Revaluing UBS

The big Swiss bank pulled together its far-flung asset managers and gave research primacy. UBS Global Asset Management’s solid three-year track record finally has consultants believing.

Certain messages are best delivered in person.

In March 2000, Thomas Madsen, the newly named global head of equities at UBS Global Asset Management, summoned 23 senior money management executives of the big Swiss bank’s asset arm from Asia, Switzerland, the U.K. and the U.S. to London’s Selsdon Park Hotel, whose grounds sprawl over 205 acres in Surrey. There, in a windowless meeting room, Madsen delivered jarring news: UBS Global AM’s three autonomous units -- Chicago-based Brinson Partners, London-based Phillips & Drew Fund Management and Zurich-based UBS Asset Management -- would immediately be consolidated into one centralized organization, based in London. “My mandate is clear -- to merge and to globalize,” declared Madsen, who had been brought in for that purpose from J.P. Morgan Asset Management the month before. As everyone in the room quickly realized, comfortable routines would be disrupted, career paths redirected and jobs put in jeopardy.

Pressure for change of some sort, however, had been swelling along with the bubble in technology and telecommunications stocks. UBS Global AM had suffered from dismal performance in the late 1990s as its traditional value managers balked at buying what they deemed to be hugely overpriced TMT stocks; they were right, of course, but UBS missed out on the ongoing boom. In 1999, a year in which the Nasdaq soared 86 percent and the Standard & Poor’s 500 index surged 19.5 percent, Brinson’s large-cap value equity portfolio actually fell 3.8 percent. UBS clients representing $21 billion in assets stalked out the door in the first quarter of 2000. Even as Madsen was speaking at Selsdon Park, UBS was digesting the loss of a $1 billion account from one of the world’s highest-profile pension funds: the California Public Employees’ Retirement System. To compound its troubles, UBS Global AM had begun to forfeit market share in the U.K. to specialist managers.

No sooner did Madsen conclude his five-minute presentation than his audience headed straight for the bar.

But as it turned out, his words -- and his subsequent actions -- provided just the tonic UBS needed. His tough-minded revamping of the firm’s money management operation sparked staff departures and client defections, the inevitable upheaval associated with any corporate restructuring. But four years later UBS Global AM has reemerged among top-performing major money managers. More than 70 percent of its institutional equity and bond portfolios have beaten their benchmarks over the past three years. For example, UBS Global AM’s global equities portfolio lost money but outgained the MSCI world free index by an average annual 4.8 percentage points for the three years ended last December.

Since January 2000 assets have grown by roughly 15 percent in dollar terms, to $463 billion. (Measured in Swiss francs, however, they have declined by approximately 10 percent, to Sf574 billion.) UBS has been raking in new institutional mandates, producing record net inflows of more than $10 billion in 2003, in contrast with a net outflow of $2 billion the year before. UBS Global AM’s profits rose 52 percent last year, to $270 million, contributing 5 percent of giant UBS’s pretax profits.

“UBS has made a lot of progress,” says Jeffrey Nipp, global head of manager research at U.S. pension consulting firm Watson Wyatt & Co. “The corner has been turned. In the past couple of years, things have run pretty smoothly, and they are doing some good things.”

The Swiss bank deserves plaudits. Even as many prominent money managers are still struggling to consolidate and globalize their operations, UBS appears to have largely pulled off this tricky maneuver. Give some of the credit to a reengineered business model that dispensed with borders between companies and gave primacy to research and risk management. But the key may have been that UBS was able to capitalize on a desperate situation to adopt desperate -- but necessary -- measures. “No fund manager is happy when clients are walking out and performance is lousy,” points out Madsen. “These are smart people, and they were ready for change.”

The rough blueprint for the turnaround strategy was drawn up in early 2000 by Peter Wuffli, then UBS Global Asset Management CEO, and Jeffrey Diermeier, a Brinson portfolio manager whom Wuffli had named the group’s first global chief investment officer. The 46-year-old Wuffli, who is today CEO of UBS Group and the bank’s No. 2 executive behind chairman Marcel Ospel, had been brought in four months earlier as a veteran troubleshooter to fix the money management operation. Longtime asset-management executive John Fraser, who succeeded Wuffli as CEO of UBS Global AM in December 2001, has strongly supported Madsen’s reorganization push.

Unafraid to smash icons, Wuffli quickly eased out Brinson founder Gary Brinson and Phillips & Drew chief investment officer Tony Dye, two of the most visible symbols of the ancien régime. Brinson, now 59, had already begun to detach himself from his old firm (which he sold to UBS for $750 million in 1995) and now manages his fortune through a family office in Chicago. Dye runs a hedge fund, the Contra Fund, out of Dye Asset Management in London. Neither would comment on their tenure at UBS.

To execute the reorganization plan on a day-to-day basis, new global CIO Diermeier tapped Madsen, who joined the Swiss bank in February 2000, to be global head of equities and a member of the UBS Global AM executive committee. Now 47, Madsen, a naturalized British citizen, had grown up speaking German at home in Madison, Wisconsin (his parents emigrated from Heidelberg). He studied securities analysis at the University of Wisconsin’s Stephen L. Hawk Center -- Diermeier attended the school five years before him -- and then went to work as an analyst at J.P. Morgan Asset Management, where he became a fund manager and eventually rose to global head of equity, research and trading.

He started out boldly with sweeping cost cuts that have reduced the group’s cost-income ratio from more than 90 percent in 2001 to 72 percent today -- 4 percentage points below the industry average, based on a PricewaterhouseCoopers survey. The venerable names Brinson and Phillips & Drew were consigned to the dustbin, and three regional investment platforms were combined into one global platform with all employees working for one firm, UBS Global Asset Management. Although the offices in Chicago, London and Zurich were preserved, overlapping operations were scrapped. The group remains far-flung, with 2,670 employees working in 11 countries, but it’s fairly lean: Costs have been cut 15 percent since 2000.

Then Madsen did something more daring. He set out to revitalize UBS’s investment process. First, though, he and Diermeier determined that the Swiss investment business should be brought inside the tent and that the value investing approach of the old Brinson and Phillips & Drew crowd should remain intact, despite the drag it had placed on performance during the tech-stock-driven bull market. “I kept being asked during the bubble whether a discounted cash flow model made sense,” Madsen says. “Well, in the bond world it’s called yield to maturity, and no one has a problem with it. The trick is to get the inputs right, and that is what puts a premium on quality research.”

Indeed, Madsen saw upgrading research as the surest way to revive performance. “I immediately brought to the table a heritage of systematically following research,” notes Madsen, a staunch believer in bottom-up stock picking. He felt that analysts should wield more influence over fund managers’ stock and bond picks. “Between 80 percent and 85 percent of the performance of equity portfolios should come from the research recommendations of analysts,” he contends.

Accordingly, Madsen more than doubled the number of UBS Global AM analysts, from 40 to 87, drawing largely from the ranks of the firm’s existing portfolio managers. Fewer of the latter were needed in the new scheme of things. Other fund managers became relationship managers. Still others quit. Today UBS Global AM has 78 equity portfolio managers and 80 fixed-income managers.

Next, analysts were arranged along both regional and global industrial sector lines. Each team covers one of 12 sectors spread across the world, and global coverage was bolstered. For example, Ilario Di Bon, one of Brinson’s most experienced analysts in Chicago, moved to Tokyo to help upgrade Japanese coverage.

To concentrate analysts’ minds, UBS stipulated that 30 percent of their pay would be tied to the performance of their regional sector selections and an additional 30 percent would be tied to the performance of their global sector team’s choices. In effect, analysts pick virtual portfolios and are judged on how those stack up against the relevant benchmarks. (The analysts are not penalized, by the way, if fund managers do not heed all of their recommendations when constructing

real portfolios.)

“The system creates honesty,” says Madsen. “There is money on the line, so the best argument, not the loudest voice, will win out. Fund managers know that these analyst recommendations are not taken lightly.”

The new order shook up both the Brinsonites and the Phillips & Drew-ers, but the changes were felt most acutely at the century-old London firm. At Brinson portfolio managers essentially followed a top-down investment strategy, but a number of the firm’s key products, such as U.S. value equities, already employed fundamental analysis of the sort that Madsen was so ardently championing. PDFM, on the other hand, followed the British practice of delegating all investment decision making -- from stock selection to portfolio construction -- to autonomous managers who essentially performed three roles: analyst, fund manager and relationship manager. Even by the standards of their home market, PDFM’s people had enjoyed considerable freedom.

“Some of the PDFM guys threw their hands up and said, ‘I’ve been doing this job for 20 years -- why do I need to listen to an analyst?’” recalls Madsen. The result was furious turnover among the Phillips & Drew old guard, which didn’t abate until late 2002.

Although the changes were wrenching, they had a positive impact overall. “If we had just kept the status quo in place, I don’t think we could have been nearly as successful,” says CEO Fraser. “We would have been neither a true global player nor a nimble boutique. We would have been a collection of very, very vulnerable midsize firms. That is not a position you want to be in.”

Fraser, 52, used to run UBS’s Asia-Pacific operation and was Australia’s deputy Treasury secretary in 1990. He sits on the powerful UBS Group management board, but he leaves day-to-day running of the investment side of the business to Madsen, and he enthusiastically embraced both the new strategy and Madsen’s leadership of the reorganization project. “Tom came with a very global view, and he was important in driving that change and the integration,” says Fraser, who is based in London along with Madsen. “There could be no turning back.”

Clients and consultants are impressed with the results. Matt Gibson of Hewitt Bacon & Woodrow in London provides this perspective: “You go to a boutique for flair. What you want from the big global players is some sense in which the depth of their resources makes a difference. The global research platform at UBS is superb.”

Eric Hunt, pensions secretary at U.K. airport operator BAA, likes the fact that UBS Global AM analysts aren’t, as he puts it, “in silos.” Says Hunt, “It’s a team-driven approach, and the process seems robust.” BAA, which has $2.7 billion in pension assets, gave UBS Global AM a $315 million mandate in global equity in October 2002.

To be sure, timing has worked serendipitously (and somewhat ironically) in UBS’s favor. The group’s concentration on value investing -- the very thing that caused it to lag behind in the late 1990s and precipitated the shake-up -- boosted its returns as value stocks roared back into favor postcrash. What’s more, pension funds have been upping their global equity mandates, and UBS Global AM’s global sector approach has proved popular. In addition, the firm remains a powerhouse in money management’s hottest asset class: hedge funds. UBS Global AM is the world’s second-largest manager of hedge funds and funds of hedge funds after Man Group, based in London.

In fact, with $231 billion in institutional funds and $203 billion in retail money to invest, UBS Global AM can claim a significant presence in virtually every asset class: fixed income ($236 billion), equities ($158 billion), real estate ($15 billion) and hedge funds ($12.1 billion). The remainder is in balanced (that is, multiasset) and tactical asset allocation accounts. UBS’s sizable private banking business is managed separately.

To complement the UBS Global AM bottom-up research, Madsen strengthened a top-down risk management system that is based on the widely admired quantitative risk tools that are used at Brinson. Fourteen-year Brinson veteran Brian Singer serves as UBS Global AM’s global head of risk as well as its U.S. CIO. Singer’s quants screen portfolios for concentrations of risk, such as sector or country slants, as well as for inadvertent correlations among different stocks. The risk management system, which is called Constellation, does not aim, however, to second-guess a manager’s choices; Singer is not a portfolio policeman. “The intention is simply to demonstrate to managers where there is risk in a portfolio so that they can ensure that they are being properly compensated for taking the risk,” he explains.

“Some firms have great research engines, and some firms have great quants,” says the ever-ebullient Madsen. “We put it all together.”

Recent returns suggest that UBS Global AM is doing something -- or several things -- right. For the past three years, the firm’s global equities ranked in the top quartile of its institutional peer group, falling an annual average 4.5 percent versus 9.3 percent for the MSCI world free index; U.S. equities declined an annual average 1.7 percent versus a 9.4 percent fall for the S&P 500; European equities had an average annual decrease of 2.6 percent versus a decline of 8.6 percent for the MSCI Europe index; and global fixed-income mandates returned 5.2 percent a year on average, compared with 4.3 percent for the Citigroup world government bond index.

The welcome result: From San Diego to Singapore, UBS Global AM’s institutional business is thriving. In 2003, UBS snared 50 net new U.K. mandates worth a total of $5 billion, reports U.K. CEO Paul Yates. In the U.S., the company reported net new inflows of $3 billion last year. In Switzerland, UBS, along with Credit Suisse Asset Management, maintains a dominant grip on both the pension and retail markets. “We have stabilized our institutional business and are now growing again,” says Fraser. “We see a world of opportunity.”

With a solid track record, UBS Global AM can draw on its greatest strength in the institutional market: its long-standing relationships with pension funds. General Motors Co., for example, has invested with either UBS Global AM or Phillips & Drew since 1958.

Plans that remained loyal to UBS Global AM through the tough times in the late 1990s are increasingly willing to buy new products from the resurgent firm. That is particularly crucial in the U.K., where the shift from balanced (multiasset) to specialist fund management is hitting managers hard. UBS Global AM today claims just a 6 percent share of the U.K. money management market, down from 15 percent in 1999.

Typically, only one or two managers have run these large balanced portfolios. When a pension fund restructures along specialist lines, multiple mandates in equities and bonds are awarded, and the best a former balanced manager can hope for is to snare one of them.

UBS Global AM has been winning these fights. In early 2003, after the Church of England Pension Board’s £400 million ($728 million) fund shifted from balanced to specialist management, the firm captured a £180 million global equities brief. Better still, specialist management carries higher fees -- roughly 50 basis points compared with 20 basis points for a balanced portfolio.

“We have had Phillips & Drew as a manager for over 20 years,” says Roger Radford, the pension board’s head of investment. “When we came to look at our managers last year, it was their long-term performance that counted. Yes, they had their well-publicized problems in the late 1990s, but the long-term record remains excellent.”

The former Brinson boasts similarly deep relationships in the U.S. Last year the Nevada Public Employees’ Retirement System added $400 million to its $1 billion fixed-income allocation to UBS Global AM, building on a relationship that stretches back to 1990. Says Jean Ledford, CIO of the $16 billion pension plan: “The performance has been good, and it’s a tremendous organization. The name over the door may have changed, but the people running our money are the same.”

To pension funds looking to bolster their nontraditional asset allocation, UBS Global AM offers an established expertise in real estate investing. The $15 billion in real estate assets that the company manages ranks it as the No. 4 global property manager after London-based J.P. Morgan Fleming Asset Management, Sydney-based Lend Lease and London-based Deutsche Asset Management. Jim O’Keefe, head of global real estate at UBS Global AM, believes that the market will increasingly globalize, playing to the firm’s strength.

The new investment process has delivered results on the European retail front, too. UBS Global AM reported $5 billion of net inflows into bond and equity funds last year, bringing total European retail assets to $150 billion. A European corporate bond fund proved popular. In both Europe and the U.S., the firm uses wholesale intermediary banks and brokers to reach retail investors.

UBS Global AM is moving to bolster its comparatively anemic U.S. retail operation. Of the firm’s $202 billion in U.S.-based assets, only $52 billion is in mutual funds. Gary Brinson focused on the institutional marketplace from the day he founded his firm in 1981, and that orientation has remained in place under UBS. Says Brian Storms, CEO of UBS Global (Americas): “There is a $6 trillion mutual fund market in the U.S. in which Brinson decided not to compete. As part of our global wealth management franchise, we are now focusing on this business.” Storms isn’t trying to turn UBS into a household brand -- he’s touting UBS Global AM’s institutional strength to win subadvisory and separate accounts. The firm now handles subadvisory accounts for Manulife Financial and ING, among others; since the first quarter of 2002, it has added $2 billion in such accounts.

Industry consultants such as Philadelphia-based Burton Greenwald endorse the retail strategy. “It’s right to go the subadvisory route,” he says. “The biggest asset UBS has is Brian Storms, a tremendous leader who really understands the mutual fund business.”

With the U.S. mutual fund market roiled by scandal, Storms sees opportunity for growth. “We are not encumbered with a legacy business in the U.S.,” he explains. “The market is stepping back from the firms that are embroiled in the scandals. That is a substantial opportunity for us.”

Still, UBS’s U.S. retail performance is merely adequate. According to Morningstar, the average UBS fund is just inside the second quartile. But UBS does boast a few pockets of excellence: It’s in the top quartile in U.S. value equities, U.S. high yield and global bonds.

A dominant force in hedge funds for the better part of a decade, UBS has $7.9 billion in funds of hedge funds. Stamford, Connecticutbased O’Connor Multi-Manager handles $3.8 billion of the assets; Hong Kongbased Alternative Investment Strategies manages $2.2 billion. To create a single brand, O’Connor and Alternative Ivestment Strategies merged in February to create the Alternative Investment Solutions unit of UBS Global AM. That entity also advises on the management of $1.9 billion for the private bank.

The company runs an additional $4.3 billion in single and multistrategy hedge funds. The only institutional asset management firm to eclipse UBS Global AM in terms of directly managed hedge fund assets is Barclays Global Investors, with $6 billion in assets. More than $2 billion of UBS’s directly managed hedge fund assets are in a macro fund specializing in foreign exchange and interest rate trading. An equity suite of funds (long-short, market-neutral and so on) runs a further $2 billion, and $300 million is invested in various quantitative strategies.

Unlike many of its rivals in the hedge fund arena, UBS cannot offer ownership stakes to its portfolio managers. But Joe Scoby, global head of Alternative Investment Solutions and Chicago-based O’Connor, says UBS still attracts top-notch hedge fund managers. “We don’t offer equity,” says Scoby, “but what we do have is a turnkey franchise in terms of logistics and expertise.”

Many UBS investment professionals resisted the new regime. But four years after Madsen’s talk at Selsdon Park, no one is looking back. As U.K. CEO Yates puts it, “Brinson and Phillips & Drew are the past, and the past is another country.”