MSDW breeds new runner in the fund management stakes

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By:
Julian Marshall
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Almost four years after its merger with Dean Witter, Morgan Stanley's new-look asset management division is finally taking shape under Mitchell Merin. Bringing the cultures of disparate investment houses under one roof has involved asking headstrong individuals to embrace a team ethic. The new beast may have the potential to achieve its aim of being the world's number one fund manager in all asset classes. Even Europe and Asia, which have so far resisted its advances, could yet succumb. However careful jockeyship will be required to keep star managers happy and the charge on course. Later this year the Morgan Stanley name will oust Dean Witter yet it is Dean Witter alumni who hold the key positions, both in the investment division and in the Morgan Stanley Dean Witter group at large where internal divisions have started to surface. Merin and his team talk exclusively to Julian Marshall

A man on the move says it’s good to talk
After trying to be in four places at once, Morgan Stanley’s chief investment officer, Joseph McAlinden, is looking forward to moving to a permanent base, on the Avenue of the Americas.

The foreign language challenge for New York
Morgan Stanley is making its latest attempt to woo UK institutions with the launch of its new multi-asset-class product.


From his office on the 66th floor of Two World Trade Center, Mitchell Merin has a good view on the world. Beyond downtown Manhattan, the Statue of Liberty and Ellis Island offer inspiration to the head of Morgan Stanley Dean Witter’s asset management business, should he need it, as he contemplates just how far he has brought the business and where its future lies: outside America.

Late in 1998 Merin was made president and chief operating officer of the group’s asset management division and handed the task of unifying a four-pronged business. It comprised Dean Witter’s and Morgan Stanley’s funds, together with the Miller Anderson & Sherrerd and Van Kampen houses, which Morgan Stanley had bought not long before the Dean Witter merger.

Merin was not blind to the complexities of the task in front of him, having been one of Dean Witter’s architects in the merger.

The laws of economies of scale dictate that having four separate businesses doing roughly the same thing is a waste of resources. It is only common sense to bring them together.

Against that, it can be argued that four into one doesn’t always go.

Merin set his mind to building a new united investment platform which would consolidate MSDW’s powerful position in the US funds market and furthermore enable it to step up efforts to grow in Europe and Asia.

       

At the same time, building the business would help to boost asset management’s standing within a group dominated by its high-profile investment banking and securities businesses and which also had a thriving credit card division.

One former Morgan Stanley insider says that a clear illustration of the relative importance of asset management within Morgan Stanley Dean Witter comes from a recent off-site meeting of senior MSDW executives. “Out of about 80 to 100 people only Mitch Merin and Dick Powers [global head of sales and marketing] were there from asset management,” he says. “I think that gives you some idea of where it comes in the pecking order.”

Outside observers also feel asset management suffers by comparison with the securities business. “I think it is fair to say that they are the second-class citizens but they are working hard to address that,” says a leading investment consultant in London. “Historically Morgan Stanley has neglected [asset management] when you compare it to its massive impact in other areas of financial services.”

Merin concedes that on this point the only way is up. “We contribute about 10% of the profits of the overall enterprise and from my standpoint I would like to see that grow,” he says.

On paper he has the backing of Philip Purcell, MSDW’s chairman, who has stated that he wants the investment division to take a greater share of the business. However a source from the old Morgan Stanley asset management operation says former MSDW president John Mack’s recent departure has not helped its status in the group.

“Mack was a real catalyst for the growth of the business,” he says. “He wanted to push it up from around 8% to 25% of the group’s revenue,” he says.

Merin’s cause, he adds, has been made that much harder by the bull market of recent years, which, while undoubtedly helping to grow assets under management, has more dramatically boosted income for the investment bank. “Securities trading has been leaping up by 30, 40, even 50% so it’s hard for the other parts of the business to keep up,” says the source. Nevertheless, the funds division’s figures look good. The group has $502 billion under management and reported net income of $683 million last year, a 52% rise on 1999.

Shareholders like asset management. It provides steady, solid earnings, unlike the racier ups and downs of investment banking and it may be partly for this reason that Purcell has been making the right noises about building the business. However doubts remain among some industry watchers as to whether he has the same enthusiasm as, say, Merrill Lynch’s David Komansky or Goldman Sachs’ Henry Paulson for making this happen.

If the business is going to grow dramatically then it must start to make real inroads into the European and Asian markets, on both the institutional and retail sides.

Playing international catch-up
Merin admits that in building up the international business, MSDW has some catching up to do on the competition. “Historically the focus principally has been domestic and retail,” he says. “Until two years ago, we did very little in retail outside of the US, except to sell to the third-party distributors – and that business was handled in the institutional, Morgan Stanley Asset Management area. Once they committed to that business in 1997 and first put resources in it, they dramatically grew assets.”

Indeed, analysts have the impression that MSDW is proud of its position in the US market, particularly in proprietary retail, which was built out of Dean Witter’s operation, and still sees that as being where its bread is buttered.

“Prior to the merger, through Dean Witter Intercapital, we built a 50% share of the proprietary fund business in the US,” says Merin. “We built something that was extraordinarily profitable, that did very well for its clients.” This came by focusing on mutual funds and the sales force – “something our competitors only started doing in recent years while we’ve been doing it since the early 1980s”. Merin adds that concentrating on asset allocation was another area where the firm stole a march. “Again it’s something which is de rigueur now but things were very different when we started. Most companies focused on stocks and bonds and selling them based on research. We were looking at the baby boomers who were coming of age and realizing that there was a lot of money that was going to come into the marketplace, that mutual funds were the product of the future, in terms of being able to develop a tool for investors to use, and then looking at asset allocation. We really attacked that market.”

Growing this part of the business had a big impact on profitability. Retail investing commands higher management fees and most of the group’s profits come from this area.

Merin is acutely aware of the need now to grow overseas. To date, though MSDW has scored some successes in Europe and Asia, it has yet to make a real splash. Indeed, the firm is somewhat vague about the total assets it manages for non-US clients. Although most global firms are happy to declare the sourcing of their funds, Morgan Stanley instead claims it is a truly global player because it invests in markets all over the world. But then, which big investment manager doesn’t?

“We consider ourselves global because, unlike many other firms, we have investors who invest on a global basis and we create products on a global basis. Many other firms can’t make that comment,” says Merin. “Yes, we’ve got more assets in clients’ hands in the US, but I think we’ve done a pretty admirable job in increasing the level of assets between 1997 and 1999 when we first focused on it.”

Merin estimates that there is about $20 billion of overseas client money, putting it a long way down the list among its peers, but he has no doubts about his strategy. “Future goal? To grow that business, grow it at a higher rate than the domestic business and eventually, in a three to five-year time frame, have it be a substantial portion of the overall business.”

He sees both Europe and Asia as offering great opportunities to the firm, but will not neglect its traditional strengths. “We want to grow in the US and continue to grow at above market rates but we want to take advantage of the new opportunities overseas and capture a major share of those markets too,” he says. “We’d like to see ourselves having similar shares overseas as we do in the US.”

Olympian ambitions
Joseph McAlinden, chief investment officer, who has been directly responsible for drawing up the new-look investment house (see box) underlines Merin’s stated ambition. “We want to be best in class,” he says. “We want to be the country that goes to the Olympics and wins gold medals in all the major categories and I think we can do that because we’ve got economies of scale.” This is the key, he adds. “You can’t do it without scale. A small or mid-sized money manager has to be a one- or two-trick pony and that’s it.”

Of course small and nimble operations will thrive in the short term and be able to beat the competition, he says, but their success will only be short-lived. “You have managers that will come out of nowhere. They will have a small, say five-person, shop. They will beat everybody in a style for five years running and then blow up and disappear. It happens over and over again,” says McAlinden. “Then you have proven winners in the business, many of which have grown organically and which serve clients in a wide array of product areas. I think it’s fairly clear that it requires scale to be able to do that on a global basis.”

The benefits will soon be clear he argues, particularly on the international side of the business which has to date not received the attention of the domestic operation.

“If anything, the international equity piece will grow faster in head count and assets under management than the US equity piece,” says McAlinden. “We want to be the first choice for anybody looking for asset management anywhere in the world. We want to be able to sit down with Aunt Molly or a major Asian government or a big Dutch insurance company.”

Of course, in seeking to expand its international business, MSDW could have taken the short cut that competitors have taken, namely to buy a business.


Merin: believes the future lies outside of the US

The most high profile example of this strategy came from Merrill Lynch, which paid out £3 billion for Mercury Asset Management in 1997 and overnight got market share in Europe.

MSDW has not been completely quiet in this regard. It took over Spanish group AB Asesores in 1999 and is in the process of acquiring the Quilter private-client business from the UK insurer for £170 million.

A bigger splash
However, neither of these acquisitions made the splash in the market that the Mercury deal did. By contrast, Morgan Stanley pre-merger, under Mack and former chief financial officer Phil Duff, showed a taste for pursuing an acquisitive strategy in the US when it took over the institutional house of Miller Anderson & Sherrerd and the mutual funds business of Van Kampen.

It has considered making larger acquisitions in Europe and looked at the possibility of buying Mercury when it was still part of SG Warburg before Merrill Lynch did. However, it wasn’t able to find common ground with Mercury’s business heads, Carol Galley and Stephen Zimmerman.

Now there is nothing of significant size available to buy in Europe, except Schroder Investment Management, whose chief executive, David Salisbury, has stated his fierce desire to preserve its independence.

Merin does not rule out further purchases but agrees that there is not much in the market. “There hasn’t been that kind of opportunity that you could say made economic sense,” he says.

If there is any hint of regret at missing out on Mercury, Merin is not letting on. “We will follow the same strategy we have been following which is to look at it market by market, country by country and then determine what the best approach is for each country,” he says. “So you can see a combination of strategies as we’ve had already, a combination of organic growth and acquisition to get to our goals.”

As part of its new attitude towards growing the international business and in order to fit in with the group’s new identity, the Dean Witter name is shortly to disappear.

Executives are vague as to when exactly this will happen but certainly by the end of 2001 the Morgan Stanley brand will dominate.

“The Morgan Stanley brand is going to be the global brand,” says Merin. “It will happen in the near future.” This is a logical step, as outside the US Dean Witter is almost unknown while the Morgan Stanley name has a certain cachet and degree of recognition.

At the same time the group is set to up its advertising and marketing to spread the name. Outside of the financial services arena, Morgan Stanley is most likely to be known for its credit card than its fund management.

“The brand itself in the retail arena is not well known,” says Merin. “We have a respected institutional brand and it’s one we need to grow.”

As part of this strategy, Richard Powers, chief sales and marketing officer, says the asset management operation will seek to build on the brand awareness that Morgan Stanley has so far achieved through its securities business and the credit card.

Above all, he is keen to stress a desire to meet customers’ requirements. “The customer is king today,” he says. “Like never before the customers get what they want in product depth, when they want it. They can buy it morning, noon and night and they can buy it internationally.”

This provides fund management companies with a challenge, he says but will also play into the superior players’ hands as it will help to distinguish the front runners from the also-rans. “If you have a strong platform, and you can take that platform and be able to deliver to the customer the type of customization they want, then that can allow us to be where we want to be – the customer’s first choice.”

Powers says commitment to the customer is a mantra across the company, not just in the asset management division. “We are getting away from how this industry used to think, which was supply push versus demand pull. We are no longer thinking about products.”

A new world of client service
Pushed on this subject, Powers cannot resist the vernacular of the marketing chief. “I’m trying, going forward, not to ever use the word ‘product’ again,” he says. “And I’m doing that because I’m trying to challenge our folks here to say: ‘We’re in a new world and it’s about serving the client’.”

It’s the kind of talk often heard at fund management groups these days. It also marks something of a change for the group. When Dean Witter Intercapital delivered the right products to the right customers, it made a lot of money. Powers knows that what will sell the business, above all, is performance. “In the same way as real estate talks about location, this business is about performance, performance, performance. It’s about always trying to meet customers’ expectations.”

To this end he can draw on ratings offered by Morningstar, which ranks 65 of the group’s funds in the four and five-star tiers.

Powers is ready to concede that from its US headquarters, Morgan Stanley needs to get to grips with the complexity of trying to develop its international business. The countries of Europe and Asia, with their wide variety of cultures, languages and regulations each present unique difficulties. Powers feels the group has the performance track record necessary to impress new clients, but that it still has work to do on how it sells itself abroad.

“Branding we have to look at and understand,” he says. “The concept will be taking this platform and customizing it, country by country. I know that’s a rather top-down approach to it but that’s how we’re going to go about it.”


Merin, McAlinden and Powers: architects of the new business
If there is a hint of the ivory tower about this then Powers is aware of the problem, though the details are still being worked out. “We have a client task force here,” says Powers. “We meet every month and we are now addressing the international aspect of branding.” He believes that the firm has a head start because of Morgan Stanley’s renown. “We have an outstanding quality name and reputation throughout the world so we have a great place to begin from.”

Beyond the issue of branding, there is also the question of fees to consider. If the Vanguard group is at one end of the spectrum with its straightforward, low cost approach to marketing funds, Morgan Stanley has placed itself at the other. Its high-quality research costs money, say consultants, and that is reflected in its fee structure though, again, the firm argues that performance is key and results speak for themselves.

“Our research shows that fees are less important if you have developed a positive relationship with the customer,” says Powers. “It’s about helping them achieve their financial aspirations. Yes, there are lots of ways that people can buy things cheaper, but it may not be the best solution for them.”

So, with the investment platform in place and with marketing strategies now under review, things look set fair for the new operation.

Merin, Powers and McAlinden can justifiably present the new Morgan Stanley they have built over the past couple of years as a better organized operation than when it was four separate businesses.

However, all cannot be said to be completely rosy in Morgan Stanley’s garden. Mack’s sudden and unexpected resignation in January was followed the next day by the departure of the head of the private-client business, Richard DeMartini, who left to head Bank of America’s asset management operation. The lure of running his own business could undoubtedly be used to explain the move. And yet people who know him say he was frustrated in his old job.

A former colleague of DeMartini and Mack, says both saw little future for themselves within the new Morgan Stanley.

Assets under management sourced from European clients ($bn)

Merrill Lynch $140
Fidelity$110
Goldman Sachs$50
Morgan Stanley$20
Figures are recent estimates provided by the fund managers
“When Mack and DeMartini decided to go, it made public what has been happening and it was only a matter of time,” he says. “If people thought that John Mack was ever going to be number one, they should have known it was never going to happen.”

DeMartini, for his part, had a difficult time trying to build the international private-client business, says the source. “It was a fairly thankless task for him, trying to build that business. When you’re starting from scratch you have to put an awful lot of work in to start with and you may not see any reward for quite some time.”

Above all, he says, senior Morgan Stanley figures started to feel the Dean Witter culture taking over, prompting a reassessment of their future in the new business. “For my part, and for one or two others, we felt it was time to look for other opportunities,” he says.

The root of this lies in the differing cultures in Morgan Stanley and Dean Witter. “If you look at where Morgan Stanley came from it was a partnership,” he says. “The idea was: hire the smartest people you can find and then let them do their thing and it worked pretty well. The Dean Witter model is much more of a command and control from the top down approach.”

Clipping the wings of portfolio managers, who often hold a high opinion of their own abilities, could be a sure fire way to prompt an exodus, he cautions.

Yet Merin and McAlinden both stress that they do not want to curb fund managers’ instincts. McAlinden insists that they are given the go-ahead to make their own decisions. “I do not believe in micro management,” he says. “Nobody gives them approved buy lists. They run the money using the styles that have worked and are proven but what we will increasingly be doing is sharing fundamental information, looking for an edge, negotiating better deals with vendors.”

McAlinden is seeking cultural nirvana. “I have been given this job because there’s the hope that I will be able to find a common culture which will keep all these people communicating and working together but still delivering their style in the best possible way.”

Trying to define a company’s culture is always likely to produce psychobabble and mission statement mumbo-jumbo. McAlinden attempts to talk straight. “Our goal when we get up in the morning and come to work is not to make money trading on our own accounts, it’s not to get paid for executing an order,” he says. “We’re not stockbrokers, we’re not traders, we are stewards of other people’s money and our goal is to deliver the best returns at the lowest risk customized to the particular accounts, and to do nothing else.”

No place for lone rangers
Those who know the business say the old entrepreneurial spirit of Morgan Stanley has been reined in by Dean Witter’s desire for control. Indeed, Thomas Bennett, head of global fixed income, says rampant individuality is unlikely to thrive in the new world order. “If you want to be a lone ranger then you probably wouldn’t select our group as the place where you want to work,” he says. “The team culture is pretty deeply embedded.”

Of course, that may be no bad thing. The Dean Witter approach may have gained extra currency as a result of the embarrassing losses of one Morgan Stanley manager, Paul Ghaffari, during the emerging market debt crisis of 1998.

Bennett, originally from the Miller Anderson & Sherrerd division, was asked to tighten up the investment process after Ghaffari, the former head of emerging debt, lost more than $200 million in the wake of the Russian crisis.

Ghaffari, who ran the Morgan Stanley Emerging Markets Debt Fund and Morgan Stanley Global Opportunity Bond Fund, resigned shortly after MSDW was forced to step in to meet margin calls for one of his highly leveraged funds.

Morgan Stanley’s response was to bring the emerging debt team to heel. Having previously been out on its own, it was now pushed in with Bennett’s high-yield group. An insider was reported at the time as saying that the move was designed to “take a team approach to portfolio management rather than the views of one individual”.

Today, Bennett will not criticize Ghaffari but says that 1998 was difficult for everyone. “In 1998 lots of things underperformed, not just emerging market debt,” he says. “Corporates in general, mortgages suffered, spreads blew out, there was a shock to the financial system and there were a lot of stresses and strains. But obviously, emerging markets were the most noteworthy part of that.”

He says bringing the emerging-markets team into the fixed-income group was a natural progression. “Years ago we had begun to collaborate with our emerging markets colleagues about how we might more fully integrate emerging corporate credit risk with our high-yield team and how we might work together,” he says. “The emerging markets sell-off really fostered closer co-operation.”

The changing nature of the markets has also made it a more logical move, he argues. Emerging debt used to be more closely aligned to emerging equity, but now it makes sense for it to be a part of the overall fixed-income effort. Bennett says they can make more use of their research team while also putting in place better risk controls.

Loose control of risk helped contribute to the investment problems but other factors were also at play. “The emerging market debacle in 1998 was a wake-up call for investors. There were big markets where two or three credits were hugely important,” he says. “The events of 1998 really reinforced to us and our clients that diversification is important.

People got hit by the systematic risks, which were higher than they thought, but people also tended to have more concentrated portfolios.”

       
Powers: "The customer is king"

With the market including Argentina, Brazil, Mexico, Venezuela and Russia, five credits made 90% of the universe. Managers were compelled to concentrate their investments for fear of missing out and underperforming. This has happened in other sectors and asset classes, as was shown by the rush to the technology sector.

“Clients that care about risk and volatility have asked themselves if they have the right sort of risk controls in place,” says Bennett. “It has given us conviction in our diversification efforts.”

His final word on Ghaffari’s style of investing leaves a strong clue as to the new investment regime at Morgan Stanley. “Before 1998 [emerging debt] reported to someone who managed it with a different philosophical approach,” says Bennett. “Post ’98 it has been fully embraced and brought into our standard fixed-income approach.”

Although Ghaffari was allowed to resign, rather than being pushed, it seems his losses were too much for the group to bear.

“Our business is Darwinism,” says Bennett. “If you do it well you get more responsibility and if you don’t, you do some other things. We’ve got a large, successful, mature fixed-income business where we discharge our responsibilities fairly well. It’s also the case that as the emerging markets grow and mature they become more fully integrated into the mainstream of fixed income.”

Ghaffari’s departure is believed by many observers to have undermined the position of James Allwin, the then head of Morgan Stanley Asset Management, who, a few weeks later in December 1998, announced he was leaving after 22 years with the firm. Allwin denied there was any connection to Ghaffari’s departure and said the business was “in great shape”.

This statement was backed up by Guy Moszkowski, fund management analyst at Salomon Smith Barney, who said Ghaffari’s performance had been a one-off and there were no hidden agendas behind Allwin’s departure. “Basically the business is doing very well,” said Moszkowski. “It really appears that what you see is what you get. Allwin really has decided he wanted to do something else.”

However, Allwin’s departure coincided with Merin’s promotion to head of the whole of the group’s asset management and the start of the process of bringing the businesses under one roof. A former colleague of Allwin says it lends more weight to the view that Dean Witter staff have been the real winners in the merger.

Merin says there is nothing sinister behind any of the departures or recent upheavals among the senior ranks at Morgan Stanley Dean Witter. He says Mack and Purcell enjoyed a good working relationship. “I watched those two guys develop a great relationship and really deliver on the promise of the merger,” he says. “Somebody had to be number two and John [Mack] agreed to do it and that was the thing that allowed the merger to go ahead in the first place. In mergers of equals it’s so much more difficult than an acquisition. In an acquisition one team goes away and the other team survives. In a merger of equals people have to come together.”

Merin argues that the company has gone from strength to strength since the merger. “There have been phenomenal increases in market share, the market cap is multiples of what it was at the time of the merger,” he says. “It’s really a changed company, it’s not what one or the other was separately. The business model has completely changed and the success has been for the shareholders.”

The management committee has changed dramatically and only three people on it at the time of the merger are still there now: Purcell, chief financial officer, Bob Scott and head of institutional equities, Vikram Pandit. “All the other people are new because there was a generational change and the business shifted to where it is again in strong hands with new leaders who are energetic and motivated and they’re a good team,” Merin says.

As for Mack, Merin believes he can take personal satisfaction from helping to build the new group. “John is going to do something else,” he says. “He leaves looking at the company and thinking the merger was a great thing and now he moves on to do something else.”

So is this the end of the growing pains caused by the merger? “I think we’ve been doing so well and we just have to look at it in terms of the track record of the company. There is nowhere in the company that you would feel that anything dramatic has happened because there are good people in all the businesses.”

From his downtown Manhattan office Merin is still tinkering with the new operation. He is working with John Schaefer, who handles global retail distribution, on who will succeed DeMartini as head of the private-client group, an important position given the growth of this market.

“If you look at our overall structure as a company we were until very recently split up so that in asset management we had the global institutional business and the domestic institutional and retail,” says Merin. “The international retail business was in a separate group and we’ve just in the past couple of weeks decided to bring all that back and to reunify the strategy, so we’ve had some aggressive growth programmes in place. What we need to do now is reintegrate the businesses, take a look at what the growth is going to be in overseas institutional, third party and retail businesses and consolidate. That’s something we’ll be much better equipped to tell you about in a couple of months.”

In other words, not everything is yet decided and Merin still has some tough decisions ahead of him. If he gets them right the rest of the industry may yet face some stern competition. Morgan Stanley has shown through the success of its investment banking business that it does not see coming second as an option.

However, in asset management it does not yet occupy such lofty heights. Rival business chiefs will not be suffering sleepless nights waiting for its new business push in Asia and Europe.

As a source at a rival US firm who once worked for Morgan Stanley points out: “They have still to convince on their international strategy. In 10 years time, we may all be calling them geniuses but they have a long way to go before that happens. It seems that now they are really trying to put the right products together and to get the distribution right. But it has taken time to get there and we’ve yet to see the big money coming in.”