Sometimes you just have to grin and bear it. That’s been the only alternative available to Old Mutual, the South African insurer that bought United Asset Management Corp. in June 2000. Old Mutual paid $2.2 billion, or 1.2 percent of assets, which seemed an attractive price to gain a toehold in the U.S. market. UAM’s problems were widely known - the firm was a ragtag collection of 41 asset manager affiliates, many of them value equity firms, which collectively suffered six straight years of net cash outflows, even as the bull market roared ahead (Institutional Investor, June 2000). But Old Mutual had confidence that it could engineer a turnaround.
A year and a half later, it’s clear that the South African firm overpaid for its American beachhead. Since September 2000 more than half the assets evaporated at Pilgrim Baxter & Associates, UAM’s best-known retail affiliate, as its signature aggressive growth funds have been pummeled. Overall, the old UAM, now known as Old Mutual U.S. Holdings, has seen total assets fall to $150 billion, from $200 billion, though the drop was largely due to the fact that Old Mutual sold off affiliates with $32 billion in assets. In November Old Mutual announced an estimated $926 million write-down on the acquisitions of UAM and Gerrard, a U.K. investment group that the insurer had bought for $748 million in 2000.
But Old Mutual soldiers on, having sold off 12 affiliates for a combined $500 million to better focus on its core operations - Pilgrim Baxter and seven other affiliates (Analytic Investors; Arcadian Asset Management; Barrow, Hanley Mewhinney & Strauss; Clay Finley; Dwight Asset Management Co.; NWQ Investment Management Co.; and Provident Investment Counsel).
Most importantly, it changed the business model for those eight affiliates, now grouped in a holding company called Old Mutual Asset Managers, when it shifted from revenue-sharing to profit-sharing arrangements. Old Mutual hopes the new structure will give managers an incentive to invest in marketing and distribution, as well as compensation for top portfolio managers. Revenue sharing in effect gave them a disincentive, as the principals at many affiliates were inclined to pocket as much of the revenue as they could at the expense of strengthening distribution. At the moment, though, 19 managers with combined assets of $58.6 billion remain under the old system.
Scott Powers, who took over five months ago as CEO of Old Mutual U.S. Holdings, is looking for internal growth, rather than following the old UAM model of growth by acquisition. “We have great investment platforms,” says Powers. “But we have to do a better job of distributing them.”
Shifting to profit-sharing relationships came at considerable cost: To persuade Pilgrim Baxter founders and major shareholders Gary Pilgrim and Harold Baxter to agree to the change, Old Mutual has already paid the two executives $220 million, with perhaps hundreds of millions of dollars more to follow, depending on the outcome of negotiations under way.
Analysts endorse the new strategy, but success - especially in the form of asset growth - is far from assured. “It’s a bit early to say whether they have turned the corner,” says Stewart Rider, a Merrill Lynch & Co. analyst.
Top management turnover hasn’t helped the cause. Powers is the third CEO since September 2000. The first, James Orr III, who now oversees the 19 affiliates that have stuck with revenue sharing, was nudged out of the top job in late 2000. Orr had succeeded UAM founder Norton Reamer as CEO and promptly sold the company. His replacement, Kevin Carter, charged with shaping U.S. operations, left the company in October, reportedly because Old Mutual decided an American would be better suited to the job. Carter was a Briton who had never worked for a U.S. firm, while Powers, a native of Boston, spent 14 years in the institutional asset management group of Mellon Financial Corp. and its predecessor.
To get the job done, Powers aims to increase cooperation among member firms, further pare the number of affiliates and expand distribution channels in markets for 401(k)s and wrap accounts.
In December five retail funds from the seven OMAM U.S. affiliates were rebranded as Pilgrim Baxter offerings. Pilgrim Baxter already sells some top-performing value funds. In addition, it has landed subadvisory work with American Express Co. and American Skandia. Remarkably, Pilgrim Baxter reported positive net new cash flow for 2001, despite losing 28 percent of its assets.
For Old Mutual, that eases some of the strain of the terms of Pilgrim Baxter’s 1995 sale to the old UAM. It bought the right to share a portion of Pilgrim Baxter’s revenues. When Old Mutual arrived on the scene, it paid an initial $220 million to increase control to 80 percent of those revenues, with an option to acquire the remaining 20 percent stake at the end of 2001 for an additional $420 million. But with Pilgrim Baxter assets down 59 percent for the year ended September 30, 2001, Old Mutual held off on exercising the option and now hopes to lower the price tag.
Passing on the option would prevent an alignment of goals between the subsidiary and Old Mutual, analysts say. “But if they exercise the option, as we see it, it is going to definitely destroy value,” says Sean Nossel, a J.P. Morgan analyst.
With profit-sharing, the interests of Old Mutual and its affiliates are far better aligned, analysts believe. That may not be enough, though. Says Citigroup/Salomon Smith Barney analyst Johny Lambridis, “My concern is that Old Mutual has paid too much to buy back those revenue-sharing agreements.”
If the analyst’s judgment proves to be correct, it wouldn’t be the first time Old Mutual overpaid to close an American deal.
Action Alert
Active money managers often find it easier to outperform their benchmarks in down markets. Last year they got their bear market, and they just squeaked by their bogey. As a group, active retail and institutional equity managers returned -11.95 percent (through December 18), versus -12.38 percent for the Standard & Poor’s 500 index.
Most active equity fund managers could only beat the S&P 500 in six of the first 11 months in 2001. All in all, it was a roller-coaster year. In both October and November, roughly 51 percent of active mutual fund managers beat the S&P 500, according to data compiled by Morningstar. But in September only 28.5 percent were able to best the index. Overall, according to Morningstar, in 2000 66.8 percent of active managers beat the S&P; in 2001 49.1 percent did so.
On the institutional side, in the third quarter the median active large-cap equity manager returned -14.7 percent, compared with -15.2 percent for the Russell 1000 core index - the main benchmark for the large-cap universe - according to a performance survey of 700 separate accounts and commingled funds by William M. Mercer Investment Consulting.
But Louis Finney, director of research at Mercer, argues that if one were to deduct management fees, which can range from 50 to 100 basis points for an institutional fund, the median performance of separate account money managers would improve significantly.
Still, “as a group, active managers will fall short of the index return by the exact amount of the costs that they incur,” says Jack Bogle, founder of Vanguard Group, which did more to popularize indexing than any other asset management firm. According to his Bogle Research Center, which is part of Vanguard, active mutual fund returns have averaged 13 percent per year since 1994, while the S&P 500 averaged a 15 percent annual gain.
“The numbers tell it,” Bogle says. “Active managers have a chance to show what they can do during a down market, and they do nothing.”
Bogle finds it telling that active managers carried on average a 3 percent cash position in April 2000, versus a 12 percent position in April 1999. After the tech bubble burst, managers presumably could have put a sizable cash position to good use. Instead, they were nearly fully invested.
Of course, some active money managers are closet indexers - which means that clients pay active management fees for something close to passive investing. Jeff Saef, head of the strategy and research team at Putnam Investments, advises pension funds to determine “whether a money manager is truly taking active bets or just indexing.” To make that judgment, Saef tells plan sponsors to closely study their managers’ portfolios and to track their trading activity.
Like most consultants, Mercer’s Finney believes there is a place for active management, but he argues that investors should think about risk-adjusted performance more than they do. “There are active managers out there who do beat the indexes,” he says. “But the question of whether active or passive managers can add value really depends on how much risk you want to take as an investor. If you want 500 basis points of outperformance, you’re going to have to take considerable risk, but if you want only 50 basis points of outperformance, that would require far less risk.” - Vince Calio
