Mr. Outside

Nikko Asset Management CEO Timothy McCarthy, the first American to run a Japanese money manager, is betting that scores of new foreign funds can jump-start his firm’s poor performance. His timing seems right.

Among his other claims to fame -- Baker Scholar at Harvard Business School in the 1970s, chief executive of Jardine Fleming Unit Trust in the 1980s, president of Charles Schwab & Co. in the 1990s -- Timothy McCarthy boasts a black belt in karate, which he acquired as a teenager.

McCarthy, appointed CEO of Nikko Asset Management Co. in March, will need all his strength and agility to turn around Japan’s third-biggest money manager. From a peak of $94.5 billion (¥10.4 trillion) in March 2000, NAM’s assets plunged by nearly 40 percent to a recent $59 billion, far more than the 2.7 percent average decline for Japanese money managers over that period. Nikko, a subsidiary of brokerage Nikko Cordial Corp., was devastated when its $700 million stake in Enron Corp. short-term debt imploded in 2001 and 2002, sparking a rash of redemptions. The firm has also been plagued by poor performance in its biggest stock funds. Its flagship active equity fund fell 21 percent from its August 1998 launch to early October 2004. The Topix, the widely used Japanese equity index, rose 1.8 percent over the same period.

“In past jobs I’ve been brought in to handle crises, but that’s not true this time,” insists McCarthy, 52, who has a talent for languages -- he speaks German, Mandarin Chinese and some Japanese -- and understatement. “These setbacks don’t mean the firm is on the critical list. But the CEO of Nikko Cordial thought we could do a lot better.”

Indeed he did, and with reason: Nikko Asset Management earned a net profit of just ¥900 million in the fiscal year ended March 2004, following a small loss the previous year.

“I want to build Nikko Asset Management into Japan’s No. 1 asset management company,” says Nikko Cordial Corp. CEO Junichi Arimura. “To do that we will need speed and global perspective. Tim has both. And I personally trust him.”

Nikko Asset Management took a first step toward independence in January 2002 when the firm appointed a career insider, Masafumi Hikima, as chief executive, breaking with a tradition of tapping CEOs from the brokerage business.

But McCarthy is a true outsider. To revitalize NAM, he has launched a major overhaul of the organization. First and foremost, he is focusing Nikko on portfolio performance. In a concerted effort to deliver superior returns, this August McCarthy unveiled a new investment platform, dubbed the World Series funds. A group of about 30 retail funds that invest in overseas markets, the World Series portfolios are subadvised to 20 foreign firms such as LaSalle Investment Management and Wellington Management Co. To motivate his staff he’s planning to introduce a stock option program that will eventually place 20 percent of the company’s shares in the hands of its employees. McCarthy is convinced that an asset manager whose staff has equity in the firm has a real competitive edge and even hired a U.S. consulting firm to prove it. The resulting study, he says, showed that firms with heavy inside ownership, like Sawakami Investment Management Co. and Sparx Asset Management Co. in Japan or Dodge and Cox and T. Rowe Price in the U.S., have provided better performance over time. “We spent a lot of time verifying this, and I was amazed how true it turns out to be,” McCarthy says. Last, he hopes to sell a stake in NAM to the public as soon as 2006.

On the job for just a few months, McCarthy recruited a strong right-hand man. Bill Wilder, the former head of Fidelity Investments Japan, signed on as NAM’s president and chief investment officer in July. Wilder played a key role in making Fidelity Japan’s No. 1 foreign asset manager.

If McCarthy can attract even a tiny sliver of Japan’s $12.8 trillion in household savings -- the second-largest pool of savings in the world -- he will count his tenure a success. But he faces daunting odds. Ultraconservative Japanese investors, scarred by 13 years of a bear market that has only recently ended, keep 56 percent of their money in bank deposits that pay less than 1 percent interest; another 29 percent is in life insurance and pension accounts that yield 1.94 percent; risk assets, such as equities, account for less than 10 percent, and toshi shintaku, the Japanese version of stock and bond mutual funds, claim less than 5 percent.

Before McCarthy’s arrival, NAM managed the vast majority of its assets in-house but used a handful of subadvisers, such as Sparx and Pimco, for a few of its funds, with combined assets of $7 billion. When McCarthy launched his World Series platform, the existing subadvised funds became part of the new lineup. Currently, Nikko brokers are marketing most of the funds to their retail customers, but NAM also deploys outside brokers and bankers for some of its products.

“I won’t be surprised if the World Series funds pull in $50 billion in the next four or five years,” McCarthy confidently declares. He predicts that NAM could boost its net profit from just $8.3 million in the year ended March 2004 to $100 million by 2006.

An optimistic outburst? Certainly. An outlandish notion? Probably not.

THROUGHOUT HIS CAREER, MCCARTHY HAS developed a reputation as a quick study and capable manager. The son of a meat company executive, McCarthy grew up in Hillsborough, a suburb south of San Francisco. After receiving his BA from the University of California at Davis, he worked as an analyst at Chemical Bank and then earned an MBA from Harvard Business School in 1978.

After working in manufacturing in Asia for several years, McCarthy joined Merrill Lynch Capital Markets in New York in 1982. For several years he worked on developing a version of the firm’s revolutionary cash management account for small corporations. McCarthy also set up a Financial Services Department that provided investment banking to corporations with up to $125 million in revenues. He left Merrill in 1987 and joined Fidelity Investments. Among his accomplishments there was the launch of Fundsmart, a multifund platform for banks and independent brokers. Eager to return to Asia, McCarthy signed on as the CEO of Jardine Fleming Unit Trust in Hong Kong in 1994.

A year later he took a job as president of Charles Schwab. Over the next three years, he launched Schwab’s online brokerage strategy, designed the firm’s successful One Source fund platform and transformed Schwab’s U.K. operation into the largest British discount brokerage.

McCarthy left Schwab in 1998, cashing in his bubble-inflated shares to join a syndicate that paid $65 million for a 52 percent stake in Ssangyong Investment & Securities Co., a troubled South Korean securities firm that was on the verge of collapse in the midst of the Asian financial crisis. He renamed it Good Morning Securities Co, introduced a mutual fund division and turned the business around. Much of McCarthy’s work was governance-related. “I hired a lot of lawyers and accountants,” McCarthy says, and the firm was able to use its reputation for good governance to pull in banking business. After boosting Good Morning’s market cap from $125 million to $1.1 billion, McCarthy cashed out at a substantial profit in the middle of 2002.

McCarthy briefly flirted with early retirement, then, in 2003, Nikko Cordial’s Arimura approached him about becoming NAM’s new chief, succeeding Masafumi Hikima, who became a senior adviser. Tempted by the challenge and the promise of a major windfall in a successful IPO, McCarthy asked for time to research the firm. “I was intrigued by finding out what we had to do to turn Nikko into a world-class asset manager,” says McCarthy, who decided to join based on his research. He became the first American to run a Japanese money manager.

Nikko Asset Management is a successor to two specialist businesses, one selling retail mutual funds, the other selling institutional asset management services. Most big Japanese asset managers have similar lineages. The mutual fund side of NAM dates back to 1959; the institutional group was created in the early 1980s, when the government began to dismantle legislation that had restricted institutional money management to trust banks and life insurance companies.

Unlike its rivals, though, NAM’s parent, Nikko Cordial, was also the rare Japanese financial services firm to have forged a partnership with a foreign company. In 1998, as the region’s economic woes were battering Japan’s already weakened financial services sector, Nikko Securities then-CEO Masashi Kaneko shocked competitors and irritated local associate Mitsubishi Group by orchestrating an alliance with U.S. insurer Travelers Group, now part of Citigroup. Under the terms of the deal, capital-starved Nikko put its investment bank into a 51-49 joint venture with Travelers and sold a 21 percent stake in itself to the U.S. insurer. (Citigroup Global Markets now owns the 49 percent position in the investment banking division, and Travelers Group International sold off a 7 percent position in the parent in September.) The Nikko-Citigroup partnership reported operating profits of ¥23.1 billion for the year ended March 2004.

But money management has proved more problematic. Whereas Japan’s No. 1 money manager, Nomura Asset Management Co., is known for its distribution strength, and such small asset managers as Sawakami Asset Management and Sparx Asset Management Co. have delivered superior portfolio returns, Nikko has produced subpar performance for three years. Within NAM, $40 billion is held in mutual funds, $19 billion in institutional accounts. Sixty percent of assets is in equity, 40 percent in fixed income.

There have been a few bright spots. The ¥30 billion Nikko Growing Venture Fund, subadvised by Angel Japan Asset Management Co., is up more than 100 percent since its July 2003 launch. Nikko has also done well with its small alternative-investments group. Its Nikko L Plus 2003-07 fund, which seeks to beat LIBOR, is up 4.94 percent since its July 2003 launch; the yen-LIBOR rate over that period was unchanged. And the Nikko Tanki Saiken Fund, a short-term bond fund, was up 4.9 percent between its October 1999 launch and the end of September 2004. The Nikkei bond performance index rose 2.9 percent during that period.

All Japanese money managers have struggled with the nation’s relentless bear market, but Nikko suffered a particularly tough blow when its stake in Enron caused massive shareholder redemptions from its foreign-currency-denominated Money Management Fund in late 2001 and early 2002. Assets in the fund plunged from ¥4 trillion in October 2001 to ¥170 billion at end of February 2002. The Enron crisis also caused Standard & Poor’s to downgrade Nikko Cordial Group from BBB+ to BBB- in February 2002, reflecting “damage” to “customer relations.” S&P subsequently raised the rating to BBB.

Nikko wasn’t the only Japanese company hit by Enron’s collapse, but it was the most heavily exposed and suffered the worst aftereffects, says Nobuyuki Fujiwara, a market analyst at Lipper Japan. The problems were compounded by an early retirement cost-cutting campaign that resulted in the loss of some of the firm’s best portfolio managers.

With fewer in-house managers, NAM fell back on using subadvisers. This strategy, born of necessity, is one McCarthy believes can be a significant competitive advantage. Japanese money managers have generally hired relatively few subadvisers for their funds, typically choosing only major industry names when they do. McCarthy thinks that NAM can distinguish itself by selecting a wide range of managers, some of them small and off the beaten track. “When you look around, you find that sometimes the best is smaller than you,” he says.

Foreign money managers, whose ranks are expected to grow to 100, will likely be eager to sign up as subadvisers to the new World Series funds. The alliance gives them access to a powerful distribution network and entry to a potentially huge mutual fund market without the huge start-up costs.

“We’re very excited to have business with a respected partner like Nikko,” says Stanley Kraska, a LaSalle Investment Management managing director and co-manager of the firm’s $4 billion global real estate securities portfolio.

For all that, it will take time to assess just how successful this World Series will be. At the end of September, total assets of the funds, including money that was invested in submanaged funds before the World Series debut, stood at nearly ¥1 trillion.

Skeptics say that McCarthy is going offshore to compensate for his lack of top-performing portfolio managers in Japan. “The subadviser scheme means that NAM takes on the role of a transfer agent,” suggests Lipper’s Fujiwara.

Charged with upgrading in-house management of active equity funds and bolstering the institutional advisory business is former Fidelity Japan chief Wilder, 53. A veteran of the Japanese asset management scene, Wilder is widely admired for making Fidelity the No. 1 foreign seller of retail equity mutual funds in Japan. He was intrigued by the prospect of preparing the company for an IPO. “At my age,” he notes, “I won’t have the opportunity to do that again.” He adds that he was also eager to return to investment management: As head of Fidelity Japan, he was consumed with issues of corporate strategy and administration. “At Fidelity the investment gates shut once you become a senior manager,” he says.

Although McCarthy and Wilder have only just begun a turnaround at Nikko, their timing does look good. The Nikkei remains a long way from its December 1989 high of 39,000, but at a recent 11,348, the benchmark index is up 49 percent from its April 2003 low of 7,607.