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Peddling Mellon in Europe

Can the Pittsburgh-based company establish itself as a major asset manager overseas? Regional chief Jack Klinck has made a respectable start, but a splashy acquisition still eludes him.

In the early years of the Great Depression, Treasury secretary Andrew Mellon endorsed the Federal Reserve Board's tight monetary policy and urged investors to "liquidate stocks. . . . It will purge the rottenness out of the system." Purging, it turned out, was exactly the wrong remedy, helping to send a weak economy into one of the most severe and prolonged downturns in U.S. history.

Mellon should have stuck to the family business, banking. Before his ill-fated government service, Andrew, his brother, Richard, and their father, Thomas, a retired judge, founded T. Mellon & Sons in 1869. It soon became one of the commercial icons of their hometown, Pittsburgh, Pennsylvania. Catering to local corporate borrowers, including steel magnate Andrew Carnegie, Mellon grew into one of the country's mightiest industrial lenders. Growth continued pretty much unabated until the mid-1980s, when management of the renamed Mellon Bank Corp. failed to foresee the shrinking fees and increasing credit risk in lending to corporate giants like U.S. Steel Corp. Awash in bad loans, Mellon posted its first-ever loss in 1987.

A new CEO, Frank Cahouet, brought in from Crocker Bank (now part of Wells Fargo & Co.) in San Francisco, took a page from Andrew Mellon by purging the bank of ill-advised corporate loans. He hived off the nonperformers into a "bad bank," Grant Street National Bank, and then gradually began steering the remaining "good bank" away from traditional corporate lending and into faster-growing, more-profitable areas, including money management and custody. In 1994, Cahouet bought Boston Co. and Dreyfus Funds, giving Mellon the beginnings of its thriving asset management business.

Cahouet's successor, Martin McGuinn, who took the helm in 1999, further honed the bank's focus by jettisoning its U.S. retail operations in 2001. Mellon, with total assets under management of $612 billion, now ranks sixth on Institutional Investor's list of the top U.S. money managers. Asset management kicks in approximately 40 percent of Mellon's total revenues; custody and other institutional services account for the remainder.

Now McGuinn is determined to lessen Mellon's reliance on the U.S., where nearly 95 percent of its assets reside and about 90 percent of its $4.6 billion in revenues are generated. He's convinced that the U.S. money management market is oversupplied and that Mellon has better growth prospects in the U.K. and Europe. McGuinn has made a pretty big bet: In March employees will move into its new European headquarters in the City of London, the eight-story, 380,000-square-foot, brick-and-glass Mellon Financial Centre.

The new building, says McGuinn, "should be seen as a symbol of our commitment to the region."

So far Mellon has taken some small, successful steps to bolster its European asset management business. It's built up a British acquisition, Newton Investment Management, made a few small investments and outright purchases, and used London-based marketers to sell U.S. products. But the bank, which started to help fund corporate customers' overseas expansions in 1904 when Andrew was still in charge, has far fewer European assets than, say, J.P. Morgan Fleming Asset Management, which has $140 billion versus Mellon's $33 billion. One problem: Despite several attempts, it has failed to acquire a major European asset manager in the past three years.

Since November 2001, 39-year-old Jack Klinck, a McGuinn protégé and former American Express executive who ran and then sold off Mellon's credit card business, has overseen Mellon Europe with a mandate to grow both its asset management and custody groups in the region.

"Mellon has been a predominantly U.S.-focused institution for most of the last century," says Klinck. "That will not change overnight. But we know the future growth of Mellon will in large part come from Europe. We are pushing ahead, and we're confident of success."

As Klinck sees it, the aging populations and looming pension reform in many EU countries offer opportunities for institutional money managers. In addition, the creation of new pools of government-sponsored assets, such as the AP funds (Allmäna Pensions Fonden) in Sweden and the National Pension Reserve Fund in Ireland, provides openings for institutional money managers.

At the moment, Mellon's European assets are managed by one firm, Newton, a London-based house it acquired in 1997. Of Newton's $33 billion in assets under management, 55 percent is institutional and 45 percent is retail. Its portfolio breakdown: 76 percent equity and the remainder in fixed income.

A founding shareholder, Mellon retains a 30 percent stake in Pareto Partners, a highly successful 12-year-old London-based currency overlay specialist with $35 billion in assets under management.

In Europe as in the U.S., Mellon has a balanced organizational structure. Its setup falls somewhere between the total integration pursued by giants like Merrill Lynch Investment Management and the decentralized model pioneered by United Asset Management in the 1980s and 1990s. MLIM runs all of its investing, marketing and distribution from one centralized organization. American Express Asset Management and other followers of UAM, which was acquired by South African insurer Old Mutual in 2000, have operated as loose alliances of boutique firms that retain substantial autonomy.

The individual money management firms that Mellon owns have wide latitude to select and oversee their investments. Marketing, on the other hand, is centralized. In Europe that means that Mellon Global Investments sells the firm's European products as well as the funds and portfolios offered by Mellon's U.S. money management arm, which includes institutional asset managers such as Boston Co. Asset Management and Franklin Portfolio Associates and retail fund families like Dreyfus Corp. and Founders Asset Management. In the alternative assets arena, the firm operates Mellon Global Alternative Investments and Mellon HBV Alternative Strategies.

"In distribution, sales and marketing, we believe in economies of scale," says Klinck. "But that is not true in the manufacturing hub of these businesses where the fund managers sit, generating alpha. We don't believe that there is a silver bullet that creates investment performance. We don't force anybody to buy into a Mellon investment philosophy or view."

Notes Andy Maguire, head of the Bolton Consulting Group's asset management practice in London: "Mellon is one of the few firms that has integrated its asset management businesses sensibly without spoiling what it bought. Its distribution strategy is also very smart. It really knows at every level the bottom-line impact of every piece of business it does. That sounds obvious, but it is really quite rare."

Certainly, Newton boasts a fast-growing asset base. In the past five years, assets have increased from $21 billion to $33 billion. What explains such a rise in a tough market environment? Credit respectable performance and effective marketing, especially in the retail marketplace. Although Newton was once regarded primarily as an institutional manager, it has made good progress in persuading independent financial advisers to sell its products.

Newton's balanced (multiasset) U.K. and European institutional equity products, with combined assets of $15 billion, have outpaced the median performance in each of the past six years, according to the Russell Mellon CAPS pooled universe.

Retail performance is similarly solid. Of 12 funds tracked by Standard & Poor's, ten are rated double-A or higher. The Newton Higher Income Fund, a portfolio of bonds and high-yielding stocks, is an especially notable success. In June, two years after manager Clive Beagle took over from his mentor, Toby Thompson, assets at the 16-year-old fund surpassed £1 billion ($1.7 billion). The fund ranks in the top quartile of U.K. income sector performance over one, three, five and ten years, according to Lipper Hindsight.

"Newton was hardly on the radar screen five years ago but is a pretty well known retail force now," says Mark Dampier, head of manager research at Bristol-based Hargreaves Landsdown, one of the U.K.'s largest independent financial advisers.

But Newton has faced its share of problems. Most dramatically, about four years after the acquisition, the firm suffered a rash of departures of key investment professionals who left as their postpurchase employment agreements expired. In addition to U.K. equity chief Thompson, the defectors included founder and chairman Stewart Newton, CEO Colin Harris, chief investment officer Charles Richardson, head of Europe Kieran Gallagher and marketer Guy Bowles.

Though there was some talk of cultural clashes at the time, most observers believe that those leaving simply had the financial wherewithal to move on. Mellon chose to stabilize the business by hiring from within. It named head of fixed income Helena Morrissey as the new CEO, and long-serving equity fund manager Jeff Munroe became CIO. It also recruited Raj Shant from Credit Suisse Asset Management to oversee the European business. Glen Pratt, a top-rated Fidelity U.K. equities manager, and Robert Stewart, from Goldman Sachs Asset Management's global equities team, joined the firm last year as well.

Until recently, consultants were wary of recommending Newton because of the staff upheaval, but good performance and a couple of years of management stability have eased concerns. "Performance hasn't suffered," says Dampier.

The Newton defections also didn't prevent Mellon from striking some valuable distribution agreements. Klinck is especially proud of a wide-ranging pact reached with Germany's HVB Group (formerly Hypo-Vereinsbank) in December 2002. HVB, Germany's second-biggest bank and Europe's largest corporate lender, pulled back from asset management in 2000 when it sold London-based money manager Foreign & Colonial Management to focus on distributing other firms' products. Under the terms of Klinck's deal, HVB will offer its institutional clients eight Mellon products, mostly fixed-income-related.

"We liked that Mellon could offer us access to boutique fund management businesses with good track records," says Harry Lusser, head of product development at HVB.

As encouraging as the HVB deal is, it isn't going to jump-start growth in the way a big acquisition would. So far a major purchase has eluded Mellon. Rival firms bought not only Foreign & Colonial in 2000, but Gartmore in 2001, Royal & SunAlliance Investments in 2002 and Rothschild Asset Management and Threadneedle Investments this year. Klinck, say sources, bid for London-based $75 billion-in-assets Threadneedle, losing out to American Express Co., which paid $570 million for the value-focused money manager.

"If Mellon wants to grow by acquisition, then it has already seen some good franchises come to market," says a top executive at a rival European money manager. "The suspicion has to be that it doesn't like paying up." Says a Mellon spokesman, "It is our policy not to comment on speculation or market rumor."

Mellon has made a few relatively small European acquisitions, mostly aimed at boosting product expertise or client distribution rather than assets. In 2002 it bought $1.37 billion-in-assets Henderson Private Asset Management from Australia-based financial services provider AMP for an undisclosed sum. This bolstered Newton's private client assets to $7.5 billion. In July 2002 it bought HBV Capital Management, a London- and New York­based hedge fund firm with $530 million in assets.

Given the dismal state of the money management business, Klinck should have more chances. An investment banker estimates that as many as 20 London-based firms could be had for a reasonable price these days.

Klinck is a naturally cautious buyer, says another banker specializing in fund management. "You can't sell him dreams," he reports. "He's interested in the financials. Still, there are some opportunities that would have dovetailed with his business that he has missed." Klinck and Mellon still have time to get it right.