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J.P. Morgan Profits From Staley Winning Formula
Restoring J.P. Morgan's luster has been a winning formula for CEO Jes Staley.
When JPMorgan Chase & Co. agreed to merge with Bank One Corp. in 2004, Jes Staley, head of the formers asset management arm, got a friendly warning about his new boss, Jamie Dimon, from a longtime colleague of Dimons. Staley had championed a closed-architecture strategy at JPMorgan Chases private bank, whereby the bank offered wealthy clients only its own in-house investment products. But Dimon, the Bank One CEO who would soon take the top job at JPMorgan Chase as part of the merger, had long advocated that banks adopt an open approach and offer clients a variety of products, including funds developed and managed by other firms. He had clashed over the issue with Sanford Weills daughter, Jessica Bibliowicz, when she was Dimons subordinate running Smith Barney & Co.s mutual funds in the 1990s, a dispute that some insiders believe led her to leave the firm.
Hes your boss now, Staley recalls the colleague warning him. You might want to rethink your view.
Staley did no such thing. Instead, the veteran banker stuck to his guns, arguing with and eventually persuading Dimon that his closed approach was the right way to go because it underscored the need for the banks fund managers to deliver strong performance. He also managed to win Dimon over to the idea of buying a hedge fund, Highbridge Capital Management, something the CEO had strongly opposed. Jes was a breath of fresh air, Dimon tells Institutional Investor, referring to the debate over closed architecture. He said from the start, We have to perform for the client.
Sticking with his convictions has been a winning formula for Staley, and for JPMorgan Chase. Since taking the helm as CEO of J.P. Morgan Asset Management in 2001, Staley has strengthened its status as one of the biggest and most diversified investment outfits in the world. The division manages $1.1 trillion in assets, including everything from mutual funds for the masses to private banking for the well-heeled to hedge funds and private equity for institutional investors. (It also supervises an additional $363 billion in custodial and brokerage accounts.) The business ranks in sixth place on the II300, Institutional Investors exclusive survey of the largest U.S. money managers, behind Barclays Global Investors, State Street Global Advisors, Capital Group Cos., Fidelity Investments and BlackRock.
Although many big fund managers were buffeted by market turmoil last year, J.P. Morgan had net investment inflows of $151 billion, attracted in no small part by the banks apparent solidity at a time when many rivals were sinking under the weight of toxic assets. The divisions private banking arm alone, which supervises $378 billion in assets, pulled in $80 billion in new money last year.
Staley runs a well-oiled operation too. Although the divisions pretax profits declined 30 percent last year, to $2.2 billion, reflecting lower asset values and reduced performance fees on hedge funds and private equity, most rivals suffered even bigger declines: 62 percent at Credit Suisse, 48 percent at BlackRock, 44 percent at UBS and 43 percent at Citigroup. J.P. Morgans pretax profit margin of 29 percent in 2008 compared favorably with those of Northern Trust Corp. (26 percent), BlackRock (23 percent), UBS (22 percent) and Citigroup (14 percent). Asset management generated $1.36 billion in net income last year, or 24 percent of the banks overall earnings.
He moved J.P. Morgan forward from being lethargic and in flux under former leaders to re-creating an organization of confidence and stature, notes John Casey, chairman of Darien, Connecticutbased research firm Casey, Quirk & Associates.
Not only has Staley restored J.P. Morgans luster, he has done so at a time when many big banks are bungling asset management or getting out of the business altogether. UBS, arguably J.P. Morgans closest peer, has seen its business decline because of subpar performance as well as the reputational damage caused by the banks massive subprime losses and its acknowledged role in helping wealthy Americans evade taxes through Swiss bank accounts. UBS suffered asset outflows of Sf123 billion ($114 billion) from its private banking arm and a further Sf103 billion from its institutional asset management unit last year. Barclays, looking to bolster its capital, last month sold its profitable exchange-traded funds business to private equity house CVC Capital Group for $4.4 billion. Frances Société Générale spun off its $235 billion-in-assets long-only fund management business into a joint venture with rival Crédit Agricole, and Credit Suisse sold its conventional non-Swiss money management business, with $67 billion in assets, to London-based Aberdeen Asset Management. Citigroup got out of the institutional money management business altogether in 2005, when it exchanged its fund arm for Legg Mason Global Asset Managements brokerage group.
But far from retrenching during the worst market since the Great Depression, Staley, with Dimons firm backing, is determined to keep growing. He wants the asset management division to generate a consistent 20 percent of the banks overall profits, or roughly double its contribution before 2008, when the financial crisis depressed earnings at JPMorgan Chases investment banking and commercial banking divisions. He insists that money management belongs firmly at the center of a big global bank and can be run profitably for the benefit of customers and shareholders alike.
We want to be one of the most respected firms in asset management, Staley told II in a recent interview. If we deliver strong risk-adjusted returns to our clients, it underscores two core value propositions of the bank: trust and financial acumen.
J.P. Morgan certainly has a hot hand in asset management, as in most other areas of Dimons swaggering empire, but Staley must overcome a number of challenges to fulfill his ambitions. Although the bank enjoyed heavy inflows in 2008, most of them went into money market and other liquid funds. With inflows of $210 billion last year, the asset management unit became the second-largest U.S. provider of money funds, totaling $617 billion at the end of March, more than half of the overall groups funds under management. Such assets arent necessarily sticky, though, as demonstrated by last years crisis, triggered when the failure of Lehman Brothers Holdings caused some money funds to drop below their $1.00 par value. Thats an extraordinarily profitable business, but its our biggest risk and our biggest opportunity, Staley says.
J.P. Morgan has also suffered notable losses in alternatives, the area where Staley has made his greatest mark. Highbridge saw its assets tumble by 37.8 percent last year, to $17.3 billion, exceeding the 24 percent decline in assets of the Hedge Fund 100, the annual list of the worlds largest hedge funds by Institutional Investors Alpha magazine (see page 82). That decline pushed J.P. Morgan Asset Management down one place, to second, in the ranking, behind Bridgewater Associates. Overall, Staleys division saw outflows of $47 billion from alternative, balanced and equity funds.
The executive also needs to turn around the lagging performance of fixed-income portfolios, a segment that accounts for $171 billion of assets under management. In September, Staley dismissed Mike Pecoraro as CIO of the New York and London-based fixed-income team, which runs nearly half the groups bond funds, and replaced him with Robert Michele, who had been global head of fixed income at Schroder Investment Management in London. It will take time, though, to improve a business that had only 43 percent of its U.S. assets ranked in the top two quartiles by performance last year, according to fund data provider Lipper. Equities, which accounted for $180 billion in assets, have performed better, with 75 percent of U.S. equity assets in the top two quartiles last year.
Jes came in, turned around performance and got assets flowing again, says John McDonald, an analyst at Sanford C. Bernstein & Co. But to realize his goals, McDonald says, Staley will have to compete with faster-growing businesses like retail, which though under pressure now, will snap back. And he still needs to battle the perception that bank-owned asset managers arent at the cutting edge.
Staley acknowledges the difficulties posed by todays market volatility. Over the past year the markets have been in cardiac arrest every relationship and every assumption I have about how stocks and bonds move in relation to each other has become irrelevant, he explains. My challenge is how to deal with that and still manage money well.
Financial turbulence may alter market relationships, but it hasnt shaken Staleys conviction about the way to run an investment business. He has based his tenure on attracting and retaining top talent, developing the broadest array of investment products to offer clients and instilling a culture of performance among his portfolio managers.
Most of Staleys key colleagues have worked with him for years. They include Paul Bateman, former chairman of Robert Fleming Asset Management, the international fund group that JPMorgan acquired in its 2000 merger with Chase Manhattan Corp., who is now chairman of J.P. Morgan Asset Management; CFO David Brigstocke and fixed-income chief Seth Bernstein, both of whom Staley brought with him from the investment bank; Larry Unrein, head of the private equity and hedge fund groups, whom Staley appointed to oversee the integration of Bear Stearns Cos. $20 billion asset management unit last year; and Eve Guernsey, a 32-year J.P. Morgan veteran who heads the asset management business in the Americas.
Staley believes that the loyalty of a close cadre of executives is crucial to the success of the business. Most of Jamies direct reports have been with him for over a decade, and they can complete each others sentences, he says of Dimon. When I put the team together in 2001, we said we have to turn this business around and were all going to get into this foxhole together.
Loyalty extends down into the ranks. Turnover among portfolio managers is 6 percent a year, compared with an industry average of about 20 percent. You cant deliver consistent investment results if you have turnover of your portfolio managers, Staley notes. The people at Wellington dont leave Wellington. To compete against the Wellingtons of the world, we have to engender a culture that keeps people in their seats. Guernsey echoes the point: If you dont have people and teams with longevity, you dont have track records. Its that simple.
J.P. Morgans supermarket approach offering everything from mutual funds to institutional products and alternatives as well as its cross-selling with other units of the broader group, is also working wonders. Roughly 70 percent of money market assets originate from other divisions of the bank; the investment bank last year introduced 460 of its clients to the private banking arm, generating more than 100 new customers and close to $3 billion in new assets.
The Teacher Retirement System of Texas awarded $1 billion of mandates to J.P. Morgan Asset Management in 2008 because it wanted a firm that could offer a broad range of products, says Britt Harris, the pension funds CIO. How many organizations in the world can provide the full range of asset classes, public and private, and can offer trading resources, proprietary research and the banks best thinking?
James E. (Jes) Staley was born in Boston in 1956, one of four children who moved frequently to follow their father, Paul, a plant manager for Procter & Gamble Co. who later became CEO of PQ Corp., a chemicals business based outside Philadelphia. Jes Staley spent his high school years in Boston, then went to Bowdoin College in Brunswick, Maine. After obtaining a bachelors degree in economics in 1979, he joined JPMorgans commercial bank training program in New York. A year later he moved to Brazil to help Morgan, then operating under Glass-Steagall Act constraints in the U.S., set up its first investment banking venture, a laboratory for the global business the bank would later develop. Brazil was formative for Staleys life as well as his career: Within days of his arrival, he met his future wife, Debbie.
While working in Brazil in 1985, Staley received a shock from back home when he learned that his younger brother, Peter, whom he had helped get a job in Morgans training program in 1983, was gay and had been diagnosed with AIDS-related complex at the time a perceived death sentence. Peter would later help found Act Up, a New Yorkbased AIDS activist group, and serve as a member of president Bill Clintons National Task Force on AIDS Drug Development. Jes Staley describes Peter as his hero for his leadership within the gay community in fighting for access to AIDS drugs. The experience also made Staley challenge the homophobic atmosphere that pervaded much of Wall Street at the time. He has worked to create an environment at J.P. Morgan that is welcoming to gays and lesbians, women and minorities, considering it both morally right and good for business. I dont think there is anything more effective in retaining talent than embracing diversity, Staley asserts.
He returned to New York in 1989 as the bank was beginning to build a securities business. That year it became the first commercial bank since 1933 to underwrite a corporate bond issue. Staley took charge of the new convertibles business after spending two months talking to experts and brushing up on options and convertible bonds. Dimon says Staleys ability to recognize what he doesnt know and turn to colleagues for guidance has been a key to his success.
Staley went on to help launch the banks equities business and by 1999 was running equity capital markets. Later that year then-CEO Sandy Warner asked him to manage the groups private banking division. The white-shoe unit had been the crown jewel of Morgans business for decades after the Great Depression, when wealthy investors sought the perceived security of a conservative and storied bank, but the business lost ground to competitors, mutual funds and hedge funds during the bull market of the 1980s and 90s.
In 2000, Chase Manhattan Bank acquired JPMorgan, and Staley co-managed the groups enlarged private bank with his Chase counterpart, Maria Elena Lagomasino. There was no small amount of postmerger tension, and the two executives clashed over strategy, with Lagomasino advocating open architecture and Staley already a fervent believer in proprietary products. What you had was a private bank at war with itself, recalls fixed-income boss Bernstein. Staley emerged on top, and in 2001 then-CEO William Harrison Jr. named him chief executive of the banks entire asset management division.
The business struggled in the wake of the collapse of the technology stock bubble: By the end of 2002, it had lost 20 percent of its institutional assets and contributed little to group profits. We were not significant to the bank as a whole, notes CFO Brigstocke.
The industry was moving toward open architecture, with banks opening their platforms to third-party products, but Staley embraced a closed approach and linked the private bank more tightly to the asset management business. Open architecture is an admission that you cant manage money well, he says. He established a portfolio construction team to design common strategies for all private bank clients a first in the industry rather than leaving investment decisions up to individual advisers. He also tapped Michael Cembalest, who had been head of fixed income, as the private banks first CIO.
The centralized approach has proved its worth during the financial meltdown, with clients saying that J.P. Morgan protected them from much of the markets downdraft. Seventy-five percent of customer assets beat their benchmarks in 2008, clients tell II, though that means that many still lost money. Inflows into the private bank have been surging. Before Jes the private bank never seemed to have the reach, the scale or the investment acumen that it needed, says Mary Callahan Erdoes, head of global wealth management.
Once he had the private bank humming, Staley turned his attention to alternatives. J.P. Morgan lacked a notable presence in the booming hedge fund space, and Staley believed that clients would be willing to pay for big returns in a fund backed by the bank. He started talking to Highbridge in late 2003. The following year, a few weeks after the merger of Bank One and JPMorgan, Staley arranged for his new boss, Dimon, to meet with Highbridges founders, Glenn Dubin and Henry Swieca. Despite his initial skepticism, Dimon told Staley that if the bank were to buy a hedge fund, Highbridge was it because the founders werent the star powers behind the firm. He didnt just bring a hedge fund to me, Dimon tells II, he brought one that was well diversified, had excellent results and whose founders were willing to do a deal that kept them on and paid them more the better they did. Dubin describes a similar meeting of minds. Dimon appreciated that from day one our goal was to create an institutionalized hedge fund business, he says. Under the $1 billion deal, the bank took a majority stake initially and will gain complete control in 2011.
Staley got an early taste of the volatility he was getting into with Highbridge. The convertible bond market collapsed early in 2005, and Highbridge lost money for four consecutive months, the first time in its history it had done so. But convertibles recovered, and 2005 turned out to be one of the firms best years.
The same cant be said for 2008. Highbridge, like much of the hedge fund industry, got whipsawed by last years financial market turbulence, particularly the seizing up of credit markets after the failure of Lehman Brothers in September. By year-end the firms flagship multistrategy fund was down 27 percent, exceeding the 19 percent decline in the benchmark HFRI index; with investors scrambling to redeem funds, the firms assets dropped by 32 percent for the year. Assets in alternatives overall at J.P. Morgan Asset Management dropped by $20 billion, or 20 percent, in 2008.
These losses havent shaken Staleys faith in Highbridge or in alternatives generally. He contends that the losses reflected the extraordinary nature of the market meltdown rather than any fundamental problem at Highbridge, and he notes that performance has bounced back smartly this year. The multistrategy fund was up 9.75 percent in the first quarter, and outperformed the Standard & Poors 500 index by 10 percentage points between January 2005 and the end of February. With $1.5 billion in new inflows and valuation gains, Highbridges assets rebounded to $21 billion at the end of last month.
When investment performance suffers, the instinct you need to refrain from is, I gotta fix it, says Staley. Your instinct needs to be, Are my portfolio managers doing what they know to do as best as they can? And then you need to support them to continue doing that.
Many of Highbridges withdrawals last year came from funds of hedge funds, a volatile client base that the firm is no longer courting. Many remaining investors like the stability the bank provides to the firm, which was the key rationale behind the acquisition. It was a comfort during this last year to have J.P. Morgan behind Highbridge, says Haim Saban, the chairman of Spanish-language media conglomerate Univision who is a private client of J.P. Morgan and an investor in Highbridge.
The J.P. MorganHighbridge deal is the poster child for success when it comes to acquiring a hedge fund, says Aaron Dorr, a managing director at investment bank Jefferies Putnam Lovell. Its helped Highbridge raise assets, while retaining a lighter touch when it comes to governance and autonomy. Although Highbridge took a beating last year, its $21 billion in assets are up from $7 billion when J.P. Morgan bought the firm. Dimons support hasnt wavered. The bank this year invested $225 million in Highbridge so the hedge fund firm could launch a new share class with a two-year lockup, a move that allows Highbridge to sit tight during shaky markets. Were going to get good returns for the bank, and at the same time, it provides even more stability to the fund, says Dimon.
Despite the head winds, Highbridge has been a success for Staley. The deal helped J.P. Morgan Asset Management lure investors to its table and proved that the firm was serious about managing money. Brigstocke says it would have taken years for the bank to build these capabilities on its own. Highbridge also benefits from the deal because investors, shaken by scandals like the Bernard Madoff fraud, are reassured by having a big bank stand behind the hedge fund. We were able to give clients what they wanted before they wanted it, Brigstocke explains.
Elsewhere, alternatives chief Unrein is looking to step up J.P. Morgans private equity investment, an area the bank largely pulled back from at the peak of the market in 2006 and 2007. J.P. Morgan raised $4.5 billion for private equity funds of funds in 2008, one of the worst years ever for the industry. Unrein, who started the banks private equity business in 1997 and ran the same business for AT&T Investment Management Corp. in the 1980s, believes that the big stock market declines of the past two years have created numerous opportunities, particularly in secondary buyouts. If we look back five years from now, and we didnt generate some of the best performance ever, Id be disappointed, he says.
Although Staley has kept faith with Highbridge despite last years poor results, he has moved to shake up his underperforming fixed-income team. The teams core bond strategy, its largest institutional offering, has floundered, with results in the bottom quartile of peers for most of the past three years. The New Yorkbased team had been heavily exposed to structured credit and nonagency mortgages rather than corporate credit. The senior team did not see the tsunami that was to overwhelm us in the U.S. mortgage market, says fixed-income chief Bernstein.
New CIO Michele brought his two deputies, Steven Lear and Lisa Coleman, with him from Schroder. Staley also added five senior credit analysts from Bear Stearns even as he announced layoffs of nearly 10 percent of the fixed-income team in November.
In addition to his long-standing focus on private banking and alternatives, Staley also wants to make J.P. Morgan a bigger player in the retail end of the market. The division manages $705 billion of mutual fund assets, but fully 80 percent of that is in money market funds. J.P. Morgan has a strong presence in Europe and Asia through the former Fleming fund business, but it lags in the U.S., where it ranks 16th among stock and bond funds providers, with $70 billion in assets. Staley aims to grow the business by strengthening distribution hes happy to take advantage of other institutions open systems, selling J.P. Morgan funds through Morgan Stanley & Co., Prudential Financial and Banco Santander and expanding the banks retirement platform, which offers J.P. Morgan and other funds to defined-contribution-plan sponsors.
Early returns on those efforts are promising. JP Morgan Funds ranked fourth among U.S. fund companies by asset inflows in the first quarter, reaping $2 billion in new money, according to Lipper.
Thats a modest start, and market volatility may well provide some upsets. But Staley hasnt gotten where he is today by doubting his convictions. You need to stay true to your investment processes through a crisis like this, he insists.