This content is from: Portfolio

Henderson Undergoes Retail Therapy

New CEO Andrew Formica makes a play for the U.K. retail investor by acquiring New Star.

Fund management has been very, very good to Andrew Formica. A young economics graduate, he joined AMP Investments in Sydney, Australia, as an equity portfolio manager in 1993, then parlayed his success there into a posting to AMP’s London arm three years later. A few years and a merger and promotion later, Formica was head of equities at the U.K.-based Henderson Group, which he helped turn into one of Europe’s most profitable and dynamic investment managers by pushing high-margin products like hedge funds. It wasn’t surprising when Henderson last August anointed the 38-year-old wunderkind as successor to CEO Roger Yates, who stepped down after nearly a decade in the top job.

Formica didn’t have any time to celebrate. Just a few weeks after he was named CEO-designate, Lehman Brothers Holdings collapsed, sending global markets into a tailspin. Four weeks later Henderson, the third-largest listed investment firm in the U.K., behind Aberdeen Asset Management and Schroders, warned that it wouldn’t meet its profit target for 2008 because of asset outflows and dwindling performance fees. The company’s stock price plummeted 18 percent on the day of the announcement. Formica, who pronounces his name "FORM-ic-a," quickly realized that business as usual wouldn’t cut it at Henderson Global Investors, the group’s fund management arm.

"The world suddenly changed for asset managers," he tells Institutional Investor in a recent interview at Henderson’s modern offices in the City of London’s Broadgate Centre. "Our revenues came under pressure, and we had to make decisions quickly. It was a baptism by fire."

Formica, a keen cyclist, quickly shifted gears. In the first few weeks after taking over as CEO in early November, he agreed to pay an undisclosed amount for a 30 percent stake in Attunga Capital, an Australian firm that manages A$150 million ($117 million) in alternative-energy assets, and he poached a five-strong currency team from Franco-Belgian bank Fortis.

In January, Formica made his boldest move yet, offering £107 million ($170 million) to acquire battered U.K. retail fund manager New Star Asset Management from its creditor banks. The deal, completed in April, adds £8.6 billion in assets, boosting Henderson’s total to £52 billion. More important, says Formica, the acquisition gives Henderson a distribution network for tapping into the U.K. retail market.

At a time when stock market declines have caused many individual investors to abandon equities, Formica’s decision to take institutional money manager Henderson more deeply into the retail market is contrarian. The U.K. mutual fund industry has shrunk around 22 percent, to £374.9 billion at the end of April, from its 2007 peak, reflecting valuation losses and withdrawals by investors, according to the Association of Investment Managers.

Formica, however, regards the depressed retail market as an opportunity. The Australian is determined to diversify Henderson, which last year relied on high-margin funds like investment trusts, hedge funds, private equity funds and structured products for more than 70 percent of revenues. The rest of its revenues came from lower-margin funds like fixed-income products, enhanced index funds and actively managed stock funds. Formica, an active, bottom-up investor, regards the acquisition of New Star as a value play. "Retail is seen as a challenged and depressed space," he says. "But the fundamentals remain sound on a long-term basis. It’s a good time to build a base."

European asset managers struggling to adjust to the sharp decline in fees stemming from the financial crisis need to find new revenue sources. The problem is acute at Henderson. The Henderson European Absolute Return Fund lost about 40 percent of its value in 2008, taking big hits on long positions in oil company stocks when crude prices plunged in the second half of the year. Poor performance, in turn, incited a wave of withdrawals by investors. The fund’s assets under management have fallen to $81 million from a peak of $866 million in 2008. Although returns have recovered this year — the fund was up 40.26 percent at the end of April — it has a long way to go to begin earning performance fees again.

The company had better performance in its fixed-income institutional funds, with 43 percent of those assets matching or beating their benchmarks. That strength helped Henderson achieve net inflows of £2.9 billion last year, but those fixed-income products generate much lower profit margins. As a result, Henderson posted a net loss of £20.8 million in 2008, compared with income of £132.2 million a year earlier, as revenues fell 20.9 percent, to £257.8 million. Performance fees on alternative products plunged by 61 percent, to £19.4 million.

"We want a new mix of clients to make us a stronger business," says Formica. "It means you can continue to invest and clients don’t feel there is pressure to cut costs and pull back at all times."

New Star propels Henderson from 26th place among U.K. managers of retail and private client funds to No. 10, with £7.7 billion in assets, according to the Investment Management Association.

The New Star deal also marks Henderson as a contender for greater scale and prominence at a time when many insiders expect Europe’s asset management industry to undergo a wave of consolidation. Formica beat out Martin Gilbert, the serial deal maker and CEO of rival Aberdeen Asset Management, to win the bidding for New Star. Aberdeen late last year acquired the non-Swiss traditional asset management business of Credit Suisse, with Sf75 billion ($63 million) in assets.

Henderson expects New Star to enhance earnings by 2010. The company is targeting a cost-to-income ratio of 40 percent or better for the acquired business, compared with a ratio of 63.4 percent for its existing operations.

Investors seem to like the deal. Henderson’s shares, which are listed on the London and Australian stock exchanges, rose 21 percent on the day after the acquisition was announced in late January and were up 39 percent year-to-date, at 80.75 pence, late last month. That compares with a 7.9 percent rise in Aberdeen’s share price this year and a 0.5 percent decline in Schroder’s.

Still, some analysts and investors question whether New Star is the right match. Founded in 2000 by British entrepreneur John Duffield, who had previously built up the U.K.’s Jupiter Asset Management before selling it to Germany’s Commerzbank in 1995, New Star grew rapidly, thanks to aggressive marketing campaigns and strong returns; it boasted £23.1 billion in assets by the end of 2007. But sharp stock market declines in 2008 and the early part of this year, as well as poor performance in U.K. equity and property funds, have caused assets to tumble. Compounding the market problems were New Star’s heavy debt load of £230 million, which was borrowed mostly to fund a 2007 capital return to shareholders, including Duffield. When the debt became unmanageable, Duffield was forced into a debt-for-equity swap that passed control of the company to its bank lenders.

"We have concerns about the New Star acquisition," says Nitin Arora, a financials analyst at Noble. "The brand is tarnished, and it is not clear Henderson will be able to keep New Star fund managers and assets and deliver on its promised cost savings." Noble has a sell recommendation on the stock.

Most of New Star’s equity funds, which account for 73 percent of the assets being acquired, ranked in the fourth quartile in 2008, according to research by Noble and U.K. brokerage Hargreaves Lansdown. Fixed-income funds, which make up about 14 percent of assets, suffered declines of 30 to 40 percent last year, with a majority ranked in the fourth quartile.

Henderson must move quickly to improve performance if it wants the acquisition to succeed. Analysts and consultants say it’s encouraging that Formica has managed to keep many of New Star’s most highly regarded managers, including Richard Pease, who runs the £476 million European Growth fund, which enjoys a four-star rating from fund performance monitor Morningstar, and Guy de Blonay, manager of the five-star rated New Star Global Financials fund.

"The only thing that matters to me is a fund’s performance," says Mark Dampier, head of research at Hargreaves Lansdown. "Henderson has every chance in the retail market with managers like Pease and de Blonay joining."

Henderson was founded 75 years ago to manage the money of British politician and financier Alexander Henderson. His fortune, built on the railway booms in Britain, Spain and South America, was later divided among family members in investment trusts such as the Lowland Investment Co., which today is managed by Henderson’s great-grandson James Henderson.

The Henderson group moved from investment trusts into managing unit trusts and pension funds, but the firm suffered badly in the stock market crash of 1987. In a bid to boost performance and assets, Henderson acquired the £2.1 billion-in-assets Touche Remnant in 1992. Then in 1998, Australian financial services group AMP purchased Henderson for £380 million and merged it with its asset management units in the U.K. and Australia, renaming the firm Henderson Global Investors.

Frustrated by the unit’s lack of profitability, AMP spun off the U.K., European and North American businesses on the London and Sydney stock exchanges in 2003. It retained a stake in the business until 2005, when the holding company was renamed the Henderson Group.

Formica, the son of a mathematics teacher and a teaching assistant, graduated from Macquarie University in Australia with a masters in economics in 1991 before starting his career with AMP two years later. After rising through the ranks as a fund manager at AMP and then Henderson, he was promoted to head of equities in 2004 and in 2006 was made joint head of the listed assets business, with responsibility for distribution and marketing.

To succeed in the U.K. retail market, Formica will need to improve performance in U.K. equities. He’s betting on Stephen Peak, head of Henderson’s pan-European equities team, to do just that. A bottom-up stock picker who uses both growth and value investment styles, Peak is taking over management of British equity funds New Star U.K. Alpha and New Star Hidden Value.

Peak also manages Henderson’s former flagship hedge fund, Henderson European Absolute Return, whose performance suffered in the second half of last year because of excessive leverage, an overweight position in resources companies and a lack of liquidity in smaller companies. When investor redemptions hit the fund, Peak had to sell companies he thought were undervalued.

This year, though, performance has turned around. The fund benefited from long positions in U.K.-based Premier Oil as well as from short positions in renewable energy stocks like Denmark’s Vestas Wind Systems and Germany’s solar cell maker Q-Cells and in East European lenders like Austria’s Erste Bank.

Formica has made big changes to Henderson’s underperforming fixed-income hedge funds. The offshore version of Henderson’s fixed-income range hedge fund, the Horizon Absolute Return Fund, fell from about €390 million in assets at the end of October 2007 to €51 million at the end of April as it got hit by outflows and illiquid positions such as U.S. asset-backed securities and high-yield corporate bonds. "We were constantly trying to do what’s best for clients in the fund and address the need for liquidity for investors coming out of the fund," says David Jacob, Henderson’s head of listed assets and a former head of fixed income at UBS Global Asset Management.

In November, Formica and Jacob replaced the manager of the Horizon fund, Daniel Beharall, with Phil Apel, manager of the Henderson U.K. Gilt and Long Dated Gilt funds, and charged Apel with refocusing Horizon on more-liquid investments like government bonds. The Long Dated Gilt fund posted a 14.51 percent return in 2008, exceeding the 13.65 percent return of its benchmark FTSE Gilts over 15 index.

Henderson needs to improve performance if it is to prevent more clients from fleeing. The £385 million-in-assets Bedfordshire County Council, meanwhile, sacked Henderson from an £80 million active U.K. equity mandate in June 2008. Henderson was supposed to beat the FTSE All Share index by 1 percentage point over a rolling three-year period on the mandate. "We didn’t believe Henderson would be able to achieve the investment performance we were hoping for," says Geoff Reader, pensions manager at the Bedfordshire fund, declining to give more details.

Formica faces no small number of challenges, but he insists that Henderson can boost performance and thrive as a leading European independent asset manager. "We make the tough decisions that others belonging to large groups don’t have to do," he says. "If you can manage through the downturn, you are a stronger business."

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