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The accidental money manager
In its headlong dash to create a global investment banking powerhouse, Deutsche Bank also acquired a huge, ungainly asset management business. Will buying Zurich Scudder help solve these problems or make them worse?
In its headlong dash to create a global investment banking powerhouse, Deutsche Bank also acquired a huge, ungainly asset management business. Will buying Zurich Scudder help solve these problems or make them worse?
By Andrew Capon
May 2002
Institutional Investor Magazine
A funny thing happened on Deutsche Bank's way to the bulge bracket.
In the process of building up world-class capabilities in trading, underwriting and advisory work over the past decade, the German giant assembled a colossal asset management operation that spans 21 countries, employs 8,000 people and oversees $979 billion. Now the bank is trying to transform this sprawling, seemingly inadvertent empire into a cohesive, money-making business.
Outgoing chairman Rolf Breuer made global investment banking his primary pursuit, leveraging Deutsche's domestic clout and putting huge sums into U.S. and U.K. acquisitions. Wielding an apparently inexhaustible wallet, Deutsche acquired London's Morgan Grenfell & Co. for £975 million ($1.5 billion) in 1989 and ten years later bagged New York's stumbling Bankers Trust Co. for $9.9 billion. Breuer's all-out campaign has succeeded. With E950 billion ($840 billion) in assets on its balance sheet, Germany's No. 1 bank generates more revenue from trading, M&A and underwriting than do U.S. blue-chip firms like Goldman, Sachs & Co. or Morgan Stanley. Last year Deutsche ranked first in debt underwriting worldwide, and its bankers counsel such top-tier companies as Deutsche Telekom, EchoStar Communications Corp. and Electricité de France.
The Morgan Grenfell acquisition included Morgan Grenfell Investment Management, a small but solid institutional franchise that oversaw £9 billion at the time of purchase, and a few retail funds. Bankers Trust came with its $285 billion money management group, then the seventh largest in the U.S. The acquisitions brought assets and people but uneven profits. And Deutsche senior management paid little attention to that side of the business. Morgan Grenfell became embroiled in a costly scandal, and Bankers Trust lost talent and assets. So tepid was Deutsche's commitment to money management that the bank was willing to swap away what many considered its crown jewel , Frankfurt-based mutual fund retailer DWS Investments , during its failed effort in 2000 to merge with rival Dresdner Bank. Essentially, Deutsche would have become a wholesale investment banking juggernaut.
The bank's indifference to lucrative DWS disgusted Michael Dobson, the Vorstand, or management board, member who headed global asset management, so much that he quit. Now running Schroders, Dobson won't comment, but colleagues say that the proposed sacrifice of the mutual fund unit persuaded him that money management was low on Deutsche's priority list.
Breuer has since pledged his commitment to the fund management business. Early last year the bank reorganized itself into "twin pillars": corporate and investment banking, or CIB, created from its securities and corporate lending businesses; and private clients and money management, or PCAM, encompassing retail operations, private banking and Deutsche Asset Management. The Vorstand has been pared from seven members to five, and this year a new group executive committee was created to streamline decision making and boost accountability.(In fact, the twin-pillar structure mirrored similar moves at other major German banks trying to improve their returns.)
Breuer brought in a phalanx of new executives, including 17-year Merrill Lynch & Co. veteran Thomas Hughes, 44, who joined DeAM last year as chief operating officer and is now its global head of asset management, and former Putnam Investments CEO William Shiebler, 60, whom Deutsche lured out of retirement this March and put in charge of DeAM's U.S. operations.
The chairman promised shareholders that asset management earnings would grow by 30 percent in 2001, outstripping investment banking. (Indeed, CIB's revenues fell from E4.1 billion to E2.7 billion last year.) But pretax earnings at PCAM slumped instead, from E1.4 billion to E397 million. The downturn in global stock markets dulled investors' appetite for funds and dragged down fee income, while costs soared beyond industry norms, peaking above 90 percent of income in the second quarter of 2001. When it became clear that radical action was needed, Deutsche flourished its checkbook again, offering $2.5 billion to buy New York,based Zurich Scudder Investments from Swiss insurer Zurich Financial Services in September. The deal closed last month.
The Scudder acquisition represents the first major purchase Deutsche has made in which expanding the asset management business and addressing some of its problems are the sole objectives. Deutsche Bank now ranks fifth, behind Fidelity Investments, UBS, Credit Suisse Group and Axa Group in the Pensions & Investments Watson Wyatt 500 ranking of the world's money managers. It plugs a geographic gap in retail asset management for DeAM, thanks to Scudder's $100 billion in U.S. mutual funds, and should strengthen its revenue base: Scudder's actively managed funds generate ten times more in fees than the passive assets that came with Bankers Trust. Scudder also brings its Private Investment Counsel group, which specializes in high-net-worth clients, as well as a substantial insurance clientele. The Scudder name will disappear everywhere except in U.S. retail, which consists mainly of the firm's mutual funds and will be run by former Scudder USA CEO Mark Casady.
Says DeAM global head Hughes, "With Scudder we now have a balanced mix of active and passive, retail and institutional." And Deutsche Bank executives boast that at 0.9 percent of assets, less than half the going rate for major cross-border asset management purchases, Scudder came cheap.
But as the bank enters a new era this month , when Josef Ackermann, the investment banker who joined Deutsche from Credit Suisse First Boston only in 1996, succeeds Breuer , the question is whether the deal will be the medicine DeAM needs or bring even more headaches. Rivals like UBS and Credit Suisse have taken years to integrate asset management acquisitions that are only now beginning to pay off. DeAM has already embarked on a widespread reorganization to streamline itself, but Scudder's absurdly high cost-income ratio of 80 percent means that major downsizing looms ahead: Executives say that up to 1,500 jobs, or 20 percent of the worldwide postmerger total, could be lost. Scudder's mutual fund offerings have already been trimmed, from 110 to 95.
In addition, Deutsche got a bargain in no small part because Zurich Scudder is a deeply troubled firm. It has been rocked by mutual fund redemptions: Net outflows were $4.8 billion in 2000 and $4.7 billion in 2001, and retail assets under management fell from $121.8 billion in 1999 to $107.1 billion last year.
Meanwhile, DeAM badly needs to boost profits. The bulk , nearly 80 percent , of Bankers Trust's portfolio consists of cash management accounts and passively managed assets. Partly as a result, in 2001 DeAM's roughly $620 billion in assets generated only $258 million in pretax earnings, down from $607 million in 2000. Profit margins ran in the teens, well below the 25 to 30 percent industry norms. DWS increased its market share in Germany, but it earned less money as investors fled equities for lower-margin bond products. And although DeAM won impressive amounts of new business in the U.K. last year, its margins slipped there, too.
Furthermore, two recent events could distract DeAM management from long-term stratetgy. In late March Michael Philipp, the American investment banker who succeeded global asset management chief Dobson and was promoted to head PCAM just four months ago, suddenly resigned. Philipp was known to be close to Ackermann, and both had been friendly with Edson Mitchell, the former Merrill Lynch banker who had spearheaded Deutsche's push into global trading until his death in a plane crash at the end of 2000. (All three opposed the Dresdner merger on the grounds that integrating the smaller bank would be a distraction that Deutsche didn't need.)
Philipp may have angered Ackermann by hiring expensive bankers at a time when the asset management division can ill afford them and when the parent bank is cutting more than 9,000 jobs, mostly in Germany, to get a grip on costs. Or he may have decided to pursue one of several nonbanking projects, including music and pottery, that he has suggested taking up full-time. In any case, Philipp's job as head of PCAM is now divided: Hughes will run global asset management, and new hire Pierre de Weck, who joined Deutsche from UBS Capital on April 1, will be global head of private wealth management.
The other potentially troublesome situation: DeAM is embroiled in the lawsuit brought against U.S. tech giant Hewlett-Packard Co. by Walter Hewlett, who is challenging the company's merger with Compaq Computer Corp. Hewlett charges, among other things, that H-P coerced shareholders into backing the merger by threatening to withhold corporate finance business. The suit claims that DeAM had promised to vote its 25 million shares against H-P management, then reversed course and supported the deal with 17 million votes, under pressure. (Four days before the vote, H-P arranged a $4.4 billion credit line co-managed by Deutsche.) Bank spokesmen decline to comment on Philipp's departure or the H-P case but say the two are unrelated.
These short-term difficulties pale beside the challenge of integrating Scudder. Industry observers point out that competitors have struggled to unite geographically and stylistically different asset management operations. Charles Burkhart, founder and CEO of Rosemont Partners, a Pennsylvania-based private equity firm, is skeptical of the global model. "There are too many cultural issues when you are trying to paste together multiple fund management firms," he says. "Business planning is often the last thing that is done in these acquisitions. You look at some of these big conglomerates, and you see some very dysfunctional firms."
DeAM executives think they can prove the exception. Says global chief investment officer Dean Barr, who since 1999 has been toiling to shape up the asset management business: "To be frank, the expectations that we can successfully integrate [Scudder] are so low in the marketplace [that] there is little downside. But I think we will surprise a lot of people." Adds Hughes: "We are convinced we have taken the right steps to make this work. When Scudder is integrated, we will have an asset management platform that befits a bank with the size and aspiration of Deutsche Bank."
Ideally, fund management is supposed to counterbalance cyclical trading and investment banking revenues and to boost cross-selling opportunities to global clients, and Hughes insists the bank's game plan is a sound one. "Strategically, asset management remains a growth engine for financial services companies in the years ahead, both on its own terms and set against other products," he says. "Despite recent economic weakness, wealth creation continues at a great pace."
Hughes also believes that the market will eventually give Deutsche Bank credit for trying to offset its volatile investment banking earnings with a more stable revenue stream from money management. At about E72, the bank's share price is down 8.5 percent year-to-date, making Deutsche the eighth-worst performer in the 66-stock Dow Jones Euro Stoxx bank index. But Hughes says that building up the asset management platform will boost Deutsche's valuation. "Analysts covering financial services firms put a higher multiple on activities in asset management versus investment banking, sales and trading businesses," he asserts. "We are in a fantastic position to generate significantly improved returns from the business."
Until 1999, Deutsche Asset Management did not even attempt to operate as a single global entity. DWS covered retail and institutional investors in Germany and sold its retail funds in continental Europe; Morgan Grenfell stuck mainly to institutional management and mainly to the U.K. The Bankers Trust acquisition provided a catalyst for rationalizing the business , there were overlaps between BT and Morgan Grenfell operations in North America, Australia and Asia , but it brought problems, too. In July 1999, before the deal closed, BT's core, four-man passive management team left for Merrill Lynch. The exodus cost DeAM an $8.8 billion account from the New York Teachers variable fund and $2.5 billion from the Virginia Retirement System.
To clean up the mess, DeAM in September 1999 brought in Barr, then State Street Global Advisors' global CIO for active quantitative strategies, together with his colleague Joshua Feuerman, now DeAM's global head of quantitative equity products. Barr, now 41, was quite a catch. A Cornell University graduate with an MBA from New York University's Leonard N. Stern School of Business, he had been instrumental in building State Street's active quant fund management business from virtually nothing to $100 billion. State Street sued to keep Barr, but a Massachusetts court ruled that the noncompete clause in his contract did not prevent him from joining Deutsche.
Just as the bank seemed to be getting down to the difficult business of integrating BT, DWS and Morgan Grenfell, the abortive Dresdner merger set the project back. After Dobson's departure, the task fell to Philipp and Barr, who was promoted to global CIO in November 2000. The names Bankers Trust and Morgan Grenfell were consigned to history, and Deutsche Asset Management became a global brand everywhere in the Deutsche Bank empire except for Europe, where DWS reigns. (In the U.K. the institutional business is called Deutsche Asset Management; starting this summer the retail business will be called DWS Investments.)
Barr says his goal has been to leverage good performance in individual regions into top performance worldwide by blending local research and portfolio management into a single global platform, eliminating overlap where necessary. In late 1999 he set up the Global Research Center in New York to push product development and tailor investment strategies for institutional clients (see story below). Barr says that DeAM can attribute $25 billion in new mandates to the center's work. DeAM has also been expanding in alternative investments, including hedge funds and real estate.
Still, despite Barr's efforts, DeAM was a bits-and-pieces house. It was strong in quant and indexed products in the U.S., in active equity in Europe and in global bonds. But it had almost no U.S. active fund management products, little presence in emerging-markets equity and patchy Asian coverage.
Zurich Scudder fills almost all the holes in DeAM's product line except for large-cap aggressive growth funds. (Barr says DeAM is shopping for an acquisition in that area.) With Scudder, DeAM's assets are 67 percent institutional and 33 percent retail; about 80 percent of the total are actively managed. Of those assets, 57 percent are in the Americas, 34 percent in Europe and 9 percent in the Asia-Pacific, where DeAM is Japan's biggest foreign active fund manager and is among Australia's top three institutional asset managers.
But Scudder is a handful. It's really two different fund management companies, Kemper Financial Services and Scudder Stevens & Clark, that Zurich Financial Services bought in 1996 and 1998, respectively. Both firms suffered from a value investing bias in the midst of the growth-stock boom of the late 1990s. As performance sagged, assets under management fell, from $297 billion in 1999 to $258.7 billion in 2001, and an outdated distribution strategy helped push profit margins into the single digits.
Integrating one acquired asset manager is tough enough. But Deutsche is actually inheriting a culture clash , between Scudder, a storied, 80-year-old partnership with headquarters on New York's Park Avenue, and Kemper, a Chicago-based, sales-driven upstart with a solid reputation in bonds. The two firms had diametrically opposed distribution models. Kemper sold load funds through such intermediaries as brokers, fund supermarkets and financial planners. Scudder, a pioneer of no-load investing, has traditionally relied on direct sales and was late to recognize the sea change occurring in mutual fund distribution: Direct sales today generate less than one third of fund sales, down from as much as 45 percent in 1995. Only late in 2000 did Scudder begin selling through intermediaries.
DeAM's Hughes notes that Deutsche is in a better position to improve Scudder's distribution than its predecessor was. "As a large global financial institution, we have more leverage with distributors than Zurich had, either because of our investment banking relationships or our ability to distribute others' products for them in Europe," he says.
U.S. chief William Shiebler, who along with Lawrence Lasser is credited with making Boston-based Putnam a mutual fund leader over the past decade, intends to push Scudder products to financial planners and other third-party distributors. "We are now 100 percent committed to the advice channel, and that is where the Scudder brand in the Americas is headed," he says. "We are determined to deliver to financial planners and their clients the very best in products and services." It doesn't hurt that value investing is enjoying a renaissance.
Even more critical than the internal fixes DeAM plans to make to Scudder is the divisionwide reorganization that the merger has inspired. As soon as the deal was announced, DeAM set up an integration planning committee made up of representatives from all the asset management functions, from marketing to settlement. Barr now oversees nine global product groups, three regional CIOs, three private-client CIOs and the investment solutions group, which includes economics, the Global Research Center, pension strategies and securities lending.
The biggest changes to divisional operations will come in research, where Scudder adds depth as well as coverage in areas like emerging-markets debt and equity, Japanese stocks and U.S. value. Before the acquisition DeAM had already put in place global, sector-based research teams, but most of its 40 analysts were based in London, a legacy of equity house Morgan Grenfell.
Now, with Scudder, DeAM will have analysts in 13 locations, with 100 covering large-cap stocks and 48 following small- and midcap companies. U.S. stocks will be tracked in New York and Japanese shares in Tokyo , both had been monitored from London. Everyone will be connected to a global research platform, so analysts can share insights from around the world about particular sectors.
Fund managers, who will pursue their regional specialties , with DWS managing German equity for retail investors and DeAM U.K. overseeing balanced mandates for U.K. institutions , will be permitted to diverge from the analysts' stock selections, and Barr hopes to encourage a "healthy competitive tension" between the two. He will oversee the investment process but stresses that day-to-day decisions will filter up through the organization, not down: "It's not about the CIO sticking his thumb in the air and saying, 'Right, everyone, it's time to go value.'" Barr says the research-driven approach is designed to generate top-quartile performance in global equities and fixed income, not just in individual markets, where DWS and Morgan Grenfell have done well in the past.
While Barr reshapes DeAM's organizational profile, his boss, Hughes, will be trying to wring costs out of the operation. Cost-cutting is a priority throughout Deutsche Bank, which needs to radically streamline its domestic retail banking and corporate lending businesses. But it's crucial in asset management. DeAM's 76 percent cost-income ratio in 2001 was above the 72 percent peer average as estimated by the annual PricewaterhouseCoopers survey of investment managers.
Hughes, a U.S. Merchant Marine Academy graduate who majored in naval architecture, wants to reduce cost-income to between 60 and 70 percent over the next 12 to 18 months while boosting operating margins from about 14 percent to more than 20 percent. The 1,500-strong personnel slash has already begun: 600 employees have received their marching orders, and 800 more have been earmarked for the ax, including investment professionals. But the Scudder merger will help, offering the usual efficiencies in back-office systems and trading technology. "If there is no attrition of assets, we can hit our 20 percent-plus target if we also meet our cost target," Hughes asserts.
To enhance margins, DeAM has been pushing alternative investments. In March the bank paid $490 million for U.S. real estate manager Rreef, whose $16 billion in property assets will combine with Deutsche's $20 billion to make the German bank one of the world's biggest investors in the asset class and one of only a handful with global expertise. "Rreef has been very successful in the asset management area for a long time," says Hughes. "It will allow us to move very quickly to a third-party asset management model in the real estate business."
An earlier alternative-investment venture is already paying off. In 1998 DeAM founded Summit, New Jersey,based DB Absolute Return Strategies, which invests in hedge funds. The group develops in-house hedge fund products, partners with external managers and also builds fund-of-funds portfolios. Its clients are 20 percent retail, 20 percent institutional and 60 percent high-net-worth individuals, and the group runs $5 billion in assets, of which $3.6 billion are in funds-of-funds.
This sizable asset total puts Deutsche in the top half dozen of the world's hedge fund players. Joshua Weinreich, who heads DB Absolute Return, believes that there is enormous scope to expand the retail business, using Deutsche Bank's distribution clout. Last year he raised close to $1 billion in two fund launches distributed through the bank to European retail investors.
Weinreich is also confident that his division can attract significant institutional money in the U.S. ITT Industries has put $50 million of its $3 billion pension fund into a highly diversified fund-of-funds product called DB100, which invests in 100 underlying hedge funds , the conglomerate's first foray into hedge fund investment. Richard Goldman, Deutsche Bank's marketing chief, reports that there is $1 billion worth of institutional business in the pipeline for DB100. And Weinreich expects to find demand for his products in Zurich Scudder's private client group.
Another star in DeAM's firmament is DWS, a retail and institutional management group with E136 billion in assets. Headquartered in an elegant 19th-century town house on a residential street not far from Deutsche's main offices in midtown Frankfurt, DWS is Germany's , and Europe's , biggest retail fund manager. (In institutional management it is No. 2 in Germany, but it has little presence elsewhere.) An incredible 23.2 percent of all German retail fund investment is in DWS products, roughly four times the penetration of leading firms in other countries.
In Germany, where 70 percent of all retail fund sales come through bank branches, DWS benefits from its position as the sole choice in Deutsche Bank's 1,500 offices. But its market share has more to do with brand recognition than with a captive audience: DWS sales outstrip those of Frankfurt-based mutual fund company Union Investment, whose products are offered at more than 6,000 cooperative bank branches, and of Deka Deutsche Kapitalanlage, owned by DGZ-DekaBank and sold through Germany's 18,000 savings banks.
A strong track record helps, too. In 2000 and 2001 DWS ranked No. 1 in five-year performance by mutual fund companies in Germany, according to Standard & Poor's. The firm has placed first for one-, three- or five-year performance every year since 1995. As for profitability, DWS accounts for 51 percent of DeAM's revenues, even though it controls only about 28 percent of the global group's total assets (before the Scudder integration). "DWS is a business every fund management CEO I know envies," says Richard Morris Jr., president of Putnam Lovell Securities.
There are reasons to believe that DWS can keep growing in Germany, where it now oversees E90 billion in assets. With the passage of the pension reform measures named after Labor Minister Walter Riester, Germans can for the first time invest a portion of their retirement savings in mutual funds. Although the Riester plan isn't as aggressive as some had hoped, Udo Behrenwaldt, DWS's chairman and DeAM's CEO for Europe, thinks it will spur market growth. Per capita fund investment in Germany is E4,500, compared with E6,500 in Italy, where DWS also has substantial operations.
DWS has done a good job of expanding outside Germany. It is the largest foreign fund manager in Poland, with a 10 percent market share; in Italy, with 3 percent; and in Spain, with 1.7 percent. In France assets under management have grown from zero in 1995 to E5.3 billion today, and in Spain from zero to E3.5 billion since 1991. "We are one of very few firms with global resources and local touch , fund managers on the ground in Austria, Italy, Spain, France," says Behrenwaldt. "We see no reason why we should not replicate our success in Germany."
Behrenwaldt's strategy is based on leveraging his brand. Later this year most of the firm's non-German affiliates will take on the DWS name. "All the market research we have seen shows that DWS is a powerful brand, not just in Germany but in the rest of Europe," says Hughes. In addition, Behrenwaldt believes that the gradual move in Europe toward open architecture , that is, financial institutions selling competitors' products , will help DWS gain even more market share. On April 18 DeAM announced a strategic alliance with the Invesco fund family to sell its products through Deutsche's distribution network, probably the first of several such agreements.
In Italy, where DWS first put down roots in 1985, the German firm has E15 billion in assets. It has strong distribution through Finanza & Futuro, a 1,400-member independent financial adviser network Deutsche purchased from Italian tycoon Carlo De Benedetti in 1995. F&F now has 51 investment centers located around Italy and can be accessed through the Internet. In addition, clients can visit any one of Deutsche Bank's 261 Italian branches to conduct business with DWS. The distribution formula has worked equally well in Spain.
DWS's growth potential is particularly strong in the U.K., where DeAM has only a 1 percent share of the retail fund market. Under the new name DWS Investments, the range of funds offered will swell from 17 to 25 over the next year and a half. The U.K. operation, Deutsche's biggest and oldest outside Germany thanks to the Morgan Grenfell acquisition, is now almost entirely institutional. It generated 22 percent of global revenues from about 20 percent of DeAM's global assets before the Scudder acquisition. But that side of the business has its problems as well.
Former CEO Keith Percy, who joined Morgan Grenfell from Phillips & Drew in 1990, built it into a top-tier firm, increasing assets under management eight-fold, to £72 billion, by 1996. The firm owed much of its success to a handful of talented portfolio managers who delivered outstanding performance in U.K. equities and balanced portfolios. Under Percy's successors , first Sir Robert Smith, then current CEO Paul Berriman , assets continued to grow and now total £90 billion. Although performance has slipped in the past couple of years, Morgan Grenfell's balanced funds remain in the upper quartile of performance for the decade. It remains among the top U.K. equity managers.
But the firm has gotten more bad press than Monica Lewinsky. In August 1996 the manager of its top-performing European Growth Trust, Peter Young, was suspended over allegations that he had broken British regulatory rules on investment in unquoted securities and had committed fraud. No one has ever been convicted on those charges, as Young has been declared unfit to plead (at one point, he appeared in court dressed as a woman and asked to be called Elizabeth), but Deutsche Bank was forced to put £180 million into the fund to reassure investors. The case damaged the Morgan Grenfell name and forced CEO Percy's resignation. The incident continues to reverberate: In January Erik Langaker, one of Young's former brokers, was found not guilty of conspiracy to defraud, giving the press a fresh opportunity to dredge up the embarrassing details of the case.
Not long after Percy's departure, a new public relations embarrassment arose. His successor, Smith, reportedly learned that star U.K. equities manager Nicola Horlick was about to jump ship with a number of key colleagues. Smith dismissed her. Horlick then led an assemblage of journalists and photographers on a bizarre odyssey to Frankfurt to plead for her job back , to no avail. (She subsequently co-founded SG Asset Management UK, where Percy has rejoined her as CEO.) Then, last year, Adrian Frost, head of U.K. equities, left to join an Edinburgh-based boutique, Artemis. Consultants say his departure is a significant loss for DeAM.
The bad publicity has made it difficult for DeAM to establish a retail presence in the U.K. "We are certainly not where we want to be in retail, and I think we have a good deal to learn about product development, sales, marketing and distribution from Udo [Behrenwaldt] and his team in Frankfurt," says U.K. CEO Berriman.
But the mantra of global resources and local touch, repeated by senior management across DeAM, will be tested in London. There, despite the scandals, DeAM's close-knit team has produced strong results for ten years. The reorganization has some observers worried that in London, at least, DeAM is fixing something that ain't broke.
"We do think it is harder to manage a global business," says a leading London investment consultant. "Will the really excellent performance we saw in the past decade start to suffer because of these changes in structure and changes in reporting lines?"
That question will resonate in DeAM's offices worldwide as Scudder is brought into the fold. But if DeAM can integrate its new acquisition while improving the entire group's financial performance, the deal may become a paragon for these cost-conscious times. If the purchase works, says Putnam Lovell's Morris, "we will see a much more industrial logic to deal making , consolidation to capture increased profitability from the same revenue basis rather than dreaming of ever-higher growth rates."
Deutsche's executives do not rule out further acquisitions. "We should be prepared to step into the market for a deal that would improve our position faster and more efficiently than trying to do it organically," says Hughes.
How well he and Barr can execute their vision is critical for new chairman Ackermann. He is taking charge of a bank whose future increasingly depends on the balance between investment banking and money management. If Deutsche Bank can globalize its fund management side as successfully as it has its investment banking business, Ackermann's tenure will be off to a glowing start.
DeAM's New York rainmakers
Global CIO Dean Barr has won a lot of business for Deutsche Asset Management. Among his first moves when he joined DeAM in 1999 was to establish the firm's Global Research Center in New York, with the brief of developing products that would help institutional clients design optimal portfolio strategies. He put at its helm 44-year-old Kenneth Yip, a former finance professor at Yale University and the Massachusetts Institute of Technology. In March 2000 Barr announced a joint venture with Andrew Lo, MIT's head of financial engineering, who runs a hedge fund in his spare time and is something of a demigod in quant circles. The center's modest goal: "to completely reinvent the process of constructing efficient portfolios," according to Barr.
Barr says that more than $25 billion in new institutional mandates for DeAM in the past two years can be directly attributed to the research center's work. In 2001, for example, it won big accounts from Archer Daniels Midland Co. and Maytag Corp. to provide fully outsourced management of their pension plans, including strategic policy and asset allocation. ADM is exactly the kind of client that DeAM is after. The global foods producer, which has an investment banking relationship with Deutsche Bank and also uses the bank for custody, appointed DeAM to run its $400 million defined benefit plan for U.S. large- and small-cap equities, international equities and fixed income. An ADM official tells Institutional Investor that DeAM showed better returns in those product areas than other bidders for its business.
Another research center product is the passively managed Growth Optimal World Equity Portfolio, dubbed Growe, which was born of an academic debate about whether market-cap-weighted indexes can be a true proxy for efficient markets. Passive indexing with market-cap weighting is inherently inefficient, critics argue, because the manager essentially keeps buying stocks that have gotten more expensive and sells those that have gotten weaker.
Growe seeks to exploit that inefficiency by periodically rebalancing portfolios using a set of patented quantitative rules. In back-testing, Growe has beaten the MSCI world index by 286 basis points annually over the past 25 years. So far these results have been supported by a six-month live track record. "One of my strongest motivations is to push the field of asset management forward," says Barr. "I think we are doing that here." , A.C.
By Andrew Capon
May 2002
Institutional Investor Magazine
A funny thing happened on Deutsche Bank's way to the bulge bracket.
In the process of building up world-class capabilities in trading, underwriting and advisory work over the past decade, the German giant assembled a colossal asset management operation that spans 21 countries, employs 8,000 people and oversees $979 billion. Now the bank is trying to transform this sprawling, seemingly inadvertent empire into a cohesive, money-making business.
Outgoing chairman Rolf Breuer made global investment banking his primary pursuit, leveraging Deutsche's domestic clout and putting huge sums into U.S. and U.K. acquisitions. Wielding an apparently inexhaustible wallet, Deutsche acquired London's Morgan Grenfell & Co. for £975 million ($1.5 billion) in 1989 and ten years later bagged New York's stumbling Bankers Trust Co. for $9.9 billion. Breuer's all-out campaign has succeeded. With E950 billion ($840 billion) in assets on its balance sheet, Germany's No. 1 bank generates more revenue from trading, M&A and underwriting than do U.S. blue-chip firms like Goldman, Sachs & Co. or Morgan Stanley. Last year Deutsche ranked first in debt underwriting worldwide, and its bankers counsel such top-tier companies as Deutsche Telekom, EchoStar Communications Corp. and Electricité de France.
The Morgan Grenfell acquisition included Morgan Grenfell Investment Management, a small but solid institutional franchise that oversaw £9 billion at the time of purchase, and a few retail funds. Bankers Trust came with its $285 billion money management group, then the seventh largest in the U.S. The acquisitions brought assets and people but uneven profits. And Deutsche senior management paid little attention to that side of the business. Morgan Grenfell became embroiled in a costly scandal, and Bankers Trust lost talent and assets. So tepid was Deutsche's commitment to money management that the bank was willing to swap away what many considered its crown jewel , Frankfurt-based mutual fund retailer DWS Investments , during its failed effort in 2000 to merge with rival Dresdner Bank. Essentially, Deutsche would have become a wholesale investment banking juggernaut.
The bank's indifference to lucrative DWS disgusted Michael Dobson, the Vorstand, or management board, member who headed global asset management, so much that he quit. Now running Schroders, Dobson won't comment, but colleagues say that the proposed sacrifice of the mutual fund unit persuaded him that money management was low on Deutsche's priority list.
Breuer has since pledged his commitment to the fund management business. Early last year the bank reorganized itself into "twin pillars": corporate and investment banking, or CIB, created from its securities and corporate lending businesses; and private clients and money management, or PCAM, encompassing retail operations, private banking and Deutsche Asset Management. The Vorstand has been pared from seven members to five, and this year a new group executive committee was created to streamline decision making and boost accountability.(In fact, the twin-pillar structure mirrored similar moves at other major German banks trying to improve their returns.)
Breuer brought in a phalanx of new executives, including 17-year Merrill Lynch & Co. veteran Thomas Hughes, 44, who joined DeAM last year as chief operating officer and is now its global head of asset management, and former Putnam Investments CEO William Shiebler, 60, whom Deutsche lured out of retirement this March and put in charge of DeAM's U.S. operations.
The chairman promised shareholders that asset management earnings would grow by 30 percent in 2001, outstripping investment banking. (Indeed, CIB's revenues fell from E4.1 billion to E2.7 billion last year.) But pretax earnings at PCAM slumped instead, from E1.4 billion to E397 million. The downturn in global stock markets dulled investors' appetite for funds and dragged down fee income, while costs soared beyond industry norms, peaking above 90 percent of income in the second quarter of 2001. When it became clear that radical action was needed, Deutsche flourished its checkbook again, offering $2.5 billion to buy New York,based Zurich Scudder Investments from Swiss insurer Zurich Financial Services in September. The deal closed last month.
The Scudder acquisition represents the first major purchase Deutsche has made in which expanding the asset management business and addressing some of its problems are the sole objectives. Deutsche Bank now ranks fifth, behind Fidelity Investments, UBS, Credit Suisse Group and Axa Group in the Pensions & Investments Watson Wyatt 500 ranking of the world's money managers. It plugs a geographic gap in retail asset management for DeAM, thanks to Scudder's $100 billion in U.S. mutual funds, and should strengthen its revenue base: Scudder's actively managed funds generate ten times more in fees than the passive assets that came with Bankers Trust. Scudder also brings its Private Investment Counsel group, which specializes in high-net-worth clients, as well as a substantial insurance clientele. The Scudder name will disappear everywhere except in U.S. retail, which consists mainly of the firm's mutual funds and will be run by former Scudder USA CEO Mark Casady.
Says DeAM global head Hughes, "With Scudder we now have a balanced mix of active and passive, retail and institutional." And Deutsche Bank executives boast that at 0.9 percent of assets, less than half the going rate for major cross-border asset management purchases, Scudder came cheap.
But as the bank enters a new era this month , when Josef Ackermann, the investment banker who joined Deutsche from Credit Suisse First Boston only in 1996, succeeds Breuer , the question is whether the deal will be the medicine DeAM needs or bring even more headaches. Rivals like UBS and Credit Suisse have taken years to integrate asset management acquisitions that are only now beginning to pay off. DeAM has already embarked on a widespread reorganization to streamline itself, but Scudder's absurdly high cost-income ratio of 80 percent means that major downsizing looms ahead: Executives say that up to 1,500 jobs, or 20 percent of the worldwide postmerger total, could be lost. Scudder's mutual fund offerings have already been trimmed, from 110 to 95.
In addition, Deutsche got a bargain in no small part because Zurich Scudder is a deeply troubled firm. It has been rocked by mutual fund redemptions: Net outflows were $4.8 billion in 2000 and $4.7 billion in 2001, and retail assets under management fell from $121.8 billion in 1999 to $107.1 billion last year.
Meanwhile, DeAM badly needs to boost profits. The bulk , nearly 80 percent , of Bankers Trust's portfolio consists of cash management accounts and passively managed assets. Partly as a result, in 2001 DeAM's roughly $620 billion in assets generated only $258 million in pretax earnings, down from $607 million in 2000. Profit margins ran in the teens, well below the 25 to 30 percent industry norms. DWS increased its market share in Germany, but it earned less money as investors fled equities for lower-margin bond products. And although DeAM won impressive amounts of new business in the U.K. last year, its margins slipped there, too.
Furthermore, two recent events could distract DeAM management from long-term stratetgy. In late March Michael Philipp, the American investment banker who succeeded global asset management chief Dobson and was promoted to head PCAM just four months ago, suddenly resigned. Philipp was known to be close to Ackermann, and both had been friendly with Edson Mitchell, the former Merrill Lynch banker who had spearheaded Deutsche's push into global trading until his death in a plane crash at the end of 2000. (All three opposed the Dresdner merger on the grounds that integrating the smaller bank would be a distraction that Deutsche didn't need.)
Philipp may have angered Ackermann by hiring expensive bankers at a time when the asset management division can ill afford them and when the parent bank is cutting more than 9,000 jobs, mostly in Germany, to get a grip on costs. Or he may have decided to pursue one of several nonbanking projects, including music and pottery, that he has suggested taking up full-time. In any case, Philipp's job as head of PCAM is now divided: Hughes will run global asset management, and new hire Pierre de Weck, who joined Deutsche from UBS Capital on April 1, will be global head of private wealth management.
The other potentially troublesome situation: DeAM is embroiled in the lawsuit brought against U.S. tech giant Hewlett-Packard Co. by Walter Hewlett, who is challenging the company's merger with Compaq Computer Corp. Hewlett charges, among other things, that H-P coerced shareholders into backing the merger by threatening to withhold corporate finance business. The suit claims that DeAM had promised to vote its 25 million shares against H-P management, then reversed course and supported the deal with 17 million votes, under pressure. (Four days before the vote, H-P arranged a $4.4 billion credit line co-managed by Deutsche.) Bank spokesmen decline to comment on Philipp's departure or the H-P case but say the two are unrelated.
These short-term difficulties pale beside the challenge of integrating Scudder. Industry observers point out that competitors have struggled to unite geographically and stylistically different asset management operations. Charles Burkhart, founder and CEO of Rosemont Partners, a Pennsylvania-based private equity firm, is skeptical of the global model. "There are too many cultural issues when you are trying to paste together multiple fund management firms," he says. "Business planning is often the last thing that is done in these acquisitions. You look at some of these big conglomerates, and you see some very dysfunctional firms."
DeAM executives think they can prove the exception. Says global chief investment officer Dean Barr, who since 1999 has been toiling to shape up the asset management business: "To be frank, the expectations that we can successfully integrate [Scudder] are so low in the marketplace [that] there is little downside. But I think we will surprise a lot of people." Adds Hughes: "We are convinced we have taken the right steps to make this work. When Scudder is integrated, we will have an asset management platform that befits a bank with the size and aspiration of Deutsche Bank."
Ideally, fund management is supposed to counterbalance cyclical trading and investment banking revenues and to boost cross-selling opportunities to global clients, and Hughes insists the bank's game plan is a sound one. "Strategically, asset management remains a growth engine for financial services companies in the years ahead, both on its own terms and set against other products," he says. "Despite recent economic weakness, wealth creation continues at a great pace."
Hughes also believes that the market will eventually give Deutsche Bank credit for trying to offset its volatile investment banking earnings with a more stable revenue stream from money management. At about E72, the bank's share price is down 8.5 percent year-to-date, making Deutsche the eighth-worst performer in the 66-stock Dow Jones Euro Stoxx bank index. But Hughes says that building up the asset management platform will boost Deutsche's valuation. "Analysts covering financial services firms put a higher multiple on activities in asset management versus investment banking, sales and trading businesses," he asserts. "We are in a fantastic position to generate significantly improved returns from the business."
Until 1999, Deutsche Asset Management did not even attempt to operate as a single global entity. DWS covered retail and institutional investors in Germany and sold its retail funds in continental Europe; Morgan Grenfell stuck mainly to institutional management and mainly to the U.K. The Bankers Trust acquisition provided a catalyst for rationalizing the business , there were overlaps between BT and Morgan Grenfell operations in North America, Australia and Asia , but it brought problems, too. In July 1999, before the deal closed, BT's core, four-man passive management team left for Merrill Lynch. The exodus cost DeAM an $8.8 billion account from the New York Teachers variable fund and $2.5 billion from the Virginia Retirement System.
To clean up the mess, DeAM in September 1999 brought in Barr, then State Street Global Advisors' global CIO for active quantitative strategies, together with his colleague Joshua Feuerman, now DeAM's global head of quantitative equity products. Barr, now 41, was quite a catch. A Cornell University graduate with an MBA from New York University's Leonard N. Stern School of Business, he had been instrumental in building State Street's active quant fund management business from virtually nothing to $100 billion. State Street sued to keep Barr, but a Massachusetts court ruled that the noncompete clause in his contract did not prevent him from joining Deutsche.
Just as the bank seemed to be getting down to the difficult business of integrating BT, DWS and Morgan Grenfell, the abortive Dresdner merger set the project back. After Dobson's departure, the task fell to Philipp and Barr, who was promoted to global CIO in November 2000. The names Bankers Trust and Morgan Grenfell were consigned to history, and Deutsche Asset Management became a global brand everywhere in the Deutsche Bank empire except for Europe, where DWS reigns. (In the U.K. the institutional business is called Deutsche Asset Management; starting this summer the retail business will be called DWS Investments.)
Barr says his goal has been to leverage good performance in individual regions into top performance worldwide by blending local research and portfolio management into a single global platform, eliminating overlap where necessary. In late 1999 he set up the Global Research Center in New York to push product development and tailor investment strategies for institutional clients (see story below). Barr says that DeAM can attribute $25 billion in new mandates to the center's work. DeAM has also been expanding in alternative investments, including hedge funds and real estate.
Still, despite Barr's efforts, DeAM was a bits-and-pieces house. It was strong in quant and indexed products in the U.S., in active equity in Europe and in global bonds. But it had almost no U.S. active fund management products, little presence in emerging-markets equity and patchy Asian coverage.
Zurich Scudder fills almost all the holes in DeAM's product line except for large-cap aggressive growth funds. (Barr says DeAM is shopping for an acquisition in that area.) With Scudder, DeAM's assets are 67 percent institutional and 33 percent retail; about 80 percent of the total are actively managed. Of those assets, 57 percent are in the Americas, 34 percent in Europe and 9 percent in the Asia-Pacific, where DeAM is Japan's biggest foreign active fund manager and is among Australia's top three institutional asset managers.
But Scudder is a handful. It's really two different fund management companies, Kemper Financial Services and Scudder Stevens & Clark, that Zurich Financial Services bought in 1996 and 1998, respectively. Both firms suffered from a value investing bias in the midst of the growth-stock boom of the late 1990s. As performance sagged, assets under management fell, from $297 billion in 1999 to $258.7 billion in 2001, and an outdated distribution strategy helped push profit margins into the single digits.
Integrating one acquired asset manager is tough enough. But Deutsche is actually inheriting a culture clash , between Scudder, a storied, 80-year-old partnership with headquarters on New York's Park Avenue, and Kemper, a Chicago-based, sales-driven upstart with a solid reputation in bonds. The two firms had diametrically opposed distribution models. Kemper sold load funds through such intermediaries as brokers, fund supermarkets and financial planners. Scudder, a pioneer of no-load investing, has traditionally relied on direct sales and was late to recognize the sea change occurring in mutual fund distribution: Direct sales today generate less than one third of fund sales, down from as much as 45 percent in 1995. Only late in 2000 did Scudder begin selling through intermediaries.
DeAM's Hughes notes that Deutsche is in a better position to improve Scudder's distribution than its predecessor was. "As a large global financial institution, we have more leverage with distributors than Zurich had, either because of our investment banking relationships or our ability to distribute others' products for them in Europe," he says.
U.S. chief William Shiebler, who along with Lawrence Lasser is credited with making Boston-based Putnam a mutual fund leader over the past decade, intends to push Scudder products to financial planners and other third-party distributors. "We are now 100 percent committed to the advice channel, and that is where the Scudder brand in the Americas is headed," he says. "We are determined to deliver to financial planners and their clients the very best in products and services." It doesn't hurt that value investing is enjoying a renaissance.
Even more critical than the internal fixes DeAM plans to make to Scudder is the divisionwide reorganization that the merger has inspired. As soon as the deal was announced, DeAM set up an integration planning committee made up of representatives from all the asset management functions, from marketing to settlement. Barr now oversees nine global product groups, three regional CIOs, three private-client CIOs and the investment solutions group, which includes economics, the Global Research Center, pension strategies and securities lending.
The biggest changes to divisional operations will come in research, where Scudder adds depth as well as coverage in areas like emerging-markets debt and equity, Japanese stocks and U.S. value. Before the acquisition DeAM had already put in place global, sector-based research teams, but most of its 40 analysts were based in London, a legacy of equity house Morgan Grenfell.
Now, with Scudder, DeAM will have analysts in 13 locations, with 100 covering large-cap stocks and 48 following small- and midcap companies. U.S. stocks will be tracked in New York and Japanese shares in Tokyo , both had been monitored from London. Everyone will be connected to a global research platform, so analysts can share insights from around the world about particular sectors.
Fund managers, who will pursue their regional specialties , with DWS managing German equity for retail investors and DeAM U.K. overseeing balanced mandates for U.K. institutions , will be permitted to diverge from the analysts' stock selections, and Barr hopes to encourage a "healthy competitive tension" between the two. He will oversee the investment process but stresses that day-to-day decisions will filter up through the organization, not down: "It's not about the CIO sticking his thumb in the air and saying, 'Right, everyone, it's time to go value.'" Barr says the research-driven approach is designed to generate top-quartile performance in global equities and fixed income, not just in individual markets, where DWS and Morgan Grenfell have done well in the past.
While Barr reshapes DeAM's organizational profile, his boss, Hughes, will be trying to wring costs out of the operation. Cost-cutting is a priority throughout Deutsche Bank, which needs to radically streamline its domestic retail banking and corporate lending businesses. But it's crucial in asset management. DeAM's 76 percent cost-income ratio in 2001 was above the 72 percent peer average as estimated by the annual PricewaterhouseCoopers survey of investment managers.
Hughes, a U.S. Merchant Marine Academy graduate who majored in naval architecture, wants to reduce cost-income to between 60 and 70 percent over the next 12 to 18 months while boosting operating margins from about 14 percent to more than 20 percent. The 1,500-strong personnel slash has already begun: 600 employees have received their marching orders, and 800 more have been earmarked for the ax, including investment professionals. But the Scudder merger will help, offering the usual efficiencies in back-office systems and trading technology. "If there is no attrition of assets, we can hit our 20 percent-plus target if we also meet our cost target," Hughes asserts.
To enhance margins, DeAM has been pushing alternative investments. In March the bank paid $490 million for U.S. real estate manager Rreef, whose $16 billion in property assets will combine with Deutsche's $20 billion to make the German bank one of the world's biggest investors in the asset class and one of only a handful with global expertise. "Rreef has been very successful in the asset management area for a long time," says Hughes. "It will allow us to move very quickly to a third-party asset management model in the real estate business."
An earlier alternative-investment venture is already paying off. In 1998 DeAM founded Summit, New Jersey,based DB Absolute Return Strategies, which invests in hedge funds. The group develops in-house hedge fund products, partners with external managers and also builds fund-of-funds portfolios. Its clients are 20 percent retail, 20 percent institutional and 60 percent high-net-worth individuals, and the group runs $5 billion in assets, of which $3.6 billion are in funds-of-funds.
This sizable asset total puts Deutsche in the top half dozen of the world's hedge fund players. Joshua Weinreich, who heads DB Absolute Return, believes that there is enormous scope to expand the retail business, using Deutsche Bank's distribution clout. Last year he raised close to $1 billion in two fund launches distributed through the bank to European retail investors.
Weinreich is also confident that his division can attract significant institutional money in the U.S. ITT Industries has put $50 million of its $3 billion pension fund into a highly diversified fund-of-funds product called DB100, which invests in 100 underlying hedge funds , the conglomerate's first foray into hedge fund investment. Richard Goldman, Deutsche Bank's marketing chief, reports that there is $1 billion worth of institutional business in the pipeline for DB100. And Weinreich expects to find demand for his products in Zurich Scudder's private client group.
Another star in DeAM's firmament is DWS, a retail and institutional management group with E136 billion in assets. Headquartered in an elegant 19th-century town house on a residential street not far from Deutsche's main offices in midtown Frankfurt, DWS is Germany's , and Europe's , biggest retail fund manager. (In institutional management it is No. 2 in Germany, but it has little presence elsewhere.) An incredible 23.2 percent of all German retail fund investment is in DWS products, roughly four times the penetration of leading firms in other countries.
In Germany, where 70 percent of all retail fund sales come through bank branches, DWS benefits from its position as the sole choice in Deutsche Bank's 1,500 offices. But its market share has more to do with brand recognition than with a captive audience: DWS sales outstrip those of Frankfurt-based mutual fund company Union Investment, whose products are offered at more than 6,000 cooperative bank branches, and of Deka Deutsche Kapitalanlage, owned by DGZ-DekaBank and sold through Germany's 18,000 savings banks.
A strong track record helps, too. In 2000 and 2001 DWS ranked No. 1 in five-year performance by mutual fund companies in Germany, according to Standard & Poor's. The firm has placed first for one-, three- or five-year performance every year since 1995. As for profitability, DWS accounts for 51 percent of DeAM's revenues, even though it controls only about 28 percent of the global group's total assets (before the Scudder integration). "DWS is a business every fund management CEO I know envies," says Richard Morris Jr., president of Putnam Lovell Securities.
There are reasons to believe that DWS can keep growing in Germany, where it now oversees E90 billion in assets. With the passage of the pension reform measures named after Labor Minister Walter Riester, Germans can for the first time invest a portion of their retirement savings in mutual funds. Although the Riester plan isn't as aggressive as some had hoped, Udo Behrenwaldt, DWS's chairman and DeAM's CEO for Europe, thinks it will spur market growth. Per capita fund investment in Germany is E4,500, compared with E6,500 in Italy, where DWS also has substantial operations.
DWS has done a good job of expanding outside Germany. It is the largest foreign fund manager in Poland, with a 10 percent market share; in Italy, with 3 percent; and in Spain, with 1.7 percent. In France assets under management have grown from zero in 1995 to E5.3 billion today, and in Spain from zero to E3.5 billion since 1991. "We are one of very few firms with global resources and local touch , fund managers on the ground in Austria, Italy, Spain, France," says Behrenwaldt. "We see no reason why we should not replicate our success in Germany."
Behrenwaldt's strategy is based on leveraging his brand. Later this year most of the firm's non-German affiliates will take on the DWS name. "All the market research we have seen shows that DWS is a powerful brand, not just in Germany but in the rest of Europe," says Hughes. In addition, Behrenwaldt believes that the gradual move in Europe toward open architecture , that is, financial institutions selling competitors' products , will help DWS gain even more market share. On April 18 DeAM announced a strategic alliance with the Invesco fund family to sell its products through Deutsche's distribution network, probably the first of several such agreements.
In Italy, where DWS first put down roots in 1985, the German firm has E15 billion in assets. It has strong distribution through Finanza & Futuro, a 1,400-member independent financial adviser network Deutsche purchased from Italian tycoon Carlo De Benedetti in 1995. F&F now has 51 investment centers located around Italy and can be accessed through the Internet. In addition, clients can visit any one of Deutsche Bank's 261 Italian branches to conduct business with DWS. The distribution formula has worked equally well in Spain.
DWS's growth potential is particularly strong in the U.K., where DeAM has only a 1 percent share of the retail fund market. Under the new name DWS Investments, the range of funds offered will swell from 17 to 25 over the next year and a half. The U.K. operation, Deutsche's biggest and oldest outside Germany thanks to the Morgan Grenfell acquisition, is now almost entirely institutional. It generated 22 percent of global revenues from about 20 percent of DeAM's global assets before the Scudder acquisition. But that side of the business has its problems as well.
Former CEO Keith Percy, who joined Morgan Grenfell from Phillips & Drew in 1990, built it into a top-tier firm, increasing assets under management eight-fold, to £72 billion, by 1996. The firm owed much of its success to a handful of talented portfolio managers who delivered outstanding performance in U.K. equities and balanced portfolios. Under Percy's successors , first Sir Robert Smith, then current CEO Paul Berriman , assets continued to grow and now total £90 billion. Although performance has slipped in the past couple of years, Morgan Grenfell's balanced funds remain in the upper quartile of performance for the decade. It remains among the top U.K. equity managers.
But the firm has gotten more bad press than Monica Lewinsky. In August 1996 the manager of its top-performing European Growth Trust, Peter Young, was suspended over allegations that he had broken British regulatory rules on investment in unquoted securities and had committed fraud. No one has ever been convicted on those charges, as Young has been declared unfit to plead (at one point, he appeared in court dressed as a woman and asked to be called Elizabeth), but Deutsche Bank was forced to put £180 million into the fund to reassure investors. The case damaged the Morgan Grenfell name and forced CEO Percy's resignation. The incident continues to reverberate: In January Erik Langaker, one of Young's former brokers, was found not guilty of conspiracy to defraud, giving the press a fresh opportunity to dredge up the embarrassing details of the case.
Not long after Percy's departure, a new public relations embarrassment arose. His successor, Smith, reportedly learned that star U.K. equities manager Nicola Horlick was about to jump ship with a number of key colleagues. Smith dismissed her. Horlick then led an assemblage of journalists and photographers on a bizarre odyssey to Frankfurt to plead for her job back , to no avail. (She subsequently co-founded SG Asset Management UK, where Percy has rejoined her as CEO.) Then, last year, Adrian Frost, head of U.K. equities, left to join an Edinburgh-based boutique, Artemis. Consultants say his departure is a significant loss for DeAM.
The bad publicity has made it difficult for DeAM to establish a retail presence in the U.K. "We are certainly not where we want to be in retail, and I think we have a good deal to learn about product development, sales, marketing and distribution from Udo [Behrenwaldt] and his team in Frankfurt," says U.K. CEO Berriman.
But the mantra of global resources and local touch, repeated by senior management across DeAM, will be tested in London. There, despite the scandals, DeAM's close-knit team has produced strong results for ten years. The reorganization has some observers worried that in London, at least, DeAM is fixing something that ain't broke.
"We do think it is harder to manage a global business," says a leading London investment consultant. "Will the really excellent performance we saw in the past decade start to suffer because of these changes in structure and changes in reporting lines?"
That question will resonate in DeAM's offices worldwide as Scudder is brought into the fold. But if DeAM can integrate its new acquisition while improving the entire group's financial performance, the deal may become a paragon for these cost-conscious times. If the purchase works, says Putnam Lovell's Morris, "we will see a much more industrial logic to deal making , consolidation to capture increased profitability from the same revenue basis rather than dreaming of ever-higher growth rates."
Deutsche's executives do not rule out further acquisitions. "We should be prepared to step into the market for a deal that would improve our position faster and more efficiently than trying to do it organically," says Hughes.
How well he and Barr can execute their vision is critical for new chairman Ackermann. He is taking charge of a bank whose future increasingly depends on the balance between investment banking and money management. If Deutsche Bank can globalize its fund management side as successfully as it has its investment banking business, Ackermann's tenure will be off to a glowing start.
DeAM's New York rainmakers
Global CIO Dean Barr has won a lot of business for Deutsche Asset Management. Among his first moves when he joined DeAM in 1999 was to establish the firm's Global Research Center in New York, with the brief of developing products that would help institutional clients design optimal portfolio strategies. He put at its helm 44-year-old Kenneth Yip, a former finance professor at Yale University and the Massachusetts Institute of Technology. In March 2000 Barr announced a joint venture with Andrew Lo, MIT's head of financial engineering, who runs a hedge fund in his spare time and is something of a demigod in quant circles. The center's modest goal: "to completely reinvent the process of constructing efficient portfolios," according to Barr.
Barr says that more than $25 billion in new institutional mandates for DeAM in the past two years can be directly attributed to the research center's work. In 2001, for example, it won big accounts from Archer Daniels Midland Co. and Maytag Corp. to provide fully outsourced management of their pension plans, including strategic policy and asset allocation. ADM is exactly the kind of client that DeAM is after. The global foods producer, which has an investment banking relationship with Deutsche Bank and also uses the bank for custody, appointed DeAM to run its $400 million defined benefit plan for U.S. large- and small-cap equities, international equities and fixed income. An ADM official tells Institutional Investor that DeAM showed better returns in those product areas than other bidders for its business.
Another research center product is the passively managed Growth Optimal World Equity Portfolio, dubbed Growe, which was born of an academic debate about whether market-cap-weighted indexes can be a true proxy for efficient markets. Passive indexing with market-cap weighting is inherently inefficient, critics argue, because the manager essentially keeps buying stocks that have gotten more expensive and sells those that have gotten weaker.
Growe seeks to exploit that inefficiency by periodically rebalancing portfolios using a set of patented quantitative rules. In back-testing, Growe has beaten the MSCI world index by 286 basis points annually over the past 25 years. So far these results have been supported by a six-month live track record. "One of my strongest motivations is to push the field of asset management forward," says Barr. "I think we are doing that here." , A.C.