Star-crossed

Just three years after State Street Corp. barreled into the ultrahigh-net-worth game, the Boston-based indexing giant may be heading for the exit.

State Street, with total assets of $788 billion, paid a hefty $217 million in February 2001 for a 75 percent stake in Bel Air Investment Advisers, a Los Angelesbased firm whose clients include such Hollywood stalwarts as Barbra Streisand and Sylvester Stallone as well as more-than-comfortable businessmen like former Chrysler Corp. chairman Lee Iacocca. Three months later the Boston bank recruited a high-net-worth money management team from rival State Street Research & Management, which it named the Professionals Group and later folded into State Street Global Advisors’ private client business.

Now, though, State Street is bailing. In late June, it agreed to sell its $11.5 billion-in-assets Private Asset Management business to U.S. Trust Corp, a unit of Charles Schwab Corp., for $365 million. Bel Air could be next, sources outside the firm report. Neither Bel Air nor State Street would comment.

Bel Air’s $3.7 billion in assets under administration remained flat from the end of 2000 through the first quarter of 2003. That’s a pretty good performance in extremely difficult markets, but all ultrahigh-net-worth specialists are grappling with margin pressures. Operating margins at many of these private client firms have dropped from about 35 percent at the market peak in 1999 to somewhere closer to 10 percent today, say experts. Although he won’t discuss specific margins, a Bel Air spokesman concedes that they have fallen considerably. A key reason: a flip-flop in asset allocations. The average Bel Air client now keeps much more of his or her portfolio in bonds, whereas the lion’s share of assets were in stocks back in 1999. Fees on fixed-income management run about half those of equities.

Bankers reckon that Bel Air would now sell for considerably less than State Street paid. The steep decline reflects not only Bel Air’s reduced cash flow but also the steep price State Street paid for the boutique. The price came to 7.8 percent of assets, compared with about 4.3 percent for comparable high-net-worth managers at the time, according to David Silvera, who does mergers and acquisitions for Rosemont Investment Partners, a West Conshohocken, Pennsylvaniabased private equity firm that focuses on asset management.

“State Street paid too much for a growth story that never materialized,” says one investment banker.

What’s more, about six months after the deal closed, its champion, State Street vice chairman and State Street Global Advisors chairman and CEO Nicholas Lopardo, retired. As a result, the merger lost a key advocate just as operating conditions were deteriorating.

The Boston money manager hoped to build out a national presence in ultrahigh-net-worth asset management. New franchises would borrow from Bel Air’s approach, which emphasizes “high touch” services for its clients and preservation of assets rather than aggressive growth. The asset manager has 265 clients, who have an average account size of $14 million. Bel Air manages about 83 percent of its assets, with the rest in commission-based accounts.

The acquirer’s strategy rested on the creation of a powerful brand built on the celebrity of Bel Air’s Hollywood clientele and the fame of athletes for whom State Street provided similar wealth management services. In turn, the high-end boutique thought State Street could help it broaden its product line to include alternative investments and provide technological help in upgrading its systems.

Building out an ultrahigh-net-worth franchise, though, was never central to State Street CEO David Spina’s larger strategy to bring the financial services giant back to basics -- focusing on indexing and custody in a trying environment. Bradley Moore, an analyst at Putnam Lovell NBF Securities, estimates that the money manager’s operating margins slumped to 23 percent in the first quarter of 2003, compared with 29 percent a year earlier and 28 percent in the first quarter of 2001. State Street’s net income fell 46 percent in the first quarter year-over-year. Spina has already bolstered State Street’s commitment to the custody market. In January the bank paid $1.5 billion to buy most of Deutsche Bank’s Global Securities Services businesses. In December 2002, as part of his effort to jettison noncore operations, Spina sold State Street’s $689 billion-in-assets corporate trust business to U.S. Bancorp’s U.S. Bank for $725 million.

State Street’s sale of its Private Asset Management business, which serves clients with more than $2 million in investable assets, further tightens the bank’s institutional focus. For New Yorkbased U.S. Trust, the acquisition of the Boston-based business will broaden its distribution in New England, a major wealth market where it lacks a strong presence. The deal is expected to close in the fourth quarter

If State Street unloads Bel Air, it would hardly be the first time that a high-net-worth acquisition has soured. Charles Schwab’s $2.7 billion purchase of U.S. Trust Corp. in June 2000 proved disappointing when hoped-for synergies didn’t materialize (Institutional Investor, December 2002).

Unlike U.S. Trust, which has been in the private client business for decades, Bel Air is a young firm. Senior managing director Todd Morgan founded Bel Air in December 1997 after leaving Goldman, Sachs & Co., where he was then a limited partner. Morgan had set up Goldman’s Southern California high-net-worth investment advisory business in 1991; six years later he persuaded two members of his Goldman team to join him in his start-up. His brother Thomas, a 12-year Goldman Sachs veteran who six months earlier had taken a job as a senior vice president at Lazard Asset Management in New York, joined as well. Bel Air set up shop in a suite of offices in the Century City area of west Los Angeles, with panoramic views of the Pacific.

“For many of us it had been a long-term dream of building and creating our own business in an image that we had fantasized about,” says Todd Morgan, who agreed to speak with II about his firm’s history and operations but not about rumors of its sale.

High net worth has always been a high-touch business based on personal contacts and connections, and over the years Morgan has grown the client roster by word of mouth. He also serves on the prestigious board of directors of Cedars-Sinai Medical Center.

Morgan started Bel Air with a modest base of former Goldman accounts (among them Streisand’s and Geraldo Rivera’s). About 25 percent of Bel Air’s clients come from the entertainment industry, with the remaining 75 percent made up of business owners, high-level executives and old-money families.

State Street’s Lopardo first heard of Bel Air when he saw a sales prospectus Goldman Sachs investment bankers had distributed. Lopardo visited Bel Air in the summer of 2000 and met Morgan for the first time. “It was a formal meeting, and I thought that he wasn’t that interested and that they’d never be the people we’d pick in the end,” says Morgan. “We grew on each other.”

Lopardo spun an appealing tale: State Street would offer Bel Air the chance to take its show on the road, opening new offices, signing new clients, using State Street capital to recruit new teams of portfolio managers. “They offered us a great range of possibilities to expand,” Morgan recalls.

Lopardo was highly regarded for his role in building State Street Global Advisors into a pension industry behemoth. He hoped, says a source who worked with him, that he would prevail against Spina, president and COO of State Street Corp., and replace Marshall Carter as CEO of the holding company when Carter stepped down in 2000. But in May, Spina got the job. (Lopardo, who now runs an investment holding company, Susquehanna Capital Management in North Reading, Massachusetts, declined to comment.)

Although Spina wanted to focus the bank on custody and indexing, he agreed to let Lopardo close the deal with Bel Air in February 2001 because of Lopardo’s sterling track record and the lure of the high-net-worth business. “Private asset management represents an enormous opportunity,” Spina said at the time.

Lopardo, say sources, hoped to create a new buzz for the high-net-worth division by leveraging the famous names of Bel Air’s clients and those of State Street’s Professionals Group, which had total assets of less than $50 million before it was folded into State Street’s private asset management business. Led by former Boston Bruin hockey player Derek Sanderson (II, February 2001), it catered to wealthy professional athletes.

In August 2001, Lopardo turned 55 and decided to retire. When he left at the end of that month, it effectively marked the demise of State Street’s high-net-worth strategy. Says Morgan: “Lopardo was the guy who shared our vision. He wanted to make us global. We figured he could help us execute.”

The State StreetBel Air expansion never got too far. Bel Air opened only one new office, in Minneapolis in 2002, with two marketing executives who have helped bring in a respectable 7 percent of total assets under administration.

If State Street is indeed selling Bel Air, the recent stock market rally may help the bank fetch a higher price. Even so, Morgan remains in an enviable position to do a management buyout. He sold Bel Air at a premium. Now he may try to buy it back at a much-reduced price. “Todd could be a double genius,” says one source.

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