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Massachusetts Miracle

MFS defied the odds - and its own consultants - to become a force in institutional asset management in less than a decade. Credit, above all, a strong corporate culture.

MFS defied the odds - and its own consultants - to become a force in institutional asset management in less than a decade. Credit, above all, a strong corporate culture.

By Rich Blake
December 2001
Institutional Investor Magazine

In 1991 Massachusetts Financial Services Co. needed to overhaul its business model. Once America's largest fund manager, descended from the firm that invented the mutual fund, MFS had fallen out of the top ten and seemed to be heading further south, hurt by fierce competition. Meanwhile, the Boston firm's modest institutional business - mostly fixed-income accounts for local banks - was walking out the door. For every dollar that came in, four left.

So in November of that year, MFS's top executives called in consultants from Greenwich Research Associates and posed this question: Should MFS, for 68 years essentially a retail outfit, plunge into the business of managing money for pension funds and other institutions? Was success in this market, one little known to MFS outside Beantown, even a remote possibility?

The consultants' reply, following a three-month study, was a resounding No. For a start, the Greenwich experts pointed out, the business was slow-growing. Overall, institutional assets under management had actually been decreasing. What's more, assaulting the pension market had proved to be perilous for retail money managers. Among the firms whose forays into the institutional market had wound up on the rocks were Merrill Lynch & Co. and T. Rowe Price Associates. Besides, chided the consultants, MFS had no name, no connections and no experience in institutional money management.

MFS decided to do what almost every company would like to do: It chose to ignore the consultants. "The report wasn't what we wanted to hear, and I suppose we just weren't ready to accept it," says CEO Jeffrey Shames, who spearheaded the pension push when he was head of equities. "We knew we had the talent and that we wanted to compete, regardless of what the consultants were telling us."

That was typical. MFS is a firm that likes to do things its own way. Cliché though it may be, the term corporate culture actually counts for something at MFS. Even hard-nosed outsiders talking about the firm can sound like they're supplying blurbs for a company recruiting brochure. "The strength of MFS is in its culture," says Henry McVey, who follows brokers and asset managers for Morgan Stanley. "People really seem to genuinely enjoy working at MFS. That's why they can attract and keep good people."

And good people, given enough encouragement, tools and time, as well as a little luck, tend to get good results. Remarkably, since MFS plunged feet first into the institutional market nine years ago, it has amassed institutional assets of $31 billion. Even more startling, MFS pulled in $6.4 billion in new institutional accounts in the first 11 months of this year. (One notable trophy client: Frank Russell Investment Management Co.) And over the past couple of years, MFS has also raked in some $10 billion in defined contribution money. "I'd like to think we're just beginning to catch up," says chief executive Shames.

How did MFS come from so far behind to become a significant contender in the institutional business?

Due credit should be given to the firm's rock-solid, if not spectacular, track record with institutional money across investment styles and asset classes. Over the past five years, MFS's composite value portfolios have achieved an average annual return of 15.1 percent, versus 10.6 percent for the Russell 1000 value index. MFS's international portfolios have returned 7.4 percent on average, versus -0.87 percent for the MSCI Europe, Australasia and Far East index. And over the same period, MFS's flagship growth portfolios have generated average annual returns of 14.7 percent, or about twice what the Russell 1000 growth index managed.

Performance isn't the only deal closer in MFS's marketing kit. Sheer determination is another. The firm has waged a dogged campaign for the hearts and minds of the gatekeepers to pension assets: the consultants. MFS's original head of institutional marketing, Thomas Cashman Jr., called on William M. Mercer Investment Consulting and Callan Associates for years before they offered him anything more than coffee and courtesy. "They tried to get in our searches for years," says a senior official of one major consulting firm. "We were reluctant to let them in because we didn't want to put our institutional clients in products that were predominantly retail. But they paid their dues, and you have to give them credit. For a long time their retail heritage got in their way."

MFS's corporate culture has also been a big factor in its success. The firm prizes teamwork, dotes on youth and seems to inspire loyalty - a commodity that has always been rare in money management. In an industry where portfolio managers flit from pillar to post, just three investment professionals, out of 160, have left MFS over the past five years. Virtually all of the firm's team of top managers, including Shames, president John Ballen, CIO Kevin Parke and research director John Laupheimer Jr., have been working there for nearly 20 years. And they're all under 46.

To be sure, MFS remains a predominantly retail shop, and that has hurt it in today's market. The firm's assets had been shrinking until recently, albeit at a somewhat slower rate than those of its rivals. Assets totaled $132 billion at the end of November, roughly $101 billion of them retail. Through the third quarter MFS's assets, institutional and retail combined, were down 17 percent (from $147 billion to $122 billion), compared with an industrywide decline of 23 percent. Almost the whole drop came in retail accounts. But lately MFS has been pulling in significantly more retail money than most of its competitors, ranking fourth behind industry titans Vanguard Group, American Funds and Pimco Funds in net new cash flows - $5.5 billion through November.

Just the same, as Shames readily concedes, "The success we are having in the institutional market couldn't have come at a better time." No doubt that is a sentiment shared by Sun Life Financial Services, which acquired MFS for $65 million in 1982. The Canadian company, which went public at $8.50 in March 2000, recently traded at 21, in large part because of MFS. The money manager kicked in about one third of Sun Life's $398 million in net earnings in this year's first three quarters and about the same proportion in 2000.

Nonetheless, MFS's profit margins could be better. "They are pretty low," says Colin Devine, an insurance analyst for Salomon Smith Barney. A knowledgeable source at the firm estimates MFS's margins at about 25 percent, compared with an industrywide average of 35 percent. That's on the anemic side, and one big reason is that MFS markets retail funds through the so-called broker-sold channel, which requires it to pay brokerage commissions up front. MFS also relies on increasingly steep revenue-sharing arrangements with brokerages (Institutional Investor, May 2001). And it's expanding aggressively overseas.

Shames is hardly oblivious to the problem. "We think we can get the margins up to 30 percent over the next few years as we take advantage of the scale we've amassed," he contends. And he has clamped down on costs - Shames and 80 other MFS executives, for instance, took pay cuts in March.

To a degree that is unusual for a CEO who isn't a founder, Jeff Shames personally embodies his firm's opportunity ethic. He grew up in working-class Framingham, a manufacturing town outside Boston, the son of a traveling salesman of children's clothing and a woman who started a market research company for local advertisers. The younger of two boys, Shames earned good grades in high school - especially in math - and rode the bench for a so-so basketball team. (He got fed up, quarreled with the coach and quit his senior year.) At Wesleyan University he studied economics, graduating in 1977.

His father thought Shames should get an office job, but he wanted to travel. So over his father's objections, he signed up for the Peace Corps. To his surprise and delight, Shames found himself assigned to teach math in Fiji. "I just assumed that I'd be digging wells in some god-awful place," he laughs, "but I ended up on a tropical island playing basketball and drinking beer." After two years in paradise, Shames resurfaced at the Department of Agriculture in Washington as a $20,000-a-year statistician. His career as a federal number-cruncher, however, was short and miserable: "I hated it," he admits.

At about this time Shames, observing that many of his Wesleyan classmates were making their way into business, decided to do the same. He applied to the Massachusetts Institute of Technology's Sloan School of Management, got in, crunched more numbers and graduated in 1983.

Most of his classmates gravitated toward investment banking. Shames, however, had been intrigued by an MIT pal's comment that money managers were the "baseball players of the financial services industry." He explains: "You compete every day, you're measured every day, and you get to see how your decisions play out, right or wrong. That appealed to me." On an MIT bulletin board, Shames saw an MFS "analysts wanted" ad. The firm had a reputation for being a good place to work, and he hadn't exactly been inundated with job offers. He responded and was eventually given an analyst job, at a salary of $35,000.

The new recruit couldn't help but be mindful of MFS's storied past. In 1924 the firm's precursor, Massachusetts Investors Trust, had essentially invented the mutual fund. For a minimum of $250 - about the price of a Model T - an investor could own a piece of the nation's first open-ended investment company, which bought the blue chips of its day. A number of closed-end investment pools sprang up to emulate MIT but were wiped out by the 1929 crash. Between October 1929 and December 1934, however, the number of MIT shareholders actually rose and assets doubled, to $30 million. A hundred dollars invested in MIT in 1924 would be worth roughly $110,000 today, a respectable 9.5 percent annualized return.

The modern mutual fund industry wasn't truly set in motion until 1936. That was the year that MIT chairman Merrill Griswold, accompanied by State Street Research chairman Paul Cabot (of the Boston Cabots) and Incorporated Investors Co. chairman (and former Maine governor) William Tudor Gardiner, held a legendary ten-minute meeting with president Franklin Roosevelt. They persuaded FDR to abandon his plans to tax fund dividends and interest income at the fund company level; instead, the money would be distributed directly to fund investors, who in turn would pay the taxes. This basically authorized mutual funds as we know them today.

But the fledgling fund industry grew slowly in the 1940s and '50s. Even as late as 1960, there were only some 200 recognized funds, with combined assets of just $14 billion, in contrast to 8,000-plus funds today, with more than $6.5 trillion in assets. In those early days MIT was far and away the biggest fund company. Between 1959 and 1969 its assets swelled from $1.7 billion to $3.4 billion.

In 1969, the year that MIT effectively changed its name to Massachusetts Financial Services, the firm snatched Keith Brodkin, a pioneer in active bond management, away from New England Mutual Life Insurance Co. to manage its fixed-income portfolios. The aggressive Brodkin went on to launch several MFS bond funds during the 1970s and became head of fixed income in 1980. Once, when the usually cool and collected portfolio manager was hollering about losing an eighth of a point on a trade, a colleague asked him why he was so upset over such a negligible amount. "Because it was my eighth," Brodkin bellowed.

Brodkin's counterpart in equities was Alden (Auggie) Johnson, a Harvard MBA who'd spent a decade as an analyst and a portfolio manager at Boston-based Eaton & Howard before joining MFS in 1967. Johnson went on to loom large at the firm as equities chief in the 1970s. Well respected as a gruff and tough taskmaster, he was also a gregarious father figure who used to hold court for young analysts in the MFS dining room, holding forth on politics and life as well as on price-earnings ratios.

Johnson's accomplishments included building up a solid variable annuity business for MFS, in collaboration with Nationwide Mutual Insurance Co. Assets totaled about $3 billion in 1981, the year the Internal Revenue Service ruled that the provider of the investment portion of a variable annuity - MFS - and the underwriter of the death benefit - Nationwide - had to share ownership. Suddenly, MFS found that it either had to go into the insurance business or sell out to an insurance company. In 1982 MFS was acquired by Sun Life for a multiple of somewhat less than 1 percent of its $9 billion in assets under management. That was roughly the going rate for money managers. (The IRS later changed its mind and decided that common ownership was no longer necessary for annuity providers.)

When Shames arrived at MFS the next year, the firm reflected the conservative stewardship of CEO Dick Bailey and his two deputies, Brodkin and Johnson. A Boston Brahmin and Harvard graduate, the 57-year-old Bailey had joined MFS as an analyst a quarter century before. The firm had something of the feel of a genteel but lively faculty club.

Shames, though still wet behind the ears, didn't hesitate to challenge his bosses. For his first major assignment as an analyst, he covered the 1983 breakup of AT&T Corp. Equities chief Johnson, who took a macro view, invested conservatively and tended to impose his views on everyone else, asserted that Ma Bell was the better bet for investors; Shames contrarily recommended the Baby Bells. "That turned out to be the right call," he notes.

It took just two years for the young upstart to become a portfolio manager. Shames picked stocks for the $100 million MFS Special Fund, a core equity fund, and from the beginning showed a flair for finding well-managed but out-of-favor companies poised for turnarounds. One of his best picks: a prescient bet on Lotus, the software maker now owned by IBM Corp.

In the summer of 1987, Shames was just hitting his stride as a portfolio manager - his fund outgained the Standard & Poor's 500 index by 18 percentage points the year before - when Johnson was diagnosed with cancer of the esophagus and informed that he had only a few months to live. Johnson told Bailey that of MFS's 25 senior portfolio managers, the one he wanted to succeed him as head of equity was the 32-year-old Shames. That fall, three days after Black Monday, Johnson died at 56. "It was difficult, but I had to step up," Shames says. "Auggie believed in me and in a group of us who represented the next generation."

The MFS youth movement gained additional momentum that same year when Bailey tapped 28-year-old John Ballen, just three years out of Stanford Business School, to become head of research, passing over several executives in their 50s.

Bailey, a 30-year company man, and his No. 2, Brodkin, a 20-year veteran and now president, soon began to feel the younger generation nipping at their oxfords. Heading into the 1990s Shames, flanked by fellow Young Turks Ballen and Parke, championed a sweeping campaign to transform MFS into a much larger and more diversified firm. "I knew that in order to compete going forward, we were going to need greater scale," says Shames.

When Bailey retired in 1991, Brodkin succeeded him as CEO, and he felt quite comfortable with the status quo. Nevertheless, he listened to Shames' case for change. "Keith was great," Shames says. "He didn't agree with a word I said, but he always heard me out. He wanted MFS to be a winner, so in the end I was finally able to get him to see it my way." Brodkin approved Shames' strategy that summer.

Shames was determined to thrust MFS headlong into the pension market. To lead the charge, he tapped 39-year-old Thomas Cashman, then the manager of MFS's small-cap portfolio. This seemed an especially apt, even serendipitous, choice. MFS happened to boast a small-cap star at a time when many plan sponsors were adding that asset class. Cashman's MFS Emerging Growth was the No. 1 small-cap fund over the ten years ended December 31, 1991 (average annual return: 18 percent). There was just one hitch: MFS had sold the fund to institutions with the promise that it would be closed as soon as its assets reached $500 million, and that happened fast. "Here we were on this institutional push, and the most viable product we had I couldn't sell," Cashman says. "It was killing me. But at the same time, we didn't want to send the message that we weren't sensitive to constraint issues."

Cashman was to be even more frustrated in his search for a head of institutional sales. He hired a number of promising sales sorts who soon revolved back out the door. The chief problem, as Cashman read it, was that they didn't fit the MFS team culture. At long last, Cashman turned to one of MFS's own clients, recruiting Joseph Trainor from Boston-based Partners Health Care, where he was chief investment officer. Cashman reckoned that Trainor's skills would be ideal for the sales job: He was personable, articulate and - best of all - well-informed about plan sponsors' needs.

By the time Trainor reported for work in August 1997, MFS had already amassed a substantial $10 billion in pension assets. The firm had scored a crucial victory in 1994 when Fortune Brands, an Illinois holding company with broad consumer interests, chose MFS to run a $25 million large-cap growth account for its $1.4 billion defined benefit plan. "They were on the fence at first, because they didn't want to be the first large fund to buy into our large-cap process," recalls Cashman. "It was a real breakthrough when they decided to give us a shot."

Still, MFS was not being taken seriously by top consultants. "We'd get into some searches, mostly through the back door, but we weren't a player," Trainor concedes. One big hurdle: Consultants insisted upon seeing a five-year track record for managing pension money in different asset classes, and MFS's four top institutional equity products - large-cap growth, large-cap value, global equity and international equity - were not that seasoned.

Just when Trainor and Cashman were beginning to gain some traction through sheer doggedness, tragedy again struck MFS. In February 1998 Brodkin checked into the hospital for a routine follow-up operation to the open-heart surgery he'd had ten years before. In the intervening decade he had been scrupulous about maintaining his health, jogging three miles a day and minding his diet. The surgery went fine, but the day before his release, the 62-year-old suffered a fatal embolism.

Shames took charge. MFS's board had already identified him as Brodkin's successor. On the bitingly cold day of Brodkin's funeral in Sherborn near Boston, Shames delivered a eulogy that brought many to tears. "Keith cared deeply about MFS and its people," says Shames. "That we continue to care about our employees in that way is his legacy."

Certainly, MFS seems to have a distinctive corporate culture. The spirit of teamwork appears to be genuine. The concept surfaces over and over in conversations with current and former employees, clients and competitors. And under Brodkin and now Shames, the sense of firmwide cooperation and cohesion is said to have deepened.

"We're a competitive group of people," says CIO Parke. "But at a lot of large firms, competition leads to an environment of distrust. We work hard at building loyalty and trust, so people don't have to worry about politics or recrimination when things aren't going so well."

Carol Geremia, who began at MFS 17 years ago as an associate marketer in the then-new 401(k) division and is now its head, has this to say: "The silent, unwavering element within MFS is the level of trust between employer and employee - the assurance that if you work hard and you're in it for the team, you'll do well. If it's all about you, then MFS is not the right place for you."

Marketing vice president David Oliveri sees a strong contrast between MFS and his old firm. "When I worked at Fidelity, it was so big you basically didn't know that many people outside your own group," he says. "You rarely if ever saw [chairman] Ned Johnson, and when you did you straightened your tie. At MFS we really are one big family."

This family philosophy can be taken to what other asset managers might view as extremes. "At most money management firms, the portfolio managers evaluate the analysts," notes research director Laupheimer. "Here it cuts both ways. The analysts review the portfolio managers, too. We want to know from the analysts what the portfolio managers contribute for the greater good of the whole team."

An additional case in point: In 1999, a demoralizing year for Graham and Dodd disciples - MFS's value managers edged out their Russell 1000 value benchmark but were still 32 percentage points behind the firm's growth managers - MFS compensated the value team members just as well as the growth team members. "While a lot of people at other firms were cleaning out their desks, I was well compensated and told repeatedly to hang in there," says Lisa Nurme, who heads the value equity team. "It was an extremely difficult year, and for the CEO and CIO to be so supportive meant a lot."

At MFS moral support counts as much as material support. The firm pays better than the norm but not a whole lot better. (Senior people do, however, have stock.) "We're not going to strive to be the highest-paying firm," says Shames with vehemence. "As a motivator, to overcompensate is toxic. You lure someone over, and you've just proven that that person will move for money."

Instead, MFS tries to make people feel valued. For one thing, it listens to them, as Bailey, Brodkin and Johnson once heard out the young Shames. The firm also performs such team-building rituals as division outings to see the Boston Red Sox at Fenway Park (presumably on the theory that shared misery creates bonds) and companywide community-service stints.

The firm's collegial ties were tested in March 1999, at the start of Shames' first full year as CEO. Top portfolio managers John Brennan and Chris Felipe, who ran, respectively, the MFS Capital Opportunities and the Massachusetts Investors Growth funds, approached Shames about starting their own hedge fund within MFS. He realized right away that the two managers would have to be compensated differently, and more richly, than their colleagues, and he considered that unacceptable. "It would have been too damaging to the culture of this place," he says, although he also knew that it would be tough to lose them. When the pair did start their own fund, they were promptly replaced by two in-house portfolio managers.

That is also in the MFS mold. Unlike many of his peers, Shames flatly refuses to recruit portfolio managers from outside his own firm: All investment talent is homegrown. "We groom people as analysts and promote from within," he says. "It creates a culture in which people feel motivated, knowing they can advance and not just slog along."

But good feeling is one thing, good performance another. MFS's big breakthrough in pitching its pension services came in 1999 when its main institutional funds started hitting their five-year thresholds with good if unsensational results, and consultants started returning calls from MFS. Steadiness of several sorts counted in the firm's favor. "Pension funds like stability of personnel running the money and consistent outperformance," says Salomon Smith Barney analyst Devine. "MFS certainly has shown they can deliver that."

Clients and prospects also seem to like MFS's brand of service. Lisa Jones, a former MFS mutual fund wholesaler who took over for Trainor as head of institutional sales in 1999, brags, "We give the $5 million client the same level of service and attention as the $500 million client." (Trainor replaced Cashman as president of the institutional business, while Cashman, though still chairman of institutional, has shifted his focus to international marketing.)

Over the past 18 months, MFS has recruited three experienced product specialists from the outside to act as senior liaisons between pension clients and portfolio managers, in addition to the firm's 20 senior sales executives. (In all, pension marketers account for 90 of MFS's 2,600 employees.)

Once in the door, MFS people can be quite persuasive. Sales executives led by Trainor and Jones say they have prevailed in all but six out of more than 50 "finals" presentations over the past year and a half. Not long ago MFS made its first appearance in Institutional Investor's "Pension Olympics" (May 2001), tied for 13th in netting new accounts during 2000 from among 1,000 of the largest pension funds. Among the $6 billion-plus funds that selected MFS were Chicago Municipal Employees' Annuity & Benefit Fund, Kmart Corp. and Milwaukee County Employees' Retirement System.

MFS snared one of the single largest pension mandates handed out this year: Frank Russell hired it to subadvise on a $1 billion large-cap value account. "MFS's value team is an undiscovered gem," says Dennis Trittin, who oversees outside management of Frank Russell's $15 billion large-cap portfolio.

Like many U.S. asset managers, MFS aims to expand overseas. Foreign assets amount to about $7 billion, or roughly 6 percent of its total assets, and MFS operates offices in London, Tokyo, Singapore, Buenos Aires and Sao Paulo. Over the past three years, it has doubled its overseas staff to about 40, and this year it hired Paul Price, formerly of Lombard Odier International Portfolio Management, to spearhead institutional asset gathering in Europe. A recent coup: Last month Andra AP-Fonden, the $5 billion Swedish national pension fund, handed MFS a $500 million global equity mandate.

"We just keep punching and jabbing," says Trainor. "It hasn't been so much a revolution as an evolution." Either way, MFS's rapid rise in the pension world has been extraordinary.