A New Look for AllianceBernstein
Peter Kraus is going all out to improve AllianceBernstein’s investment performance.
Among the battered, depleted and demoralized ranks of the world’s financiers, Peter Kraus surely stands out as one of the charmed survivors. Kraus, 56, spent most of his career at Goldman Sachs Group, becoming one of the firm’s premier bankers, before shifting to co-head of its asset management business. He left early last year and landed at Merrill Lynch & Co., where fellow Goldman alum John Thain made him head of strategy. When Merrill was sold to Bank of America Corp., he collected a reported $25 million bonus. Not bad for three months’ work.
Kraus will need all of his skills and good fortune to see him through his new job. On December 19 he was named chairman and CEO of AllianceBernstein Holding, a leading asset manager that has been hammered by the global financial crisis. Kraus succeeds Lewis Sanders, 62, an investing legend who spent 40 years at the firm and its predecessors and is regarded by some as among the greatest of all value players — after Warren Buffett, of course.
Sanders worked hard to steer the firm through the crisis, cutting costs and hewing to his value discipline as he bought up shares of financial companies that never rebounded. But nothing stemmed the spread of the rot. Though known for its superb stock picking, AllianceBernstein has fared much worse than most rivals over the past year or more. Returns for both the firm’s institutional and retail investors trailed those of its peers’ by about 90 percent in 2008.
Kraus takes the reins at AllianceBernstein in an extraordinary period of upheaval. The travails of commercial and investment banks may dominate headlines, but the financial crisis has also wounded money managers, whose revenues come from fees on assets under management. That revenue model drives impressive earnings growth when markets expand but has caused sharp contractions as the market crisis has depressed the prices of stocks, bonds and commodities around the world. Hurt by sorry returns and investor withdrawals, AllianceBernstein’s assets under management plunged by 44.8 percent from the peak of $837 billion on October 31, 2007, to $462 billion on December 31, 2008. The company suffered $44.2 billion in net outflows last year.
AllianceBernstein has faced adversity before. If anything, it has thrived on it. Performance at value-oriented predecessor Sanford C. Bernstein & Co. suffered during the oil shocks of the ’70s, the savings and loan bust of the ’80s and the technology boom of the ’90s. Each time, Sanders stuck to his guns and waited for the market to catch up. He was vindicated repeatedly, an experience that inevitably fed his confidence. Institutional Investor summed up Sanders’ — and Bernstein’s — approach in 1989 thus: “Sometimes Wrong, but Never in Doubt.” Directors of AXA Group, the French insurance conglomerate that controls AllianceBernstein, evidently weren’t willing to wait years for another rebound.
It’s far from certain that Kraus can quickly manufacture any such rebound. The financial markets and the economy remain in a deep funk. He will have to work hard to earn his compensation, which includes a salary of $275,000 and a $6 million cash bonus for 2009.
Nor has recent history been kind to other would-be bank saviors. John Thain rode in from NYSE Euronext to clean up Merrill, only to be ousted by Bank of America in January, barely a year later. Another Goldman alum, Robert Steel left the Treasury department in July to run Wachovia Corp., which nearly succumbed before being bought by Wells Fargo & Co. in October. After 14 months on the job, Citigroup CEO Vikram Pandit is breaking up that reeling financial empire, even as reports swirl that his job is on the line.
Kraus faces a restive clientele. Though some investors pulled their assets last year, others remained loyal — to Sanders. “We always associated the things we liked about Bernstein with Lew, and his departure caused me to want to reassess my views on the firm, depending on their commitment to their past disciplines,” says Matt Clark, chief investment officer of the $8 billion South Dakota Retirement System, which moved the $30 million it had invested in other AllianceBernstein funds into the All Asset Deep Value Fund in September. In January, Clark says, he told the firm that South Dakota, which manages most of its funds in-house, was taking all that money back.
Notes Robert Lee, a securities analyst at Keefe, Bruyette & Woods, of AllianceBernstein: “Their performance has been poor, and they need to demonstrate in the not-too-distant future that they can turn it around. That’s not easy. There are institutional clients who can lose faith, and it takes time to earn that back if you lose it.”
Kraus brings to this challenge proven skills as a banker and a strategic thinker. He also benefits from a long relationship with AXA chairman and CEO Henri de Castries. They met in 1991, when Kraus joined a Goldman team that advised the Equitable Life Assurance Society of the U.S. on a large and complex deal involving Paris-based AXA — and first met de Castries, then finance director of AXA, and AXA founder Claude Bébéar, who was then CEO. In the deal, Equitable demutualized and AXA invested $1 billion in the firm, which went public in 1992. One measure of Kraus’s relationship to the French: In addition to running AllianceBernstein, he joins AXA’s seven-member management board, a position Sanders did not hold. The board membership places Kraus on the same level as his boss, Christopher (“Kip”) Condron, who as CEO of AXA’s U.S. unit, AXA Financial, oversees AllianceBernstein. Kraus explains his board seat by noting that, during his career at Goldman, he advised some of the world’s largest insurance companies on demutualization and mergers. “Lew doesn’t have my background in insurance,” says Kraus. “I can be useful to AXA in helping them chart a course of growth and opportunity.”
So much for insurance. Though widely respected for his intellect and drive, Kraus, unlike Sanders, has no experience as a hands-on money manager. He has spent most of his career in investment banking. And his otherwise strong record at Goldman Sachs Asset Managament was marred in 2007 by a collapse in hedge fund performance. Global Alpha, a complex hedge fund, fell by about 40 percent. In addition, GSAM was forced to inject $2 billion into another hedge fund that had plunged, the Global Equity Opportunities Fund. Excluding money market funds, GSAM suffered an $11 billion net outflow during the quarter ended May 30, 2008. Kraus left in March 2008, although he maintains that the hedge fund performance wasn’t the reason for his departure. “That was no fun, but that was nine months after I decided to retire,” he claims.
Kraus has wasted little time in making changes at AllianceBernstein. One of his first decisions was to shut down the $1.9 billion All Asset Deep Value Fund, which Sanders launched last June and managed himself. It was structured as a limited partnership, like a private equity fund. Sanders put $50 million of his own money into “Lew’s fund,” which posted a small profit for 2008, according to the company. In January the firm closed down the fund, says Kraus, because of a “key man” clause citing a manager the fund could not run without.
Kraus has already made critical changes in the leadership of the value investment team. Effective February 2, he named Sharon Fay to be the new head of the value equities business, which makes up 38 percent of the firm’s assets — and houses its most brutally hammered investment strategies, which fell 32 percent in 2008. Fay, who was CIO for global value equities in London, succeeds a 25-year Bernstein veteran, Marilyn Fedak, whom clients had long regarded as Sanders’ closest confidante in the management of deep-value strategies. Fedak becomes vice chairman of investment services. John Mahedy, who was Fedak’s co-CIO for U.S. large-cap value equities, now reports to Fay.
Kraus has begun to reexamine investment disciplines, scrutinizing AllianceBernstein’s quantitative investment processes, which Sanders developed three decades ago and married to fundamental, bottom-up stock-picking strategies.
Kraus brings a ton of energy to the job. His business day starts at 7:30 a.m., when he arrives at the office after a workout at a local gym or a jog around his block on New York’s Upper East Side. (He’s in the process of moving to 720 Park Avenue, one of the city’s most exclusive and elegant buildings, where he and his wife bought a $37 million apartment last year.) Once at the office, which is decorated with about a dozen pieces from his vast collection of abstract European and American paintings and sculpture (see sidebar), Kraus prints out documents that were too long to read on his Blackberry on the way to work and gets his London-based global head of client service and marketing, David Steyn, on the phone for business updates. By 8:00 a.m. he is meeting with heads of the investment and sales teams.
A POLISHED NETWORKER and corporate politician, Kraus was raised in Philadelphia, where his father was national sales manager of Bache & Co., a securities brokerage that, after a series of mergers, is now part of Wells Fargo. After receiving a bachelor’s degree in 1974 from Trinity College, where he studied economics and French history, he traveled in Europe for six months. Returning to New York, he took night classes to qualify as a certified public accountant and received an MBA from New York University, joining the mortgage-backed securities unit of Peat, Marwick, Mitchell & Co., an accounting firm that later became part of KPMG. He moved Goldman as an investment banker in 1986 and four years later was transferred to Tokyo. In 1991, Henry Paulson Jr., who was then co-head of investment banking at Goldman and, more recently, served as Treasury secretary in the George W. Bush administration, called him back to New York. He joined a Goldman team advising AXA on the Equitable Life deal, made partner in 1994, and four years later became co-head of Goldman’s financial institutions group. Kraus advised on landmark deals like the $16 billion acquisition of BankBoston Corp. by Fleet Financial Group and the $22 billion purchase of General Re Corp. by Warren Buffett’s Berkshire Hathaway.
Colleagues at Goldman Sachs Asset Management, of which Kraus became co-head in 2001, describe him as more of a strategist than a day-to-day manager. For starters he kept his old office at One New York Plaza to stay near his former investment banking colleagues rather than move around the corner to 85 Broad Street, where the investment management teams were located. Together with co-head Eric Schwartz, he drove GSAM deeper into the burgeoning hedge fund business. Goldman’s assets more than tripled, from $257.9 billion in 2000, the year before Kraus took over GSAM, to $809.1 billion in 2007, his last full year at the company. By 2008, GSAM ranked No. 12 on the II 300 list of largest asset managers, up from No. 19 in 2001, when he started.
“Peter is a gifted strategic thinker. I have always been impressed by his capacity to see the big picture while immersing himself in detail,” says George Walker, who ran alternative investments at GSAM before leaving in 2006 to head the investment management division of Lehman Brothers Holdings. He led a management buyout of that division in December.
Kraus’s upbringing in the worlds of banking and the arts was very different from that of Sanders, the son of a gas station proprietor in Uniondale, New York. Sanders started his career as a research assistant at a Wall Street start-up in 1968, a year after the firm was founded by value investor Sanford C. Bernstein. Fresh out of Columbia University with a bachelor’s degree in operations management, Sanders covered the hospital supply and office equipment sectors. II ranked him as a No. 1 analyst on the All-America Research Team for two years in a row, 1978 and 1979. He became known for sticking to value principles and committing to sectors that appeared distressed but that he believed would ultimately rise. He was also an early adopter of mathematical investment models to screen stocks, marrying them with fundamental, bottom-up stock picking. Rising rapidly, Sanders became a director at Bernstein in 1972, CIO in 1979 and president in 1981.
Sanders was widely admired throughout the firm for his analytical mind and his unshakable devotion to the deep-value investing discipline, learned from founder Bernstein, according to longtime friend and colleague Roger Hertog. Hertog also joined the firm in 1968, and he and Sanders became close friends. Hertog, who was chief operating officer for a period of time, retired in 2006. “Lew is a very scientific, thoughtful, highly analytical person,” he says.
Sanders saved Bernstein in one crisis after another, believing that a disciplined approach to value investing, even when the pack is running scared, pays off in the long run. “All you can say with any sense of reliability is that if you were an investor today, if you were to look back some years from now, even if things got worse first, your investments would probably be among the most rewarding. Because you bought maybe not at the low, but in a fairly advanced state,” Sanders said in an an interview shortly before his resignation. In 1990, when Bernstein had $9.5 billion under management, more than one third of its assets were in financial institutions that had lost 35 percent of their value that year — not unlike the predicament that the firm finds itself in now. Sanders dismissed critics and predicted that his deep-value portfolio would bounce back, and he was vindicated. The Russell value 1000 index returned 31 percent from 1991 to 1994, whereas the Russell growth 1000 index produced only 11 percent. Sanders faced a similar crisis when tech stocks took off and numerous Bernstein clients fired the firm between 1998 and 2000 and took their money to growth managers. Hertog estimates that as many as 25 percent of Bernstein’s clients decamped.
Hertog watched Sanders studiously avoid losing his temper, even as high-net-worth clients assailed him for refusing to buy hot tech stocks that they saw their friends getting rich from (at least on paper), while he invested their money in railroads, toilet fixture manufacturers and slow-growing consumer products companies that he regarded as safe bets. “A client actually said, ‘The reason I can’t take it anymore is that you guys are buying the same stocks my grandfather owned. I want to own what my children own,’” Hertog recalls.
In 1999 founder Bernstein died of cancer at 72, leaving the company’s fate in Sanders’ hands. With all the pressure from unhappy investors, Sanders went looking for a partner in the growth universe, ultimately aligning with Bruce Calvert, who was then CEO of Alliance. In 2000, Alliance acquired Bernstein, an institutional house with a thriving private client business and $88 billion in value stocks, for $3.5 billion. Alliance, a mutual fund giant with $368 billion in growth stocks, was controlled by AXA Financial, which was advised by Goldman.
The merger could not have been better timed. The bursting of the dot-com bubble that year left egg on the faces of the Alliance growth team, but the Bernstein value team rode the value rally. The Russell growth index fell 9 percent in an extended slide from 2000 to 2006, while Russell value shot up 58 percent, according to Lipper data. Calvert remained CEO of the new AllianceBernstein, and Sanders played to his strengths as firmwide CIO. Then Alliance got caught in the market-timing scandal in 2003. The Securities and Exchange Commission found that the firm had allowed some investors to trade in and out of mutual funds to the detriment of long-term investors. AXA Financial negotiated a $600 million settlement with the SEC.
With the backing of de Castries, Sanders succeeded Calvert as CEO in June 2003 and as chairman in November 2004, taking the corner office, overhauling senior management and launching new products. In September 2003, for example, the firm launched a suite of six mutual funds called AllianceBernstein Wealth Strategies, designed to bring AllianceBernstein institutional products to the retail market. Five of these funds used a blend of existing fixed-income and equity strategies from both the Alliance growth and Bernstein value sides of the house.
During the next few years, Sanders presided over a period of growth for the firm. Boosted by a resurgent market, AllianceBernstein’s profits rose steadily, from $705 million in 2004 to $1.26 billion in 2007.
The firm also focused on building a defined contribution business to hawk to plan sponsors. After that business grew from practically zero in 2002 to $15 billion by the middle of 2006, Sanders stepped on the gas, setting up a new sales unit called Defined Contribution Services and putting Richard Davies, who had been running the firm’s college savings business, in charge. Davies was given a team of 11 of the firm’s foremost experts in defined contribution products and tasked to hire six more from the outside. They were given cubicles and offices intermingled with those of AllianceBernstein’s defined benefits sales force. That business has stalled, hampered by the soured stock markets: At the end of 2008, it had about $18 billion in assets, plus a further $3.5 billion in mandates the firm had won but has not yet funded.
Sanders also tinkered with the investing culture on the legacy Alliance side of the house, reeling in the freedom of individual portfolio managers. For example, the Alliance team changed its decision-making process from one in which any growth portfolio manager had the authority to instantly buy or sell a stock at any time of the day or night without asking anyone, to one where buy-and-sell decisions were made by the investment committee of a fund or product. The intent was to prevent the firm from inadvertently owning too much of any one company, such as Enron Corp.; former Alliance large-cap growth manager Alfred Harrison had bought 1.3 mil-
lion shares for Florida’s state pension fund just two weeks before Enron filed for bankruptcy.
The changes caused some disruption. A number of senior portfolio managers departed, among them Harrison, who decamped in December 2004. Star portfolio manager Thomas Kamp left in February 2006 to become CIO of Cornerstone Capital Management in Minneapolis; U.S. growth strategies chief Paul Rissman retired in January 2008, according to Lisa Shalett, who became global head of Alliance Growth Equities that month. “You have seen a movement toward team process and a minimizing of creativity,” says Chris Riley, an investment consultant at Ennis Knupp + Associates in Chicago.
With the onset of the credit crisis, AllianceBernstein’s fortunes turned down suddenly and sharply. Profits for the fourth quarter of 2007 shrank 15.6 percent, to $309.7 million, because of sharp declines in hedge-fund–related performance fees and mark-to-market losses in investments for deferred employee compensation plans. Profits have fared worse since, slumping 68 percent in 2008’s fourth quarter to just $97 million. For the year income was off 33 percent, to $839 million. Company shares, at $16.68 on February 2, are down 75 percent since January 1, 2008.
The culprit? Performance. The problem was that, rather than balancing each other off, the value and growth sides of the house both piled into one bad bet after another as the credit crunch worsened. The firm’s six main institutional value equity strategies missed their benchmarks by an average of 7.7 percentage points for 2008, and the firm’s eight main institutional growth equity strategies underperformed their benchmarks by an average of 6.5 percentage points, according to tables posted on the AllianceBernstein Web site. The firm began the year overly concentrated in financials, energy giants and tech companies and subsequently added to holdings of such troubled firms as American International Group, Lehman Brothers, Fannie Mae and Freddie Mac, convinced that they were nearing a bottom. The temptation to load up was irresistible to Sanders, who thought that the market trough would be short because the last ten recessions, excluding the Great Depression, had lasted less than a full year, on average. “Our first reaction when a stock goes down in price is that it’s more interesting than it was. And the history of value is that almost all of its return premiums are from the fact that that’s usually true,” he told II in an interview in late November. “This year the stocks did not recover.”
Indeed. For the 12 months through December 31, 2008, according to eVestment Alliance, a firm in Marietta, Georgia, that tracks institutional fund performance, Alliance Global Research Growth Equity, which invests about 40 percent of its assets in the U.S. and 60 percent overseas, was down 52.58 percent, underperforming its benchmark, the MSCI world index, by about 12 percentage points. Bernstein Global Value Equity was down 50.58 percent over the same period, about 10 percentage points worse than the MSCI world index.
The firm didn’t do much better in its more lucrative hedge funds, where it has about $5.5 billion under management. The largest of these, Global Diversified Strategies, lost 38 percent from January 1 to September 30. The smallest, the Multi-Strategy Fixed Income fund, was down 87 percent from January 1 to October 31.
As performance declined investors withdrew funds across all sales channels — institutional, retail and private client. Sanders struggled to right the ship; beginning in the third quarter, he started cutting costs.
He redeployed top talent too. He shifted Bernstein veteran Seth Masters from his post as CIO of blend strategies and put him in charge of an expanded defined contribution services unit. He replaced Masters in blend strategies with Marc Mayer, who had been in charge of mutual fund sales.
And Sanders kept tinkering with investments, refining stock-picking criteria up until his departure. In late 2008, for example, he decided that the firm should avoid stocks of companies that had overloaded their balance sheets with debt.
But his efforts failed to reverse the company’s slide, and toward the end of the year, Sanders conceded that his view of the financial crisis had been flawed. In his interview with II , he acknowledged that both the Alliance growth and Bernstein value sides of the house had made the “mistake” of loading up on the most-troubled U.S. financial stocks under the assumption that they would bounce back long before the end of 2008. Sanders also admitted that he had rejected the possibility that last year could have been any worse than earlier downturns he had faced.
“It was far worse,” he lamented. “We made some judgments that turned out to be wrong.”
Patience was wearing thin across the Atlantic, though. As soon as the Merrill sale to Bank of America was announced in mid-September, de Castries reached out to Kraus and the end of Sanders’ reign at AllianceBernstein was set in motion.
“Lew had a conversation with the board over a number of periods of time, and they decided together that this was the time for him to retire,” Kraus says. Now it’s his job to get AllianceBernstein back on track during the worst financial crisis in living memory.