and outflows have led to a drop in market share, to 1.2 percent from 7 percent at the firm’s peak in the 1990s.
In March 2005, Parker tapped Schwarzer from DWS in Frankfurt to fix Scudder. The executive is scathing about what he found. “There was no performance culture, no business strategy,” he says.
Under a turnaround strategy known internally as “R Cubed” (for restructure, refocus and rebuild), Schwarzer has embarked on a wholesale transformation of distribution and a drastic winnowing of fund offerings. He shifted away from direct sales early last year and turned to third-party distributors such as Merrill Lynch, Citigroup, Wachovia Corp. and Edward Jones. “Investors want advice,” he says. The business suffered outflows of $7 billion in 2005 and $3 billion in 2006. He expects outflows to continue this year because of the switch from direct sales.
Schwarzer insists DWS Scudder can grow with a more focused and innovative lineup. He has reduced the number of funds from about 200 to 70 and is betting on existing top-rated funds like the DWS Global Opportunities Fund, which outperformed its benchmark MSCI EAFE index by 2.82 percentage points, annualized, in the five years to October 19, according to Morningstar.
He is also launching new funds managed from Frankfurt and sold into the U.S., such as the DWS International Value Opportunities fund, which invests in large-cap stocks and is managed by Klaus Kaldemorgen, a veteran DWS fund manager and head of equities in Frankfurt. And Schwarzer started the DWS RREEF Global Real Estate Securities Fund, run by RREEF fund manager John Robertson. Most recently, DWS Scudder began selling the DWS Climate Change Fund, the first mutual fund in the U.S. that invests in companies expected to benefit from a shift toward energy efficiency and non-carbon-based fuels.
Still, overall performance at DWS Scudder needs to pick up in the competitive U.S. fund market. After returning slightly more than rivals did in 2005 and 2006, the DWS Scudder funds have struggled this year, with a total return of 0.9 percent, compared with their category average of 1.3 percent, according to Morningstar.
“We need to continue to grow our strategic business to compensate for the outflows,” Schwarzer says. “We have a $70 billion gap in assets under management between us and the top ten players in the U.S. adviser-driven business.” Deutsche wants to be in the top ten, he says. That’s still far from Scudder’s glory days, when it enjoyed a top-five spot.
DWS Investments, the bank’s money manager in Frankfurt, is similarly centralizing operations in Europe by closing investment management offices in France, Italy and the U.K., even as it continues to sell funds into those markets. DWS, which was founded in Germany in 1956, enjoys an enviable position domestically thanks to the distribution of Deutsche’s retail banking network. It leads the German mutual fund market with a 21.9 percent share.
Now Stephan Kunze, a former head of German equity derivatives at ABN Amro Bank whom Parker hired in 2005 to head DWS Europe from Frankfurt, is focusing on selling more funds outside Germany. He is increasing the group’s sales force significantly across Europe, with a particular emphasis on Switzerland and Poland.
Like other parts of DeAM, DWS is focusing on selling more high-margin alternative investments, quantitative funds and such structured products as guaranteed funds. Structured products make up a massive 75 percent of DWS’s new business sold through independent financial advisers, Kunze says. The bulk of DWS’s inflows are coming through IFAs this year.
The changes at DWS and elsewhere have remade Deutsche Asset Management in Parker’s own image as a trading-oriented outfit with a strong accent on alternative investments. “These products are in line with the DNA of the bank, which is innovative and strong in derivatives,” he says. But like any trader, Parker knows he must soon demonstrate that his bets will pay off. As he puts it with characteristic bluntness, “You’re only as good as your last trade.”