Tune-up time at GMAM
What does General Motors know about managing other people’s money? Not much, but after landing Xerox’s $8 billion retirement plan, it’s suddenly a player on the pension scene.
What does General Motors know about managing other people’s money? Not much, but after landing Xerox’s $8 billion retirement plan, it’s suddenly a player on the pension scene.
By Justin Dini
Institutional Investor Magazine
What’s good for General Motors is good for America’s investors - or so the No. 1 U.S. carmaker hopes.
In a bold play to establish itself as a major force in the ranks of U.S. money managers, General Motors Asset Management is out on the streets looking to run other companies’ pension money. Until last fall it had managed to bring in only the $10 billion pension plan of Delphi Automotive Systems Corp., a former GM subsidiary. Then, in October, it landed the $8 billion pension business of beleaguered Xerox Corp., and now GMAM, with $118 billion in pension funds, is trying to kick into high gear.
The copier account joins the Delphi plan in a newly formed unit, General Motors Trust Co., which will handle all external accounts. It rolls off the assembly line flashing an impressive pile of assets for what remains, essentially, a start-up operation. “With $18 billion, we’ve got a good base to build on,” says W. Allen Reed, the CEO of GMAM.
Reed has some other assets to build on as well. Chief among them is the widely respected Myra Drucker, the former Xerox chief investment officer who is now running GM Trust.
GM’s foray into asset management comes as part of the carmaker’s companywide effort to get its costs under control. Running the $65 billion GM defined benefit pension fund (GMAM oversees an additional $35 billion in GM’s 401(k) plan as well as the $18 billion in external assets) cost the company $605 million in net service expenses in 2000. Bringing in other corporate plans should defray some of those costs, which is one reason Reed decided four years ago to nudge GMAM into external money management. At the same time, he hopes the move will help dissuade his existing money management staff of 120 from jumping to more lucrative jobs at established investment firms. “This is about creating an asset management company that is a professional growth opportunity for our staff,” Reed says.
GMAM’s plan sounds reasonable, but its success is far from assured. It faces tough competition from traditional asset managers in the slow-growth defined benefit marketplace, and it must overcome a lack of marketing expertise. On the sales front, GMAM will be competing head-to-head with many of the pension consultants whose support it will need to win clients. GMAM plans to outsource portfolio management to independent firms as part of a manager-of-managers strategy - that’s likely to alienate many of those critical gatekeepers, who sell similar programs of their own.
“I don’t think they will be successful,” snipes one investment consultant. “They don’t have the credibility or the performance history.”
“I know there are some delicate lines to walk here,” acknowledges Jack Miller, GM Trust’s top marketing executive. “We’re not trying to replace the consultants, and we certainly don’t see ourselves as competitors.”
GM isn’t the first big company to venture into the asset management business. General Electric Co. began managing other companies’ assets in 1988; today GE Asset Management runs $32 billion from such companies as DaimlerChrysler Corp. and Raytheon Co. as well as from public funds like the New York City Teachers Retirement System. All of the money is internally managed. Caterpillar Investment Management, established by heavy equipment manufacturer Caterpillar, last year reported $600 million in external assets under management. Owens-Illinois, which makes glass and plastic containers, operated money manager Harbor Capital Advisors ($17 billion under management) between 1986 and 2001, when it sold the unit to Netherlands-based Robeco Groep for $490 million.
“GM’s entry into the business is a big deal,” says Jack Boyce, senior vice president and director of institutional retirement services at GE Asset Management. “GM is a high-quality investment manager,” he adds, with enormous resources at its disposal.
Of course, even if a rash of new clients sign up with GM Trust, it won’t make a dent in the company’s bottom line. The carmaker earned $1.5 billion on revenues of $177.3 billion in 2001. Even the most optimistic projections for money management are nowhere near that. SEI Investments Co., for example, has $77 billion in assets under management and earned net profits of $99 million on revenues of $598 million in 2000. “GM Trust could do fabulously well in a year and it would still not match the equivalent of one day’s operations in GM’s car sales group,” says Scott Sprinzen, an analyst at Standard & Poor’s. But he adds: “They’ve got this huge money management platform. Why not try and turn it into a profit center?”
As part of a new discipline at its parent, GMAM this year will begin operating as a separate business unit with its own profit and loss statement. “Historically, it has been a cost center,” says John Devine, GM’s vice chairman and chief financial officer. The new business “isn’t going to be a significant source of profits, but we think we can make some money there.”
To produce those profits Drucker and Miller, a former pension executive at Philip Morris Cos. and marketer at J.P. Morgan Investment Management who joined GMAM four years ago, must try to perfect a winning formula for performance while building a sales culture. Miller, who has assembled a six-person sales and marketing staff, knows that will take time. “As a plan sponsor, you don’t have a sales mind frame,” Miller says. “We’ve essentially got to move from a buyer’s mentality to a seller’s mentality, and that isn’t an easy shift. Are we 100 percent there yet? No.”
GMAM is hoping that a “we’re all in this together” approach will work as an effective pitch. “The alignment of interest between GM and its client is fairly unusual,” Drucker says. “GM’s pension money is sitting right alongside the Xerox pension money, right alongside the Delphi pension money and right alongside that of any new clients that come in.”
GM Trust will put two management models out on the display room floor. In its fully loaded option, dubbed “flexible plan outsourcing,” it will try to persuade companies to hand over management of their entire pension funds. GM Trust would provide asset and style allocation models, performance monitoring, administration and back-office processing, as well as portfolio management. It will also offer a stripped-down version for small and midsize plan sponsors that want to invest a portion of their assets in GMAM-managed portfolios, including private equity funds.
The internal organizational structure gets a little complicated. GM Trust, as a subsidiary of GMAM, will house the assets of any new plan the company signs up. Reed will continue to run GM’s in-house pension funds as the president and CEO of GMAM. Drucker, as CIO of GM Trust, will continue to set the asset allocation and investment strategy for Xerox; she’ll also serve as the chief liaison with her former company and as an investment adviser to new clients.
The groundwork for money management expansion was laid by GMAM in 1998, when it changed its administrative structure to “unitize” its assets under management. Rather than owning shares in a particular company, GM’s pension funds own units in, for example, the GMAM international equity fund, just as a retail investor might own shares of a Fidelity Investments or Vanguard Group mutual fund. GM’s original notion was to allow employees in the company’s 401(k) plan to invest in GMAM’s funds, along with their other plan options; doing so would help GM spread the costs of managing its defined benefit plan to its defined contribution plan, since participants would contribute some of the management fees.
Essentially, GM Trust is now extending the same option to other plan sponsors. Xerox had adopted a similar unitized approach in 1993, which made absorption of its plan fairly hassle-free. Rather than giving GM Trust $25 million (often the minimum a money manager requires to open a separate account) to invest in, say, junk bonds, an institutional client will buy a specific number of shares in GM’s high-yield bond fund. The vast majority of each fund’s assets is managed by two or three outside firms, overseen by an in-house team of GMAM staffers; typically 15 percent of the fund’s assets are internally managed by a GMAM portfolio manager.
New clients will pay fees that Reed says “are competitive with the marketplace.” Among manager-of-managers firms, fees can range anywhere from 50 basis points for an investment-grade bond fund to 200 basis points for a specialty asset class like an emerging-markets fund, according to consulting firm Capital Resource Advisors. GM Trust will also offer discount rates that reflect the size of the mandates they win from companies. In any case, GMAM has picked a tough time to launch its new venture.
Over the past decade GM and Xerox pension fund portfolios have both delivered solid returns. Xerox doesn’t report its plan’s performance, but Drucker says that it has consistently ranked in the top quartile of big pension funds since 1992. GMAM, too, doesn’t break out its fund returns, a practice that may have to change if it wants to be a truly competitive force in asset gathering. But Goldman, Sachs & Co. automotive analyst Gary Lapidus estimates that GM’s pension assets returned roughly 12 percent a year between 1993 and 2000. Reed says that returns were higher than that, but he won’t offer any specifics.
Last year GM’s pension fund suffered its first downturn in more than a decade. The company’s $64.6 billion retirement plans declined 5.7 percent, versus their expected return of 10 percent, leaving GM with a $9.1 billion unfunded liability. CFO Devine says that the shortfall will shave $1.37 per share off GM’s 2002 pretax earnings because of an additional $1.1 billion in pension expenses.
The bear market stung a lot of pension funds, of course; the S&P 500 index declined 12.4 percent last year. GMAM knows that it is moving into institutional money management just as assets are falling and profit margins are narrowing. “Profit margins may be going down, but it is still a pretty attractive business,” Reed says. “Besides, have you seen the margins in the car business lately?”
GENERAL MOTORS has been an innovator in money management for a long time. Back in 1950, with the Big Three carmakers symbolizing America’s postwar economic prowess, GM broke fresh ground in the pension world when then-CEO and president Charles Wilson proposed to a skeptical United Auto Workers union that the $200 million pension fund should invest some portion of its assets in stocks. At the time, no other corporate or public pension fund did so.
Wilson - who famously told the Senate Armed Forces Committee, “What is good for the country is good for General Motors, and what’s good for General Motors in good for the country” - assured his workers that their pension plan wouldn’t buy GM stock, a restriction that has long since been lifted. He also pledged not to buy more than 5 percent of any one company’s outstanding shares for the plan. The UAW initially balked at Wilson’s proposal, but the CEO persuaded the union that by investing in equities, GM could afford to guarantee its workers more generous pensions. The UAW eventually agreed to the changes. Other companies followed suit, and by 1975 some 50,000 U.S. pension plans owned stock.
Stocks, bonds or cash, though, GM wasn’t doing all that good a job building its workers’ nest eggs. By 1980 it had some $11 billion in its pension fund, managed by a group of 17 banks and insurance companies, but for the five-year period ended December 31, 1980, GM placed dead last out of 19 plan sponsors in a peer group survey.
Something had to be done. So W. Gordon Binns, then GM’s assistant treasurer, took over the plan. The previous coordinators of the pension fund’s investments were outsiders who did little more than keep tabs on the portfolio managers at the banks and insurance companies, reporting back to GM’s board of directors. Binns adopted a much more aggressive investment strategy, which included pushing GM to become one of the first funds to diversify into alternative assets.
His overhaul helped rev up the pension fund’s returns. Between 1984 and 1994, it returned an annualized 13.5 percent, versus its internal benchmark of 10 percent. Following Binns’s retirement at the age of 65, Reed took over as president and chief executive of what was then called GM Investment Co.
After 17 years in finance, including a stint as assistant treasurer at Delta Air Lines, Reed had joined GM in 1984 as head of pension investments at its newly acquired subsidiary, Hughes Aircraft Corp. Reed helped set up Hughes Investment Management as a separate investment arm and dramatically changed its approach - shifting away from U.S. growth stocks to a more diversified mix of equity styles and asset classes, including private equity, distressed securities and high-yield bonds. He also increased the in-house management of the $7 billion fund. After a fairly extensive search, GM promoted Reed, by then Hughes’s treasurer, to chief executive of the money management group in 1994. That year plan assets totaled $50 billion.
In his first year at GMAM’s helm, Reed, with an eye toward shopping money management services to outside clients, flattened the outfit’s management structure. Each of the five asset classes in the GM portfolio was given its own managing director, reporting directly to the new CEO. Reed thought the change would make individual portfolio managers more accountable and bolster performance. In 1998 he hired Jack Miller as GMAM’s first business development executive.
Miller quickly pulled together sales and marketing staff to peddle some of GM’s specialty asset classes, including private equity and high-yield bonds, to outside clients. “We started with the alternative area,” Reed says. “Then we began to talk to some people about some of our other multimanager funds.” The going has been slow. GMAM has yet to land an account for those other multimanager funds, which include real estate securities and emerging markets. And only now is it about to close its first private equity fund that includes other plan sponsors. It spent more than a year putting the deal together.
In 1999 GMAM signed its first outside client, though its own marketers had nothing to do with the score. Soon after GM spun off automotive equipment maker Delphi Automotive Systems in May 1999, Delphi became GMAM’s first external account.
About a year later Reed and Drucker hooked up through a mutual acquaintance, Gary Glynn, the president and chief investment officer of the $11 billion U.S. Steel & Carnegie Pension Fund. Drucker was looking for ways to change Xerox’s approach to pension management. By the late 1990s it had become increasingly clear to her that maintaining a solid staff of in-house investment pros was becoming more difficult. “For years at Xerox, we had a small but always a very accomplished staff,” Drucker says. “The challenge wasn’t so much in attracting really talented people but in retaining them, because I had no career paths in investment to offer.”
Drucker says she began contemplating radical changes in 2000, when Xerox started reeling from shrinking revenues, declining market share, a stomach-churning drop in its share price and an accounting scandal in its Mexican unit. During that period, the company lost some valued investment staffers, including Drucker’s deputy, Mary Cahill, who left to run Emory University’s endowment.
“As things got tougher for Xerox, coincidentally we went through another cycle of losing some critical people,” Drucker says. “At that point, I began thinking to myself, what do I and my team really know how to do very well? We know how to run pension funds.”
In the fall of 2000, Drucker informally approached her boss, then-Xerox treasurer E. Margie Filter, to get permission to explore a new management structure for the company’s pension funds. She and Reed first discussed a potential alliance in December 2000 at GMAM’s Fifth Avenue headquarters in Manhattan.
The two quickly discovered how similar their investment philosophies were. Both favor active management with a balance of value and growth stocks, and both advocate strong in-house research teams. (GMAM now employs 17 investment analysts.) Both also saw immediate benefits to some sort of alliance.
Xerox talked to several other traditional money managers, but Drucker felt certain that GMAM was the best fit. In April she recommended the outsourcing deal to the Xerox board, and in late August the directors signed on. Reed and Drucker spent the next two months hammering out the complex contracts for the transition, and Xerox and GMAM finally inked the agreement on October 27.
“This was an ideal business opportunity for us,” Reed says. “It isn’t necessarily the kind of thing that you’d find just by going out into the marketplace. It is absolutely unique.”
From Xerox’s perspective, the deal with GM Trust gives the struggling technology company access to a greater range of pension fund resources - staff, software, infrastructure - than it would have on its own. “We had a very small staff here, and GMAM’s expertise and resources were very attractive for that reason,” says company spokesperson Christa Carone, adding that the decision to outsource management of the fund was not related to Xerox’s larger business struggles.
One obvious bonus Reed got with Xerox was the esteemed Drucker, who began her career in finance in 1972 as a quantitative investment analyst at INA Capital Management. Later, at Drexel Burnham Lambert, she pioneered the use of quantitative systems to actively manage endowment, pension and individual equity portfolios. In 1982 Drucker joined Xerox as a portfolio manager. She left in 1986 to run International Paper Co.'s pension assets, returning in 1992 as Xerox’s chief investment officer.
“Under Drucker, Xerox became better known for its pension management than it did for its xerography,” quips Richard Charlton, president of New England Pension Consultants.
To push GMAM’s full-service plan, in which the firm handles every aspect of pension fund management, Drucker will make personal sales pitches to important potential clients. “I don’t think many people really understand what flexible plan outsourcing is,” she says. “Getting the message out there is probably going to be the most important thing we do.” Drucker’s reputation in the pension business will at the very least open some doors.
As she takes charge of GM Trust, Drucker and her team are working hard to persuade consultants that GM’s manager-of-managers program and its flexible plan outsourcing strategies do not pose a threat to the consultants’ own businesses.
GM Trust may also have to assuage the concerns of potential clients over its down year in 2001. Reed blames the 5.7 percent decline in the GM retirement plans on the company’s June 2000 decision to move $5.6 billion of its Hughes Electronics Corp. tracking stock into the pension fund in an ill-advised attempt to reduce the unfunded year-end 1999 liability of $4.6 billion. Then last October GM agreed to merge Hughes, which owns the nation’s biggest satellite TV distributor, DirecTV, with satellite television company EchoStar Communications. Under the terms of that agreement, Hughes stock is worth $18.44 a share, down from a split-adjusted $30.85 in June 2000, slicing the value of the Hughes shares in GM’s pension funds from $5.6 billion to $3.35 billion.
GMAM’s other account, the Delphi plan, also suffered a bad year, with assets down roughly 6 percent as of mid-December, though its troubles were unrelated to the Hughes saga. In December Delphi told analysts that poor returns will lead to a doubling of its pension expense this year, to about $350 million on a pretax basis, requiring the company to make larger contributions to the fund than it had expected. Still, Alan Dawes, Delphi’s chief financial officer, says the company’s pension returns over the past several years under GMAM have been “in line with or slightly better than our competitive benchmarks.” To be sure, last year was dismal for nearly every pension fund in the country.
For its part, GMAM posts a motley collection of returns for its specialty funds, which appear in the portfolios of both Delphi’s plan and GM’s own pension plans. GMAM’s international investments held their own against their benchmarks last year. Net of fees, the $10.8 billion international equity portfolio was off 17.7 percent for the year. Its customized benchmark, a blend of Morgan Stanley Capital International’s Europe index and MSCI’s Pacific index, was down 19.1 percent. For the same period, GMAM’s $2 billion Emerging Markets Equity Fund declined 1.5 percent, compared with the -2.4 percent turned in by the MSCI emerging markets free index.
On the other hand, GMAM’s $4.6 billion High Yield Fixed Income Fund eked out a 0.8 percent return last year, a far cry from the 5.8 percent gain in the Credit Suisse First Boston high yield index. GMAM’s $600 million Real Estate Securities Fund produced a 7.2 percent gain, but the Wilshire real estate index did better, gaining 10.5 percent.
Xerox, for its part, has already dismissed some of its 20 external managers as part of the GMAM deal, though it won’t reveal any specifics. “We’re still evaluating some of our managers,” Drucker says. “That’s still a work in progress.” At the same time, although more than 50 percent of the Xerox assets have already been integrated into the GMAM-managed funds, a sizable portion is still being managed in “Xerox only” funds, by the same managers who were handling them before GM Trust arrived on the scene. Some of those firms may eventually pick up some GM assets or some new external accounts as well. “There could be some opportunities for some of these firms down the road,” Reed says.
Meanwhile, chief marketer Miller is shopping GM Capital Partners I, the first private equity fund for which GMAM has sought other plan sponsor partners. The firm has lined up commitments from the $112 billion New York State Common Retirement Fund, which has pledged $100 million, and the $12 billion Canada Pension Plan Investment Board, which has committed $150 million. GMAM will unveil the fund sometime in the next few months.
For its fully loaded flexible plan option, GMAM is targeting spin-offs and newly merged companies, thinking they should find outsourcing especially attractive. A GMAM spokesman says that the firm is in “discussions” with a number of potential clients, but that no such deals are imminent.
A copy of the Xerox deal would be nice, of course, but it’s a long shot. Says Miller: “We don’t expect the next client to hand us $8 billion. If the next one brings us a billion, we’ll be happy to take it.”