Can Dobson fix Schroders?

MICHAEL DOBSON IS SWIMMING AGAINST THE TIDE -- OF HISTORY. As chief executive of 198-year-old British financial dynasty Schroders, Dobson is charged with turning a staid and esteemed firm into a lean, mean money manager. No one would envy him the task. Schroders lost £8.1 million ($12.5 million) before taxes in 2001, its first loss since the bank went public more than two decades ago. Margins are a paltry 5 percent, compared with industry norms of 20 to 30 percent. By midyear 2002 assets under management had plunged to £102 billion, from £142 billion at the beginning of 2000 -- the result partly of client attrition and partly of the worst bear market in two generations. At 584 pence, Schroders' shares are down about two thirds from their £15.90 peak two years ago. The firm's dwindling market capitalization means it is barely clinging to its membership in the FTSE 100 index of the U.K.'s leading companies.

Family-controlled since its creation, Schroders is one of a vanishing breed in the City of London: an independent financial house that has, so far, resisted selling out to a deep-pocketed bank or insurer. Its largest shareholder, Baron Bruno Schroder, wants to keep it that way. And Dobson insists that Schroders can be reborn as a stand-alone money manager, able to compete with such global giants as Capital Guardian Trust Co. and Fidelity Investments, manufacturing products for retail and institutional clients around the world.

"Independence has been a winning strategy in the U.S., and I see no reason why Schroders can't replicate that in Europe," he declares.

During his first year at the helm, Dobson has worked overtime to make it happen. He has cleaned house, axing many top executives (and often replacing them with former colleagues of his own). He has brought in a new crop of fund managers to boost performance and round out Schroders' investment expertise. In September he hired Richard Horlick, who ran Fidelity's U.K. operations from 1994 to 2001, to oversee Schroders' global institutional business. The personnel shuffle has borne fruit. At the end of 1999, more than three quarters of Schroders' portfolios -- institutional and retail alike -- were below their benchmarks; at midyear 2002, 68 percent of institutional and 75 percent of retail funds were outperforming.

Dobson, formerly head of Deutsche Asset Management, is getting a grip on costs, which spiraled out of control during the bull market, by consolidating back-office functions and trimming jobs. He has also tackled endemic weaknesses at Schroder & Co., the firm's struggling private banking unit, and at its U.S. subsidiary, Schroder Investment Management North America. Some analysts are impressed. "My sense is that the new management has given a much-needed impetus to Schroders," says Philip Middleton, head of specialty finance research at Merrill Lynch & Co. "It seems to me to be a much sharper organization than it was under the previous chief executive."

At least some pension funds agree. In August Cambridgeshire County Council retained Schroders to manage £250 million of its £750 million fund, sacked J.P. Morgan Fleming Asset Management and gave Schroders an additional £60 million to manage in U.K. and international bonds. Says Tony Cummings, a specialty finance analyst at Bear, Stearns & Co.: "Schroders would have almost certainly lost that business 12 months ago. It's an encouraging sign that a corner has been turned."

But Schroders still faces a strategic crisis. One problem is its size: In a fund management industry bifurcating between global heavyweights and featherweight boutiques, Schroders is a drifting middleweight. It barely scrapes into the top 20 of Institutional Investor's list of European fund managers by assets (see Euro 100), and it ranks 60th globally. It lacks the scale to offer the product range that ensures a Fidelity or Vanguard Group a stable of winning funds regardless of market conditions.

Another problem is distribution. Independent money managers thrive in the U.S. because the market has plenty of disinterested intermediaries selling funds, from financial supermarkets to independent advisers. In Europe sales power still rests largely with big banks and insurers, most of which sell only proprietary products. According to Morgan Stanley, even distributors that sell third-party funds -- a practice known as open architecture -- don't give them more than 30 percent of their shelf space. Manufacturers like Schroders must pay huge distribution fees -- as much as 60 percent of revenues, according to management consulting firm Oliver, Wyman & Co.

Then, too, Schroders' traditional strengths have turned into weaknesses. So-called balanced management, in which pension funds award one or two external managers large mandates and give them discretion over asset allocation, provided the firm's bread-and-butter business during the 1980s and early 1990s. But funds are increasingly turning to specialists, hiring many money managers, each with expertise in a particular asset class, to execute an investment strategy decided on by the plan and its consulting firm. Now Schroders is scrambling to climb on the specialist bandwagon, which is already full of competitors.

In any case, Schroders is heavily dependent on fickle institutional clients, which make up 80 percent of its assets under management. Its portfolio is 74 percent equities, which is not the current asset class of choice. And 60 percent of the firm's assets are from U.K. clients. Sums up Sarah Ing, specialty finance analyst at UBS Warburg: "Too much U.K., too much institutional and too many equities. Schroders is in the wrong bits of the asset management business."

Dobson argues that Schroders is a firm in transition, still moving from bank to specialist asset manager. (It sold its investment banking business to Citigroup subsidiary Salomon Smith Barney in 2000, for $2.2 billion -- just in time for global markets to go into free fall.) Dobson says his strategy is focused on diversifying the client and asset mix. For example, he plans to beef up fixed income from its current 21.5 percent of assets, double the firm's alternative investments (from 5 percent of assets now) and raise the ratio of retail to institutional assets, although he has not set a specific target.

Dobson also argues that Schroders' independence is a core strength that safeguards the company's integrity. "Independence is a great asset, particularly with increased focus on conflicts of interest," he says. "If you look at the top 20 asset management companies in Europe, there is only one independent firm: Schroders. We don't have a brokerage arm, we don't have an investment bank, we aren't owned by a commercial bank, we aren't owned by an insurer. We are a pure asset management firm."

The CEO believes that by refusing to sell out to a big distributor, Schroders is positioning itself for a European future in which third-party fund sales are the rule, not the exception. (Schroders' products are already sold through American International Group, AMP, Canada Life Financial Corp., Norwich Union, Scottish Mutual Assurance, Scottish Widows, Skandia and Zurich Financial Services, among others.) And he is confident that the firm's solid track record in U.K. equities, U.K. bonds and Asian stocks will give those funds an advantage over competitors. "I have come from Deutsche, which has a trillion under management and a huge banking network through which it can sell products," he says. "I won't pretend there aren't some advantages to that model. But open architecture is a reality, and it means distributors are looking for best-of-breed products."

He had better be right. In August 2001 Baron Schroder and his relatives, who together hold 48 percent of Schroders' shares, ousted CEO David Salisbury, a lifelong Schroders veteran. The official explanation was that the firm needed a change. But current and former employees say Salisbury was fired for questioning the firm's viability as an independent.

Dobson is under pressure to make the independence strategy work. His contract expires in 2004 -- the same year Schroders will reach its bicentennial, an anniversary the family no doubt wants to celebrate in style. If Dobson can bolster the bank's flagging fortunes and position it solidly among Europe's major money managers, he will earn himself a warm baronial handshake, not to mention a multimillion-pound bonus on top of his £10.5 million in guaranteed compensation.

DOBSON ARRIVED AT SCHRODERS WITH PLENTY of baggage. He is most famous for rising from relative obscurity in 1989 at the tender age of 36 to become CEO of Morgan Grenfell & Co., which had just been bought by Deutsche Bank. Between 1993 and 1998 Dobson headed Deutsche's investment banking division, then known as Deutsche Morgan Grenfell, and became only the second non-German to join Deutsche's board of directors. However, his influence began to wane in the mid-1990s. The late Edson Mitchell, whom Dobson had hired from Merrill Lynch to head global markets, displaced him as Deutsche's investment banking star. In 1998 Dobson was shuffled sideways to head asset management, before resigning in 2000 in protest of chairman Rolf Breuer's abortive plans to merge with Dresdner Bank and sell off Deutsche's stellar fund management business, DWS Investments, to Allianz.

His meteoric ascent has made Dobbo -- as he is widely, if unfelicitously, known in the City -- a man about whom many people have strong opinions, whether or not they know him personally. Those close to him say he is charming and engaging. But he is more often described as arrogant and aloof. One analyst who follows Schroders even admits, "Secretly, I would love it if he failed."

Now 50, Dobson has much in common with his boss. Both men are products of Eton College and Oxbridge. Both abhor publicity. At 6-foot-4¹/2, Dobson can look the 6-foot-6 baron more or less in the eye. Most important, he hews to the family line on independence.

Immediately upon taking office, Dobbo began filling key slots at the bank with like-minded individuals. He sacked chief financial officer Nick MacAndrew, who had spent his entire career at Schroders and had been CFO for ten years, and brought in Jonathan Asquith, his former chief operating officer at Deutsche Morgan Grenfell. Asquith, a descendant of former Liberal prime minister Herbert Asquith, had joined the Morgan Grenfell graduate trainee program straight from college, just as Dobson had. And like Dobson, Asquith fought at DMG for the values of the old-style merchant bank, resisting those of Mitchell and his American traders. Now Dobson is counting on Asquith to help shave Schroders' 80 percent cost-income ratio.

Next, Dobson launched a purge at private banking division Schroder & Co., where assets under management slipped from £6.7 billion at year-end 2001 to £6.4 billion in June 2002 and revenues have recently been no better than stable. He fired CEO Mike Bussey (who has since been hired to head Rothschild Group's private client division) and replaced him with Sally Tennant. Tennant headed Gartmore Investment Management's institutional business during its most successful period, in the early and mid-1990s, and was a partner at Beaumont Capital Management, the hedge fund business that Dobson founded and that Schroders acquired in October 2001 to gain his services.

More controversially, Sharon Haugh, chairwoman of Schroder Investment Management North America in New York, was shown the door in May. Dobson cites poor performance at the bank's U.S. arm, which manages $32 billion in U.S. pension fund money. Haugh, 56, responded by filing a multimillion-dollar suit against Schroders for age discrimination. No successor has yet been named, although Dobson says he will fill the post by year-end.

But Schroders' most important new hires have been at headquarters in London. Global institutional chief Horlick, a product of Harrow School and the University of Cambridge, presided over a highly successful period for Fidelity in the U.K. -- assets rose from less than $10 billion to $60 billion on his watch. As a veteran of one of the world's most successful independent specialists, Horlick's job is to help John Troiano, head of U.K. and European institutional management, revamp Schroders' product line and spread the word that the new Schroders is no longer just a balanced shop.

Troiano himself has gone a long way in the past couple of years toward freshening Schroders' portfolio management. He has expanded the European and U.S. equity and global fixed-income teams, introduced a sector-based approach to equity management and created a dedicated client-services division. In July 2000 he hired Susan Haroun from UBS Brinson to oversee the institutional investment process. That same year, he brought Deborah Chaplin from Zurich Scudder Investments to manage Schroders' core Europe, Australasia and Far East (EAFE) international equity portfolios. Both Haroun and Chaplin come from Continental asset managers that fought their way to success in the ultracompetitive U.S. institutional arena. Troiano also brought in Baring Asset Management's star European equities manager, Mark Pignatelli, who was recently promoted to chief investment officer.

Pignatelli's ex-boss at Barings, U.K. hedge fund manager Crispin Odey, thinks Schroders is shaping up under Dobson. "Schroders used to strike me as being a bit like the civil service. Now there are seriously good people in the senior positions: Dobson, Asquith, Horlick, Pignatelli. That's real talent, and they have a shot at turning it round," says Odey.

The new blood was badly needed. Schroders had underperformed during the best of the bull market. In both 1998 and 1999, it turned in bottom-quartile performance in two of its core portfolios: multi-asset-class balanced management, mostly for U.K. pension funds, and U.K. equities. Even though Schroders has not traditionally been considered a value manager, Troiano explains, "this was partly the result of very strange markets. We took the view that the valuations of many businesses were at odds with the fundamentals. We were right, but in the short term, that hit our performance."

The management shake-up has helped. For the three years ended in June, Schroders had median or better performance in balanced management and in all equity asset classes except emerging markets (though it is in the top quartile year-to-date), according to the Russell/Mellon Caps performance measurement service. There are pockets of stellar results over one and three years in U.K. and Japanese equities and in U.K. bonds. "There has been a major turnaround in performance," declares Dobson. "We are increasingly being included on consultants' shortlists."

But even the best portfolio managers can slip up. Pignatelli made a famously bad call in early 2001, betting that U.S. interest rate cuts heralded the end of the global bear market. Instead, European stocks kept falling, and Pignatelli's flagship Schroder European Fund wound up in the bottom performance decile for the year, according to Standard & Poor's. And in retail Schroders hasn't broken out of the pack. Fund-rating groups such as Micropal give 31 percent of its retail funds four stars or more -- just above the 30 percent industry average and nowhere near Fidelity's 63 percent.

Total assets under management fell in the first half of 2002, to £102 billion, from £110 billion in the first half of 2001. But attrition of assets has slowed -- to £2.3 billion, compared with £5.6 billion in the first half of last year. Profits dropped to £46.8 million, 37 percent less than in first-half 2001. Nick Sykes, a senior investment consultant at William M. Mercer, thinks Schroders has yet to live down the stale reputation it earned at the end of the past decade. "In this business perception lags reality," says Sykes. "Schroders has been seen as a problem house because of 1998 and 1999. The hangover from the late 1990s may linger for a while yet."

That sums up Dobson's biggest challenge. In asset management, stand-alone manufacturers live and die by performance. And that, ultimately, may be beyond his control.

SCHRODERS IS A SURVIVOR AMONG THE GREAT family-controlled British banks, such as Barings and Robert Fleming, that were swept away in the 1990s when globalization and bulge-bracket investment banks overcame their genteel variety of capitalism. The firm was born when Johann Heinrich Schröder traveled from Hamburg to London in 1804 and formed a banking business with his brother. They established J. Henry Schröder & Co. in 1818, and during the 19th century it became one of Britain's preeminent merchant banks.

Like its U.K. peers -- including Robert Fleming, Morgan Grenfell & Co. and S.G. Warburg & Co. -- Schroders 50 years ago considered fund management secondary to the more glamorous business of deal making. But from the 1970s onward, as companies built up pension schemes and investments institutionalized, the merchant banks' asset management function grew in importance.

Schroders became one of the U.K.'s Big Four domestic managers (along with Gartmore, Mercury Asset Management and Phillips & Drew), which seemed to win every pension mandate awarded in the early and mid-1990s. Only Mercury, once part of S.G. Warburg and now owned by Merrill Lynch, was more conspicuously successful, with more assets under management and a larger domestic market share.

Internationally, Schroders was arguably the most prominent British firm, having built a strong U.S. institutional presence in the 1980s with EAFE-linked equity portfolios. It won big mandates from the Colorado Public Employees' Retirement Association, the state of Hawaii and the Minnesota State Board of Investment, among others. Overall, funds under management grew from $29 billion in 1987 to $78 billion at the end of 1993. By the close of the decade, the firm clocked in to the II Euro 100 ranking at E230 billion ($215 billion).

But in some ways Schroders' greatest strength was also a liability. During the 1980s and early 1990s, U.K. pension funds largely ignored the governance structure their American counterparts were adopting. In the U.S. consulting firms decided on asset allocation, then awarded a fund's money to multiple managers in specialized investment niches. British funds, even the largest, continued giving discretion to a small number of managers -- the balanced approach. The Big Four dominated the business.

Thus they had the most to lose when U.K. pension funds began taking the specialist approach in the mid-1990s. Specialist mandates command better fees -- 25 to 100 basis points, compared with 10 to 25 basis points for balanced briefs -- but they are also smaller. In many instances, clients yanked balanced mandates of hundreds of millions from one or two managers and parceled them out to as many as a dozen specialists. Even those incumbents that retained a few bits lost millions in assets. For example, the British Broadcasting Corp. pulled a £700 million balanced mandate from Schroders last year, though the firm continues to manage a £750 million global equities brief. Other clients, such as the Bristol-based Environment Agency, sacked Schroders outright.

Schroders is concentrating on earning its stripes as a specialist. Recent client wins include a £280 million mandate in sterling bonds from the pension fund of Yorkshire Electricity Group, a E93 million Pacific Basin equities account from the National Pensions Reserve Fund of Ireland and a $70 million Asian equities mandate from Sweden's AP7.

A net loss of £4.3 billion in institutional business in the first half of this year, compared with £6.9 billion in 2001, positively surprised analysts, most of whom had predicted a steeper plunge. The worst outflows were in the U.S.

In retail, however, Schroders is firing on all cylinders. Retail funds under management stand at £12.6 billion -- double the amount in 1999 -- or about 14 percent of total assets. In the first half of 2002, net retail sales of £2 billion were 120 percent higher than in first-half 2001.

The firm sees great potential among continental European retail customers, who are contributing more and more to Schroders' total funds. Out of £4 billion in gross sales during first-half 2002, the Continent accounted for £1.9 billion. And according to Feri Fund Market Information, Schroders ranked sixth among cross-border fund groups in average net sales during the second quarter. Its close rivals include Fidelity, Franklin Templeton Investments, J.P. Morgan Fleming and Morgan Stanley -- exactly the kind of company Dobson wants Schroders to be keeping.

But Dobson has trouble spots to fix. One is Schroder & Co., the private banking division for which the firm had such high hopes in 2000. After the investment bank was sold off, management excitedly talked about private banking as a future powerhouse business. But despite the cachet of the Schroders name, the talk has not yet translated into clients and profits.

New CEO Tennant wants to position Schroder & Co. as a purveyor of investment products, not just a place to keep checking and savings accounts. Since taking control in May, she has revamped the bank's system for determining optimal asset allocations for clients. She has expanded the product line with more alternative investments, including a soon-to-be-launched fund-of-hedge-funds, and has inked an exclusive agreement with Frank Russell Co. to offer its manager-of-manager products (in which Russell allocates money to other managers) alongside Schroders' in-house funds. Says Tennant: "This takes open architecture to a higher level. Frank Russell has a first-class product which will offer our clients access to some of the best money management talent in the world."

Another problem area is the U.S., which Dobson says is a priority. Assets have declined by approximately 25 percent thanks to a combination of declining markets and poorly performing EAFE portfolios. "The U.S. still accounts for 16.5 percent of our business [by assets in June 2002], but it is fair to say we are not as strong there as we were five years ago," Dobson admits. The unit's new CEO will have to improve the EAFE portfolios' performance and polish Schroders' reputation among consultants.

Dobson's efforts to reinvigorate management, turn investment performance around and redirect Schroders into more profitable areas have not yet had much impact on the bottom line. He has a lot more work to do on the firm's cost base, which was built to handle substantially more assets and bull markets. (His record as a cost cutter is good: At Morgan Grenfell, first as deputy chief executive and then as CEO, Dobson slashed 25 percent of the workforce -- approximately 500 jobs -- between 1988 and 1990.)

His principal lieutenant in this campaign is new CFO Asquith, most recently in charge of private client business at Barclays. Asquith has promised to get head count down to 2,500 by the end of this year, from 2,890 in January. (That's already down from 3,178 at the beginning of 2001.) Some of the job cuts will result from closing as many as ten of the 40 former marketing offices for the old investment banking business -- in South Africa and Thailand, among other places.

The bank will also continue a number of outsourcing projects that previous management had begun. These include subcontracting Schroders' entire fund administration, custody and accounting processes to J.P. Morgan Chase & Co.'s investor ser-vices division. Asquith predicts that this and other initiatives will shrink Schroders' cost base by more than 25 percent, to the tune of £60 million, by 2003. Says Dobson, "Once the restructuring of the cost base is complete, we will be a very efficient firm, able to run substantially more assets at little extra cost."

Analysts think Dobson could boost profitability by playing the ace up his sleeve: £700 million of surplus capital, left over from the sale of the investment bank, that could help pay for a strategic acquisition. So far, hanging on to the money has looked smart -- as markets have collapsed, fund managers just keep getting cheaper. But analysts are growing impatient. Says Martin Cross at Teather & Greenwood, "Even a modestly successful acquisition should treble the return on equity, because the £700 million is earning cashlike rates of return." Fund management analyst John Kirk at Fox-Pitt, Kelton agrees. "I think Dobson should make a clear announcement on what he intends to do with the £700 million by the year-end," he says.

Dobson is delphic about what he might do with that money. "In the current market environment, we would like to be stronger in fixed income," he says, immediately adding: "We could look to strengthen our European business. There are a range of things we could do."

SO FAR, THE ALL-IMPORTANT CONSULTANTS WHO dictate which fund managers win pension fund money are cautiously impressed by Dobson's first-year performance. "I think Schroders has a clear idea of what it needs to do to be credible in an age of specialist fund management where big firms have to compete with boutiques," says Mercer's Sykes. "In some areas it is already there."

Assuming Sykes is right, and Dobbo does turn the bank around, that still leaves questions about Schroders' future. One option, quietly bruited about by some in the City, might be going private. The £700 million cash surplus wouldn't go very far toward buying distribution power in Europe, or even much in the way of manufacturing. Instead, the family could put it toward a buyout (Schroders' total market cap is about £1.2 billion, so the family's stake is worth some £580 million), raising the difference in private equity. Should the market and the bank's fortunes recover, the baron and his relatives could wind up with a company worth three times what it is now.

For now -- publicly, at least -- no one is suggesting that such a course of action is imminent. And for the family to realize their putative profit, they would have to loosen their grip on control. Unless and until they do, Dobson's job is to keep on fighting the tide.