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Despite its parent's woes, Threadneedle is thriving. Might the good news inspire Zurich Financial to cash out?

Despite its parent's woes, Threadneedle is thriving. Might the good news inspire Zurich Financial to cash out?

By Andrew Capon
January 2003
Institutional Investor Magazine

Most of Zurich Financial Services' global outposts are besieged. One exception is its midsize money manager, Threadneedle Investments, which is flourishing in the midst of a tough market.

Through November Threadneedle, with total assets of £45 billion ($70 billion), reeled in £2 billion in institutional mandates and £1.5 billion in net new retail accounts while many of its rivals suffered outflows. Credit strong performance, solid marketing and an effective and occasionally outspoken CEO, Simon Davies, 43, an Oxford University graduate who joined the company as chief investment officer back in 1995.

"At the end of the day, the business is all about a successful investment process that delivers results. If your investment process is drivel, you don't have a business," says Davies, whose staff of 854
includes 102 investment professionals, with 69 designated as fund managers.

The group's success provides a welcome relief for Zurich Financial, which announced aftertax losses and special provisions of $2 billion for the six months ended June 30, despite an 18 percent rise in gross written premiums, to $20 billion. To take advantage of firming rates in property/casualty insurance, Zurich, which has a market capitalization of $15 billion, was compelled in October to issue a rights offering worth $2.5 billion at a 50 percent discount to its share price -- a humbling but an unavoidable exercise.

Some investors and analysts speculate that Zurich may yet decide to sell off Threadneedle and estimate that the business would command a price above £450 million, or better than 1 percent of assets under management. In April the insurer dumped its much larger money management unit, troubled U.S.-based Zurich Scudder, which Deutsche Bank picked up for $2.5 billion, a relatively modest 0.9 percent of assets.

CEO Davies has heard the periodic rumblings of a sale, but says he is not distracted by them. "I can't do anything about the speculation," he says. "But I am unaware of losing a single potential client because of it. If we continue to deliver investment performance, we will thrive as a business. Everything else stems from that."

Performance has been strong throughout Threadneedle, whose assets are 74 percent institutional and 26 percent retail. (The firm currently sells its retail funds in Austria, Germany and the U.K., and will soon market them in France and Switzerland as well.) Of the firm's assets of £45 billion, £23 billion is in equity, £16 billion is in fixed income, £3.5 billion is in real estate and £2.5 billion is in cash.

Although many money managers are content to be placed in growth- or value-style boxes, Davies resists categorization. In their equity portfolios Threadneedle stock pickers can move from growth to value as they see fit. "It used to drive consultants up the wall, but now they see the value of being flexible in the performance we have delivered," Davies says.

Threadneedle deploys a team approach in its investment process. "We believe collective thinking is the best sort of thinking," says Davies. However, the structure also ensures that individuals take responsibility. For example, in U.K. equities one fund manager is responsible for a top-20 list of stocks with recommended weightings, another for a broader approved list. Threadneedle is also in the right part of the retail market at the moment. It concentrates on selling its funds through independent financial advisers. That top end of the retail business has proved more resilient to the bear market than self-directed investors have.

Among the firm's strongest performers is the flagship £8 billion Allied Dunbar Pension Managed Fund, the largest in Threadneedle's stable. The balanced fund ranks in the 13th percentile among U.K. balanced pension managers tracked by Standard & Poor's. The rating agency puts the performance of Threadneedle's fund family second only to that of Fidelity Investments in the U.K. In Germany the funds' returns lead those of the firm's peers, according to a survey by independent financial adviser Feri Trust.

"We rate Threadneedle highly," says Meera Patel, a senior analyst at Hargreaves Landsdowne, a Bristol-based independent financial adviser. "It has a good product offering in all the core areas."

Threadneedle is the product of the merger of the investment divisions of Allied Dunbar and Eagle Star, U.K. insurance companies that were acquired by Zurich in 1994. Paul Manduca, then head of retail at Henderson Investors, took charge as CEO of the new money management division that year.

A year later he recruited Davies from Gartmore Investment Management, where he had run the international equities division during a particularly strong period for the firm. Davies became Threadneedle's chief executive in 1998 when Manduca left to join Rothschild Investment Management. (Manduca became Deutsche Asset Management's European CEO last month.) Davies set out to bring in new assets -- and did.

The bulk of Threadneedle's assets come from Zurich's insurance funds as well as from funds that are marketed through the insurer or its subsidiaries. But on Davies's watch Threadneedle has pulled in an impressive £10 billion from outside sources, half from pension accounts and half from retail customers.

Threadneedle was helped by the fact that it was the first British investment house to set up open-ended investment companies, or OEICs, in 1998. Because these funds can be easily registered in other European countries while traditional U.K. unit trusts cannot, Threadneedle was able to make new sales while keeping its costs down. "All we have to do to sell into France is hire a sales team and put some French-speakers into our call center," says Davies.

If its assets were stripped out of Zurich Financial, Threadneedle would stand about 50th in Institutional Investor's ranking of Europe's biggest money managers. Although it sells in just three countries, the money manager ranks in the top ten in cross-boarder European retail sales in 2002, averaging net fund sales of E148 million ($152 million) per month, according to Feri Fund Market Information, a London-based subsidiary of Feri Trust.

Threadneedle's institutional business is flourishing as well. Among defined benefit plans the firm has recorded some notable wins, including a £205 million U.K. equities mandate from the Bath and North East Somerset Council pension fund. Pensions manager Tony Worth chose Threadneedle because of its track record. Its brief: to outperform the FTSE all-share index by 2 percentage points a year for three years, net of fees.

In the defined contribution market, Threadneedle won over more than a dozen new clients in 2002. The highest-profile recruit is U.K. retailer Marks & Spencer, which closed its defined benefit plan to new members last year. Although its new defined contribution plan currently has next to nothing in assets, it is expected to grow to become one of the U.K.'s largest.

Davies has been bringing in new talent as Threadneedle's assets have grown. This summer the firm hired Mark Holden from ABN Amro as a fund manager in its U.K. equities group, Charles Franklin from Deutsche Asset Management to head Japanese equities and Christopher White from Legg Mason to head U.K. income funds.

"You need new blood to challenge what you do and how you do it. Your biggest enemy in this business is complacency," says Davies. "BMW makes good cars, but if it rested on its laurels, its competitors would quickly catch up."

Like many money managers, Threadneedle has recently joined the rush to offer hedge funds. It has introduced two long-short funds, Crescendo UK and Crescendo Europe, which now have a combined £650 million in assets. The European hedge fund was launched on September 1, 2000. In 2002, through November, it had returned 4.75 percent in euro terms; since inception it has returned a cumulative 20.2 percent. The U.K. hedge fund opened for business on June 1, 2001. Last year through November it returned 10.01 percent in sterling terms; since inception it has returned 32.9 percent. Both funds are closed to new investors.

The Threadneedle CEO doesn't believe that the new hedge fund presence will damage the team ethos he has fostered. "No one gets through the door if they don't believe in working in a team," he says. Patel at Hargreaves Landsdowne thinks this team approach is one of the firm's strongest points. "It always concerns us when fund managers leave a company, but at Threadneedle we are less concerned because of the collective decision making," she says.

As he assesses his firm's competitive position, Davies feels comfortable with Threadneedle's midsize stature. Back in 1995, he recalls, Goldman, Sachs & Co. published an influential report on the asset management industry that argued that a firm could only succeed as either a small, nimble boutique or as an enormous behemoth. "That was utter rubbish," Davies says. "I bet many of the firms that rushed into acquisitions regret it now."

Although he enjoyed his years as a portfolio manager, Davies does not miss the rush of daily stock picking. From time to time, however, he'll make an appearance on the investment floor of the firm's City offices. "I enjoy the occasional rant," he says.