LAST FALL THE TOP BRASS OF EATON VANCE Corp. summoned the 525 employees at its Boston headquarters to a mandatory meeting about the future of the 83-year-old asset manager. Amid rumors that leveraged-buyout investors were circling the firm, CEO James Hawkes and president Thomas Faust outlined an ambitious plan to propel Eaton Vance -- a bit player in the consolidating money management business despite a decade of brisk growth -- into the industry’s upper echelon alongside such giants as Fidelity Investments, Capital Group Cos.’ American Funds complex and Franklin Resources. Hawkes, a former U.S. Navy officer, christened the project Catapult and livened up the late-September presentation with video clips of warplanes taking off from aircraft carriers.
“Eaton Vance is a mainstream firm and a premier asset manager,” Hawkes told his charges. “There’s just one problem: The world hasn’t figured it out.”
He was right on both counts. Hawkes and Faust had spent much of the previous decade diversifying the money manager beyond its roots as a niche manager of conservative investments for wealthy individuals, adding stock funds and boosting performance. But clients and the outside brokers who distribute its funds had, for the most part, failed to recognize the firm’s transformation.
One year later Eaton Vance is still trying to get its message off the flight deck. Markets have turned treacherous, particularly for the bonds and bank loans that the money manager’s flagship debt funds hold, while the firm itself is caught in an unusually tumultuous time. This month Hawkes, having reached the mandatory retirement age of 65, turns the tiller over to Faust, 49.
The firm, known for a steady-as-she-goes culture in which staffers rarely leave, is confronted with an unusually high level of turnover in its senior ranks. Joining Hawkes, a 37-year Eaton Vance veteran, in retirement this month are CFO William Steul and chief legal officer Alan Dynner. Longtime distribution chief Wharton Whitaker passed away in February. Eaton Vance shares, among the stock market’s best performers over the past quarter-century, are off 18 percent from their early July high of $47.69. Following June’s $5.7 billion LBO of $172 billion-in-assets Nuveen Investments by Madison Dearborn Partners, deal makers are once again mentioning Eaton Vance as a target for buyout firms or acquisition-happy rival managers. However, any such deal would have to be friendly; through a unique ownership structure designed to fend off a hostile takeover, Faust and 17 other executives control all the company’s voting shares, and the CEO is adamant about keeping the firm independent.
Arkansas native Faust is plenty ambitious. He wants to more than triple Eaton Vance’s $150 billion in assets under management, to $500 billion, by 2015, in an effort to stave off potential suitors by boosting the money manager’s earnings and market value. The CEO is wasting no time putting his own stamp on the firm, most notably by turning to outsiders to fill the key vacated positions -- a move sure to ruffle feathers at such a tradition-bound institution. Succeeding Steul and Whitaker “respectively” are Robert Whelan, who joined as director of finance in April from Boston Private Wealth Management Group, and Matthew Witkos, previously head of global distribution for IXIS Asset Management Advisors Group. The firm hired Witkos in May, reportedly luring him with an annual compensation package worth more than $3 million -- far above the typical pay range for such a position. Witkos is now looking for a chief marketing officer, to fill a newly created post at Eaton Vance. A search is ongoing for a new legal chief.
Faust’s plan involves a big move into international funds -- possibly by way of acquisitions -- and redoubling a two-year-old effort to push into the institutional business, which accounts for just $6 billion, or 4 percent of assets under management. He is also eager to improve distribution of Eaton Vance’s mutual funds, currently sold almost entirely through outside brokers and advisers, in an effort to double the firm’s 1 percent market share.
The new CEO is counting on dislocation caused by recent fund industry mergers and acquisitions to create opportunities. During the past two years, Merrill Lynch & Co. folded its investment management business into giant fixed-income manager BlackRock, Citigroup swapped its fund management unit for the brokerage operations of Legg Mason, and Power Financial Corp. bought $192 billion-in-assets Putnam Investments. Faust sees these deals freeing up scarce distribution capacity in the brokerage operations run by Merrill and Citi, giving his firm a chance to win market share.
In mutual funds he is particularly focused on growing assets in large-capitalization equity products, the business’s single biggest pool of money and one in which Eaton Vance has a paltry $22 billion.
“My job is to get the word out that we have a broad range of capabilities,” says Faust, who became chief investment officer in 2000, after a long tenure as an analyst and portfolio manager, and was named Hawkes’s heir apparent in January 2006.
“Fidelity, American Funds and Franklin Templeton are the types of diversified firms that we want to emulate,” says Hawkes.
Eaton Vance will also have to keep an eye on its exposure to risky corporate debt, however. So far the firm appears to be weathering the storm triggered by the implosion in mortgage-backed securities during the spring and summer. Through September 26 its flagship $5.5 billion Eaton Vance Floating-Rate Fund was up 1.54 percent on the year, better than 57 percent of its peers. Its Income Fund of Boston, a high-yield portfolio, returned 2.96 percent during the same period, besting 48 percent of peers.
Faust aims to build from strength. A key element of his growth strategy is to continue expanding Eaton Vance’s $32 billion in closed-end mutual funds, a category in which it trails only Nuveen and BlackRock. In the past year the firm has launched two mammoth closed-end funds, which offer a set number of shares to investors in an IPO, giving managers a stable pool of assets that cannot be withdrawn by investors. February’s IPO of the Eaton Vance Tax-Managed Global Diversified Equity Income Fund, at $5.5 billion, was the biggest closed-end offering in history and followed a similar, U.S.-focused fund that raised $2.6 billion in November.
Not everyone, however, is convinced that the firm can become one of the industry’s giants. Some analysts and shareholders question its timing in pressing further into equities several years into a bull market. Others worry that by trying to transcend its boutique roots and provide a full range of products to a wider array of clients, Eaton Vance will lose what made it special in the past. Much of its allure has been derived from its image as a boutique provider of high-performing municipal bond, tax-managed equity and bank-loan funds to rich, conservative investors.
“I would worry if they want to be a big shop like American or Fidelity,” says Rachel Barnard, a Morningstar analyst who has been bullish on Eaton Vance stock for years. “They’ve really dominated their niches with good long-term track records. I wouldn’t want to see them spoil the secret sauce.”
EATON VANCE TRACES ITS ROOTS TO TWO VERY DIFFERent, yet equally distinguished firms. Eaton & Howard was founded in 1924 by Charles Freedom Eaton Jr., scion of a wealthy Maine lumber family, and John Glenny Howard, a bond salesman from Buffalo, New York; it was one of Boston’s first investment firms, looking after the assets of wealthy families. Vance, Sanders & Co., founded in 1944, was a prosperous fund underwriting and distribution company. Eaton & Howard expanded into mutual funds and by 1959 was one of the country’s biggest managers, with $350 million in assets. Vance Sanders went public in 1959 and by the 1960s had become the biggest U.S. fund distributor.
The bear market and stagflation of the 1970s hit both firms hard, and in 1979, Vance Sanders acquired Eaton & Howard. During the 1980s the firm largely missed out on the boom in mutual funds, which were growing in popularity as a new bull market began and corporations began offering defined contribution retirement plans. Eaton Vance managed some equity funds, but its track record was subpar, and it failed to keep up with the asset growth of better-performing competitors. Attempting to build on the firm’s strengths and to compensate for its then-poor record in stock funds, Hawkes launched a family of municipal bond funds as well as tax-efficient stock funds, all natural fits for the asset manager’s core of affluent clients.
Still, the firm continued to grow far more slowly than rivals that had stronger stock fund businesses and serious institutional and non-U.S. businesses. As the bull market kicked into high gear in the mid-1990s, it increasingly looked like time had passed Eaton Vance by. In 1996 the bulk of its assets -- 51 percent -- were in out-of-fashion municipal bond funds. Equities represented just 21 percent of assets, with another 15 percent in bank loans, 11 percent in taxable bonds and 2 percent in money market funds. During the two years ended June 30, 1996, mutual fund assets grew by 50 percent industrywide as the stock market boomed, but by a mere 10 percent at Eaton Vance. The firm was constantly talked about as a takeover target as consolidation began to grip the asset management business.
“We weren’t participating in the equity markets,” recalls Hawkes. “When you have equities, you can grow in your sleep as the markets appreciate.”
Hawkes set about refashioning the business, challenging his colleagues to break from the firm’s conservative culture and aggressively expand into riskier stock funds. He entrusted the most important component of his plan, building a bigger presence in mainstream stock funds, to Faust, who in 2001 succeeded Hawkes as CIO. Faust certainly knew the value of hard work. He had grown up in tiny Helena, Arkansas (population 6,300), where his father, grandfather and uncle ran a sawmill.
“The worst days in the investment business are better than the best days in the sawmill industry,” says Faust, who had never boarded an airplane until he left Helena in 1976 for the Massachusetts Institute of Technology, from which he has bachelor’s degrees in mechanical engineering and economics. “Adversity means having a bad trading day rather than a fire.”
But the most important lesson he learned from the mill, says Faust: “It’s hard to make headway in a commodity product.”
In the funds business, distinguishing products meant improving performance. Faust, who joined the firm in 1985 as an analyst covering natural-resources companies, believed returns were being held back by the practice of clearing all investment ideas through two committees -- one specific to the particular fund’s style and another that had authority over all stock picks. Under this system an analyst would come up with an idea, visit the company, prepare an evaluation and present it to the investment committees.
“If it was a good idea, by the time the lightbulb went off and the idea was approved by the committee, we would miss the first 15 to 20 percent of the appreciation,” says Faust. “It was very inefficient for serious fundamental investing.”
Faust disbanded the committees and let analysts make investment decisions directly, and the move paid off in spades. In 1996 only one of Eaton Vance’s 24 equity funds ranked among the top 20 percent of its peers over the previous three years. Today, 67 percent of the firm’s equity funds beat the three-year performance of their peer groups on an asset-weighted basis, according to fund data provider Lipper. An impressive 92 percent beat their peer groups’ ten-year returns.
Under Hawkes the company also pushed into new markets. One was retail separate accounts, a business that, after three acquisitions, has grown to $9.7 billion in assets.
Overall, the firm’s asset base has soared, from $17 billion in 1996 to $150 billion. It now has a diversified product lineup, split among municipals, taxable fixed income, bank loans and equities. Where most assets were once in fixed income, the firm now boasts a 65-35 split between equities and bonds. About 19 percent of its assets are in closed-end funds, which are not subject to redemptions, to balance out the 36 percent of assets in open-end mutual funds and a smattering of cash in other areas, including subadvisory mandates for other firms and institutional portfolios. Earnings have increased 18 percent annually, and shares of the company, publicly traded since 1979, have soared from a lowly $3 apiece to $38, giving Eaton Vance a market value of nearly $5 billion and making millionaires of scores of employees -- all of whom own stock.
THAT’S AN ADMIRABLE RECORD FOR JUST ABOUT ANY firm. But for all its recent success, Eaton Vance remains a minnow among whales. It ranks as the 53rd-biggest U.S. money manager, with just one tenth the assets of third-ranked Capital, whose American Funds complex alone boasts more than $1 trillion under management, and fourth-place Fidelity. Its equity funds have performed well -- over the past ten years, on an asset-weighted basis, they rank in the top one third of all such vehicles, according to Morningstar -- but are hamstrung, say Hawkes and Faust, by the persistent perception of Eaton Vance as a niche debt manager. The firm also lacks sufficient heft in managing money for pension funds and other big institutions, as well as in international products -- it ranks just 74th among domestic money managers in non-U.S. equity assets.
Changing perception is a job that will fall mainly to Witkos, the new head of distribution. At IXIS he assisted in putting together a single brand for the $223 billion asset manager -- an affiliation of smaller firms spread around the globe -- and helped put together two major acquisitions. Before that he worked with GE Asset Management to start its mutual fund business.
“Eaton Vance is at a tipping point,” says Witkos, 42. “We have a brand gaining momentum, performance, an existing client base. What we have to do is introduce our existing clients to new capabilities.”
Which is to say that Eaton Vance must get better at cross-selling. Witkos admits there is no easy solution for this, beyond pushing its 154-strong sales force to improve relationships with the brokerages that distribute the firm’s funds. To do this Witkos plans to boost Eaton Vance’s traditional, relationship-based selling with a data-mining initiative that will show which firms, branches and brokers are generating sales and analyze both client profitability and the timing of sales and redemptions, with the goal of better targeting distribution efforts.
The sales chief expects that large-cap growth and large-cap value will power much of the funds’ expansion. Witkos plans to aggressively market the firm’s large-cap funds to 401(k) plans and overseas investors. He is hiring a chief marketing officer to broaden distribution beyond national brokerage firms to banks, insurance companies and defined contribution plans.
Catapulting itself into the ranks of one-stop investment shops will require Eaton Vance to expand several fledgling businesses. The firm is a newcomer to the institutional market, which it entered in 2005. That’s a big disadvantage to overcome because pension funds and other institutions tend to stick with managers for years before considering a switch. But Eaton Vance thinks it can leverage its existing product expertise into the sector. Lisa Jones, who joined the firm in May 2005 as head of institutional from a similar job at MFS Investment Management, has built an infrastructure from scratch, creating a sales and marketing team of 19 people and rolling out institutional portfolios in large-cap value, small-cap core and emerging-markets equity. Jones’s group has grown assets to $6.3 billion, up from $4 billion when she joined. Her big asset-gathering success thus far has been doubling the size of Eaton Vance’s institutional high-yield bond business.
“We began life by managing money for high net worth,” says Jones, a 17-year MFS veteran. “Institutional naturally follows from that. The platform is there; we just need to raise awareness.”
Jones is hoping that Eaton Vance can capture a part of the burgeoning liability-driven investments market. The Pension Protection Act of 2006, in a move to strengthen defined benefit plans, requires plan sponsors to value their assets and liabilities more frequently. But doing so can make plans’ performance more volatile and add balance-sheet risk. LDI strategies, which include extending the duration of bonds to match liabilities to a coupon or principal payment, are one way to cope with this problem. Shortly after hiring Jones, Eaton Vance tapped Daniel Strelow and Jeffrey Rawlins, who had worked together for 17 years at State Street Research & Management, to co-head a new liability solutions group.
Faust also sees an opportunity in Eaton Vance’s international business. The firm manages just $18 billion in non-U.S. assets, and it has little in the way of in-house international investing expertise, having hired outside managers to handle most of its non-U.S. funds. That will change, says Duncan Richardson, a 30-year veteran of the firm who is now CIO of equities. The only question is how. He and Faust prefer to build an overseas effort from scratch, but they are also considering expanding through acquisitions.
“Acquisitions can be tricky, and organic growth is valued higher by the market,” says Richardson, 50. Faust says the firm will make a decision over the next one to two years on whether to build or buy -- or somehow mix the two strategies.
Richardson believes Eaton Vance also has room to grow in closed-end funds, where it has succeeded through innovation. One example: It has a patent pending for the process it uses to create income in its equity portfolios, which involves using options and moving in and out of stocks to capture their dividends. Such strategies and products will serve Eaton Vance well as the baby boom generation moves closer to retirement age, he believes.
“We haven’t always been first to do things,” says Richardson. “But we’ve rethought problems and come up with unique solutions.”
Can Faust and his team vault Eaton Vance into money management’s elite? More than tripling assets to reach its goal of $500 billion is a stretch, despite the firm’s track record. Sales efforts in mutual funds appear to be paying off thus far; assets rose 31 percent, to $117 billion, during the 12 months ended July 31.
But competitors aren’t standing still. Last year assets in the industry grew by nearly 17 percent, double the rate of 2005, according to Institutional Investor‘s survey of the 300 biggest U.S. fund companies. Reaching the half-billion mark in assets would only propel Eaton Vance to 19th place today. If Faust truly wants to propel his firm into the elite tier occupied by Fidelity and Capital, he has an awfully long way to go.
