Riding the Wave
Our inaugural Latin America Executive Team takes the region’s companies by storm
Too Big to Revive?
Housing problems threaten Moynihan’s turnaround bid at giant Bank of America
On the Rebound
Securitization shows signs of life, but low rates, new rules block a full recovery
NOVEMBER 2010 WWW.INSTITUTIONALINVESTOR.COM
Doing Well,
Doing Good
A new generation of fund managers finds that investing with a conscience can bring its own rewards. PAGE 37
RFK Center president Kerry Kennedy Follow Institutional Investor on twitter.com/ inst_investor
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SDOM THE FUTURIST THE CHARTIST
CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE
FEATURES
NOVEMBER 2010
50
58
54
COVER STORY
37 Doing Well,
Doing Good 38
42
THE INSTITUTIONS:
THE MANAGERS:
No Turning Back
Money from Trees
BY IMOGEN ROSE-SMITH
Influential institutional investors are changing the way they invest — for good.
BY KATIE GILBERT
Asset managers are finding an unlikely new source of alpha: responsible investing.
58
THE 2010 LATIN AMERICA EXECUTIVE TEAM
50
Latin America Leads theWay CAPITAL MARKETS
Unlocking the ABS Market BY CHARLES WALLACE
Securitized bonds may have helped cause the crisis, but their revival is critical to the recovery.
54
BY LESLIE KRAMER
Taking advantage of the region’s growth, corporate leaders are transforming their companies into world-class contenders.
BANKING
Can Moynihan Manage BofA? BY MATTHEW MILLER
The bank’s new CEO has smoothed relations with regulators, but housing problems loom.
VOLUME XLIV, NO. 9 • AMERICAS EDITION
Web institutionalinvestor.com
RESEARCH
WEB EXCLUSIVES
TECH TIP
Visit our web site for details of our annual rankings of the top asset managers in Europe and India.
Fran Hawthorne examines the funds that participants in defined contribution plans love the most.
Use your smartphone scanner app to read the latest hedge fund news from blogger Stephen Taub. COVER PHOTOGRAPH BY ETHAN LEVITAS
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WISDOM THE FUTURIST THE CHARTIST
CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOP
7
ETC
RESEARCH & RANKINGS
72
THE EURO 100
Subdued Spirits BY NEIL SEN
Market rebound lifts Europe’s fund managers, but profitability remains a tough challenge.
7
76
OPENING
Ticker Prop trading goes underground • U.S.-listed Chinese companies are homeward bound • Copal’s SG deal shows the appeal of outsourcing • Secondary private equity deals are surging • Five Questions For Felix Rohatyn • People Faces in Finance • This Month in Finance
THE INDIA 20
Margin Pressure BY NIRAJ BHATT
With fee changes stifling fund launches, managers must tout performance.
80
TRADING
Life in the Fast Lane BY JOHN AIDAN BYRNE
20 DONE DEALS
26 GREEN SHOOTS
BY NEIL SEN
BY FRANCES DENMARK
South Korea asserts itself with a hostile takeover of the U.K.’s Dana Petroleum.
Green ETFs have proved to be a tough sell.
22 MARKETS
28 ALTERNATIVES
Northern Seoul
PPIP, Hooray BY LESLIE KRAMER
Can the Public-Private Investment Program keep delivering outsize returns?
24 THE BUY SIDE CAPITAL
18
College Try BY FRANCES DENMARK
Schools enjoy success with endowment outsourcing. RAINMAKERS
Frequent Flier BY XIANG JI
Paul Weisbrich makes aerospace and other cross-border deals soar.
Color Barrier
Nothing Gained BY UDAYAN GUPTA
VC funds take the heat for a dismal decade.
30DEFINED CONTRIBUTIONS Pension Corner
BY MAUREEN NEVIN DUFFY
Plan sponsors are pushing workers to save more.
25 THE BUY SIDE
32CEO INTERVIEW
BY IMOGEN ROSE-SMITH
BY FRANCES DENMARK
Ex-Goldman quant Mark Carhart launches a firm.
Duke Energy’s James Rogers has nuclear ambitions.
Quick Study
5 Inside II 103 Inefficient Markets 105 Unconventional Wisdom 106 The Futurist 108 The Chartist
Nuke Power Corp.
To see the latest on these stories or provide feedback, visit institutionalinvestor.com
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STOCK EXCHANGE: DANIEL ACKER/BLOOMBERG
18
Amid the controversy over high frequency traders, costs trend lower.
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EDITOR-IN-CHIEF William H. Inman AMERICAS EDITOR Michael Peltz INTERNATIONAL EDITOR Tom Buerkle ART DIRECTOR Nathan Sinclair MANAGING EDITOR Thomas W. Johnson LONDON BUREAU Loch Adamson (Chief) ASIA BUREAU Allen T. Cheng (Chief) WEB MANAGER Barry Whyte WEB EDITOR James Johnson
WEB PRODUCTION/DESIGN Michelle Tom WEB INTERN Franziska Scheven SENIOR WRITER Frances Denmark STAFF WRITERS Imogen
Neil Sen
Rose-Smith, Julie Segal,
REPORTER Xiang Ji
SENIOR CONTRIBUTING EDITORS Firth Calhoun,
Nick Rockel
SENIOR CONTRIBUTING WRITERS Hugo Cox,
Katie Gilbert, Fran Hawthorne, Jonathan Kandell, Leslie Kramer, Scott Martin, Ben Mattlin, Craig Mellow, Virginia Munger Kahn, Rosalyn Retkwa, Cherry Reynard, David Rothnie, Harvey D. Shapiro, Henry Scott Stokes, Paul Sweeney, Stephen Taub SENIOR EDITORS Tucker Ewing, Jane B. Kenney (Editorial Research) ASSOCIATE EDITORS Denise Hoguet, Fritz Owens (Editorial Research)
COPY EDITORS Monica Boyer, Ruth Hamel,
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EUROMONEY INSTITUTIONAL INVESTOR PLC CHAIRMAN Padraic Fallon DIRECTORS Sir Patrick Sergeant, The Viscount
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INSTITUTIONAL INVESTOR, 225 Park Avenue South, New York, NY 10003; (212) 224-3300; Fax: (212) 224-3171. www.institutionalinvestor.com London Bureau: Nestor House, Playhouse Yard, London EC4V 5EX, U.K.; (44-207) 303-1703; Fax: (44-207) 303-1710 Hong Kong Bureau: 27/F, 248 Queen’s Road East, Wan Chai, Hong Kong; 852-2912-8030; Fax: 852-2842-7011 © 2010 Institutional Investor, Inc. (ISSN 0020-3580) No statement in this magazine is to be construed as a recommendation to buy or sell securities. Neither this publication nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without the prior written permission of Institutional Investor magazine. For reprints and Web links, contact: Dewey Palmieri (212) 224-3675; Fax: (212) 224-3563; e-mail:
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Mort est mort BUSINESS WAS GOOD. BUSI-
ness was death. Alfred was a master of the business. He invented propellants for rockets, explosives for bombs, and guns that could shatter cities. He thought of himself as a good person who happened to be doing well financially. That illusion exploded when he read his premature obituary in a French newspaper: “Le marchand de la mort est mort” (The merchant of death is dead). The inventor, it stated,“became rich by finding ways to kill more people faster than before.” Not the legacy Alfred had in mind. He rewrote his will, using his great fortune from arms to establish awards for scholars in chemistry, economics, physics and medicine, as well as for practitioners of peace. Few know the origins of dynamite. Everybody knows the prizes named for dynamite’s inventor, Alfred Nobel. It’s a familiar and formidable challenge: finding ways to do good while doing well. In the aftermath of a market imploded by fraud, greed and corporate malfeasance, a handful of institutional investors are search-
ing for benefits loftier and of longer duration than those from the traditional (and quite legitimate) means of making money. Investors call this approach “ESG,” an acronym derived from ventures showing environmental promise, social soundness and high-principled governance. In this issue (page 37) we profile a cross section of ESG pioneers who are tilting against the conventional investment wisdom, in which profit considerations define the worthiness of capital propositions. Despite long odds, a gallery of skeptics and a field littered with failed idealists, a surprising number of these investors are making good money at making good.
A good man who rewrote a legacy of killing more people with greater speed.
— WILLIAM H. INMAN EDITOR-IN-CHIEF
[email protected]
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OPENING November 2010 News and views from the world of finance
Paul Volcker’s rule is likely to shift prop trading, not end it
VOLCKER: MARKO GEORGIEV/BLOOMBERG NEWS; NEW YORK STOCK EXCHANGE: DANIEL ACKER/BLOOMBERG
WALL STREET
poses a risk to big banks and thus to the financial system. Or has it? “We are not ending prop trading,” says Yale finance professor Gary Gorton. “We are just moving it. And the key question is, will regulators know where it has gone?” Maybe even more worrisome is what sort of entities will arise to do the prop trading that banks used to do. And are
PROP TRADING GOES UNDERGROUND IT’S TOO LUCRATIVE TO JUST ABANDON The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law in July by President Obama, appears to have put to rest any worries that proprietary trading — betting with the house’s money— INSTITUTIONALINVESTOR.COM
they likely to provide for a more robust American financial system than the heavily regulated (albeit teetering) conventional Wall Street model? The act, as written, largely implements former Federal Reserve chairman Paul Volcker’s recommendation that banks cease to engage in proprietary trading. (Nonbanks can continue to do so, subject to additional regulatory limits and capital requirements.) Of course, banks can continue to
make markets and trade on behalf of their clients. The argument made by the financial institutions formerly known as investment banks is that they have been largely exiting the prop trading business anyway, with Dodd-Frank merely providing a final push. It is undeniable that most banks have stumbled in recent years in their once-lucrative prop trading activities. Take Morgan Stanley, which had a loss approaching $10 bil-
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Prop trading isn’t going away. It just won’t be called prop trading. — Roy Smith Stern School of Business
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Goldman Sachs to JPMorgan Chase, has announced that it is dismantling its prop trading desks. (Several of Goldman’s prop traders are decamping to Kohlberg Kravis Roberts.) Then, can we say that as a result of the firm hand of DoddFrank, along with adverse economic trends, prop trading’s excesses are truly over? “Of course not,” contends Roy Smith, a professor at New York University’s Leonard N. Stern School of Business and a former president of Goldman Sachs International. “DoddFrank will not restrain banks from doing what they were doing before. They are just doing it in a different wrapping.” Smith argues that firms
EXCHANGES
HOMESICK FOR CHINA U.S. LISTINGS LOSE CACHET More than 600 Chinese enterprises have listed on U.S. stock exchanges to gain access to America’s dynamic capital market. Now many want to abandon America and list at home to be part of an even more dynamic market: China’s. They feel that they’re misunderstood in the U.S. and that this translates into depressed share prices. U.S.-listed Chinese companies trade at an average 30 percent discount to the Hong Kong Stock Exchange’s price-earnings ratio of 16 and at a nearly 50 percent discount to the Shanghai Stock Exchange’s average P/E of 22, says Jenny Zhan, who helps manage GMO’s $10 billion emerging-markets fund. Yet repatriating could turn out to be complicated for Chinese companies. They will have to overcome U.S. regulatory hurdles to delist, notes Sherry Yin, a Beijing-based partner with law firm
are simply transferring their prop units to market-making desks, where they can claim the positions are on behalf of clients. And prop traders who decamp to form hedge funds are likely to receive seed capital from the traders’ former banks. “Prop trading isn’t going away,”Smith says.“It just won’t be called prop trading.The rules as written will have no real impact.” Still, the rules will have an impact on where the trades take place, either hidden among market-making activities or redirected to hedge funds. That is why some industry observers are concerned that
Morrison & Foerster in San Francisco. Not a single Chinese company has delisted in the U.S., and only one — Nasdaq-listed Harbin Electric, a maker of electric motors — has announced plans to do so. Nor would the companies necessarily be welcomed home with open arms. Beijing’s current policy is not to allow delisted companies to relist on Chinese exchanges’ A-shares main board. Instead, says Hu Ruyin, director of the Shanghai exchange’s research center, regulators are considering launching a special “foreign company board” next year. “The Chinese government should open a direct channel for Chinese foreign-listed companies to come back to list in China to enjoy China’s prosperity,” Zhang Xiaoping, chairman of Nasdaq-listed SORL Auto Parts, told a gathering in Beijing last month of 200 senior executives of overseas-listed companies, arranged by the newly formed China Overseas Listed Corporations Association. The theme: “Returning Home.” Regardless of the barriers, Chinese exchanges are preparing for a wave of returning companies, says Ren Guangming, Beijing representative of Hong Kong Exchanges and Clearing, which runs the Hong Kong stock exchange. Companies with China-related revenues that have delisted abroad and relisted in Hong Kong have seen their market capitalizations soar, he says. “We Chinese asset managers know better how to differentiate between high-quality Chinese firms and those who aren’t high quality,” asserts Ben Zhang, a portfolio manager at Shenzhen-based China Merchants Fund Management Co. — ALLEN T. CHENG
the change is not necessarily for the better. Yale’s Gorton is among them. “It’s damaging for regulators not to know where prop trading is,” he says. “It’s naive to always think that if we get these activities out of banks we will be better off.” Gorton sees the push of prop trading into the margins as merely obscuring future problems rather than diminishing them. Moreover, he points out, the trading ban is merely one in a string of new regulations — increased capital requirements chief among them — that threaten traditional investment banking.“This is a transition period for investment
banking,”Gorton says.“Where does the business go and how will it work?” Will whatever model that eventually emerges pose less systemic risk than the current investment banking platform? Hedge funds are not necessarily the best replacement. For Smith, who was an investment banker at Goldman before joining Stern in 1987, the end of bank-domiciled prop trading is just part of an inchoate financial landscape that is highly uncertain and possibly threatening. “There are many snakes in the grass, waiting,” he says. — David Adler INSTITUTIONALINVESTOR.COM
JEROME FAVRE/BLOOMBERG NEWS
lion on its mortgage-backedsecurities trading desk in 2007 and other setbacks in credit trading. As a result, the bank started to shut its proprietary mortgageand credit-trading businesses that year, but retains two prop quant trading businesses. However, their future as “proprietary” in nature is doubtful — they contributed only 2 percent of the firm’s revenues in 2009. Indeed, Morgan Stanley has been looking for outside investors for two years, says a source close to the bank. Morgan Stanley is hardly alone: Bank after bank, from
Hong Kong expects a wave of relistings
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Corporate & Investment Banking | Sales & Trading | rbccm.com This advertisement is for informational purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. RBC Capital Markets is the global brand name for the capital markets business of Royal Bank of Canada and its affiliates, including RBC Capital Markets Corporation (FINRA, NYSE, SIPC); RBC Dominion Securities Inc. (IIROC & CIPF) and Royal Bank of Canada Europe Limited (authorized & regulated by FSA). ®Registered trademark of Royal Bank of Canada. Used under license. All rights reserved. The period July 1, 2009 – June 30, 2010. All currencies converted to USD. Includes fixed income, equity and FX.
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next stage in the over the past three years, to ance of a lead analyst at a evolution of the $50 million. client firm. outsourcing mar“We help clients save Khosla says that the finanket,” notes Eamonn between 50 and 70 percent cial crisis has helped Copal Kennedy, London on research costs,” boasts recruit talent from Wall Street and the City of London to research director for Copal CEO and co-founder head up teams in India and Datamonitor Group. Rishi Khosla, who set up and China. Recent hires, he says, Copal is fast ran an early-stage venture have come from Credit Suisse becoming a fund while at GE Capital. research pow“Everyone is focused on cost. Group, Sanford C. Bernstein & Co. and UBS. Copal’s chairerhouse, yet it The fact is that outsourcing Copal’s man, Andrew Melnick, was research is a model people Khosla: is little known co-director of global investoutside its circle accept today.” Sounder ment research at Goldman Indeed, certain of Copal’s research? of clients — not clients are also shareholders, Sachs & Co. from 2002 to unintentionally. 2004, and before that director Launched in 2002, including Bank of America RESEARCH MADE IN INDIA Merrill Lynch, Citigroup of global securities and ecothe London-based COPAL’S SG DEAL nomic research at Merrill. outfit now employs and Deutsche Bank, which SHOWS THE APPEAL collectively hold a 20 percent “It’s very simple,” contends 1,200 people and OF OUTSOURCING stake. Spokespeople at the three Khosla. “Where’s the growth has offices in Beibanks, however, declined to in the global economy? It’s jing, Buenos Aires, India and China. So, many Dubai, Hong Kong, discuss how they use Copal’s Last month Société services, citing the sensitivity people want exposure to New Delhi and New York. Générale disclosed that it Many of its researchers have of the subject. The firms’ own these markets. People we hire was handing over analysis master’s degrees in finance or clients may not be aware that wouldn’t be star analysts but of 200 global companies to business from top schools in some of their research could would be the senior person on Copal Partners, a research India, where 1,000 of its staff bear a “Made in India” label. Wall Street writing or publishfirm whose analysts are are based. Copal is one of a handful ing the reports. These people based primarily in India. Copal’s 70 clients include are leapfrogging in their career of outsourcers that specialize Copal’s reports, geared to eight of the top ten bulgeand getting exposure to highin helping clients conduct the SG’s private clients, are to bracket investment banks, growth markets.” full range of research, from be rigorously vetted by the along with asset managers, By the same token, many time-intensive data mining bank’s own analysts and coprivate equity firms and hedge companies now listing in and analytics to penning branded “Société Générale funds. Its revenues have tripled New York and London entire reports under the guidand Copal Partners.” For SG, the arrangement is an PRIVATE EQUITY economical way to substantially SECOND WIND augment the output of the ten in-house analysts serving its When many pension plans and college endowments were hit with big losses during the financial crisis and found it tough to meet payout deadlines or fund school budprivate wealth customers. And gets, one solution seemed obvious: sell off some private equity interests to raise cash. for Copal, the deal is a real coup, Investment firms geared up for a deluge of deals. because it is the first time its Yet as bid-ask spreads widened, many CIOs held back. But now, belatedly, the reports will be released under its secondary-deal spigot has opened full blast. “There have been 100 secondaries in 2010 own name, not that of a client. alone, and more are rolling in every day,” report Sean Hill and Malcolm Nicholls III, attorneys at Proskauer Rose in New York. Deal flow is heading to between $20 billion and The SG-Copal partnership is $25 billion this year, estimates William Murphy, a managing director at Cogent Partners in notable as well because it attests New York. In April Paris-based AXA Private Equity, a secondary fund of funds, bought to just how pervasive outsourc$1.9 billion worth of private partnership interests from Bank of America, in one of the largest ing of global equity research secondary deals on record. has become — for better or What caused the market turn? Investors’ worst fears weren’t realized, says Joshua Lerner, finance and entrepreneurship professor at Harvard Business School. As markets recovered, worse — as financial firms have private equity firms were able to write down valuations, reducing secondary-market shed analysts and cut costs in discounts. “It’s a market in equilibrium now, which makes transaction activity possible,” the aftermath of the financial explains Murphy. Access to secondary deals is not only about bargain-hunting. Investors crisis.Such knowledge-process can develop relationships with coveted private equity firms. — FRANCES DENMARK outsourcing “represents the INSTITUTIONALINVESTOR.COM
PAPER: RICHARD MEGNA
Global Research Private Equity
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KER OPENING FIVE QUESTIONS PEOPLE THIS MONTH IN FINANCE RAINMAKERS DONE DEALS MA Global Research
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We help clients save 50 to 70 percent on research costs. And everyone is focused on cost today. — Rishi Khosla Copal Partners
”
In any case, Copal enjoys a clear-cut cost advantage over global banks, a fact that Khosla insists will ultimately produce sounder research. His case: “We can add more value because our comparative cost of doing the research is that much lower,” he says. “So we can spend more time on any one company. Our clients don’t necessarily want to reduce research budgets. They want to conduct deeper research and get more for the budget.” Ultimately, Copal’s clients’ own clients — investors — will be the judge of that. — Allen T. Cheng
Meyer. (Rohatyn confides that in all their decades working together, he unfailingly addressed him as “Mr. Meyer” or “Monsieur.”) A rainmaker’s rainmaker, Rohatyn, now 82, played a pivotal role in Lazard deals over five decades. For instance, he engiFIVE QUESTIONS FOR FELIX ROHATYN: neered most of ACCIDENTAL ITT Corp.’s many INVESTMENTBANKER acquisitions. His toughest financial assignFew financiers’ memoirs ment, however, came when he open with more drama volunteered to lead a bailout than Felix Rohatyn’s Deal- of his adopted city and later ings: A Political and Financial served as the longtime chairLife, published this month by man of New York’s Municipal Simon & Schuster. It describes Assistance Corp. (MAC), set how the Rohatyns, well-to-do up in 1975 to help Gotham Austrian Jews living in Paris, stay afloat. escaped Nazi-occupied France Preferring deal making to by cramming possessions into managing, Rohatyn declined their car and piling mattresses to become CEO of Lazard. on the roof, and joining a cara- He left the bank altogether in van of refugees bound for the 1997 when president Bill ClinSpanish border. They might ton appointed him ambassanot have made it across but for dor to France. a guard’s choosing to take a He recently returned to cigarette break and wave them Lazard as special adviser to through rather than examine chairman and CEO Kenneth their papers. Felix was just 12. Jacobs. Last month Rohatyn Rohatyn spent his teenage sat down with Institutional years in New York City before Investor Staff Writer Imogen earning a BA in physics at Rose-Smith to talk about capiMiddlebury College. Upon talism, the global economy graduating in 1949, he got a and his current concerns. job through family connecYou say in your book that tions at Lazard Freres & Co. capitalism got away from He hadn’t intended to itself — focusing more on become a banker — his father making profits than on what’s owned a brewery. But he took best for clients. to investment banking and, Capitalism, if we just let it go in particular, deal making on unchecked, can lead to a under the tutelage of Lazard’s very bad end. While I was in formidable CEO Andre
1
France [as ambassador] in the late ’90s, I tried very hard to promote modern American capitalism to the French. And I started thinking about it more and more, and reading a lot about the New Deal and the history of this country.
2
What was your conclusion?
That is when I really began thinking of myself as a Democrat.
3
At MAC, you unsuccessfully pressed the fiduciary for New York State’s pension funds, Arthur Levitt, to buy New York City bonds. Do public funds have an obligation now to buy the bonds of distressed cities or states?
I’m still not sure of the answer to that. There is clearly an argument to be made that pension funds, and similar instruments, belong to their shareholders and that Levitt was right. He was following what he saw as his fiduciary responsibility — but somewhere there must be a higher moral responsibility.
4
How do you see the global economy right now?
5
What are your current concerns?
I have a sense that we are running out of capital. There is not enough capital in the world to deal with the demands that are being made on it. If true, that means that money is going to be more expensive.
I’ve been spending my time on infrastructure issues. This is an investment that is hugely important to our nation. Every day we are falling behind in infrastructure investment. That just can’t be for a major Western country. INSTITUTIONALINVESTOR.COM
ADAM ROUNTREE/BLOOMBERG NEWS
come from emerging markets. “Having people on the ground in China to research Chinese companies listed abroad is necessary,” Khosla argues. “You need local language skills also in Korea and Japan.” Nevertheless, the Copal CEO doesn’t discount the impact of the Internet in making outsourcing feasible. “You can cover companies from anywhere via the Internet,” he says, somewhat contradictorily. “In the days when you were focused on being on site, then you could say you have to be on site. But today, you have no additional information advantage with site visits.”
Consider a fund’s investment objectives, risks, charges, and expenses carefully before investing. The prospectus contains this and other information about the fund. Contact your financial professional for a prospectus and read it carefully before investing. The Fund seeks long-term capital appreciation by employing a “market neutral” strategy that utilizes both long and short equity positions. The Fund may invest in derivative securities, which may carry market, credit, and liquidity risks; small- and mid-cap stocks, which may be subject to more erratic market movements than large-cap stocks; foreign securities, which are subject to the risks of currency fluctuation and political uncertainty; and short selling (borrowing securities), which may prevent it from implementing its investment strategy due to its obligation to cover its short position at a higher price, resulting in a loss. This loss is potentially unlimited. In addition, selling short is a form of leverage, which may exaggerate an increase or decrease in the Fund’s NAV. See the Fund’s prospectus for complete details of these risks. These risks may result in greater share price volatility. There is no assurance the Fund’s objective will be achieved. It is anticipated that the Fund will typically have low net exposure to the equity markets and therefore the Fund’s returns should not be significantly affected by broad equity market movements. In pursuing its market neutral strategy, the Fund seeks total return greater than the return on 3-Month U.S. Treasury Bills, as measured by the Citigroup 3-Month T-Bill Index. The index return is similar to the return an investor could expect from the Fund (gross of fees) if the Fund’s managers do not generate alpha in a given period. There is no assurance the Fund’s objective will be achieved. Alpha measures risk-adjusted performance, factoring in the risk due to the specific portfolio rather than the overall market. A high value for alpha implies that the portfolio has performed better than would have been expected, given its volatility. The Citigroup 3-Month T-Bill Index is an unmanaged index representing monthly return equivalents of yield averages of the last 3-month Treasury Bill issues. It is not possible to invest directly in an index. ©2010. Prudential Financial. Mutual funds are distributed by Prudential Investment Management Services LLC, a Prudential Financial company and member SIPC. Jennison Associates is a Prudential Financial company. Prudential Investments, Prudential, Jennison Associates, Jennison, the Prudential logo, and the Rock symbol are service marks of Prudential Financial, Inc., and its related entities, registered in many jurisdictions worldwide. 0184794-00001-00
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PEOPLE ‘JOISEY GUY’
CORZINE; NOBELIST DIAMOND; HENRY’S STRIKER TORRES As a former chairman of Goldman (“Government”) Sachs and an ex-governor of New Jersey, Jon Corzine is politically well connected in the Garden State. But that may not be viewed as an unalloyed asset since filmmaker Peter LeDonne’s The Soprano State, based on the New York Times bestseller about corruption and political abuse in New Jersey, opened in late October. Narrated in a gravelly Joisey accent by actor Tony Darrow, who played Lorenzo (Larry Boy) Barese on TV’s The Sopranos, the 80-minute documentary delves into a number of highprofile scandals involving such characters as “the king of double-dipping,” former state senator Wayne Bryant, and Newark’s notorious former mayor Sharpe James, who was indicted on 25 corruption charges. Corzine, 63, who vowed to clean up Camden, seems to have been caught up in New Jersey’s dubious political culture all the same. LeDonne’s film zeroes in on Corzine’s relationship with ex-girlfriend Carla Katz, who headed a New Jersey public employees’ union while Corzine was in office, posing a potential conflict of interest. — Julie Segal
DIAMOND SPARKLES When Senate Republicans used an obscure procedural rule to block Peter Diamond’s nomination to the Federal Reserve’s board of governors in August, Alabama’s Richard
Shelby explained that it was because Diamond didn’t have broad enough macroeconomic experience. The Royal Swedish Academy of Sciences seems to disagree. Last month it awarded the 70-year-old MIT professor (and two others) the Nobel Prize in economic sciences. The Academy cited Diamond for his groundbreaking work on how regulation and economic policy affect the job market. But Diamond has also written on pensions, arriving at recommendations that would cause a Frenchman (and many U.S. Democrats) to mount the barricades: lower benefits, increase contribution rates and raise the retirement age. Still, after learning that Diamond had won the Nobel, Senator Shelby retorted that the Royal Swedish Acad-
emy “does not determine who is qualified” to serve on the Fed board. — Franziska Scheven
KUNG PAO KISSINGER The setting was a study in yin and yang, the Chinese philosophy of interconnected opposites. The largest investment house in the largest socialist country held its 15th anniversary gala in the chandeliered Louis XVI Suite of New York’s Waldorf-Astoria hotel, a palace of art deco grandeur built on the fortune of John Jacob Astor, America’s first multimillionaire and a smuggler of Chinese opium. Attending the soiree: Henry Kissinger, once Nixon’s chief China basher, later associated with the opening of its markets; and Robert Rubin, former Treasury secretary, who once famously railed against
China’s trade imbalances. Both men joined in for an evening of champagne and kung pao in a show of respect (the Mandarin term: kowtow) to the China International Capital Corp. (CICC), an investment behemoth that has financed more than $193 billion in global M&A activity.“China is likely to be successful moving ahead,” Rubin said, with masterful understatement.“When I first came to Asia,” Kissinger recalled,“China’s trade was less than that of Honduras.”And much of the trade was verbal. “We just called each other a lot of names,” he said,“and the Chinese repertoire was not bad.” Kissinger, a sonorous 87, asked to be invited to the bank’s next big party, in 15 years. — William Inman INSTITUTIONALINVESTOR.COM
CORZINE: ANDREW HARRER/BLOOMBERG NEWS; DIAMOND: MIKE MERGEN/ BLOOMBERG NEWS; KISSINGER: DANIEL ACKER/BLOOMBERG
JOISEY GUY
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SIDE GREEN SHOOTS ALTERNATIVES DEFINED CONTRIBUTIONS CEO INTERVIEW COVER STORY CA Counterclockwise from top left: Jon Corzine, Peter Diamond, Herny Kissinger, Peer Steinbrück, John Breckenridge, John Henry
“This project will solve the bottleneck issue of wind power development — the very limited capacity to transmit power from the offshore wind farms to the onshore grid,” contends Breckenridge. — Xiang Ji
HENRY LOOKS FOR NET GAINS
STEINBRÜCK: JOSE GIRIBAS/BLOOMBERG NEWS; BRECKENRIDGE: ANDREW HARRER/BLOOMBERG; HENRY: JASON GROW/VIA BLOOMBERG NEWS
PEER STEINBRÜCK ON FINANCE As German Finance minister under Angela Merkel from 2005 to 2009, Peer Steinbrück was known as much for his blunt speech as for his pragmatic policies (such as not wanting to expand social welfare). Both aspects of the 63-year-old Northern German are amply on display in Unterm Strich (“Bottom Line”), his new book discussing Germany’s and Europe’s economic predicament in the wider world. He criticizes Germany’s undercapitalized banks and poor political leadership — including that of his own Social Democratic party. Europe, with its mounting debt, he says, is on the brink. “Greece was just a foretaste INSTITUTIONALINVESTOR.COM
of what could happen to the Euro idea,” he warns. Inevitably, Steinbrück takes on the finance industry. “We have taken a few steps toward taming the financial markets,” he told a Der Spiegel interviewer after his book was released, “but we have not come nearly far enough to rule out a repetition of the crisis. The most important question hasn’t been answered yet: Who’s in charge, politicians or the financial industry?” — F.S.
A MIGHTY WIND Last March, while sharing a ski lift in Vail with Robert Mitchell, CEO of power transmission company TransElect, renewable-energy investor John Breckenridge got to chatting about
undersea electric cables. The conversation turned out to be as inspiring as the scenery. Last month Breckenridge, head of the North American investment team for Good Energies, a New York–based green-energy investment firm, and Mitchell unveiled an audacious venture to build an underwater transmission line from northern New Jersey to northern Virginia to carry electricity generated by offshore wind turbines. Called Atlantic Wind Connection, the venture is expected to cost around $5 billion and provide transmission capacity for 6 gigawatts of offshore wind power — enough to supply nearly 2 million households along the Eastern Seaboard — when it’s completed in 2030.
As a successful managed-futures trader, John Henry is well aware that a winning bet can hinge on a single factor. In the case of his latest big investment — U.K. Premier League soccer team Liverpool FC — that vital element could be Fernando Torres, the superstar striker whom Liverpool acquired from Atlético Madrid for some $40 million in 2007. Lately Torres, 26, hasn’t been scoring goals at anything like a pace that would justify his $175,000-a-week salary. Indeed, Liverpool — off to its worst start in 57 seasons — risks a humbling relegation to the Championship Division. Henry has been in a serious come-from-behind position before, however — albeit in a very different sport. When he bought the Boston Red Sox baseball franchise in 2002, they too were in dire need of a turnaround; two years later they won the World Series. Can Henry also revive the team known as the Reds? Although Torres failed to score in Liverpool’s game with Everton on October 20 — as Henry watched pensively from the club’s Anfield stands — the Spanish striker did make the decisive goal the following week, giving Liverpool its first Premiership win since August. Fernando played “an awful lot better,” said Liverpool manager Roy Hodgson. Might it have been the Henry Factor? — Imogen Rose-Smith
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PENSIONS • Budget shortfalls in Illinois and Kentucky have forced public pension plans there to sell off assets to meet obligations. Although officials at the funds downplayed the moves, they conceded that if their underfunded status and benefit liabilities continue into next year, they might have to reconsider their funds’ investment strategies and shift out of illiquid investments. It’s difficult to determine how widespread the problem may be, but observers note that with many states facing budget woes, it’s conceivable that many more pension funds will begin selling assets to meet liabilities. — Money Management Letter
COMPLIANCE • Chief compliance officers of swap dealers and major swap participants are facing a range of new responsibilities under reforms imposed by the DoddFrank Act, according to Stuart Wexler, general counsel of ICAP. Buried in a provision in the act on swaps entities is a section that ramps up chief compliance officers’ duties in several ways, Wexler told delegates at a Securities Industry and
become an attractive spot for creative industries, drawing such tenants as CBS Radio, New York magazine, Viacom and WNYC. — Real Estate Finance and Investment
OPTIONS • Options trading executives have noticed increased demand for performance metrics as more clients incorporate options into their trading portfolios. The increasing sophistication of the options market and potential changes to its structure are driving demand. Trading volume has grown by more than 10 percent since 2009, according to TABB Group.“There is a void in the options marketplace for transaction cost analysis, unlike in equities,” says one chief investment officer. TCA proves that you are trading the right way.“TCA for options doesn’t have to be sophisticated like some of the benchmarks for equities, but it does need to be something,” the CIO adds. — Wall Street Letter
DERIVATIVES REAL ESTATE • Manhattan value-added player Beck Street Capital is betting on the city’s Hudson Square district to become a big development area over the next five years. “It became clear more people were coming into the area when they started installing more traffic lights,” says Beck Street founder Kevin Comer. “New York is always about the next hot neighborhood. Fifteen years ago it was the Meatpacking District, then West Chelsea. You see the restaurants come in, then retail and then the galleries.” This submarket, along the Hudson River between TriBeCa, SoHo and the West Village, has
• Could “liquidity options” stand in for cash and liquid securities in a financial pinch? Professionals Maxim Golts and Mark Kritzman note in II’s fall Journal of Derivatives that “many investors, especially endowments and foundations, have committed a substantial fraction of their wealth to illiquid investments, such as hedge funds” and that this shift presented “considerable challenges as they faced unanticipated capital calls in the recent global financial crisis.” They argue that “it may be more efficient to purchase liquidity options, which would be favorably priced if the investor’s perceived likelihood of a liquidity event
is sufficiently higher than the market’s.” After suggesting how to structure and price such options, they conclude that “although liquidity options may not be suitable for all circumstances, we believe they can be an attractive alternative to cash reserves, especially when the broad market has not yet discounted an impending shift to financial turbulence.”
COMMODITIES • Is now the time to add commodities to your portfolio? Academics C. Mitchell Conover, Gerald Jensen, Robert Johnson and Jeffrey Mercer examined that question in II’s fall Journal of Investing: “Our findings showed strong support for the contention that commodity futures offer equity investors considerable benefits as an investing tool. Surprisingly, the benefit of supplementing a portfolio with a commodity exposure was relatively invariant to the equity investors’ investment style. Investors choosing a relatively conservative approach of targeting large-cap stocks achieved very comparable benefits to more aggressive investors that followed momentum and small-cap strategies.” Finance industry news briefs compiled by Institutional Investor’s Newsletters and Journals divisions. INSTITUTIONALINVESTOR.COM
ANDERS WENNGREN
THIS MONTH IN FINANCE COMMODITIES DO DIVERSIFY
Financial Markets Association event. For instance, it calls on them to ensure compliance with all rules and regulations relating to swaps. Wexler questioned whether having to “ensure compliance” means, among other things, that compliance officers will have the right to fire a senior officer over a disagreement about a compliance issue.“That’s a dramatically different way to think about the role of compliance than we’re used to,” he said. — Derivatives Week
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Achieving more together
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TICKER FIVE
McGladrey Capital’s Weisbrich: Part banker, part psychologist
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CAPITAL
I
BEN CLARK
INVESTMENT BANKER PAUL WEISBRICH’S PASSION FOR
airplanes is rooted in a childhood spent in Westchester, California, not far from where aviator Howard Hughes had his manufacturing plant and airport. As senior managing director and head of the aerospace group at Costa Mesa, California–based McGladrey Capital Markets, Weisbrich specializes in middle-market cross-border deals. That’s why British metals manufacturer Hampson Industries turned to him for urgent advice six years ago. To diversify its product line and customer base, the West Midlands company wanted to buy Grand Prairie, Texas–based Texstars, a leading producer of canopies for combat aircraft, including the F-16 Fighting Falcon. Texstars had been put on the market by private equity shop American Capital of Bethesda, Maryland, but to Hampson’s chagrin the U.S. firm didn’t shortlist its bid. American Capital was uneasy about a cross-border deal with a company that was little understood across the Atlantic. The resourceful Weisbrich set out to get Hampson back into the auction. Thanks to a relationship with the seller’s adviser, Charlotte, North Carolina–based Edgeview Partners — a middle-market investment bank like McGladrey — he helped Hampson craft better pricing and deal terms, and it won Texstars for $41 million. Weisbrich and his team then sourced three more U.S. companies in the advanced composite materials industry and advised Hampson on their acquisition. As a result, the company has transformed itself from a basic metals supplier into a force in the burgeoning advanced INSTITUTIONALINVESTOR.COM
composites market, posting double-digit average annual revenue growth since 2004. “Paul is a great ambassador for us and always kept our name at the forefront,” says Howard Kimberley, finance director at Hampson. Weisbrich, 50, who has an MBA from the University of Southern California, began his career in 1982 as a foreign exchange analyst at Banc of America Securities in Los Angeles. He joined McGladrey in 2001 after a three-year stint running his own M&A firm in LA. Weisbrich has advised some 350 companies, many of them in the aerospace and defense industries. In a world of blockbuster deals — almost 60 percent of the $1.23 trillion deal volume in the first half of 2010 came from transactions north of $1 billion, Dealogic reports — Weisbrich favors opportunities in the $15 million to $500 million range. Unlike bigger deals, these still revolve around personalities. “They want to go to dinner and get to know the buyers personally,” he says of entrepreneurs who cherish their companies like babies. “There’s more deal crafting going on, and you have to be half banker and half psychologist.” In Hampson’s 2007 acPaul Weisbrich makes quisition of Composites aerospace and other Horizons Inc. of Covina, cross-border deals soar. California, Weisbrich deftly BY XIANG JI maneuvered around a delicate father-son rift. CHI’s founder and chairman, Thomas Hynes, wanted to sell the company to the highest bidder and retire. His son, CEO Jeffrey Hynes, preferred a buyer that would keep growing CHI — ideally, with him in charge. Weisbrich persuaded Hampson to offer a full valuation of $23 million and an earn-out structure that would let Jeffrey Hynes stay on as CEO and keep his hand in CHI’s expansion. Cross-border deals have suffered with the broader market in the past two years, but Weisbrich’s pipeline is full. U.S. and overseas buyers and sellers are warmer to one another than a decade ago, he says: “European bidders have become more aware of the type of premium to buy a good U.S. company.”The average European premium for U.S. businesses in 2009 and 2010 was 44 percent above the target’s share price a week before any announcement — the highest in ten years, according to Dealogic.“The biases against them on whether they can put the check on the table are gone,”Weisbrich adds. ••
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T
Dana is part of a North Sea oil renaissance
HIS TIME THE KOREA NA-
tional Oil Corp. didn’t miss out. Thwarted in two previous attempts to acquire European oil and gas explorers, KNOC shed its conservative image in August by launching a £1.9 billion ($2.98 billion) hostile bid for U.K. driller Dana Petroleum. The successful unsolicited offer is the biggest ever by a South Korean company and just the second by an Asian state-owned entity, according to Dealogic. Suddenly, China and India aren’t the only nations willing to pay big premiums for Western-owned resources companies. The Dana deal also coincides with something of a renaissance in the North Sea oil industry. KNOC first approached Aberdeen-based Dana in June with an indicative offer of £17 a share, then upped the ante to £18. “We had been tracking Dana for KNOC for 18 months,”says London-based Philip Noblet, co-head of M&A for Europe, the Middle East and Africa at Bank of America Merrill Lynch, and the South Koreans’ financial adviser.“We knew from our Westhouse Securities. Also, contacts in the industry it was highly unlikely that the U.K. market has always South Korea asserts itself with a hostile welcomed foreign buyers there were any other potential buyers around.” Impressed by KNOC’s thoroughness, big institu- takeover of the U.K.’s Dana Petroleum. offering good prices. BY NEIL SEN tions were quickly won over. Richard Buxton, head Yet going hostile was bold of U.K. equities at London’s Schroder Investment by any standard. Dealogic Management — the top holder of Dana stock, with data shows that the only a 13 percent stake — says KNOC did its homework previous successful hostile and talked extensively to institutional shareholders. bid by an Asian state-owned Schroder was happy with KNOC’s valuation of Dana.“We valued company took place in 2007, when Beijing-based Sinosteel Corp. the company’s existing producing assets at over £13 a share, so paid $1 billion for Midwest Corp. of West Perth, Australia. anything on top of that was a premium for the company’s potential For an organization with KNOC’s record, the Dana bid looks bolder success with the drill bit,” Buxton explains. still. In 2007, KNOC was outbid by Italy’s Eni for London-based Burren Dana, however, spurned KNOC’s offer as inadequate and oppor- Energy, and last year it lost Geneva’s Addax Petroleum Corp. to Sinopec tunistic, arguing that the company was worth more than £21 a share Corp. of China. Dana’s disengagement made hostilities inevitable, based on an independent expert’s valuation using oil price forecasts. Noblet says, adding,“And such was the level of shareholder support for It also said that it was acquiring assets that would push its stock above a bid at £18 a share that, reputationally, KNOC could not have walked £30. But Seong Hoon Kim, senior executive vice president of KNOC, away without presenting the offer to shareholders.” countered that £18 was a full and fair value. While some analysts think KNOC overpaid for Dana,Westhouse’s KNOC’s readiness to pay a 60 percent premium to the share price Hart says it made a good move at a fair price. Amid a mounting realas of June 30 — the day before news of its initial approach to Dana ization that the departed oil majors did not fully exploit its resources, broke — also strengthened its bid. By August, KNOC had nonbind- the North Sea has been home to some sizable discoveries of late. ing letters of intent from shareholders representing 48.6 percent of “KNOC has acquired a useful platform for exploration and appraisal company stock. New York–based BlackRock and J.P. Morgan Asset projects at a time when activity in the North Sea is growing, activity Management joined Schroder in supporting KNOC. which could have a knock-on effect on valuations,” Hart says. KNOC owed much of its newfound confidence and urgency to a Dana’s new South Korean owner may have discovered its cour$6.5 billion cash injection from Seoul earlier this year; the company age — and its cash — at the right moment. •• has been charged with doubling South Korea’s oil production by Comment? Click on Banking & Capital Markets 2012. “The Koreans are trying to catch up with other Asian counat institutionalinvestor.com. tries,” says David Hart, an oil and gas analyst at London-based INSTITUTIONALINVESTOR.COM
DANA PETROLEUM VIA BLOOMBERG
Northern Seoul
NATHAN ALLEN GE Capital
SUSAN ROACH
GE Healthcare
WARNER THOMAS
President & COO, Ochsner Health System
OCHSNER STANDS AT THE “FOREFRONT OF HEALTHCARE
IN LOUISIANA. WE’RE PROUD TO STAND WITH THEM. When the people of Southeast Louisiana seek high-quality care, they turn to a healthcare provider ranked by HealthGrades™ among the top 5% of hospitals in the U.S. for clinical excellence – the not-for-profit Ochsner Health System. I work for GE Capital. For almost 10 years, we’ve been using our healthcare experience to structure financing solutions that ensure Ochsner has access to state-of-the-art healthcare technology. And by providing access to GE’s expertise in healthcare, we’re able to assist them in ways that go beyond lending. Who else can do that?”
GE Capital is invested in Ochsner Health System.
gecapital.com
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RIVATE ASSET MANAGERS WHO
partnered with the U.S. Department of the Treasury to invest in residential- and commercial-mortgage-backed securities through the Public-Private Investment Program (PPIP) couldn’t be happier with the government’s decision to interfere in Wall Street. An October quarterly report by the Treasury, marking the program’s first anniversary, shows the eight PPIP funds posting internal rates of return ranging from the high teens to the low 50s. That’s good news for the funds’ clients and U.S. taxpayers, who together invested $29.4 billion in PPIP. But several managers are warning investors to expect mid- to high-teen annual returns over the life of the funds, which have a three-year investment AllianceBernstein’s window and a five-year wind-down. “We are confident that Phlegar: Saving powder the fund’s structure will continue to generate attractive relative for the CMBS market returns in the future, but it’s still too premature to tell if current capital appreciation trends are sustainable,” says Jonathan Lieberman, head the drop in housing prices. of residential and consumer debt at Subprime delinquencies fell Can the Public-Private Investment Program from 52 percent early in 2010 New York–based investment adviser keep delivering outsize MBS returns? Angelo, Gordon & Co., whose fund’s to about 46 percent in the third BY LESLIE KRAMER 52 percent return made it the top PPIP quarter, according to Andrew performer. “It’s a nine-inning game, Rabinowitz, COO and partner and we’re still in the third or fourth at New York–based Marathon inning,” adds Lieberman, whose firm Asset Management, which saw co-manages the fund with Norwalk, its PPIP fund gain 44.3 percent. Connecticut-based GE Capital Real Estate. The CMBS market hasn’t fared so well. Phlegar thinks it’s too early PPIP aimed to kick-start trading in the stalled $2.1 trillion RMBS to aggressively allocate to this sector, given that bond prices have and CMBS markets, while giving financial institutions an oppor- risen substantially while commercial real estate keeps eroding. His tunity to scrub some of their more-illiquid assets off their balance firm, which has invested 80 percent of its capital, is holding off on sheets. “The idea was to alleviate the uncertainty and lack of price deploying the rest. “We are saving some powder for when and if the discovery in the RMBS and CMBS markets, which was causing a market provides us with a more attractive entry point,” Phlegar says. dislocation for the banks and marketplace,” says David Miller, CIO Anticipation of the program’s launch boosted the demand for of the Treasury’s Office of Financial Stability. The Treasury poured mortgage-backed securities, triggering a trading surge among banks $7.35 billion of equity into the program and lent $14.7 billion to the and broker-dealers. In response, however, some banks and institufund managers, which raised the remaining $7.35 billion. The funds tions decided to keep their assets rather than sell at a loss. So although are mandated to invest in mortgage-backed securities rated triple-A PPIP improved transparency and trading, it hasn’t cleansed balance prior to 2009; many have since deteriorated in price and ratings. sheets of MBSs. Nor has it increased lending, Phlegar adds. Before PPIP was announced in March 2009, the MBS market had Renewed interest in these securities has PPIP managers agreeing ground to a halt, says Jeffrey Phlegar, president of special opportunities that the MBS sector is now more of an alpha play, requiring a high and advisory services at New York’s AllianceBernstein, a PPIP manager level of expertise to analyze the underlying real estate assets and the that returned 40.8 percent.“There was no liquidity in the asset class, as credit markets. “There is still a lot of good opportunity out there, the paper was perceived as being too risky, compounded by bad words but it’s going to be more about asset selection than a macro play,” like‘subprime’ being thrown around,”he explains. PPIP helped create a Marathon’s Rabinowitz says. •• valuation framework that righted dysfunctional markets, Phlegar says. Comment? Click on Banking & Capital Markets By most accounts, the program is a success. A decline in residenat institutionalinvestor.com. tial mortgage delinquencies has lifted the RMBS market, despite
PPIP, Hooray
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W WHEN WALÉ ADEOSUN, CIO AND TREA-
surer of Rensselaer Polytechnic Institute, decamped to Manhattan’s Chesapeake Asset Management in April — along with his two investment staffers — RPI’s trustees and president Shirley Ann Jackson had a decision to make. Should the Troy, New York–based engineering school rebuild its investment office or find another way to manage its $800 million endowment fund? CFO Virginia Gregg says RPI didn’t really have a choice.“We were in a position where our entire investment group left together and gave us four months’ notice,” she explains. “We felt we did not have enough time to furiously hire a group back in.” So RPI hired Boston’s HighVista Strategies, an endowment-style investment manager, to take on its portfolio. Management of CharOutsourcing has become a viable way for lotte, North Carolina, Schools are enjoying success with schools to ensure that their funds are profesfell 22.8 percent; and endowment outsourcing, but returns vary. sionally managed without having to staff up. HighVista lost 16.6 BY FRANCES DENMARK Several firms now offer this service, touting their percent. Despite these ability to invest like a top endowment. The oldnosedives, clients like est is Investure, founded in 2003 by longtime RPI and Vermont’s University of Virginia endowment manager Middlebury College Alice Handy in the college town of Charlothave no regrets. “We tesville. Most — including Makena Capital Management in Menlo are very pleased with the outsourcing decision,” says Churchill Park, California, and Chapel Hill, North Carolina–based Morgan Franklin, a trustee emeritus of Middlebury and executive vice presiCreek Capital Management — were established by former endow- dent and COO at Boston’s Acadian Asset Management. “It helped ment officers. Trying to match endowments at their own game was a us enormously through the downturn and more than paid for itself.” noble goal back when Harvard University and Yale University were During the 2009–’10 fiscal year, Middlebury earned a healthy 17.7 generating annual returns of more than 20 percent. Since the market percent return. collapse began in 2007, however, it’s taken on a different emphasis. Now the picture has brightened for everyone. Endowments gained Wilshire Associates’ Trust Universe Comparison Service (TUCS) an average of 12.22 percent in the 12 months ended June 30, accordreported a –19.14 percent average return for all endowments and ing to TUCS. But returns vary. Among the Ivies, Harvard gained 11 foundations for the year ended June 30, 2009. The highest-profile percent from June 2009 through June 2010, besting Yale’s 8.9 percent schools posted some of the largest declines, partly because of high investment return. Princeton University jumped 14.7 percent, while allocations to public and private equity as well as to illiquid invest- Columbia University beat them all with a 17 percent gain. ments. Harvard’s endowment lost 27 percent of its previous $36 bilWhile Adeosun still oversaw the RPI endowment, it ended 2008– lion value, while Stanford University’s fund dropped 26 percent. ’09 down 19.7 percent. It has since bounced back. Gregg calls perEndowment-style funds did not escape the carnage. In keeping formance “positive this year, within the average endowment range.” with their mandates to emulate the management styles of top schools, She’s hoping for better things in 2011. RPI hired HighVista for its most suffered portfolio losses above those of the average endow- focus on risk management and capital protection, and for its smaller ment. According to one investor, for the 2008 calendar year, Morgan size, the CFO notes.“We’ve been pleased by these six months,” Gregg Creek’s Endowment Fund dropped 24.3 percent; Global Endowment says. “We outsourced and are sort of in process.” •• INSTITUTIONALINVESTOR.COM
MAXWELL HOLYOKE-HIRSCH
College Try
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RVIEW COVER STORY CAPITAL MARKETS BANKING THE 2010 LATIN AMERICA EXECUTIVE TEAM TH
Quick Study
Ex–Goldman Sachs quant Mark Carhart is launching a new firm. BY IMOGEN ROSE-SMITH
F
OR MORE THAN A DECADE AT
Goldman Sachs Group, Mark Carhart helped run the giant bank’s famed Global Alpha hedge fund. Under Carhart and Raymond Iwanowski, the quantitative fund became one of the largest and most successful in the industry, yielding annualized returns of 12 percent over a dozen years. At its height in mid-2006, it had more than $12 billion in assets. Then came the summer of 2007, when Global Alpha, like nearly all quant funds, dramatically stumbled. It ended the year down 40 percent; 18 months later, Carhart and Iwanowski retired from Goldman. Now Carhart, 44, is launching his own quant shop, Kepos Capital. Having learned from 2007 — and from 2008, when the entire hedge fund industry almost melted down — he aims to show that quantitative global macro is stronger than ever. Carhart had better deliver. “Hedge funds need to prove they can add value,” says Michael Rosen, CIO of Santa Monica, California–based investment consulting firm Angeles Investment Advisors, which has invested in quant hedge funds in the past. “There are so many ways that investors can be hurt — high fees, poor transparency, misalignment of fees.” Deep in fundraising mode, Kepos is avoiding the press. But last year, Carhart gave Institutional Investor his views on how he thinks the asset management industry should evolve. Investors, he said, must do a better job of separating alpha and beta — and refuse to pay 2 and 20 for market-driven returns. Kepos charges a standard management fee but only applies an incentive fee to net alpha returns. Carhart has recruited an impressive team. Kepos’s 27-member professional staff includes director of research Giorgio De Santis, former co-head of research at Goldman, and chief risk officer Attilio Meucci, who was previously in charge of research at Alpha, Bloomberg’s portfolio analytics and risk platform. Robert Litterman, a 23-year Goldman veteran who headed risk at the bank and advised Singapore’s sovereign wealth fund, chairs the academic advisory board. INSTITUTIONALINVESTOR.COM
That body comprises six academics, among them John Cochrane, AQR Capital Management Professor of Finance at the University of Chicago’s Booth School of Business, and Kent Daniel, professor of finance and economics at Columbia Business School and another Goldman alum.The board offers Kepos — which is predictably secretive about the precise nature of its trading algorithms — access to the latest academic research. It will also act, the firm’s prospectus says, as “a critical sounding board when we present our new research in our internal seminars” and “will also function as a recruiting platform.” If this sounds like some idyllic college think tank, don’t be surprised. Carhart, who taught at the University of Southern California’s Marshall School of Business and was a senior fellow at the Wharton School of the University of Pennsylvania, has a decidedly professorial air. But for Kepos, which began trading partners’ capital this month and aims to start running client money in January, business won’t be about how many Ph.D.s it can hang on the walls of its offices, in the Renzo Piano–designed New York Times Building in midtown Manhattan. Institutional investors want to know that the lessons of 2007 weren’t lost on Kepos and other quant funds. “Quantitative managers need to prove that they have a robust investment process in place,” consultant Rosen says. “No investor should commit capital without having done their own deep due diligence and making sure they really understand the process.‘Trust me’ is not a good enough answer.” Carhart has told prospects that he learned several things from 2007. First, size is important. Most quants trade in so-called liquid markets, but there’s only so much alpha, and liquidity vanishes fast in a crisis. It’s tough for larger funds to unwind positions. Global Alpha got too big, — Michael Rosen, Angeles some involved with it now admit. Investment Advisors The second takeaway was the value of new ideas. Quant hedge funds had piled into similar trades; using strategies that weren’t so secret after all, they often bought and sold on the same signals. Hence, Kepos’s heavy reliance on research and idea generation. The last, and maybe the most important, lesson was risk management. In the past, says a former Goldman partner who worked with Carhart, quants didn’t factor the proverbial black swan into their portfolio construction. Running at full tilt, they had no capacity left to deal with an extreme event. As the ex–Goldman partner points out, Carhart began applying these lessons at his old firm. In 2008, one of the worst years ever for hedge funds, Global Alpha finished up 2 percent. Last year, using new strategies that Carhart and Iwanowski helped build, the fund surged 30 percent. Carhart was always a fast learner. ••
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Quantitative managers need to prove that they have a robust investment process. ‘Trust me’ is not good enough.
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Comment? Click on Asset Management at institutionalinvestor.com.
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Color Barrier
Stung by political uncertainty, green ETFs have proved to be a slow-growing, volatile sector. BY FRANCES DENMARK
T
HE EXPLOSION IN EXCHANGE-TRADED
funds means that any investable idea that can be indexed will find a second home as an ETF. The 1,000-plus U.S.-based ETFs now have $814.6 billion in assets, according to New York–based investment firm BlackRock. But not all of them are created equal. Thanks to the growing appetite for all things green and clean, ETFs that capture this burgeoning investment category have been coming online for the past five years. Yet for all the hoopla, they have gained traction very slowly. With its 2005 launch of the WilderHill Clean Energy ETF, Wheaton, Illinois–based Invesco PowerShares Capital Management has grabbed the lion’s share of assets. To date, this fund has $540 million of the total $800 million in green ETFs. According to investment
research firm Morningstar, an ETF must break $50 million to turn a profit. Only six of the nine green ETFs have done so, and just four have passed $100 million. PowerShares also has green ETFs focused on water resources and global wind, as well as a global nuclear fund for folks who see carbon-free atomic energy as a clean source of power. Because of their controversial nature, nuclear investments are sequestered in their own fund, and they do not appear in any of the other green ETFs. In keeping with the evolving nature of green investments, PowerShares also offers what it dubs “progressive” funds in transportation and energy. These funds allow investors to access companies in transition: Representing a combination of traditional fossil fuels and newer green technologies, such stocks have not reached pure-play status. Green ETFs are clearly a nascent category, and one with glacierpaced investor interest. It hasn’t helped that returns are extremely volatile. In the past 12 months, the sector performed twice as poorly as the broader market, according to Robert Wilder, CEO of cleanenergy tracker WilderShares of Encinitas, California. Wilder created the original clean-energy index, which is licensed by PowerShares. The clean-energy ETF and its WilderHill index were down 17 percent for the year at the end of August; the solar index had fallen 25 percent, while the wind index had lost a third of its value. “With anything green, it’s really quite wild,” says Wilder, who started his eponymous index in 2004 with partner Joshua Landess. “I’ve seen it double, then be down 50 percent.” Uncertainty in the political environment, which dictates much of the future for green investments, has hurt the green ETF sector. This is especially true in the U.S., where government subsidies have declined and there’s still no comprehensive climate bill. Oil and gas prices also influence green ETFs, as does the overall health of the economy. Caveat emptor, agrees Deborah Fuhr, global head of ETF research at BlackRock in London. “Many people are getting a social conscience, people talk about sustainable energy, but that doesn’t necessarily mean the stocks in that sector will go up,” Fuhr says. Another red flag: ETFs labeled “green” or “clean” can have other thematic exposures, and there are few pure plays. For example, some investors may consider a water investment part of the resource category rather than a green idea. Green ETFs also tend to be top-heavy with big companies because of industry consolidation.“It’s important to know what’s inside these ETFs,” cautions Fuhr. Despite these drawbacks, Trillium Asset Management Corp. holds one of the ten largest positions spread among three PowerShares green funds, along with Bank of America Corp., Charles Schwab Corp. and Morgan Stanley. No wonder: The Boston-based investment advisory, which caters to high-net-worth individuals as well as to Catholic organizations and other small endowments and institutions, is solely devoted to sustainable and responsible investing. Trillium equity research analyst and assistant portfolio manager Natasha Lamb says that despite its commitment to green ETFs, her firm has reacted to the recent volatility. “To a large extent, we’ve sold off a bit of our exposure,” she discloses, pointing to green ETFs’ overweight in solar energy companies and their tendency to move in lockstep. •• Comment? Click on Green Investing at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
WIND TURBINES: TOMOHIRO OHSUMI/BLOOMBERG; CAPITOL: ANDREW HARRER/BLOOMBERG
SIDE CAPITAL GREEN SHOOTS ALTERNATIVES DEFINED CONTRIBUTIONS CEO INTERVIEW COVER
Deutsche Bank Corporate & Investment Bank
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OOTS CAPITAL ALTERNATIVES DEFINED CONTRIBUTIONS CEO INTERVIEW COVER STORY CAPITAL
Nothing Gained Venture capital funds have themselves to blame for a dismal decade. BY UDAYAN GUPTA
I
N THE YEAR 2000, RIDING A WAVE OF
blockbuster IPOs and spectacular returns, venture capital funds raised a record $105 billion. A decade later — the length of the typical cycle for a venture capital partnership — the results are in, and they’re ugly. In June and October, London-based alternative assets research firm Preqin privately circulated two reports covering some 100 venture funds launched in 2000. The funds’ median internal rate of return since inception was –0.3 percent, perhaps the poorest showing by a group of funds in venture capital history. Just 3.9 percent of them posted IRRs of 20 percent or more. “We have seen the enemy, and it is us,” says Jonathan Flint, cofounder and general partner of Boston-based Polaris Venture Partners, one of the largest East Coast venture funds. Easy access to capital, overexpansion and bureaucratization , and the bear market of the early 2000s all contributed to the industry’s current sorry state, Flint explains. Then there are the zombie funds, whose portfolios bulge with living dead companies. Who’ll give them a proper burial? Still, Flint believes venture capitalists have learned from their mistakes. Besides shrinking their partnerships and funds, they’re going back to what venture funds do best: financing and developing innovation. The new, nimbler venture capital fund is also part of an attempt to fight off the so-called superangels — investors who have raised modest funds to support emerging companies. As venture funds return to their roots, they may start looking like they did in the early days: small, hungry and entrepreneurial. A healthier economy and a stronger stock market should also revive the venture business, says Joseph Cohen, former chairman and CEO of New York–based Cowen and Co., one of the banks that specialized in underwriting venture-backed companies in the 1980s and ’90s. Large acquisitions will inject new capital and restore investor interest in venture-backed companies, predicts Cohen, who is now chairman of New York family investment firm JM Cohen & Co. A recent example is French pharmaceuticals giant Sanofi-Aventis’s hostile $18.5 billion bid for Cambridge, Massachusetts–based Genzyme Corp.
Venture funds that launched in 2000 capitalized on their predecessors’ wild run during the 1990s. In 1997, for instance, top-decile funds earned an average 188.2 percent internal rate of return, while the IRR for the top quartile was 56.1 percent, according to Boston-based investment consulting firm Cambridge Associates. The venture industry also caught the updraft of a hot IPO market. Between 1993 and 1999 some 1,300 venture-backed companies went public, raising vast sums. But most of the large 2000-vintage venture funds, especially those bigger than $500 million, had a tough time returning their initial capital net of management fees, expenses and carried interest. Among the notable underperformers: Sevin Rosen Funds of Dallas and Mayfield Fund and U.S. Venture Partners, both of Menlo Park, California — three illustrious shops that have financed some of the most successful companies of the past three decades. Here’s what went wrong. Buoyed by the promise of ’90s-grade returns, investors offered venture funds truckloads of capital. All that cash was too much to manage, but the funds were in no mood to turn it down. Getting bigger would allow them to invest in bigger deals as well as fatten their fees. And instead of syndicating those deals, they could do all the financing themselves. Most important, size would attract new business and let them specialize. “It became a classic case of buying high and then not having anywhere to go,” says Robert Raucci, a founding managing partner at New York investment firm Newlight Management, who used to invest in venture funds for institutional clients. Con— Jonathan Flint vinced they could quickly cash Polaris Venture Partners out, venture firms made hefty investments in companies when valuations were at their peak, Raucci adds. But then markets slumped and valuations dropped. “As exits — IPOs and M&As — became scarce, they had to pour even more capital into existing companies to keep them afloat,” Raucci says. Venture funds still have plenty of reasons to worry. Regulations that inadvertently limit research coverage, especially for emerging companies; lower trading profits, thanks to online brokerages; a shift from long-term investing to short-term trading — all of these things work against them. “The markets in which venture capitalists and venture-backed companies thrived are simply not there,” Cohen says. ••
“ ”
We have seen the enemy, and it is us.
Comment? Click on Hedge Funds/Alternatives at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
THIS TRADER JUST OUTPERFORMED VWAP BY 20 BASIS POINTS
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This communication is directed only at persons who have professional experience in the investments which may be traded over the systems and certain high net worth organizations. Communicated by Bloomberg Tradebook LLC, member of FINRA (www.finra.org)/SIPC/NFA. Bloomberg Tradebook Canada Company Member of CIPF, Bloomberg Tradebook Limited. BLOOMBERG, BLOOMBERG PROFESSIONAL, BLOOMBERG TRADEBOOK are trademarks and service marks of Bloomberg Finance L.P. (“BFLP”), a Delaware limited partnership, or its subsidiaries.
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Pension Corner
Defined contribution sponsors are pushing hapless workers to save more for retirement. BY MAUREEN NEVIN DUFFY
T
HE STRUGGLE OF GOVERNMENTS AND
corporations to sustain America’s defined benefit pensions may grab all the headlines, but there’s a parallel crisis brewing among defined contribution plans. Employees enrolled in these plans must decide how much to save — and the way things are going, most of them won’t have enough for retirement. Employers are trying to turn the tide by taking workers’ contributions from their pay whether they’ve signed up for the company plan or not. So far, it’s helping. Somebody needs to act. Three quarters of participants in defined contribution plans will fall short of their retirement goals, according to an October report from Financial Engines, a Palo Alto, California– based company that provides investment advice to plan participants through managed accounts or over the Internet. Passivity and lack of investment skill are the chief villains. Roughly 25 percent of employ-
ees enrolled in defined contribution plans let one fifth of their account balances languish in company stock instead of diversifying, says Christopher Jones, CIO of Financial Engines, whose study of 2009 data spans 2.8 million 401(k) portfolios at 272 plan sponsors. Workers also neglect the balances they roll over from former employers’ plans into IRAs.“Our data show that most people who own an IRA are not contributing,” says Craig Copeland, senior research associate at the Employee Benefit Research Institute (EBRI). The median IRA account barely topped $20,000 at the end of 2008,Washington-based EBRI notes. Even when combined with non-traditional IRAs, the average IRA balance is less than $70,000.“There’s a lot of inertia among participants in 401(k) plans,”Copeland says. “The typical [defined contribution] participant is neither very well informed nor particularly engaged in the process,” adds Jones, who looks to management to help break the block. “Employers are going to determine the success of our retirement system in this country.” Auto-enrollment plans — which require employees to opt out — and automatic escalation of contributions boost savings rates, Copeland and Jones have found. Dropout rates decline too. Among clients of New York– based J.P. Morgan Retirement Plan Services, less than 12 percent of participants had opted out of auto-enrollment as of last December. These changes to defined contribution plans have raised participation, agrees Tom Kmak, CEO of Fiduciary Benchmarks, a Portland, Oregon–based firm that builds benchmarks for plan sponsors. Optout-style plans took off after the Pension Protection Act of 2006. In 2007 the Department of Labor freed plan sponsors from potential liability for enrolling employees automatically in managed accounts. Employer-driven plans are outpacing traditional opt-in plans. Participation is 92 percent with opt-out plans, compared with 75 percent for opt-in, Copeland says, and Financial Engines reports similar findings. After employers in the latter’s survey reenrolled staff in managed accounts, almost twice as many were on track for retirement: 57 percent versus 31 percent for opt-in plans. In one client case study by J.P. Morgan Retirement Plan Services, participation in plans that added opt-out and auto-escalation features swelled from 65 percent to 90 percent in the first 30 days. Meanwhile, the average contribution rate rose to 7.07 percent of salary from the standard auto-enrollment rate of 5 percent. Despite the safe harbor provided by legislation and Department of Labor guidelines, most plan sponsors still only offer automatic enrollment to new hires, experts say. This restriction may stem from concerns about the cost of reenrolling employees, says Copeland, who has noticed that some plan sponsors have reduced their matching contributions since the financial meltdown. Going back to reenroll staff could even affect the cost-benefit analysis, he adds: “If there is a high turnover in the labor force, administrative costs of starting up and canceling plans would not be cheap.” That kind of help isn’t a luxury for tomorrow’s retirees, many of whom are still gravely unprepared. •• Comment? Click on Asset Management at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
KEITH NEGLEY
IVES CAPITAL DEFINED CONTRIBUTIONS CEO INTERVIEW COVER STORY CAPITAL MARKETS BAN
THIS TRADER JUST TRADED 30% OF THE AVERAGE DAILY VOLUME IN 2 MINUTES
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TERNATIVES DEFINED CONTRIBUTIONS
CEO INTERVIEW COVER STORY CAPITAL MARKE Duke Energy’s James Rogers foresees a 40-year march to green energy
E EVER SINCE THE LATE 1980S,
James Rogers has been beating the drum for green energy as an answer to global warming, putting him in the vanguard of climate-change activists. But what’s most remarkable is that Rogers happens to be CEO of Duke Energy Corp., the huge electric and gas utility that ranks among the U.S.’s biggest emitters of carbon dioxide. Moreover, that dubious distinction is one the Charlotte, North Carolina, utility won’t be relinquishing any time soon. It is the only power company in the U.S. that is simultaneously building two coal-burning plants, which are due to come online in 2012. And coal, although it is both abundant and cheap, is a notorious pollutant compared with natural gas or nuclear power. What explains the apparent paradox between Rogers’s green persona and Duke’s seemingly retrograde strategy? A self-proclaimed pragmatist, he argues that a climate-friendly Duke Energy’s James future will require a 40-year forced Rogers is counting on to carry consumers into the brave new world of alternative march. So how do new coal plants fit nuclear energy to power his energy sources that he envisions arriving around 2050. ambitious green agenda. (The coal plants under construction by Duke are efficient into this scenario? Rogers frames the history of BY FRANCES DENMARK enough to qualify for a combined $258.5 million in cleanpower generation as one big cleanup coal tax credits.) effort. “When people were burning In the meantime, Duke Energy must serve a big and growcoal and wood in the fireplace and ing marketplace. It supplies electricity to 4 million retail using kerosene lights, going to eleccustomers in the Carolinas and the Midwest, and distributes tricity automatically cleaned up the cities,” he points out. Then the natural gas in Ohio and Kentucky. Duke’s commercial unit operClean Air Acts and subsequent amendments got utilities to clean ates power plants for municipalities, other utilities and industrial up power plants. Now that coal plants built in the 1970s and ’80s facilities. Its international division runs plants in Latin America. In are reaching the end of their lives, Rogers says, the U.S. will have to addition, Duke has a portfolio of renewable-energy ventures — wind, build fewer but more-efficient coal and other types of power plants solar and biomass — that now supply roughly 1,000 megawatts of INSTITUTIONALINVESTOR.COM
ANDREW HARRER/BLOOMBERG
Nuke Power Corp.
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IONS CEO INTERVIEW COVER STORY CAPITAL MARKETS BANKING THE 2010 LATIN AMERICA EXE
the company’s nearly 40,000 megawatts. In all, some 40 percent of Duke’s power comes from non-carbon-producing sources, including water and nuclear energy. Born in Birmingham, Alabama, Rogers, 63, graduated from Emory University with a degree in business and spent three years as a reporter for the Lexington Herald-Leader before going to law school at the University of Kentucky. After clerking for Kentucky’s Supreme Court, he was named an assistant state attorney general and consumer advocate under then–Democratic governor Julian Carroll. In 1977, Rogers moved to Washington, going back and forth between the Federal Energy Regulatory Commission, where
“If you’re serious about addressing the climate problem, you have to be serious about embracing nuclear power.” he handled litigation, and Akin Gump Strauss Hauer & Feld, where he became a partner in 1983. Enron Corp. chief Kenneth Lay hired him away in 1985 to run Enron’s gas pipeline business, but Rogers left in 1988 — more than a decade before Enron’s notorious bankruptcy — to head Indiana utility PSI Energy. He oversaw PSI’s 1994 merger with Cincinnati Gas & Electric Co., yielding Cinergy Corp., which he also ran. When Cinergy and Duke Energy merged in 2006, creating the U.S.’s third-largest electric utility, Rogers became CEO, president and board chairman. He spoke with Senior Writer Frances Denmark during a visit to New York in late September. Institutional Investor: What drives your interest in green energy? Rogers: I’m in the business of making billion-dollar decisions, and as
a pragmatist, I’m an advocate for advancing [green] issues, in part so that I can deliver on my job one: making energy as affordable, reliable and clean as possible. Whether it’s a coal plant at $3 billion or a nuclear plant at $12 billion to $14 billion, I can make more-informed decisions about huge investments that will last 50 years if I know the [environmental] rules, even though a cleaner carbon footprint in our generation facilities is going to translate into higher prices.
So where are energy prices headed?
As you look out over 20 to 30 years, you’re going to see the real price of electricity rise. It’s going to be driven by the need to spend more on an aging system. We’re retiring depreciating plants and building new ones. The price is going to rise because we are modernizing the grid with two-way communication, and we’re looking at modernizing our meter system with two-way communication. [This saves energy by, for instance, letting a so-called smart meter temporarily shut off a refrigerator when a customer runs a dishwasher, to avoid a surge in demand.] What can Duke Energy do about controlling costs for its customers?
We can help them reduce usage as prices go up. That makes it easier for us to make investments [in new plants] — which drives our earnings growth — and yet minimizes the consumer backlash from rising prices. Our customers’ frustration won’t be as great if they are able to take action to optimize their electricity usage and minimize their bills.
Which of all the alternative energy sources holds the most promise?
If you look out over the next decade, the Environmental Protection Agency is going to write a set of regulations requiring us to shut down as much as one third of the existing coal fleet [of plants] in the United States.And that coal fleet is going to have to be replaced by something. Will it be natural gas? Will it be nuclear? Will it be renewables? One of the great challenges confronting us is what mix of those three do we need to replace one third of the U.S. coal fleet. What would you push for if you were drafting U.S. energy policy?
The way I see it, we have lots of energy and environmental policies, but they’re not comprehensive and coordinated.What’s missing is a comprehensive approach that recognizes that energy and environmental issues are inextricably linked and that sometimes when people make environmental policy, they are indirectly making energy policy, and vice versa. What has Duke done to minimize carbon emissions?
We’ve invested over $1.5 billion in wind power. We build the plants and sell them under long-term contracts to utility companies in other regions of the country. We’re doing the same thing with solar in our commercial business. But we’re also putting solar panels on the rooftop within our regulated business in North Carolina. And we have two nuclear plants on the drawing board. [Duke is also awaiting regulatory approval of a newly completed nuclear plant in Cherokee County, South Carolina.] Would it be out of the question to replace Duke’s coal-burning plants with cleaner nuclear ones?
If you’re serious about addressing the climate problem, you have to be serious about embracing nuclear power, because it is the only technology that will allow us to achieve both sufficient electricity and zero greenhouse gases 24/7. We’ve been able to safely and reliably provide power from nuclear plants for 40 years. China has also embraced nuclear power.
Yes. We have several partnerships with Chinese companies, including China Huaneng Group, China’s largest power generator. They’re building 24 nuclear plants, while we’re not turning dirt on a single one here at home. China has an economic imperative to build power generation to bring electricity to its people, the way we did in the 20th century. We’ve also partnered with ENN Group, one of China’s largest private energy companies. What do you expect ultimately to gain?
We need to cooperate with them because it will benefit the people of both countries. In the infrastructure business, if you’re building 24 plants, the real innovation comes as you build each new generation. You will build it cheaper and more efficiently. The Chinese are going to develop the construction processes and capabilities to build facilities cheaper than we’ll be able to build them in the United States. We can learn from their experience. That is very counterintuitive to Americans’ way of thinking today. What do you say to people who deny global warming?
There’s a wide number of people that don’t believe it, for a variety of reasons. But even if it didn’t exist, what would I change about my strategy? We are building plants today that are modernized and have significantly reduced the emissions per kilowatt hour. We would be doing that anyway. •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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doing g doing d i g wel well, we , we wel well l, doing g doing good g g good doing g doing doing g gd wellll,, w w wel wel we ll, wel doing g doin doing d oo od good good doing ing g wel well, we doing good
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COVER STORY
THE INSTITUTIONS / PG 38 THE MANAGERS / PG 42
S
ocially responsible investing has traditionally been a tough sell. In the past the smart-money crowd equated responsible investing with poor investing. That mentality, however, is changing. A growing number of pension funds and other institutions have come to believe that doing good and doing well are no longer mutually exclusive. Increasingly, these investors have found that companies that take environmental, social and governance, or ESG, factors into consideration when running their businesses do better financially than those that ignore them. Although money managers have been slower to embrace the practice, they too are now seeing the monetary benefits of incorporating environmental and ethical considerations into their analyses. As more institutions and managers start rewarding “good” companies with increased investment dollars — creating a truly virtuous circle — investors really might start changing the world. PHOTOGRAPHS BY ETHAN LEVITAS
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COVER STORY
THE INSTITUTIONS
No Turning Back Influential institutional investors are changing the way they invest — for good.
By Imogen Rose-Smith
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GROWING UP IN THE 1960S AND EARLY
’70s, Kerry Kennedy spent her summers on Cape Cod, in Hyannis Port, Massachusetts, with her many siblings and cousins at the Kennedy Compound. The three homes that make up the compound, located on six neatly manicured acres alongside Nantucket Sound, are still owned by the Kennedys, who descend on the Cape every summer. This year was no different, except that Kerry, the seventh of Robert and Ethel Kennedy’s 11 children, persuaded her family to open its doors for three days to a serious cause: expanding fiduciary responsibility. That’s how a group of some 150 people — among them, 31 fiduciaries representing some of the U.S.’s largest public pension plans, including the California Public Employees’ Retirement System, the Florida State Board of Administration and the North Carolina Retirement Systems, as well as corporate pension plans, sovereign wealth funds, university endowments and foundations — found themselves invited to the Kennedy Compound in RFK Center president Kerry Kennedy wants fiduciaries to be more responsible investors INSTITUTIONALINVESTOR.COM
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If the entire investment landscape changes by one small little fraction, the impact could be on hundreds of millions of people.
late July. Ethel Kennedy greeted the guests, who could have a much bigger impact than any on-thesneaked glances at the family photos that clutter ground initiative that the center might undertake. almost every surface of her longtime residence and “If the entire investment landscape changes by chatted with other members of the clan, including one small little fraction, the impact could be on Kerry’s brother Bobby Jr. and cousin Ted Jr., before hundreds of millions of people,” Spilker explains. wandering out onto the wooden deck. From there Spilker, Kramer and Kennedy insist they are no they made their way inside a large tent, decorated Bambi-eyed idealists. But until recently, mainstream with strings of twinkling lights, where dinner, featurasset managers considered them to be exactly that. ing New England clam chowder, was served. Now, however, the brain trust behind the Compass James Wolfensohn, former head of the World Conference is among a growing number of investBank and a longtime friend of the Kennedys, gave the ment professionals and thought leaders who believe keynote address. The world, the veteran investment that pension plans and other institutions have a fiduciary obligation to consider ESG factors when banker told his audience, is changing fast. In 30 years they invest. In fact, they say, consideration of such as much as half of global GDP will come from India principles is critical to successful long-term asset and China, he said. “And the thing is that, for those of us that live in the currently viewed rich world, this — Mark Spilker, former management — an argument that has gotten a boost is a change of proportions that our generation has co-head, Goldman Sachs from recent events, including the economic meltnever seen before,” he explained. “The change in Asset Management down, the BP oil well disaster and the Massey Energy itself is dramatic in terms of numbers, but the most Co. mine explosion, as well as from growing evidence dramatic change is what’s going to happen in the of the impact of climate change and the importance economics. And it’s not just in the economics; it’s of good corporate governance. what is happening socially and intellectually in those “A fiduciary with an investment vehicle like a countries.” In this new world order, Wolfensohn sugpension fund or endowment with a long time horigested, fiduciaries will need to rethink not only where they put their zon should be thinking about conditions that will affect investment money but how they invest and what they value. In short, they are returns over ten to 30 years,” says New Jersey’s Kramer. going to have to focus on investing for the global good. Institutional investors have historically not considered ESG The evening kicked off the first RFK Compass Conference, orga- factors to be important; most believed looking at these issues to be nized by the Robert F. Kennedy Center for Justice & Human Rights, at odds with what they did. Traditionally, the most common way to the not-for-profit organization founded in 1968 by the late Robert approach ESG factors has been through so-called socially responsible Kennedy’s family and friends to carry on his legacy. Kerry, president investing, or SRI. In its earliest form, SRI consisted of screening out of the RFK Center, and a group of its supporters — including Orin “bad” securities, like the stocks of tobacco makers or companies Kramer, a hedge fund manager and New Jersey State Investment that manufactured land mines. For many of the pioneers of Modern Council board member; Marc Spilker, former co-head of Goldman Portfolio Theory — an investment approach, favored by institutions, Sachs Asset Management; and Robert Smith, founder and CEO of that emphasizes diversification — such screening was foolhardy. $3 billion, San Francisco–based private equity firm Vista Equity “It is hard to do well by doing good when you shrink your opporPartners — put the conference together because they believe that tunity set,” says Mark Anson, a former CIO of CalPERS. “In fact, issues of environmental impact, socially responsible investing and mathematically you are wrong.” corporate governance, which commonly go by the label ESG, are A rain forest of academic literature published on SRI indicated more important than ever for investors. that, at best, screening had no impact on returns. Many continued to “This is not something that is abstract,” says Kerry Kennedy. believe, sometimes with good reason, that socially responsible funds “These are real issues that fiduciaries are dealing with every day.” underperformed the market. As a result, SRI was relegated to a group The recent economic meltdown, she says, is just one factor causing of values-driven investors — religious organizations, hospitals and investors to step back, take a look at what they do and realize just the like. Without role models among mainstream investors, public how important ESG considerations really are. pension funds in particular were reluctant to consider what in the past Some might puzzle over why a human rights organization like half dozen years came to be termed ESG. the RFK Center cares what an institutional investor like the New Socially responsible investing was also dogged by an all-orJersey state pension system does with its money, but for the center’s nothing attitude. “There was this sense that you couldn’t be a little supporters, this makes a lot of sense. “Kerry got together a group bit pregnant,” says Lyn Hutton, CIO of Wilton, Connecticut–based of people who were really inspired by her, and we’re doing this for Commonfund, which manages $25 billion in foundation and endowher and to support her work in human rights,” says Kramer. Adds ment assets. This led many institutions to throw up their hands. “A Spilker, “The mission of the RFK, doing social justice and human lot of investors got stuck in these abstract conversations,” says John rights, is one of the truly honorable things in the world to be doing.” Goldstein, co-founder of Imprint Capital Advisors in San Francisco, Expanding fiduciary responsibility to include ESG factors, he says, one of the only consulting firms to focus exclusively on advising investors on ESG and other impact investments. But as the discussion shifts from screening out bad stocks to Hedge fund manager Orin Kramer says fiduciaries continued on page 82 need to focus on long-term returns
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COVER STORY
THE MANAGERS
Money from Trees
Asset managers are finding an unlikely new source of alpha — responsible investing.
By Katie Gilbert
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PIERRE LAGRANGE, CO-FOUNDER OF $22 BILLION HEDGE
fund firm GLG Partners, cares about sustainability, but not in a way that would make anybody confuse him with a tree-hugging hippie (despite his shoulder-length locks). In his mind, the most important aspect of problems like greenhouse gases, disappearing natural resources and rising global temperatures is not that they could spell the end of life on earth as we know it. It’s that they present an incomparable investment opportunity. As Lagrange, who owns a HarleyDavidson, told the United Nations’ General Assembly two years ago when he participated in an informal meeting on investments and climate change,“The environment will be as big as the Internet in its impact on companies and consumer behavior.” To try to capture what he called “green alpha” at the U.N., this spring Lagrange rehired Jason Mitchell, a former long-short portfolio manager who had left the London-based firm in mid-2008 to become chief operating officer of a water treatment company in sub-Saharan Africa. Since April, Mitchell’s job at GLG has been to develop an investment strategy that looks to profit from the problems surrounding sustainability, and the world’s responses to them. Lagrange isn’t the only alpha-hungry hedge fund manager who has recently begun searching for investment returns in environmental, social and demographic issues, long considered either too soft or too irrelevant to turn the heads of cold, hard capitalists. New York–based Marathon Asset Management, a $10.5 billion Jason Mitchell rejoined GLG Partners to run a sustainability hedge fund
credit-oriented hedge fund firm, recently introduced a share class that screens investments based on sustainability issues. Auriel Capital Management, a $340 million London hedge fund firm, has brought on Adam Seitchik, a former chief global strategist at Deutsche Asset Management, to demonstrate how a built-in consideration of extrafinancial factors can punch up performance. “Hedge funds are purely alpha-driven, so obviously the hedge funds that are doing this see real value in this data,” says Darragh Gallant, who runs Jantzi-Sustainalytics, the North American arm of Amsterdam-based Sustainalytics, a research firm that provides analysis on the environmental, social and governance performance (commonly referred to as ESG) of thousands of publicly listed companies. Gallant adds that she’s seen a recent surge of interest from hedge funds in the firm’s research. Hedge fund managers aren’t alone. Private equity giant Kohlberg Kravis Roberts & Co. is rapidly expanding its Green Portfolio Program, which places a premium on improving the environmental performance of the companies it invests in. (Companies in the program now make up 30 percent of KKR’s private equity investments.) “This really plugs right into our existing infrastructure,” says Elizabeth Seeger, who came from the New York–based Environmental Defense Fund to manage KKR’s green initiative. “It’s still all about creating value. In this case, we’re creating two types of value: the environmental benefit as well as the financial benefit.” The tentacles of sustainable investing reach further still, touching equity and fixed-income strategies, mutual fund and institutional offerings, and alternative and core investment products. At Scotland’s $260 billion-in-assets Aberdeen Asset Management, the head of socially responsible investing research, Cindy Rose, is pushing for equity analysts and portfolio managers firmwide to use environmental, social and corporate governance criteria to help pick stocks. F&C Investments, a $150 billion asset management firm based in London, started the Emerging Markets ESG fund in March for a group of institutional clients who were looking to invest in emerging-markets equities but were concerned about the corporate governance risk and sustainability problems often inherent in such investments. “I think it’s part of the maturing of the sustainable investment industry, and part of the definition of mainstreaming, that this is being seen as valuable across the spectrum of asset classes,” says Michael Jantzi, CEO of Sustainalytics. The growing legion of mainstream money managers embracing sustainable investing distance themselves from their industry forefathers, the pioneers of values-based socially responsible investing, or SRI. This new crop of managers is unabashedly all about smarter investing and improved returns, not ideological debates about how to make the world a healthier and happier place in which to live. (GLG’s Mitchell, for one, says he doesn’t entertain discussions about the ethics of his investments.) These managers have been pushed to consider sustainable investing from a fresh perspective for multiple reasons: Their institutional investor clients are more likely to assume a concern for sustainability as part of their fiduciary roles (see “No Turning Back,” page 38); a growing body of academic research suggests that INSTITUTIONALINVESTOR.COM
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COVER STORY
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What this rebranding does that is beneficial, both from a financial and societal point of view, is it puts the ESG issue front and center for money managers.
companies scoring higher on ethical, environmental The value lies in each manager’s respective approach and social issues have better financial results; and a to ESG. In other words, the devil is in the investment handful of high-profile money managers are establishprocess details. ing track records on sustainable investment strategies “It’s not a silver bullet where you can say, ‘I’ve that have outperformed their peers. No wonder some got this ESG rating that’s going to give me a posiof these managers claim to have found, or be well on tive return,’” says Bruce Kahn, a senior investment their way to finding, a better way to invest. analyst at Deutsche. “If that were the case, it would While the word “sustainability” is often used to be commoditized like P/E ratios. Then there’d be no connote environmental preservation and all things value to it. It’s in the subjectivity that the portfolio green, sustainable investing has much broader managers bring when they make an investment and implications. It is meant to take into account a wider in using this information to influence that subjectivpicture of a company’s operations than a traditional ity. That’s where the value is.” investing process might and thereby gain greater ESG implementation is often a process of trial insight into the real health, and potential future and error. GLG, for example, launched a long-only health, of a business. Sustainable investing emphaenvironment fund in 2007, using data from Trucost, sizes a company’s environmental impact, social a London-based company that offers research that responsibility and response to human rights issues, shows analysts and portfolio managers the carbon and corporate governance structure, all of which —C.D. Baer Pettit, MSCI footprints of the companies they follow. Lagrange arguably play important roles in the sustainability and other members of the investment team believed of that company — and its share price. For example, that by investing in companies that were 30 to 50 a large company’s supply chain might connect it percent cleaner than the rest of the market, they could to labor rights violations in a developing country, unearth some green alpha. But, as Mitchell recalls, or its board of directors might be too cozy with its it wasn’t that easy. executives — situations that are potential causes of “A filter based purely on quantitative environmenscandals, litigation or reputational damage for a tal data just doesn’t capture factors like regulatory corporation.“Why wouldn’t a professional money manager want to change,” he says.“We’ve learned that you can’t let something like this know this stuff?” asks Amy Domini, founder and CEO of New York– blindly guide investments. You can use it as an initial screen and then based Domini Social Investments, and one of the pioneers of SRI. apply layers of intelligence on top of it, but you can’t allow this filter The vast majority of money managers, however, have long to just steer the fund.” resisted incorporating environmental, social and governance data In other words, successful integration doesn’t mean treating ESG into their investment processes. Responsible investing was for information as a factor that money managers base all decisions on, decades considered the domain of fringe money managers, whose or ignoring it completely, but simply using it as another tool among rhetoric boasted that they could help investors do their part to a wide array. improve the world. But when it came to performance, SRI managers More than a few signs indicate that’s exactly where the industry’s could only tepidly assert that, at best, their responsible investing headed as ESG becomes more mainstream. In June, MSCI acquired tactics wouldn’t affect returns. Most in the larger investment com- RiskMetrics Group, a provider of risk management analytics that munity balked, insisting that imposing nonfinancial constraints on had months before acquired KLD Research & Analytics and Innovest an investment portfolio could only hurt. Portfolio Solutions, both longtime SRI research houses. C.D. Baer That widely held wisdom is rapidly dissolving. Pettit, global head of client coverage and marketing at MSCI, says “More and more, we’re seeing evidence that these factors are actu- that clients had been pushing the firm to offer ESG analytics. He ally impacting security valuations,” says Kevin Parker, global head believes that folding the ESG indexes into MSCI’s suite of products of $725 billion Deutsche Asset Management, which has integrated — and putting MSCI’s name on them — will not only satisfy that ESG data into the research platform that portfolio managers access demand but drive new demand among the firm’s wide base of clients. throughout the firm. “So from a fiduciary standpoint, we would be “What this rebranding does that I think is beneficial, both from a remiss in our duties if we did not take this into account.” financial and societal point of view, is it puts the ESG issue front and Still, not everyone is convinced that the benefits of ESG outweigh center for money managers,” says Pettit. the costs. This is especially true among U.S. money managers, for whom the discussion surrounding sustainable investing is less devel- IN THE EARLY 1980S, AMY DOMINI WAS WORKING IN oped than it is in Europe and Australia, where more investment Harvard Square as a retail stockbroker at a small regional brokerage. With a growing level of curiosity, she noted that many of her vehicles integrate ESG data in a fundamental way. Capturing the benefits of ESG isn’t as easy as turning on a sus- clients were coming to her with specific companies or sectors that tainable-investment switch within a fund. Managers who have they refused to invest in. For example, a bird-watcher asked Domini successfully found ways to implement it tend to echo the same point: what to do about her investment in a large paper company. Another wanted to avoid defense contractors. She set out to research their common plight, which she took to calling “ethical investing.” ComAs global head of Deutsche Asset Management, Kevin Parker wants ing up empty-handed (save for one article on the Pax World Fund, everyone in his firm to understand the importance of ESG factors
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There was very little widespread support of SRI. The market is driven by performance, and the SRI funds weren’t leaping to the top of the charts.
the first mutual fund that integrated social criteria, Pickens. Still, shareholder activism was too rare founded by two American Methodists in 1971), even to be called a niche strategy: “It was a piccolo she prepared an adult-education class on how to that you heard once in a while in the symphony,” invest with ethical concerns in mind. She had no Whitworth says. sooner submitted the lesson plans than a publisher In 1995, Whitworth and David Batchelder, who contacted her and asked if she’d consider writing had worked together as executives at Pickens’s a book. In 1984 she published Ethical Investing. Mesa Petroleum Co., founded Relational InvesIn her book, Domini briefly discusses negative tors after winning a $200 million mandate from the screening, which is how most investors up to that California Public Employees’ Retirement System point had addressed their social concerns: Anti– as part of its new corporate governance program. Vietnam War activists avoided buying stock in Dow CalPERS remains their largest client, representing Chemical Co., the producer of napalm; religious about $1.4 billion of their San Diego–based firm’s investors avoided so-called sin stocks like alco$6.1 billion in assets. By the mid-1990s a small industry had sprouted hol and tobacco companies; others divested from around SRI. Research shops that specialized in data companies that did business with apartheid South and analytics for SRI managers had emerged: Kinder, Africa. But in her book Domini was more eager to talk about positive screening. Lydenberg and Domini founded KLD in 1988, and “An investor is by definition looking for things to —Burt Greenwald Jantzi Research came along in 1992. (Jantzi and buy, not looking for things not to buy,” says Domini. B.J. Greenwald Associates Sustainalytics merged last year.) Other organizations “People didn’t want to just divest. They wanted to were formed to research and increase awareness of focus on things that people needed: access to medithe burgeoning industry. The Coalition for Envicine, healthy food, better energy systems.” ronmentally Responsible Economies (Ceres) came Though the title of Domini’s book didn’t stick as together in 1989, and KLD helped found the Social a term for investing — the market preferred “SRI,” Investment Forum in 1995. which had been coined about a decade before — In addition to the handful of mutual fund comthe ideas in it proved foundational. In 1990, Domini and partners panies that offered SRI products, a few other large firms waded Peter Kinder and Steven Lydenberg introduced the Domini 400 into the industry by offering separately managed accounts to social index, which tracked 400 mainly large-cap corporations institutional investors with specific requests. State Street Corp. was chosen for their positive social and environmental track records. among the first of the major firms to provide this service, which it “I wanted to build a record so that if investing this way cost money, began in 1987, screening out companies or sectors to fulfill each I could say, ‘This’ll cost you an average of 30 basis points a year,’” institutional client’s request. says Domini. “I didn’t see why it would cost money, but I thought, “The people in SRI vehicles were evangelists for the cause,” says ‘Fine, let’s see if it does.’” Burt Greenwald, president of Philadelphia-based consulting firm B.J. Indeed, the Domini 400 Social index (now the MSCI KLD social Greenwald Associates.“There was very little widespread support of index) provided the first hard evidence that this type of investing SRI.” The main problem was still performance. “The broad market didn’t have to cost money. In its first few years, it performed roughly is driven by performance, and the SRI funds weren’t exactly leaping in line with the market. Since then, it’s done better: As of October 31 to the top of the charts,” Greenwald says. the index’s annualized return for the past decade was 0.07 percent, In 2000, however, a new law in the U.K. led to something of a sea beating the Standard & Poor’s 500 index’s –0.95 percent return. change, at least on that side of the Atlantic. An amendment to the The performance of Domini’s index encouraged a slight change 1995 Pensions Act required pension schemes to disclose the extent of rhetoric around socially responsible investments. Rather than to which they considered social, ethical and environmental issues in touting ethical investing as worthwhile even at a cost, the handful their investment processes. Over the next few years, similar legislaof SRI evangelists could say that they offered a “free good” — in tion spread across Europe. Such legislation meant a spike in investor other words, their style of investing could improve society without demand for SRI products, and the offerings in the European SRI impacting returns. But the tactic was still limited to values investors; realm, particularly for institutions, quickly expanded. the larger investment community didn’t pay much attention. No such laws followed in the U.S., though in 2003 the Securities Around this time, shareholder activism was starting to gain and Exchange Commission introduced a measure that shone a spottraction. The concept of banding investors together to change light on mutual funds’ proxy voting, requiring that fund companies a company’s internal practices wasn’t a new one: In 1967, Saul disclose all relevant policies and actions. For the first time, U.S. Alinsky had led a successful shareholder campaign against East- investors had a guaranteed look into how their mutual funds were man Kodak Co. to get the photo company to improve its minority responding to shareholder resolutions on everything from corporate hiring and training processes. But it wasn’t until the late 1980s governance to social and climate-change issues. Corporate goverand early ’90s that shareholder activism was seen as a financially nance shortcomings — of the type Whitworth and Batchelder had viable proposition, says Ralph Whitworth, who during that begun mining for value a decade earlier — had recently leaped to the period was president of the United Shareholders Association, an fore. In the early 2000s investors witnessed some dramatic demoninvestor advocacy group started by corporate raider T. Boone strations of how governance breakdowns could impact shareholder
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COVER STORY
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We rank companies on ESG, but we don’t believe that the ESG ranking is all that matters. ESG gets a vote, but it doesn’t get veto power.
value, via scandals and subsequent meltdowns at many firms are stepping back and asking what real Enron Corp., Tyco International and WorldCom. integration might look like. In June 2004 the term “ESG” burst onto the scene “We rank companies on ESG, but we don’t and ushered in much more than a change in vocabubelieve that the ESG ranking is all that matters,” lary. “Environmental, social and corporate goversays Auriel Capital Management’s Seitchik. “ESG nance analysis” first appeared in a U.N. Environment gets a vote, but it doesn’t get veto power and it’s Programme Finance Initiative report — actually, a not the dominant vote.” Before joining Auriel in collection of 11 studies of nine brokerage houses mid-2009, Seitchik was CIO of Trillium Asset Manthat the U.N. had commissioned — overwhelmingly agement Corp. and the chief global strategist at supporting the conclusion that ESG factors did in Deutsche. He’s now helping Auriel integrate ESG fact affect long-term shareholder value. The new into its investing process. term, scrubbed of values and ethics connotations, The poster child for ESG investing is Generaand the paper’s conclusion that ESG was material to tion Investment Management, founded in 2004 by performance, helped spark the collective idea that onetime Goldman Sachs Asset Management CEO ESG integration could itself be a source of alpha. David Blood and former U.S. vice president Al Gore. Paul Hilton, director of advanced equities research —Adam Seitchik Although Gore is best known for his fight against at Bethesda, Maryland–based Calvert Asset Manage- Auriel Capital Management global warming, environmental factors are just ment Co., says the new buzzword played a crucial one piece of the investment puzzle at Generation. role in the growing institutionalization of ESG that The firm’s global equity fund, which accounts for soon followed the U.N. report. $6.2 billion of the London-based firm’s $6.9 bil“Investors really picked up on this when they saw lion in assets, invests in 30 to 50 large- and midcap the transition from values-based SRI to proactive companies based on what Generation considers to ESG investing,” explains Hilton, whose firm manbe sustainable long-term businesses. According to ages more than $14.5 billion, $5.3 billion of which are SRI assets.“A sources, Generation has beaten its benchmark, the MSCI world lot of that had to do with having the language right.” index, by 800 basis points a year, on average, since 2005. In 2009 The Social Investment Forum reports that in the U.S. so-called the fund was up 49.03 percent, trouncing the index by more than 18 SRI assets rocketed to $2.29 trillion in 2005 from $639 million a percentage points. decade before. Two years later that figure had jumped to $2.71 trillion, an increase of 18 percent (between 2005 and 2007 the broader DEUTSCHE’S KEVIN PARKER TRACES THE ROOTS OF HIS universe of professionally managed assets increased only by 3 interest in climate change to a vineyard that he bought in 1993 in the percent). To arrive at these totals, the SIF sends surveys to institu- Languedoc region of France. He decided that he’d convert the vinetional investors and money managers, asking them to reveal how yard to organic and biodynamic farming, and noted that the Château much of their assets are subject to “environmental or social criteria, Maris wine produced there seemed to benefit from the extraction of all chemicals, pesticides and fertilizers from the production process. policies or screens.” Following the U.N. report and the release of a few others like it, Ruminations on the sustainability of soil led Parker to study the susmainstream managers were eager to figure out how to tap the alpha tainability of air and water, and before long he was educating himself that ESG was said to provide. A smattering of funds sprang up on about the debate surrounding greenhouse gas emissions. He became the theory that investing along specific ESG themes (most often convinced that the science behind climate change is so indisputable specifically environmental ones) would be the best way to capture that, as he puts it,“if you’re arguing against the reality of greenhouse ESG opportunity. Widely read academic research contributed to the gases heating up the planet, you’re a modern-day Don Quixote.” In 2004, Parker changed jobs, moving from global head of excitement: “The Eco-Efficiency Premium Puzzle,” published in the Financial Analysts Journal in the spring of 2005, concluded that a equities at Deutsche to chief of investment management. Not long portfolio containing companies with high “eco-efficiency” — high thereafter, the firm added climate change to its list of megatrends production relative to the amount of waste they created — performed that would shape the asset management industry. Deutsche organized mandatory training events to impress upon its portfolio better than a portfolio with more-wasteful companies. Deutsche Asset Management was one of the forerunners in managers and analysts the importance of climate change and its launching thematic strategies focusing on climate issues. Deutsche relevance to what they did. The theme of Deutsche’s 2007 annual managing directors’ conferestablished its first climate-change mutual fund in 2006, and by March 2009 the firm had $4 billion in climate-change strategies. ence was climate change, with Al Gore as the featured speaker. This Today some $8 billion of its $725 billion under management falls year’s conference focused on sustainability, and speakers included under this umbrella, and products range from mutual funds to Jared Diamond, a scientist and author of the book Guns, Germs, and Steel; Mindy Lubber, president of Boston-based sustainable investing institutional and alternative strategies. But these strict thematic funds have performed with wildly varying coalition Ceres; and representatives from individual companies like results. After all, the “eco-efficiency” idea was generally the theory Cisco Systems, who described the ways in which they are factoring GLG was so excited by when it implemented its ultimately unsuc- climate change into their business models. continued on page 87 cessful carbon-tracking strategy in 2007. As GLG has now done,
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We didn’t create the leading ETF provider. You did.
At iShares, we believe the value of leadership isn’t measured by numbers. Otherwise, our ten years of experience, 200-plus ETFs and status as the world’s leading ETF provider1 would be enough. More important is what it means to you as an institutional investor—deep resources dedicated to finding smart solutions for your needs. Let’s create something together. Call our dedicated Institutional Team at 1-800-743-9285 or visit iShares.com/institutional.
iShares has been serving the institutional market for 10 years and holds a 47% AUM market share.2 800
US ETF $AUM
700
iShares $AUM
$789
$618
AUM ($Billions)
600
$542 500 $432 400 $311
300 $236 200 $157 100 0
1
70 $ 8
$87
$106
$18
$31
$58
‘00
‘01
‘02
‘03
$
$114 ‘04
$171 ‘05
$251
‘06
$329
‘07
$372 $258
‘08
‘09
Source: Global ETF Research & Implementation Strategy Team, BlackRock, Bloomberg, as of 12/09. Based on number of ETFs, AUM and market share. Source: FactSet, Bloomberg and BlackRock, as of 12/09.
2
Call 1-800-iShares to request a prospectus, which includes investment objectives, risks, fees, expenses and other information that you should read and consider carefully before investing. Investing involves risk, including possible loss of principal. The iShares Funds are distributed by SEI Investments Distribution Co. (“SEI”) and advised by BlackRock Fund Advisors (“BFA”). BFA is a subsidiary of BlackRock Institutional Trust Company, N.A. (“BlackRock”), neither of which is affiliated with SEI. ©2010 BlackRock. All rights reserved. iShares® is a registered trademark of BlackRock. All other trademarks, servicemarks or registered trademarks are the property of their respective owners. iS-2802-0710
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CAPITAL MARKETS
O UNLOCKING
ABS MARKET BY CHARLES WALLACE
the
Mortgage-backed and other securitized bonds may have helped cause the financial crisis, but their revival is critical to the recovery.
J
PMORGAN CHASE & CO. MADE A MATTER-
of-fact announcement late last month that passed almost unnoticed in the financial world. The House of Jamie Dimon said it had sold a $1.1 billion securitized bond issue backed by a pool of commercial mortgages. Though the announcement of a ten-figure securitized bond was a weekly, if not daily, event just three years ago, that’s certainly not been the case since the financial crisis blew up the securitization market in 2008. Still, JPMorgan’s commercial-mortgage bond issue — two times oversubscribed — was a signal that one of the most crucial components of the capital markets is healing, albeit slowly. “The commercial-mortgage securitization market is back up and running,” says Jeffrey Perlowitz, head of the securitization desk at Citigroup in New York. “The market is functioning terrifically. There is a huge demand for paper, all the way from below-investment-grade to triple-As.” That’s a huge relief to a segment of the finance industry that was once a pillar supporting the American economy. As recently as 2007, when the market reached its zenith, there were $9.1 trillion in mortgagerelated securities outstanding and an additional $2.4 trillion of bonds backed by such things as auto loans,
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credit card debt and student loans. That was equal to about two residential-mortgage-backed securities, known in the trade as privatethirds of the market capitalization of all the stocks listed on the New label RMBSs. There has been just one new private-label RMBS issue, York Stock Exchange. worth only $238 million, in the two years since the market imploded. But the securitization boom also inspired a flurry of dubious innova- That compares with $789 billion of new issuance in 2006 alone. tion: subprime mortgages, liar loans and collateralized debt obligations Will the asset-backed market ever fully recover? William Gross, that bundled mortgages and other asset-backed securities together in founder and co-CIO of Pacific Investment Management Co., the the mistaken belief that diversification would lower risk. Then came world’s largest bond investor, says his firm remains bullish on secueven-more-exotic securities, known as synthetic CDOs and CDOs- ritized debt. Some $10 billion of its $250 billion Total Return Fund is squared, that sliced and diced other CDOs and combined them into in nonagency RMBSs, and Gross is investing in auto loans and credit packages that became time bombs on investors’ balance sheets. card debt as well.“They represent attractive value with decent default “These deals didn’t exist because there were people out there who assumptions,” he says. But the market faces a lot of obstacles. For example, interest rates said, ‘I need to build a factory’ or ‘I want to liquefy my credit card portfolio so I can extend new credit,’” says Ronald Borod, Boston- are now so low that some banks find it more profitable to keep loans based head of the securitization practice at law firm DLA Piper.“They on their balance sheets than to securitize them. The spread between existed because bankers were saying, ‘Look at the arbitrage we can what they pay depositors for their funds and what they earn by lendmake by bundling these assets together and selling them at a higher ing that money out to credit card borrowers far surpasses what they price than we bought them at.’” would earn on a securitization. The market began to crumble in 2007 when two Bear Stearns Another question mark is a rule change by the Financial Accounting Cos. hedge funds heavily invested in subprime-mortgage-backed Standards Board late last year that altered the way banks must consolisecurities collapsed. Eighteen months later, after Lehman Brothers date assets, leaving many bankers wondering whether securitization Holdings had failed and American International Group had barely is still an efficient solution for such things as credit card receivables. escaped the same fate, the market for securitized debt was totally Also putting a damper on new issuance is a sheaf of new regulafrozen, except for debt issued by government-backed agencies, tions coming from Washington, which was chagrined and angered which carries an implicit guarantee from Uncle Sam. To make matters by the financial crisis. The Dodd-Frank Wall Street Reform and worse, some now say securitized debt issued during the boom was Consumer Protection Act contains an entire section putting limits the primary cause of the financial crisis. on how securitizations can be carried out and on how the ratings “For me, it was very unfortunate to watch so many of the good agencies will be allowed to participate in the business. The Federal things that structured finance had done for the marketplace being Deposit Insurance Corp. weighed in on September 27 with a new thrown out with some of the problems that took place,” says David comprehensive securitization regulation that includes a requireJacob, head of structured-finance ratings at Standard & Poor’s. He ment that banks retain a 5 percent slice of the credit risk of bonds previously spent 14 years at Nomura Securities International, includ- issued after January 1 of next year. These regulatory changes may ing several as head of U.S. fixed-income research. “We’re trying to force banks to charge more for their services, or prompt them to figure out how to emerge from this so that structured finance will exit segments of the market entirely. once again be a very important part of the capital Perhaps the greatest impediment of all is the fact that the federal government, thanks to its control markets,” Jacob says. “It’s probably not going to be of the Federal Housing Administration and its conas big as it was, but a significant component of it.” servatorship of Fannie Mae and Freddie Mac, now Clearly, if there is going to be an economic recovoversees between 90 and 95 percent of new issuery, securitization will have to play a major role. But one or two bond issues, even large ones like JPMorance in the $10 trillion RMBS market. The Obama gan’s, or another a few weeks earlier by Citigroup administration has so far not made any proposals and Goldman Sachs Group for $788 million of for reform of Fannie and Freddie that would create commercial mortgages, do not make a trend. The an opening for private capital to come back to the securitization markets are still way below the levels market in any significant amount. Even if reforms that were reached in the heady days of 2007, when are adopted, it could be five to ten years before the $246 billion in commercial-mortgage securitizaprivate-label market for residential mortgages is tions were issued. This year only about $9 billion of revived. By contrast, in Europe, where there is no new securities and refinancings were issued through direct government involvement in housing finance, September 30, according to figures compiled by private-label securitization is flourishing once again Thompson Reuters. (see sidebar, right). It’s a similar story elsewhere in the asset-backed And if all that is not bad enough, sloppy paperwork for 2005–’08 securitizations — which was world: Auto loan securitization is a bright spot with revealed this fall when several U.S. banks temporarily $38.5 billion so far this year, but that’s still below halted foreclosures because of potentially faulty the $82 billion issued in 2006. Securitized bonds backed by credit card receivables are down to just loan documentation — has called into question the $5.1 billion, compared with $99 billion in 2007. But — Ronald Borod legality of some of the RMBSs issued during the DLA Piper the real disappointment is private-sector-originated boom period. At the least, this could force banks to
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These deals didn’t exist because there were people out there who said, ‘I need to build a factory’ or ‘I want to liquefy my credit card portfolio.’
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ON THE MEND The European ABS market is surprisingly strong. Although the market for private sector residential-mortgagebacked securities is frozen in the U.S., it has recently shown signs of life in the U.K. and the Netherlands, where there is no competition from government-backed lending agencies like Fannie Mae and Freddie Mac. Surprisingly, the primary investors snapping up these securities are U.S. banks hunting for higher yields. The biggest recent deal was a £4.7 billion ($7.4 billion) issue in September by Royal Bank of Scotland Group, which originated the loans with National Westminster Home Loans. A week later, Dutch insurer Aegon completed the sale of €842 million ($1.17 billion) worth of mortgages in the Netherlands. In total, for the first nine months of this year, European mortgagebacked issuance reached $50 billion, up from $9 billion for all of last year. Of course, that’s
still well below the $300 billion in RMBSs issued in 2006. Jean-David Cirotteau, senior asset-backed securities analyst at Société Générale in Paris, says the principal ABS markets in Europe, particularly in Germany, are for U.K. and Dutch mortgages and auto loans. Spain and Ireland used to be major issuers of securitized debt, but those markets dried up with the housing bust. The European Central Bank tried to support the assetbacked market by allowing the use of ABSs as collateral for refinancing operations during the financial crisis, so that banks could fund ABSs even when investors fled the market. Beginning in January of this year, a steady trickle of German auto loan issuance showed that the ABS market was slowly returning to life, but it is still restricted to a handful of countries. Credit terms are much stricter, with investors demanding that the cushions for losses, known as credit enhancements, be much larger than in past transactions. Cirotteau says the recent issue of U.K. and Dutch bonds was helped by the fact that they are paying 120 to 170 basis
buy back tens of billions of dollars in loans; at worst, it could prompt investors to legally challenge entire bond issues. FITTINGLY, SECURITIZATION WAS BORN FROM RESIDEN-
tial mortgages, in 1970, when the Government National Mortgage Association, also known as Ginnie Mae, guaranteed the first securities that pooled mortgages and passed the principal and interest payments through to investors. In a typical securitization, the issuer sells loans to a special purpose vehicle, which then transfers the assets to a trust. The trust then trades the assets for cash from an underwriter, which sells bonds backed by the pool to investors. The investors receive the principal and interest payments monthly. The innovation of “pass-through” securitization allowed banks to get mortgages off their balance sheets, so they no longer had to face the risk that interest rates might shift suddenly, while investors such as insurance companies and pension funds had an investment that would not be affected by the bankruptcy of the lender and often had a higher credit rating than the financial institution that made the loans. A later innovation carved the mortgage pools into slices known as tranches, with different repayment schedules and subordinate levels of risk. The top tranche, often up to 80 percent of the security, was rated triple-A and entitled to first payment of the principal and interINSTITUTIONALINVESTOR.COM
points over LIBOR, compared with only 25 basis points for ABSs in the U.S. That helps explain why U.S. investors were among the biggest players in the deals. “JPMorgan bought huge amounts of U.K. and Dutch RMBS for its own purposes, and there were other large U.S. banks participating in the market,” Cirotteau says. U.K. and Dutch financial institutions have been under pressure to sell their loans because they have no funding alternatives such as covered bonds, which are the primary financing vehicle for housing loans in Germany and Scandinavia and were a big factor recently in Spain. Stephen Hynes, head of securitization, group treasury, at RBS, says the September transaction was his bank’s first mortgage securitization sold to investors since June 2007, although other major U.K. banks have done large deals earlier this year. Hynes says one of the attractions of the U.K. securitization market is that none of the prime mortgage bonds issued in the past few years has been downgraded. The RBS deal involved only prime mortgages with an
average loan-to-value ratio of 75 percent. “It’s very strict credit criteria, and there are no impairments allowed,” he says. “It doesn’t fall into the category of near-prime or Alt-A or even further down the credit curve.” Now that spreads for RMBSs are in the triple digits, it’s an extremely attractive asset class for fixed-income investors. “There’s a significant amount of interest from U.S. investors, which has helped us to build momentum,” Hynes adds. RBS sold only the triple-A and double-A tranches of the deal and retained the rest. There is an ongoing discussion in the U.K., similar to one taking place in Washington, about whether to force banks to keep a 5 percent piece of the credit risk of securitized transactions, to make sure they have “skin in the game” and don’t sell poorly performing loans to unwitting investors. Hynes notes that because of new capital rules, banks have to keep securitized transactions on their balance sheets: “In the last decade securitization was more about capital relief as much as funding, but there’s no doubt that the pendulum has swung in the direction of funding.” — C.W.
est. Other tranches were rated from double-A to triple-B in a process known as a “waterfall,” with the bottom tranche taking the first loss if borrowers failed to repay. The lower-rated tranches offered higher yields and appealed to a different set of investors. The mortgage-backed market grew steadily through the decades, especially after the savings and loan crisis of the early 1980s reduced that source of funding. In 1996, for example, there were $440.7 billion of mortgage-backed securities issued by agencies such as the Federal Housing Administration, Fannie Mae and Freddie Mac, according to the Securities Industry and Financial Markets Association. Private-label issuance was just $51 billion. By 2006 agency issuance had risen to $1.2 trillion and private-label issuance had ballooned to $789 billion. Mortgages weren’t the only loans being packaged and resold. In 1985, Marine Midland Bank used the securitization process to issue a $6 million bond backed by auto loans; this type of instrument has since become a major part of the ABS industry. Banks began to use securitization for everything from credit card receivables to student loans and the memorable sale of a $55 million bond backed by David Bowie’s songs, the first use of securitization with intellectual property as collateral. Nonmortgage ABS issuance reached $753 billion in 2007. The increase in private-label securitization was accompanied by continued on page 90
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BANKING
Brian Moynihan is trying to fix the house that Ken Lewis built
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CAN MOYNIHAN MANAGE BANK OF AMERICA? New CEO Brian Moynihan has soothed relations with regulators, integrated Merrill Lynch and led a profit revival at the giant lender, but housing problems threaten the bank’s recovery.
By Matthew Miller
O
N OCTOBER 7, BANK
of America Corp. chief executive Brian Moynihan received a telephone call from Barbara Desoer, president of the bank’s home mortgage division. A storm had been building for two weeks over shoddy paperwork in the U.S. mortgage market, prompting Bank of America, GMAC Mortgage and JPMorgan Chase & Co. to suspend foreclosure filings in 23 states where court orders are required to seize a house and triggering investigations into possibly fraudulent practices by attorneys general from dozens of states. For Bank of America, which originates one in five U.S. mortgages and services nearly 14 million loans worth a total of $2.1 trillion, the controversy carried enormous risks. Desoer, who had launched an internal review of the bank’s procedures on September 22, told the CEO that questions by officials and consumer advocates had reached such a fever pitch that the bank should temporarily freeze all foreclosures. Moynihan didn’t waste time. The next day, in a bid to get ahead of the problem, the CEO declared a nationwide moratorium on foreclosures while Bank of America checked the documentation on 102,000 delinquent mortgages. “What we are trying to do is clear the air and say we will go back and check our work one more time,” he told reporters at the National Press Club in Washington, where he had traveled for
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the annual meetings of the International Monetary Fund and the BofA’s legacy operations, chipped in $1.1 billion of net income in World Bank. Ten days later the bank announced it was resuming the same period. foreclosure proceedings, saying its review had not uncovered any Those results, and Moynihan’s restless energy and comprehensive errors in loan information. command of BofA’s sprawling operations, are winning over many Moynihan has been trying to clear the air on a number of fronts of the bank’s critics. “He appears to be more outgoing and engaged since being thrust into the top job at Bank of America at the start than Ken Lewis,” says Jonathan Finger, a minority shareholder who of this year. His predecessor, Kenneth Lewis, who built the bank helped lead a revolt last year that blocked Lewis’s reappointment as into a behemoth in a decade of deal making, retired early under chairman and who initially opposed Moynihan’s appointment as pressure after his costly acquisitions of subprime mortgage lender CEO. “He’s focused on managing the company that he inherited, Countrywide Financial Corp. and investment bank Merrill Lynch & and that includes a lot of repair work.” Co. nearly brought the bank down in 2008. Bank of America needed For all the progress made, though, the hardest part of Moynihan’s $45 billion in federal bailout funds — an amount equaled only by restoration job is yet to come. As its name suggests, Bank of America Citigroup — to survive the financial crisis. remains inextricably tied to the struggling U.S. economy. The bank To restore the bank to health, Moynihan has been waging a holds 12 percent of U.S. deposits, claims relationships with one half of multipronged offensive. He has worked tirelessly to repair BofA’s all U.S. businesses and is the nation’s leading issuer of debit cards and relations with regulators and politicians, embracing rather than its second-largest issuer of credit cards. More than 80 percent of BofA’s fighting regulatory reform. The bank was the first to abandon over- revenue last year came from domestic operations. With the recovery draft charges on debit cards to comply with tough new U.S. rules on flagging, unemployment near double digits and consumers still looking how customers are charged for overdrawing their accounts, a move to pay down their debts — U.S. consumer credit has contracted for six that is expected to reduce revenues by a $1 billion annually. He has straight quarters — the prospects for growth are limited.“A company accelerated the integration of Merrill Lynch’s investment banking of this size whose business is primarily serving U.S. consumers isn’t and wealth management businesses with BofA’s huge commercial going to escape what’s going on in the U.S. economy,” says Richard and retail banking network, helping to unlock the potential of Lewis’s Bove, Florida-based banking analyst with Rochdale Securities. A tougher regulatory climate also promises to diminish returns. empire. The CEO has also traveled the globe, from London and Paris to Beijing and Tokyo, to reassure and motivate his troops after the The bank estimates that new rules limiting overdraft charges, turmoil of the previous two years and to demonstrate to top clients credit card rates and fees, and fees paid by businesses on debit card that BofA is eager to do business. transactions will reduce revenues by $4.3 billion a year. Bank of “The franchise build is over for Bank of America,” Moynihan America took a one-time charge of $10.4 billion in the third quarter told investors at a conference in New York in September. “Now it is for lost debit card revenue, turning a $3.1 billion operating profit just time to operate.” into a $7.3 billion net loss for the period. Although the bank largely Moynihan’s no-nonsense approach is starting to bear fruit. Net complies with the higher capital requirements that will be phased income for the first nine months of the year, excluding noncash in under the new Basel III accord, global regulators are currently goodwill impairment charges, increased threefold, to $9.4 billion, negotiating a capital surcharge to apply to systemically important even as revenue declined by 7.1 percent, to $87.8 billion. The gains banks, such as Bank of America. reflect an improving credit trend. Provisions for bad debts, which Shareholders, who have had their stock massively diluted by the peaked at $11.7 billion in the third quarter of 2009, have steadily Merrill Lynch acquisition and by a $19.3 billion stock offering in declined, reaching $5.4 billion in the same quarter December 2009 to finance the repayment of bailout this year. BofA released $1.8 billion from its loan-loss funds, may not see stock buybacks resume until 2012. reserves in the third quarter and $1.5 billion in the Real dividends, beyond the nominal 1 cent-a-share second, bolstering profits. Those reserve releases payout the bank has been making since the third quarwere the first in more than two years. ter of 2008, may take even longer to arrive. BofA’s Ironically, Merrill Lynch, whose subprime losses return on equity, excluding goodwill impairment nearly torpedoed Bank of America at the end of charges, was 5.06 percent in the third quarter, trailing 2008 and prompted Lewis’s departure, is playing a JPMorgan (9.8 percent) and Wells Fargo & Co. (11.2 major part in the turnaround. Global banking and percent). markets, the division that includes the investment To top off the challenges, the troubled U.S. housbank, produced net income of $5.6 billion in the first ing market continues to cloud the bank’s outlook. nine months of the year. Although that was down 35 Complaints about poor paperwork — notably, the percent from a year earlier, reflecting lower trading use of so-called robo-signers who signed off on thousands of foreclosure demands without verifying loan profits, it represented more than half of the group’s — Brian Moynihan information — could still impede BofA’s attempts to total profits. In the first nine months of this year, the Bank of America seize homes from delinquent borrowers. Even worse, bank ranked second in global investment banking revenues, with $3.3 billion, trailing only JPMorgan, last month a group of mortgage-backed-securities according to data provider Dealogic. Wealth maninvestors, including the Federal Reserve Bank of New agement, which combines the activities of Merrill York, BlackRock, Pacific Investment Management Lynch’s so-called thundering herd of brokers with Co. and Metropolitan Life Insurance Co., demanded
The franchise build is over for Bank of America. Now it is just time to operate.
”
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PREVIOUS SPREAD: BRENDAN HOFFMAN/BLOOMBERG
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JIN LEE/BLOOMBERG
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that Bank of America repurchase mortgages that were packaged into $47 billion worth of MBSs, alleging that the bank had misrepresented the quality of those loans and failed to service them properly. Fears that investors could force Bank of America to buy back some of the $2.1 trillion worth of mortgages that were securitized by Countrywide and BofA over the past decade sparked a sell-off that pushed BofA’s shares down 17 percent in two weeks last month; they ended the month at $11.45, down 42 percent from their 52-week high back in April. Uncertainty “will continue to weigh on the shares until investors become more confident in the loss exposure for the company,” wrote Christopher Mutascio, an analyst with Stifel, Nicolaus & Co., who downgraded Bank of America shares to hold from buy. Christopher Gamaitoni, an analyst at Compass Point Research & Trading, estimates that BofA could be forced to buy back as much as $35 billion in mortgages. The array of challenges facing Moynihan poses a larger question. Lewis’s acquisitions built Bank of America into the largest U.S. bank, with $2.3 trillion in assets, 284,000 employees and operations that run the gamut from credit cards Sallie Krawcheck’s wealth management business is a key growth priority to consumer banking to money management to underwriting stock and bond sales by mulitinational corporations. into NationsBank Corp. with a string of acquisitions in the South That diversity provides numerous income streams. But it also carries and Southwest, then paid $43 billion for Bank of America in 1998 in what was then the largest-ever U.S. banking merger. multiple risks. Lewis, a 30-year bank veteran before he succeeded McColl as “Bank of America is a relatively new company and hasn’t had time to breathe,” says Paul Miller, chief bank analyst at FBR Capital chairman and CEO in 2001, spent even more lavishly, with the aim of Markets in Arlington, Virginia.“Moynihan is trying to make it work, creating a universal banking powerhouse. He acquired FleetBoston Financial Corp. for $47 billion in 2004, credit card giant MBNA but the question remains, is it too big to manage?” Moynihan, a tireless executive and a veteran boardroom survivor, Corp. for $35 billion in 2006 and Chicago-based LaSalle Bank Corp. makes no bones about the enormity of the task he faces. “We need for $21 billion in 2007. Lewis considered the purchase of Merrill to restore the trust of customers in our industry and our company Lynch his crowning achievement, telling Institutional Investor last and the brand,” he said in a recent interview at the bank’s Charlotte, year that the firm represented “the final piece of the puzzle.” The $29.1 billion all-stock deal was negotiated at the height of the North Carolina, headquarters. He aims to do just that by emphasizing profitability over volume, reducing the company’s riskiest lending financial crisis, on the same fateful weekend in September 2008 when and trading activities, and strengthening Bank of America’s balance Lehman Brothers Holdings collapsed. In their haste to conclude the sheet. He is shutting down the bank’s proprietary trading activities deal, Lewis and his colleagues failed to fully grasp Merrill’s exposure and selling noncore businesses, and has reduced BofA’s risk-weighted to speculative mortgage securities. As markets tanked, Merrill’s assets by $86.8 billion and boosted tier-1 common capital by $14 bil- losses ballooned to $15.8 billion in the fourth quarter of 2008 and lion, to $124.8 billion. led to bare-knuckle talks with the U.S. Treasury Department and the Moynihan plans to generate profit growth by enhancing Bank of Federal Reserve over whether the transaction would be completed. America’s retail network with technology and expanding relationPublic anger mounted after reports emerged that the investment ships with institutional and corporate customers. BofA will invest bank paid out $3.6 billion in bonuses to top managers ahead of the in businesses that “have a stronger growth potential,” particularly deal’s close, even as Bank of America sought to stanch Merrill’s growinternational investment banking and wealth management, he says. ing red ink with federal bailout funds. The bank eventually received $45 billion in funds from the Treasury’s Troubled Assets Relief ProBANK OF AMERICA ROSE TO PROMINENCE THROUGH THE gram, including $20 billion to cover losses at Merrill Lynch, allowing vision and deal-making skills of a series of aggressive bankers. U.S. regulators to impose unprecedented controls at the bank, includThomas Storrs turned the former North Carolina National Bank into ing key boardroom changes that ultimately led to Lewis’s departure. a regional player by venturing into Florida in 1982, in the early days The U.S. Securities and Exchange Commission filed charges claimcontinued on page 95 of interstate banking. His successor, Hugh McColl, turned NCNB INSTITUTIONALINVESTOR.COM
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THE 2010 LATIN AMERICA EXECUTIVE TEAM
Latin America
Leads theWay
ILLUSTRATION BY GLUEKIT
A fresh generation of corporate executives is taking advantage of the region’s dynamic growth and transforming its companies into world-class champions.
By Leslie Kramer INSTITUTIONALINVESTOR.COM
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Latin leaders (from left) Raúl Jacob, Southern Copper Corp.; Rafael Matute Labrador, Wal-Mart de México; Ricardo Andrés Sierra Fernández, Cementos Argos; Marcos Marinho Lutz, Cosan; and Luis Llanos Collado, Empresas CMPC
Leaders of Latin
American public companies should be sitting pretty these days. Many of the region’s local economies are enjoying real gross domestic product growth rates that are among the highest in the world, improvements in corporate reporting and disclosure are reassuring foreign investors more than ever, and many companies are trumpeting sound fundamentals and robust profits. However, skittishness about the strength and sustainability of the global economic recovery — particularly in the U.S. — continues to cast a long shadow over Latin American and other emerging markets, with investors demonstrating a willingness to yank money out of equities at the first sign of trouble anywhere in the world. “The two biggest issues right now are the downshift in U.S. economic data over the summer and the second stage of quantitative easing in the U.S.,” explains Ben Laidler, director of Latin American INSTITUTIONALINVESTOR.COM
equity research for J.P. Morgan in New York.“On the back of that has been the flow-of-funds story into the emerging markets in all sectors, which in turn has produced lots of noise on capital controls. Overall, global drivers predominate.” And those drivers can wreak havoc. Case in point: Sovereign-debt woes half a world away, in Dubai and then in Europe, sent Brazil’s benchmark Bolsa de Valores, Mercadorias e Futuros Bovespa index plunging nearly 11 percent at the start of the year, as investors fled stocks in search of safer havens. Those losses were reversed by April, but then China’s announcement that it was reining in its stimulus spending, in an attempt to cool down its own overheating market, sent the Bovespa tumbling 19 percent by May. It subsequently recovered, gaining 19 percent through September, as Brazil’s — and the region’s — torrid growth showed no signs of slowing. Just the opposite, in fact.
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THE 2010 LATIN AMERICA EXECUTIVE TEAM THE 2010 LATIN AMERICA EXECUTIVE TEAM: MOST HONORED COMPANIES
focus on the many positives as they expand their reach, Total increase shareholder value First IR IR Rank Company Country Sector Place CEOs CFOs Pros. Cos. and lay the foundation for long-term success. 1 Cosan Brazil Agribusiness 8 2 2 2 2 The corporate leaders who 2 OdontoPrev Brazil Health Care 7 2 1 2 2 have done the best job of ris2 PDG Realty Brazil Real Estate 7 2 2 1 2 ing to the challenge are cited 4 Cemex Mexico Cement & Construction 6 2 1 1 2 in the tables on the surround4 Itaú Unibanco Holding Brazil Banking & Financial Services 6 2 1 1 2 ing pages in our inaugural 6 CPFL Energia Brazil Electric & Other Utilities 5 2 0 1 2 ranking of the Latin America 6 Suzano Papel e Celulose Brazil Pulp & Paper 5 2 2 1 0 Executive Team, which high6 Vale Brazil Metals & Mining 5 1 1 1 2 lights the region’s best CEOs, CFOs and IR Professionals, 9 América Móvil Mexico Technology, Media 4 1 2 1 0 & Telecommunications as well as the companies with 9 Lojas Renner Brazil Consumer Goods & Retailing 4 1 0 1 2 the most-valued investor relations, as determined by anaBrazil Oil, Gas & Petrochemicals 4 1 1 1 1 9 OGX Petróleo e Gás Participações lysts on both the buy and sell 9 Vivo Participações Brazil Technology, Media 4 1 0 1 2 sides. (More-detailed results & Telecommunications can be found on our web site, institutionalinvestor.com.) The most honored comLast month the International Monetary Fund revised its 2010 pany is Cosan. Buy- and sell-side analysts agree that the Brazil-based forecast for the region upward, predicting that GDP growth in sugar and ethanol producer is home to the Agribusiness sector’s No. 1 Latin America and the Caribbean would accelerate by 5.7 percent CEO (Marcos Marinho Lutz), CFO (Marcelo Eduardo Martins) and this year (compared with 4.8 percent for the global economy), with IR professional (Luiz Felipe Jansen de Mello); they also say Cosan the most vigorous growth expected in Paraguay (up 9 percent), provides better investor relations than any of its peers. Uruguay (8.5 percent), Peru (8.3 percent), and Argentina and Brazil Much of that success is attributable to Lutz, who was appointed (7.5 percent each). Much of that growth is fueled by worldwide to the top post in October 2009 and wasted no time in making his demand for the region’s commodities. mark on the company, the world’s largest sugar-cane processor.“It’s Investors keep pouring money into Latin America, especially the been a year of big structural changes during a challenging time,” says more-developed markets of Brazil and Mexico, in search of gains the 41-year-old Lutz, who is based in São Paulo. they can’t find in Europe and the One change that caught the world’s attention took place in FebruU.S. (where the IMF expects 2010 ary, just a few months after Lutz was named CEO: Cosan signed a nonbinding memorandum with Europe’s largest oil company, Royal GDP growth of only 2 percent and Dutch Shell, to form a $12 billion joint venture for the production 2.6 percent, respectively).Accordof ethanol from sugar cane. The deal became binding in August, ing to the Institute of International Finance, a Washington- based although it is still awaiting regulatory approval. Lutz predicts it will association of banks and other close near the end of the first quarter. financial institutions, the region Under the terms of the agreement, Shell will put up $1.6 billion in is on track to see capital inflows cash plus other assets, including more than 2,700 service stations, in excess of $213 billion this year, and Cosan will put up 23 cane-crushing mills and more than 1,700 up nearly 56 percent from last gas stations (it owns the rights to the Esso and Mobil brands in Brazil) year’s $137 billion. Of that total and other assets. In addition, Cosan will transfer some $2.5 billion a whopping $148 billion will be in liabilities to the as-yet-unnamed venture, leaving it room to bordirected to Brazilian equities, the row money to finance acquisitions. “The JV will be supported by — Marcos Marinho Lutz IIF predicts. a strong balance sheet, strong cash flow generation and a steady Chief Executive Officer Throughout Latin America a Cosan basis of distribution operations,” Lutz says. “Cosan will see a large new wave of chief executive offiincrease in equity by obtaining this new partner. The opportunities cers, chief financial officers and for growth are huge.” directors of investor relations is The deal will enable Cosan to increase production of ethanol working to transform its companies into regional dynamos. These throughout Brazil and better position both companies to explore business leaders know that to maximize their companies’ potential new opportunities for producing and selling ethanol globally, he in a time of robust growth and extreme volatility they have to help adds. Cosan, which currently accounts for 5.7 percent of the world’s investors keep negative financial news in context — that is, that most ethanol market, could see that figure soar to 20 percent as a result of of it has little or no lasting impact on the region’s markets — and the partnership with Shell. Listed below are companies ranked by first-place positions won. Two top spots are available per category, for a total of eight overall.
“We offer a portfolio of possibility to investors.”
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For now, Lutz says, Cosan will focus on increasing ethanol sales in Brazil, where there is a ready market. In 1993 the Brazilian government mandated that gasoline sold in the country must contain 22 percent ethanol by volume; that figure increased to 25 percent in 2007. Flexible-fuel vehicles, which run on any proportion of gasoline-and-ethanol mix, were introduced in Brazil in 2003 and by last year accounted for more than 90 percent of all new-vehicle sales. “Brilliant”is the word one portfolio manager uses to describe Cosan’s joint venture with Shell. “It will help the company position itself for sustainable, long-term growth, especially given the rising interest in climate change and the need to lower emissions, without shifting the focus away from the company’s core efficiencies,” this buy-sider says.“Cosan’s manage— Rafael Matute Labrador ment team has consistently shown Chief Financial Officer that they understand what it takes Wal-Mart de México to stay on top in a rapidly changing environment.” The global financial crisis — and its continuing reverberations — underscored the need for Cosan to diversify its operations, which is what attracted Lutz to the Shell venture. “In the past, when we were pure players on sugar, we were more exposed, as everything was based on the price of commodities,” he explains.“We designed this venture to help us prepare for any difficult times to come. We offer a portfolio of possibility to investors.” Those possibilities even include an infrastructure play. Cosan is majority owner of Rumo Logística, which oversees the shipping of sugar from production sites to storage at the Port of Santos, where it operates the world’s largest sugar-export terminal. Cosan exports about 70 percent of the sugar and 30 percent of the ethanol it produces each year. In July asset managers TPG Capital of Texas and Gávea Investimentos teamed up to buy a 25 percent stake in Rumo Logística, paying Cosan 400 million reais ($226 million). The infusion of capital will enable the company to invest in other infrastructure projects throughout Brazil. As the company has expanded, so has its shareholder base. Once a favorite of niche investors, Cosan is now drawing a lot of money from mainstream investors, Lutz says. “We are large enough in terms — Luis Llanos Collado of liquidity for most investors, and Chief Financial Officer we have become a very compelling Empresas CMPC story in terms of strategic positioning,” he explains.“People buy
“We don’t use the word ‘recession.’”
“It’s in economic downturns that opportunities arise.”
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THE 2010 LATIN AMERICA EXECUTIVE TEAM: BEST COMPANIES BY COUNTRY Listed below are the top companies ranked in each country by total positions won (first, second or third place). Companies can rank twice in the CEO, CFO and IR Company categories (buy- and sell-side votes are tallied separately), and up to six times in the IR Professional category (voters can select more than one IR Professional per company), for a maximum of 12 positions per company. Rank Company
Sector
Total Positions
Brazil 1
Fibria Celulose
Pulp & Paper
9
2
Banco Bradesco
Banking & Financial Services
8
2
Cosan
Agribusiness
8
2
Gerdau
Metals & Mining
8
2
PDG Realty
Real Estate
8
2
Suzano Papel e Celulose
Pulp & Paper
8
2
Ultrapar Participações
Oil, Gas & Petrochemicals
8
2
Vale
Metals & Mining
8
Chile 1
Empresas CMPC
Pulp & Paper
7
2
Lan Airlines1
Aerospace, Transportation & Industrials
2
3
Banco Santander–Chile
Banking & Financial Services
1
3
Empresa Nacional de Electricidad
Electric & Other Utilities
1
3
S.A.C.I. Falabella
Consumer Goods & Retailing
1
3
Sociedad Química y Minera de Chile
Agribusiness
1
Colombia 1
Cementos Argos
1
Wal-Mart de México
Consumer Goods & Retailing
8
2
América Móvil
Technology, Media & Telecommunications
7
2
Cemex
Cement & Construction
7
1
Southern Copper Corp.2
Cement & Construction
2
Mexico
Peru Metals & Mining
1
1In August 2010, Lan Airlines of Chile and Brazil’s Tam Linhas Aéreas
announced their agreement to merge. 2In July 2010, Americas Mining Corp. (also a subsidiary of Grupo México)
proposed the merger of itself with Southern Copper Corp.
our stock to gain exposure to all of our operations, and they like that we control the chain.” They also like the profits that the company is racking up. For fiscal 2010, which ended in March, Cosan’s net revenue increased a jawdropping 143 percent, year over year, from R6.3 billion to R15.3 billion. “That is huge growth during crisis times,” Lutz says proudly. Phenomenal growth through strategic expansion in tough times is a trait that Cosan shares with Wal-Mart de México, the top-ranked company in Mexico. In February the discount retailer, which is 68 percent owned by Wal-Mart Stores of Bentonville, Arkansas, acquired from its parent company Walmart Centroamérica in a
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THE 2010 LATIN AMERICA EXECUTIVE TEAM
$36.6 billion pesos ($2.8 billion) deal; the latter subsidiary operates hundreds of stores in Costa Rica, El Salvador, Guatemala, Honduras and Nicaragua. To close the deal, Walmex offered Centroamérica stockholders the option of receiving cash or new shares in the consolidated company; most opted for the latter. “That most shareholders chose to keep the stock was a sign of their belief in the potential of the company,” observes Rafael Matute Labrador, the top pick among buy- and sell-side analysts for Best CFO in Consumer Goods & Retailing. “For the first time we are operating in more than one country,” says Matute, 50, who has been CFO since 1998, noting that the deal made strategic sense because “there is very high similarity between customers in Central America and Mexican consumers.” Consolidating the two businesses has created opportunities to streamline costs, improve operational efficiencies and increase shareholder value, the Sinaloa-based finance chief adds. “Our sales growth has been remarkable, given the very challenging environment,”says Matute. In the second quarter, the first full quarter following the integration of the two companies, Walmex reported a 26.7 percent increase in net sales over the comparable period in 2009, to 80.6 billion pesos ($6.5 billion), and a 21 percent increase in net earnings, to 5.7 billion pesos; last month it reported a — Ricardo Andrés Sierra year-over-year net profit increase Fernández of 10 percent, to 4.25 billion pesos. Chief Financial Officer “‘Every day low prices’ is not just Cementos Argos a slogan for us, it’s a strategy. We don’t use the word ‘recession.’” Looking for ways to cut costs and pass the savings on to consumers “is in the DNA of the company,” Matute adds. For example,“we used to have a labor-intensive distribution network but have moved toward installing automated distribution centers that have increased output by 40 percent” and increased the number of stores served by a single distributor by some 33 percent, he says. As a result,“with our growth we didn’t need to lay off workers — we just didn’t hire as many more people,”Matute explains. He believes the potential for expansion will remain strong for a long time. “The region is very attractive,” he says. “We looked at the number of cities we are in already and where we could go, and that showed us the larger potential. There are currently 145 million inhabitants in the region, and over the next 15 years there will be another 25 million in the productive age of new customers.” Walmex in February announced plans to build 330 more stores throughout the region by the end of this year — or the equivalent of increasing floor space by 11 percent — and hire 7,000 new employees. It is already Mexico’s largest private sector employer, with some 180,000 workers. With such a good story to tell, Walmex makes sure its shareholders are kept informed of every development.“We give more information than is required by law,” proclaims Matute.“Every month we publish
“We are having an infrastructure boom in Colombia.”
THE 2010 LATIN AMERICA EXECUTIVE TEAM: BEST CEOS Listed here by sector are the executives who rated highest when buy- and sell-side analysts were asked to choose the top-performing CEOs in their domains. Sector
Buy Side
Sell Side
Aerospace, Transportation & Industrials
Constantino de Oliveira Jr., Gol Linhas Aéreas Inteligentes
Bernardo Vieira Hees, América Latina Logística1
Agribusiness
Marcos Marinho Lutz, Cosan
Marcos Marinho Lutz, Cosan
Banking & Financial Services
Roberto Egydio Setubal, Roberto Egydio Setubal, Itaú Unibanco Holding Itaú Unibanco Holding
Cement & Construction
Lorenzo Zambrano Treviño, Cemex
Consumer Goods & Retailing
José Galló, Lojas Renner Alessandro Giuseppe Carlucci, Natura Cosméticos
Electric & Other Utilities
Wilson Ferreira Jr., CPFL Energia
Wilson Ferreira Jr., CPFL Energia
Food & Beverages
José Antonio do Prado Fay, Brasil Foods
João Mauricio Giffoni de Castro Neves, Cía. de Bebidas das Americas
Health Care
Randal Luiz Zanetti, OdontoPrev
Marcelo Noll Barboza, Diagnósticos da América; Randal Luiz Zanetti, OdontoPrev2
Metals & Mining
Roger Agnelli, Vale
André Bier Gerdau Johannpeter, Gerdau
Oil, Gas & Petrochemicals
Eike Fuhrken Batista, OGX Petróleo e Gás Participações
Bernardo Afonso de Almeida Gradin, Braskem
Pulp & Paper
Antonio dos Santos Maciel Neto, Suzano Papel e Celulose
Antonio dos Santos Maciel Neto, Suzano Papel e Celulose
Real Estate
José Antonio Grabowsky, PDG Realty
José Antonio Grabowsky, PDG Realty
Technology, Media Roberto Oliveira & Telecommunications de Lima, Vivo Participações
Lorenzo Zambrano Treviño, Cemex
Daniel Hajj Aboumrad, América Móvil
1Bernardo Vieira Hees stepped down as CEO of América Latina Logística in
September 2010. 2Tie.
sales reports on our web site. We improved our quarterly conference calls; now they are webcasts that include slides and transcripts, both in English and Spanish.” In addition, the company hosts an annual shareholders meeting each February that includes tours of local stores and distribution centers, presentations from executives and at least one lunch or dinner with all of the company’s vice presidents.“It is really an important opportunity for shareholders to meet the entire management team, and it is also webcast,” says Matute. The investor relations team, which includes a director and an assistant manager, arranges one-on-one meetings between executives and investors, regardless of the number of shares they own. “We meet with at least one or two investors per week, and I personally meet with around 30 percent of them,” Matute notes, adding that about 20 percent of his time is devoted to investor relations. “The INSTITUTIONALINVESTOR.COM
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THE 2010 LATIN AMERICA EXECUTIVE TEAM: BEST CFOS Listed here by sector are the executives who rated highest when buy- and sell-side analysts were asked to choose the top-performing CFOs in their domains. Sector
Buy Side
Sell Side
Aerospace, Transportation & Industrials
Arthur Piotto Filho, Cía. de Concessões Rodoviárias
Arthur Piotto Filho, Cía. de Concessões Rodoviárias
Agribusiness
Marcelo Eduardo Martins, Cosan
Marcelo Eduardo Martins, Cosan
Banking & Financial Services
Caio Ibrahim David, Itaú Unibanco Holding
Domingos Figueiredo de Abreu, Banco Bradesco
Cement & Construction
—1
Rodrigo Treviño, Cemex
Consumer Goods & Retailing
Rafael Matute Labrador, Wal-Mart de México
Rafael Matute Labrador, Wal-Mart de México
Electric & Other Utilities
Eduardo Antonio Gori Sattamini, Tractebel Energia
Miguel Días Amaro, EDP – Energias do Brasil
Food & Beverages
Leopoldo Viriato Saboya, Brasil Foods
Nelson José Jamel, Cía. de Bebidas das Americas
Health Care
Luis André Blanco, OdontoPrev
Carlos Alberto Bezerra de Moura, Diagnósticos da América
Metals & Mining
Paulo Penido Pinto Marques, Cía. Siderúrgica Nacional
Guilherme Perboyre Cavalcanti, Vale; Paulo Penido Pinto Marques, Cía. Siderúrgica Nacional2
Oil, Gas & Petrochemicals
Marcelo Faber Torres, OGX Petróleo e Gás Participações
Almir Guilherme Barbassa, Petróleo Brasileiro
Pulp & Paper
Bernardo Szpigel, Suzano Papel e Celulose
Bernardo Szpigel, Suzano Papel e Celulose
Real Estate
Michel Wurman, PDG Realty
Michel Wurman, PDG Realty
Technology, Media Carlos José García & Telecommunications Moreno Elizondo, América Móvil
Carlos José García Moreno Elizondo, América Móvil
1No CFO met the minimum vote requirement. 2Tie.
level of interaction increased this year, especially from the CEO and me, basically for two reasons: We became an international retailer, and we have a new CEO.” Scot Rank Crawford, formerly chief operating officer, was appointed to the top job in January after Eduardo Solórzano was promoted to president and CEO of Walmart Latin America. Analysts are impressed with the management team’s efforts.According to Loredana Serra, leader of Morgan Stanley’s top-ranked troupe in Retailing on the 2010 Latin America Research Team,“Three factors set Walmex apart from the competition: a multiformat approach that enables it to appeal to the full range of potential customers and gives it maximum flexibility to grow, an unwavering focus on lowering costs and passing the savings on to consumers, and a management team that is focused on delivering superior return on investment.” Those factors are interwoven, Matute observes: “By maintaining INSTITUTIONALINVESTOR.COM
our focus on exceeding our customers’ expectations, we are able to exceed our shareholders’ expectations, too.” PUNDITS OFTEN SAY THE ECONOMIC CRISIS resulted in a
tectonic shift in the financial landscape, but that phrase is more than just a metaphor to Luis Llanos Collado. The CFO of pulp and paper products manufacturer Empresas CMPC (the highestranking Chilean company on the Latin America Executive Team) was jolted awake at 3:34 on the morning of Saturday, February 27, as an earthquake measuring 8.8 on the Richter scale — the strongest earthquake in the region in half a century, and nearly 20 times more powerful than the temblor that had reduced Port-au-Prince, Haiti, to ruins the previous month — rattled central Chile. “When the tremor started the high-frequency pitch I heard reminded me of the 1985 earthquake, but soon I realized that this was a bigger one,” recalls Llanos, 48. The intense shaking lasted an agonizing minute and a half; when it subsided he was relieved to discover that his family — his wife, two daughters and two sons — were unhurt, and the house sustained only minor damage. “After the first shock communication networks were jammed and operated only intermittently, and the main electric grid went down,” the Santiago-based executive explains. “With some effort — through SMS messages and fixed telephone lines — I was able to communicate with the rest of my family, and I was relieved that everybody was fine.” Llanos next turned his attention to his company and its employees. “A few minutes after the first shock, after hearing radio broadcast reports about how shakes were felt in distant places like Puerto Montt and Valdivia in southern Chile and Mendoza in Argentina, I realized that the epicenter must have been close to our main industrial concentration area near Concepción,” he says.This incident fit squarely with what CMPC executives call its “probable maximum loss event” scenario. Llanos immediately started to try to communicate with executives in charge of the company’s facilities in that area. “Our first priority was to locate and check the status of all our per— Raúl Jacob Manager of Investor Relations sonnel in the affected areas and Southern Copper Corp. help them to get supplies; fortunately, nobody in our personnel or their relatives suffered significant injuries,” Llanos says.“Then our focus was to speed up the damage assessment. We contacted main equipment suppliers and consultants, and by Monday many engineers and technicians were on flights from Europe and North America to reach Chile through Argentina — Santiago’s international airport was shut down — to help us. The work needed to restart operations was huge and had to be done under difficult logistic conditions and recurrent aftershocks, many of them reaching magcontinued on page 98
“We believe our company is the best copper play for investors.”
Con•stan•cy (n): Performing as designed regardless of market conditions.
While everything seems to be changing in the world of Stable Value, count on MetLife’s steadfast commitment to this market. Stable Value continues to play an important role in today’s retirement plans with an estimated 27% of all 401(k) assets invested in these funds.* And it’s easy to see why. Stable Value funds offer higher returns than other low risk investments while still providing the safety and security of the book value guarantee that plan participants need. At MetLife, our Stable Value guarantees are easier to understand. Perhaps that’s one reason why over $22 billion is invested in MetLife’s Stable Value offerings today. After 30 years of providing Stable Value solutions to plan sponsors and Stable Value fund providers, we know the market and we’re here to stay. Let MetLife bring constancy to your plan. Call a Stable Value expert at 888-217-1858 to schedule a meeting.
*The Hewitt 401(k) Index™ Observations—Year End 2009 GIC—Stable Value Metropolitan Life Insurance Company, New York, NY 10166. © 2010 MetLife, Inc. PEANUTS © UFS, Inc. L0310094001[exp0311][All States][DC].
STABLE VALUE REPORT
Stable Value Funds
Still a Safe Haven
S
retirement plan record-keepers. table value funds, which Post-financial crisis, the move proved to be one of the toward conservative investment few asset classes able to strategies has reinforced the stability preserve principal and of stable value funds, says Steven deliver steady returns throughout Dorval, managing director of defined the financial crisis, have continued contribution investments at New to offer a safe haven for defined York Life Investments. “Stable contribution plan participants. As value funds will remain a very of June 30, 2010, stable value funds viable investment option for today’s were returning 3.25 percent, which is more than 300 times greater than plan participant. They provide the money market funds, according principal preservation characteristics to the Stable Value Investment desired for risk adverse investors, yet Association (SVIA). also provide an attractive yield that “Stable value funds remain one of can outpace inflation,” he points out. the best kept secrets of institutional While retirees are increasingly money managers,” says Warren using stable value to provide a Howe, managing sales director for predictable, steady payout or income MetLife’s stable value markets team. stream to complement their defined “This type of investment option benefit plan and/or social security offers consistent, predictable growth benefits, stable value funds are used The move toward conservative over the long term, making it a very under many different circumstances. For example, a young employee attractive investment choice for investment strategies has reinforced who works for a company for only employees, especially during times the stability of stable value funds. a year or two may benefit from a of economic uncertainty.” guaranteed product like stable value. Looking back to December of The limited assets that employee accumulates in the account, says 2008, stable value funds returned on average 4.75 percent, at a Howe, are not subject to the market volatility inherent in equitytime when most other 401(k) assets were posting negative returns. based products. “The one-two punch of capital preservation and positive return “Stable value funds are really suitable for all types of retirement makes stable value a great diversifier,” says SVIA President Gina Mitchell. “A 401(k) investor can use stable value quite effectively plan investors,” says Eric Hasenauer, managing director and to adjust the level of risk in his or her 401(k) asset allocation to a head of institutional sales for Aviva Investors North America. level of comfort to achieve his/her investment goals.” She notes, “Regardless of your age, it makes sense to have an allocation to too that stable value funds have the least correlation with other stable value along with more aggressive investment options to try 401(k) asset classes. and preserve principal and participate in potential upside in the Comparable to intermediate bonds but with less volatility, capital markets.” stable value funds are offered in approximately half of all defined Stable Value’s Challenges contribution plans in the US. The funds hold high-quality bonds Like all investments, stable value funds were not immune along with interest-bearing contracts from banks and insurance to the impacts of the financial crisis. For one thing, the tough companies, and the contracts have a wrapper that guarantees the market has made it hard for providers to get new “wrap” net asset value will remain stable for a specified period regardless contracts, which are issued by banks and insurance companies of market conditions. Plan sponsors typically access stable that provide the financial protections against volatility to a value funds through retirement plan intermediaries—pension specific stable value fund. consultants or financial advisors—or directly or indirectly through November 2010 Institutional Investor • Sponsored Report • 1
STABLE VALUE REPORT
Frank Act) has passed into law and is also expected to drive change in the stable value community. According to Seller, FinReg could have had a sizable influence on the stable value fund market because the initial draft of the bill considered defining wrap contracts Gina Mitchell Gregg Seller as “swaps.” This could have limited the SVIA Great-West Retirement Services number of providers willing to provide wrap contracts. The final bill, however, contained favorable language specifi cally addressing stable value wrap “The credit crisis created a supply and demand imbalance contracts. The new language requires the U.S. Commodity in the stable value space such that wrap capacity became very Futures Trading Commission (CFTC) and the Securities Exchange scarce,” says Hasenauer. “Wrap fees went up considerably Commission (SEC) to jointly study and report on whether stable and almost doubled what they were before the credit crisis.” value investment contracts fall within the definition of a swap and In addition, wrap providers now require a more conservative the requirements of the new law. The study must be completed investment policy. In some cases, they also place restrictions on other funds that may be offered in the plan and/or restrictions within 15 months after the enactment of financial reform, in on transfers. consultation with current stable value regulators: State Insurance “One of the effects of the financial crisis has been that this once Commissioners, Department of Treasury, OCC (Office of the relatively sleepy asset class has received a lot more interest by Comptroller of the Currency), and Department of Labor. all parties,” says Gregg Seller, senior vice president “The Dodd-Frank Act’s broad swap definition of government markets for Great-West Retirement was crafted to capture products that contributed Wrap providers Services. Specifically, general account providers to the financial market crisis by avoiding now require a are now being asked to provide a great deal of regulation,” says Mitchell at SVIA. “Recognizing more conservative that stable value investment contracts did not information regarding their ratings and the quality investment policy. contribute to the financial crisis and that stable of their portfolio. Adds Cathe Tocher, senior vice In some cases, they also place value has a long and strong history of regulation president of investments for Great-West, “Some restrictions on and performance, the Act charged the CFTC and separate account stable value fund managers have other funds in the SEC with studying the issue.” left the business due to poor performance and/or the plan or on While FinReg, so far, has not had a direct impact negative market-to-book value differentials in the transfers. portfolios they manage.” on the stable value community, Dorval at New York While the extraordinary market events of the past Life Investments thinks the indirect implications two years have placed unprecedented stress on all asset classes of FinReg have been telling. “We are seeing a fundamental reincluding stable value, MetLife’s Howe believes that the reassessment of the role stable value plays in organizations’ core examination and focus this has triggered will make stable value business models,” he says. “For many, FinReg has made capital products stronger, “and those who purchase them will be more scarce and has forced providers to question their commitment to attuned to the unique benefits that a well designed stable value their stable value business. I think in the next 24 months we are fund can bring to their plan and its participants.” going to see major shifts in the market place, beyond what we US Financial Reform (also known as FinReg or the Doddhave already seen.” “One of the effects of the financial crisis has been that this once relatively sleepy asset class has received a lot more interest.”
Stable Value Provides Capital Preservation and Consistent Steady Returns 4.0000%
Volatility of Returns (December 1998 through June 2010) 3.0000%
2.0000%
1.0000%
-1.0000%
12/1/1988 6/1/1989 12/1/1989 6/1/1990 12/1/1990 6/1/1991 12/1/1991 6/1/1992 12/1/1992 6/1/1993 12/1/1993 6/1/1994 12/1/1994 6/1/1995 12/1/1995 6/1/1996 12/1/1996 6/1/1997 12/1/1997 6/1/1998 12/1/1998 6/1/1999 12/1/1999 6/1/2000 12/1/2000 6/1/2001 12/1/2001 6/1/2002 12/1/2002 6/1/2003 12/1/2003 6/1/2004 12/1/2004 6/1/2005 12/1/2005 6/1/2006 12/1/2006 6/1/2007 12/1/2007 6/1/2008 12/1/2008 6/1/2009 12/1/2009 6/1/2010
0.0000%
-2.0000%
-3.0000%
■ Stable Value Funds ■ iMoneyNet Money Market Funds ■ Barclays Intermediate Gov/Credit Index
- 4.0000%
Source: Stable Value Investment Association (SVIA)
2 • Institutional Investor Sponsored Report • November 2010
“The one-two punch of capital preservation and positive return makes stable value a great diversifier.”
Choosing Stable Value Providers The extraordinary economic events of the past few years, including regulatory changes, have emphasized to plan sponsors the importance of understanding the stable value arrangements they select. “Plan sponsors evaluate many of the major characteristics that ensure stable value’s benefit responsiveness,” says Mitchell. “Sponsors also evaluate the investment contracts that are critical to a stable value fund.” Stable value arrangements may include traditional guaranteed investment contracts (GICs), separate account GICs, synthetic GICs or a combination of these. When evaluating a separate account or synthetic GIC structure, MetLife’s Howe says, the elements that the fiduciary should consider include not only the selection of the underlying investment strategy and manager, which are similar to
NEW YORK LIFE RETIREMENT PLAN SERVICES
A Growing Awareness of Stable Value Funds An interview with Steven Dorval, managing director of defined contribution investments at New York Life Investments How have the ongoing concerns about liquidity and credit quality in the financial markets affected the structure of stable value funds? We are not seeing a change in the structure of these funds quite yet. What we are seeing is a greater awareness of the diversity of structures that already exist. The market is facing capacity constraints, liquidity and credit quality concerns, along with provider stability questions. We are seeing advisers and sponsors who are looking beyond the popular synthetic multi-wrap products and re-examining more traditional stable value offerings such as general account products and GICs. How have advisers and consultants changed their due diligence process when it comes to selecting and monitoring a stable value fund? No doubt you are seeing greater scrutiny on stable value funds by the financial professional community. We are seeing advisers insist that stable value funds be part of an open architecture platform. No longer will advisers passively accept a proprietary offering. Advisers are more aware of fees, book-to-market value ratios, and credit quality of the issuer. A comprehensive due diligence process on the stable value fund is now commonplace. What are some of the current concerns that plan sponsors have about stable value funds? Sponsors are looking at stable value through two different lenses. As organizations, they need to understand how the revenue generated from the fund can help pay for the plan—if there are contractual obligations that could make switching plan providers in the future onerous—and if the provider of the fund’s guarantee is financially secure and committed to staying in the stable value business. As advocates for their participants, they
need to ensure that the product can generate an acceptable amount of yield and at the same time is truly a financially stable product. What responsibilities does a sponsor have in educating participants on the role a stable value fund plays in an appropriate asset allocation policy? Sponsors have the same obligations in educating participants about stable value funds as they would any other investment offering, though I can tell you many participants struggle with the most basic definition of stable value products. During the most recent market turmoil, many participants were frantic to find a “safe” investment in their 401(k), not realizing the basic structure and features of their stable value fund. Sponsors, advisers and their plan providers need to work in conjunction to ensure participants are aware of the basic premise behind stable value funds. In the next five years, how do you see the role of stable value funds evolving in a typical 401(k) participant’s portfolio? I don’t think anyone doubts that stable value funds will continue to play an important role for 401(k) participants going forward. I expect we will see stable value funds playing a larger role for participants in the near future. The two most critical factors in the size of that role are how retirement income solutions evolve over time and how stable value funds might work within automatic features imbedded in 401(k) plans. Retirement income solutions are actively being debated, developed and refined throughout the financial services industry. Stable value funds could ultimately prove to be a transition solution for participants, going from the accumulation stage of retirement planning to living in retirement, as the industry weighs the benefits and timing of guaranteed income streams. Additionally, the role stable value can play in automatic plan features such as automatic enrollment, automatic increase, and rollovers is still being debated.
“I expect we will see stable value funds playing a larger role for participants in the near future.”
Contact Information Steven Dorval New York Life Retirement Plan Services 781-619-2000 www.nylim.com
New York Life Retirement Plan Services is a division of New York Life Investment Management LLC., which is a subsidiary of New York Life Insurance Company.
Sponsored Statement • November 2010
STABLE VALUE REPORT
“It is critical for the plan sponsor to recognize and become educated about the wide variety of regulations that govern each type of arrangement.” Warren Howe MetLife
those associated with other investment alternatives, but also the ability and experience of the fixed income manager in managing assets specifically for a stable value program. “With the potential mixture of investment managers, wrap providers and contract features available today, it is critical for the plan sponsor to recognize and become educated about the wide variety of regulations that govern each type of arrangement, as well as the potential variations in wrap contract provisions and guarantees,” Howe says. “This is in addition to the more familiar due The financial diligence they conduct with regard to security of the investment strategy and guidelines.” provider is the Other factors to consider include number one the “credit quality of the provider, priority of plan the credit quality and duration of the sponsors. underlying securities, the historical interest rates, historical market value to book value, and expenses,” says Seller at Great-West. He highlights the importance of finding out exactly what the book value wrap covers and doesn’t cover. “Financial security of the provider, who is ultimately backing the fund, is the number one priority of plan sponsors,” says
Dorval. “They need to ensure that the stable value fund is indeed stable for their participants. We are seeing a flight to quality. Beyond that, sponsors are looking for the right type, or structure, of stable value for their plan’s objectives and philosophy.” As always, Dorval adds, fees and revenue share are an Eric Hasenauer Aviva Investors important decision-making criteria. North America “Quality of investment management is very important,” says Hasenauer at Aviva Investors. “Today, the new capacity being offered is in the form of a bundled product, where one organization is offering both the wrap and the asset management service. So you want to look at that combination of solid investment management process and performance, along with the capital strength of a wrap provider.” ● “The new capacity being offered is in the form of a bundled product, where one organization is offering both the wrap and the asset management service.”
Stable Value Offers Higher Return Potential than Money Market Funds 4.500000
Growth of $1 (December 31, 1998 through June 30, 2010) 4.000000 3.500000
■ Stable Value Funds ■ iMoneyNet Money Market Funds ■ Barclays Intermediate Gov/Credit Index
3.000000 2.500000 2.000000 1.500000
1.000000 0.500000 0.000000
12/1/1988
6/30/2010
Source: Stable Value Investment Association (SVIA)
Stable Value and Money Market:
Similar on the Surface, But Not the Same
T
he purposes of a money market fund are to provide current liquidity, which it does by maintaining an effective duration of about 45 days, and to preserve principal, which it does by maintaining a net asset value of $1.00. Money market funds operate essentially as demand deposit accounts. When this capability is embedded inside a qualified plan the demand deposit feature might be viewed as a mismatch for the qualified plan. Money market funds carry no guarantees; their ability to deliver on their investment objective relies on how the funds are permitted to invest and the short maturities associated with the permitted investments. Stable value, on the other hand, has been developed specifically for qualified plans, and generally has an effective average duration of two to three years or more. This is in
4 • Institutional Investor Sponsored Report • November 2010
part possible because, while funds inside a qualified plan may be reallocated, there are very stringent restrictions on funds leaving the plan altogether, which in turn makes investing for a longer time horizon possible and practical. Hence, returns are much higher for stable value funds than for money market funds. After all, liquidity on demand is expensive. On average, stable value returns range from 140 percent to 160 percent of those of money market funds, with average returns for stable value and money market over the past 10 years through 2008 of 4.7 percent and 2.9 percent, respectively; for 2008, the figures were 4.7 percent and 2.0 percent, respectively. ● Source: MetLife Stable Value Study 2010/Hueler Analytics Stable Value Pooled Fund Index
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INSIDE: THE EURO100
Market rebound lifts assets, but firms still face pressure. Page 72
THE INDIA 20
Regulations curb fund managers’ enthusiasm. Page 76
Taking Stock of Costs
Amid the controversy over high frequency traders, transaction costs trend lower still. Page 80 INSTITUTIONALINVESTOR.COM
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EAM RESEARCH THE EURO 100 THE INDIA 20 TRADING INEFFICIENT MARKETS UNCONVENTIONAL
A
A YEAR OF CHANGE FOR FUND MANAGERS
Although money managers have weathered the financial crisis better than most banks, the industry has not escaped unscathed. Change is clearly visible in the Euro 100, our annual ranking of the region’s largest asset managers (right), with Germany’s Allianz displacing longtime leader UBS. With margins being squeezed and some banks still under pressure to shrink, there could soon be more movement in the ranks. India’s money managers are also experiencing margin pressure, despite astonishing growth: Assets under management at that country’s 20 biggest firms bolted nearly 65 percent in the 12 months through March (see “Regulatory Reform Pressures Margins,” page 76), but fund launches have slowed as firms grapple with new regulations. The May 6 “flash crash” sparked fresh concerns about the impact of high frequency trading on stock markets. Yet the trend of ever-lower equity transaction costs appears intact, especially outside the U.S., according to our exclusive annual survey (“Traders Thrive on Life in the Fast Lane,” page 80). — Tom Buerkle
Managing Editor Thomas W. Johnson Senior Editors Tucker Ewing Jane B. Kenney Associate Editors Denise Hoguet Fritz Owens
Cover photo by Daniel Acker/Bloomberg
THE 2010 EURO 100
Spirits Subdued Despite Asset Rise
Market rebound lifts Europe’s fund managers, but profitability remains a tough challenge. BY NEIL SEN
C
oming to grips with the new normal. From consumers to corporate executives to government officials, everyone in the West seems to be struggling to position themselves for a postcrisis world of slow growth, high unemployment and excessive debt. Most countries have emerged from recession, but there’s little sign of the feelgood factor that typically characterizes a recovery. European fund managers know this predicament well. There is no small amount of relief in the industry at the rebound in financial markets from the depths of early 2009. The value of assets under management has risen smartly over the past year and a half, offering breathing space to money managers, and some segments, such as emerging-markets funds, are experiencing strong inflows. Yet the industry remains much more subdued than it was in the middle of the past decade, when buoyant markets and investor enthusiasm drove double-digit growth rates. Revenue growth is sluggish, with many investors preferring low-risk, lowmargin products, and many managers continue to experience net outflows. Weak prospects for economic growth and concerns about a tougher regulatory environment are clouding the outlook. It’s no wonder that
fund company executives sound wary. “We’re now entering another period of anxiety,” says James Charrington, chairman of Europe, Middle East and Africa at BlackRock in London. “Investor confidence in the industry has yet to return.” Hendrik du Toit, CEO of Investec Asset Management in London, is equally
cautious, saying “2011 could be tough.” He adds, “We have to expect a slower market for new business.” The scars left by the crisis are clearly evident in the Euro 100, Institutional Investor’s exclusive annual ranking of the region’s largest money managers. Total assets under management of the top 100 managers rose by 7 percent in 2009, to €16.9 trillion ($23.6 trillion) at the end of the year, but that figure remained well below the recent highwater mark of €20.65 trillion, reached at the end of 2006. The turmoil of the crisis has also produced some dramatic changes at the top of the list, where Allianz replaces longtime leader UBS. The German insurer rises one place to take the No. 1
EUROPE’S TOP 100 MONEY MANAGERS RANK 2009 2008*
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
FIRM
1
2
Allianz Group1 (Munich, Germany)
€1,419,568
€1,137,721
2
1
UBS (Zurich, Switzerland)
1,335,000
1,276,000
3
4
AXA (Paris, France)
1,015,050
981,479
4
5
Credit Suisse Group (Zurich, Switzerland)
826,109
788,881
5
—
Amundi Group2
669,872
—
6
—
BlackRock3 (New York, U.S.)
663,4684
—
7
8
Natixis Global Asset Mgmt (Paris, France)
498,540
440,227
8
7
Deutsche Asset Mgmt5 (Frankfurt, Germany)
494,749
464,867
9
10
Aviva (London, U.K.)
421,586
389,681
10
19
BNP Paribas Investment Partners (Paris, France)
420,9196
205,065
(Paris, France)
11
11
Generali Group (Trieste, Italy)
355,206
340,908
12
15
Legal & General Investment Mgmt (London, U.K.)
350,128
271,412
13
—
ING Investment Mgmt7 (Amsterdam, Netherlands)
343,153
—
14
17
Prudential8 (London, U.K.)
321,992
230,707
15
—
Old Mutual (London, U.K.)
316,681
— 177,489
16
23
J.P. Morgan Asset Mgmt (London, U.K.)
279,7264
17
20
State Street Global Advisors (Boston, U.S.)
262,2644
201,831
18
16
HSBC Global Asset Mgmt (London, U.K.)
261,601
226,890
19
18
Intesa Sanpaolo (Torino, Italy)
225,839
213,786
20
38
Lloyds Banking Group
204,565
112,272
21
48
BNY Mellon Asset Mgmt11 (Boston, U.S.)
204,1084
89,199
10 (London, U.K.)
9
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L WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE THI spot, with €1.4 trillion in assets, an increase of 24.8 percent for the year. The firm’s ascent has been helped by big gains at its giant U.S.-based bond specialist subsidiary, Pacific Investment Management Co., and by the January 2009 acquisition of Cominvest Asset Management, which ranked No. 61 last year, with €55.4 billion in assets. Allianz has continued to gain strength this year. Its asset management unit, Allianz Global Investors, had third-party net inflows of €60 billion in the first half of 2010, up from €27.7 billion in the same period last year. “We are glad to see that clients who had lost trust in our industry for a while are strongly coming back,” says Joachim Faber, the unit’s CEO. UBS slips one place to second,
“WE HAVE TO EXPECT A SLOWER MARKET FOR NEW BUSINESS.” ending its 12-year reign at the top. The Swiss bank, which suffered massive losses on subprime mortgage securities and needed a government capital injection, saw its assets grow by 4.6 percent in 2009, to €1.3 trillion, as outflows of investor funds eroded much of the impact of market gains on its portfolios. The losses have been concentrated in the bank’s
wealth management division, which caters to high-net-worth individuals, but those declines have been narrowing. The division had net inflows of Sf1.2 billion ($1.2 billion) in the third quarter of this year, compared with net outflows of Sf8.1 billion in the second quarter and outflows of Sf26.6 billion in the third quarter of 2009. France’s AXA and Credit Suisse Group rise one place each, to claim the No. 3 and 4 spots, respectively. Amundi Group, formed by the 2009 merger of the asset management businesses of French banks Crédit Agricole and Société Générale, debuts in fifth place, with €669.9 billion in assets. New York–based BlackRock follows in sixth place, a big leap from the No. 25 spot a year earlier. Its
assets surged to €663.5 billion from €157.8 billion, thanks to its 2009 acquisition of Barclays Global Investors. The rebound in asset levels has been felt unevenly across the industry. “Assets under management are growing again, but revenues have not been growing in line with them,” says Dominique Carrel-Billiard, CEO of AXA Investment Managers, the insurer’s asset management arm. “This is because much of the money has gone into relatively low-margin fixed-income products rather than higher-value-added equity or alternative products.” AXA has also continued to suffer outflows at its U.S. value-oriented fund management subsidiary, AllianceBernstein. The net effect? Although AXA IM has
EUROPE’S TOP 100 MONEY MANAGERS RANK 2009 2008*
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
FIRM
22
—
Aegon Asset Mgmt12 (Hague, Netherlands)
23
21
MEAG Munich Ergo Asset Mgmt (Munich, Germany)
RANK 2009 2008*
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
FIRM
€193,012
—
43
22
Julius Baer Group17 (Zurich, Switzerland)
€103,248
€184,476
192,687
€184,690
44
39
KBC Asset Mgmt (Brussels, Belgium)
101,778
112,177
45
46
Goldman Sachs Asset Mgmt International (London, U.K.)
101,6324
83,399
24
26
Pioneer Investments (Milan, Italy)
175,823
153,488
25
29
Crédit Mutuel Group (Paris, France)
172,500
147,489
46
47
Swiss Life Group (Zurich, Switzerland)
99,608
90,262
26
27
Pictet & Cie (Geneva, Switzerland)
170,289
139,606
47
57
Nordea Investment Mgmt (Stockholm, Sweden)
90,970
72,281
48
51
Groupama Asset Mgmt (Paris, France)
88,770
81,293
49
53
PGGM Vermogensbeheer (Zeist, Netherlands)
88,600
71,334
50
44
Invesco (Atlanta, U.S.)
51
52
Dexia Asset Mgmt (Paris, France)
82,449
79,300
52
58
Franklin Templeton Investments (San Mateo, U.S.)
81,2604
63,985
27
35
Schroder Investment Mgmt (London, U.K.)
164,874
113,185
28
28
APG Investments (Heerlen, Netherlands)
161,460
136,979
29
31
Union Asset Mgmt Holding (Frankfurt, Germany)
158,903
131,783
30
37
Aberdeen Asset Mgmt (Aberdeen, U.K.)
158,214
112,396
31
12
Société Générale Group13 (Paris, France)
156,668
329,754
18
88,1314
103,228
32
32
Standard Life Investments (Edinburgh, U.K.)
154,063
127,202
33
—
ABN Amro Bank (Amsterdam, Netherlands)
152,000
—
53
—
GAM Holding19 (Zurich, Switzerland)
76,360
—
111,563
54
54
AmpegaGerling Asset Mgmt (Cologne, Germany)
75,504
68,038
34
40
Fidelity International (Pembroke, Bermuda)
147,79614
35
30
Sal. Oppenheim jr. & Cie.5 (Luxembourg)
137,000
132,000
55
77
Swedbank Robur (Stockholm, Sweden)
71,652
55,400
36
41
Robeco Group (Rotterdam, Netherlands)
134,910
110,667
56
56
Danske Capital (Copenhagen, Denmark)
70,441
66,290
37
42
SEB Group (Stockholm, Sweden)
132,000
109,483
57
63
Threadneedle Asset Mgmt (London, U.K.)
67,209
52,133
38
43
BBVA Asset Mgmt (Madrid, Spain)
129,78315
106,050
58
65
Henderson Global Investors (London, U.K.)
64,567
49,807
39
34
Santander Asset Mgmt (Madrid, Spain)
123,741
118,301
59
70
Baillie Gifford & Co. (Edinburgh, U.K.)
62,993
43,927
102,034
60
68
Bank Sarasin & Co. (Basel, Switzerland)
62,983
113,919
61
59
161,784
62
60
40 41 42
45
F&C Asset Mgmt (London, U.K.)
36
Deka Investment (Frankfurt, Germany)
24
Swiss Re
16 (Zurich, Switzerland)
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110,179 110,027 105,162
46,822
Legg Mason (Baltimore, U.S.)
59,700
4
59,654
Northern Trust Global Investments (London, U.K.)
56,8354
59,212
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EAM RESEARCH THE EURO 100 THE INDIA 20 TRADING INEFFICIENT MARKETS UNCONVENTIONAL seen its overall assets rise by €25 billion in the first half of this year, to €523.8 billion, the unit’s underlying earnings declined by 15 percent in the period, to €150 million. Other big asset managers also face some stiff headwinds. BlackRock had $2.3 billion of net outflows from its EMEA clients in the second quarter of 2010. The firm ascribed the decline to clients’ concentration issues following the BGI acquisition and to general market concerns about active quantitative management, one of BlackRock’s leading investing styles. Yet, in spite of the challenging economic and market environment, some European managers are generating strong growth, particularly in their emergingmarkets portfolios. Aberdeen
Asset Management, which has grown rapidly through acquisition in recent years, enjoyed £2.1 billion ($3.3 billion) in net inflows into its equity funds in July and August. “Asset managers have had a good run,” says CEO Martin Gilbert. “We haven’t been hit as hard as banks by the downturn, and we’ve benefited from huge inflows in equities. In certain of our Asian funds, we’ve actually had to restrict inflows.” Similarly, Investec, which ranks No. 70, with €46.1 billion in assets, had overall inflows of £4.7 billion in the financial year ended March 31. “We’re enjoying an unprecedented boom time, with record inflows and healthy profits,” says du Toit. With performance uneven and margins being squeezed,
many industry executives see continued pressure for acquisitions. The total value of M&A deals involving European asset managers declined to $7.6 billion in 2009 from $15.5 billion in 2008, according to data provider Dealogic, but deal making could pick up with asset levels recovering. Some banks in particular need to make strategic decisions soon to avoid stagnation, says London-based Gregory Ehret, head of EMEA at State Street Global Advisors, which is No. 17, with €262.3 billion in assets under management. “Banks will have to make some firm yes or no decisions about what to do with their asset management arms,” he says. “They will either have to boost assets by making acquisitions, or they
will have to sell off or wind down their businesses.” Aymeric Poizot, director of the EMEA fund and asset manager rating group at Fitch Ratings in Paris, says a wave of divestitures by distressed sellers hit hard by the financial crisis is largely over. “Now we’re more likely to see certain banks make disposals because asset management is not a core part of their business,” he says. “We will also see more consolidation because asset management is a fragmented industry, especially in difficult segments such as funds of hedge funds and in countries such as Italy.” For most banks asset management represents less than 15 percent of their bottom line, so the business is seldom regarded as indispensable, Poizot notes.
EUROPE’S TOP 100 MONEY MANAGERS RANK 2009 2008*
FIRM
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
RANK 2009 2008*
FIRM
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
63
64
ATP (Hillerod, Denmark)
€55,999
€51,438
76
—
Carmignac Gestion (Paris, France)
€32,657
—
64
67
DnB Nor Asset Mgmt (Oslo, Norway)
52,989
48,250
77
85
Baring Asset Mgmt (London, U.K.)
32,615
€23,430
65
69
Banque Cantonale Vaudoise (Lausanne, Switzerland)
51,220
44,887
78
79
M.M.Warburg & CO (Hamburg, Germany)
32,300
29,200
79
81
PFA Pension Group (Copenhagen, Denmark)
29,967
27,461
80
83
Irish Life Investment Managers (Dublin, Ireland)
29,625
25,713
66
72
Vontobel Group (Zurich, Switzerland)
50,548
41,930
67
55
Union Bancaire Privée (Geneva, Switzerland)
50,233
67,263
68
71
Signal Iduna Group (Dortmund/Hamburg, Germany)
50,000
40,200 81
62
Mn Services (Rijswijk, Netherlands)
28,846
69
66
Ignis Asset Mgmt (Glasgow, U.K.)
49,424
48,801
82
90
Marathon Asset Mgmt (London, U.K.)
28,166
21,019
70
78
Investec Asset Mgmt (London, U.K.)
46,061
30,811
83
80
Hermes Fund Managers (London, U.K.)
27,315
28,278
84
82
Morgan Stanley Investment Mgmt (London, U.K.)
27,2094
26,000
85
—
Pohjola Asset Mgmt (Helsinki, Finland)
27,182
—
86
100
First State Investments (Edinburgh, U.K.)
27,042
15,448
87
89
MMA Finance20 (Paris, France)
26,200
21,300
88
84
Record Currency Mgmt (Windsor, U.K.)
24,882
25,231
71
75
Mondrian Investment Partners (London, U.K.)
44,107
33,633
72
73
Alecta Investment Mgmt (Stockholm, Sweden)
43,786
36,708
73
—
Covéa Finance20 (Paris, France)
42,400
—
74
86
Storebrand Investments (Oslo, Norway)
42,148
23,066
75
74
Swisscanto Asset Mgmt (Zurich, Switzerland)
40,092
36,452
Assets are as of December 31 of the respective year. Asset totals for 2008 may differ from those previously published because of rounding. Italics in the table indicate that 2008 assets have been revised. *Ranks as published in the 2009 Euro 100. 1In January 2009, Allianz Global Investors acquired Commerzbank’s Cominvest Asset Management, which ranked No. 61 last year, with €55.4 billion. 2Amundi Group was formed by the December 2009 combination of Crédit Agricole Asset Management Group and Société Générale Asset Management; the former ranked No. 9
last year, with €441.4 billion; the latter ranked No. 12, as part of Groupe Société Générale, with €269.2 billion. Amundi is 75 percent owned by Crédit Agricole and 25 percent owned by SocGen. 3BlackRock acquired Barclays Global Investors in December 2009; BGI ranked No. 3 last year, with €1.08 trillion, and BlackRock ranked No. 25, with €157.8 billion. 4Total does not reflect worldwide assets; it includes only European-derived assets invested domestically or internationally and non-European assets slated for investment in Europe.
24,273
5Sal. Oppenheim jr. & Cie. was acquired
11Previously listed as Bank of New York Mellon
by Deutsche Bank in March 2010. 6Includes assets of Fortis Investments, which was acquired in April 2010 and which ranked No. 13 last year, as part of Fortis Bank, with €160.2 billion. 7Previously listed as ING Group. As a result of restructuring, 2008 numbers are not comparable. 8Previously listed as Prudential Group. 9Does not include €32.4 billion in balanced funds. 10Previously listed as Lloyds TSB Group. Lloyds acquired HBOS in January 2009.
Corp. In November 2009, BNY Mellon Asset Management acquired Insight Investment Management (Global), which was No. 33 last year, with €122.4 billion. 12Previously listed as Aegon. As a result of restructuring, 2008 numbers are not comparable. 13As a result of a reorganization of Société Générale Group’s asset management businesses, Société Générale Asset Management became part of Amundi Group in December 2009. Société Générale Group owns 25 percent of
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L WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE THI Among the potential deals is the planned sale of UniCredit’s money management business, Pioneer Investments. The Italian bank ran up large losses in its Eastern European network during the crisis, forcing it to raise capital twice in the past two years and, ultimately, prompting the departure of longtime CEO Alessandro Profumo in September. Natixis Global Asset Management (No. 7, with €498.5 billion), among others, has expressed interest in Pioneer, which stands at No. 24 in the Euro 100 with €175.8 billion in assets. Similar speculation is swirling around No. 20 Lloyds Banking Group’s €157.5 billion-in-assets pension and money management unit, Scottish Widows Investment Partnership. Lloyds won’t con-
firm or deny any sale intentions, but it faces pressure to shrink its operations to repay the bailout funds it received from the U.K. government, which owns 43 percent of the bank. “Most banks would sell their asset management arms if they were offered a good price, because they are not core parts of their business,” says BlackRock’s Charrington. “The problem is, however, that there aren’t many buyers around.” Still, money management is likely to remain a core business for many banks, particularly at a time when weak economies and higher capital requirements are squeezing their lending operations. “UBS is committed to asset management, and I unashamedly believe you can run a strong business within a
EUROPE’S TOP 100 MONEY MANAGERS RANK 2009 2008*
TOTAL ASSETS UNDER MANAGEMENT (€ MILLIONS) 2009 2008
FIRM
89
87
Bank of Ireland Asset Mgmt (Dublin, Ireland)
€24,829
€22,703
90
93
Handelsbanken Asset Mgmt21 (Stockholm, Sweden)
24,814
18,890
91
88
Universities Superannuation Scheme (London, U.K.)
24,723
22,187
92
—
BlueBay Asset Mgmt (London, U.K.)
23,930
—
93
—
Lombard Odier Investment Managers22 (Geneva, Switzerland)
23,307
—
94
—
Ashmore Investment Mgmt (London, U.K.)
22,047
—
94
98
Gartmore Investment Mgmt (London, U.K.)
22,047
16,531
96
99
Lazard Asset Mgmt (New York, U.S.)
21,474 4
16,585
97
50
Zürcher Kantonalbank (Zurich, Switzerland)
21,395
18,990
98
91
Raiffeisen Capital Mgmt (Vienna, Austria)
21,215
99
94
Capital Group International (London, U.K.)
21,098
100
95
Arca SGR (Milan, Italy)
20,749
Amundi Group, which is listed separately. 14Total reflects worldwide assets; includes non-
European-derived assets. 15Does not include private banking assets. 16Swiss Re sold Conning & Co. to Aquiline Capital Partners in October 2009. 17Previously listed as Julius Baer Holding. Julius Baer Holding’s private banking and asset management operations became GAM Holding, a separately listed entity, in October 2009. 18Previously listed as PGGM. 19Julius Baer Holding’s private banking and
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19,964 23
18,83024 18,748
asset management operations became GAM Holding, a separately listed entity, in October 2009. 20Covéa Finance and MMA Finance merged in May 2010. 21Previously listed as Svenska Handelsbanken Group. 22Previously listed as Lombard Odier Darier Hentsch & Cie. As a result of restructuring, 2008 numbers are not comparable. 23Estimate. 24Includes only Europe-based institutional clients.
“CLIENTS ARE INTERESTED IN REAL ESTATE AND PRIVATE EQUITY AS THEY SEARCH FOR MORE YIELD AND CAPITAL GAINS.” bank,” says John Fraser, CEO of UBS Global Asset Management. But, he acknowledges, “other banks might feel it’s not a very exciting business, with profits that don’t make a big impact on the share price. It’s also true that some of the big independents are doing well.” Other players believe banks are just as likely to be buyers as sellers. Consider Aberdeen’s Gilbert, who has more experience than most in M&A. “I think banks will be back in the market seeking to buy asset managers,” he says. “The recurring fee element makes it an attractive business.” Gilbert’s own appetite isn’t great, though. He plans to focus on organic growth after having acquired most of Credit Suisse’s non-Swiss fund management business for £250 million in July 2009 and picking up RBS Asset Management in February 2010 for £85 million. The Credit Suisse deals helped to push Aberdeen’s assets under management to €158.2 billion at the end of 2009, lifting the firm seven places in the Euro 100, to the No. 30 spot. Another hot-button issue for fund managers looking to recover is regulation. Many executives complain that the European Union’s Capital Requirements Directive, which
requires up to 60 percent of bonuses to be deferred for three to five years, as well as the U.K. Financial Services Authority’s Remuneration Code are draconian and unfairly drag money managers into regulations designed for banks. “There is a need to persuade the regulators and the public that asset management is a very different kind of business from banking,” says BlackRock’s Charrington. In short, there are plenty of reasons to be cautious about the industry’s outlook. Yet the market recovery has given many players a boost, and indications of a renewed appetite for risk among investors is making some managers more optimistic. “I don’t think we’ve seen the end of the postcrisis rebound,” says AXA IM’s Carrel-Billiard. “There are signs that clients are increasingly interested in real estate and private equity as they search for more yield and capital gains in a low-interest-rate environment.” State Street’s Ehret sees a similar recovery in animal spirits. “It’s been an interesting recovery, with passive managers enjoying a particularly strong pull in the market,” he says. “There’s now plenty of rerisking going on and a rapid move to alternative asset classes.” At UBS, Fraser believes the worst is over. “We are finding that risk appetite is coming back, and we are enjoying good inflows from third parties into both wholesale and institutional capabilities, including hedge funds and real estate,” he says. “We took a hammering two years ago from the issues facing the bank, but these are now well and truly behind us.” The crisis was deep and painful, though, and memories are bound to linger. No one is taking growth for granted any more. •• Comment? Click on the Research tab at institutionalinvestor.com.
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O 100 RESEARCH THE INDIA 20 TRADING INEFFICIENT MARKETS UNCONVENTIONAL WISDOM THE F THE 2010 INDIA 20
Regulatory Reform Pressures Margins
With fee changes suppressing new funds, India’s managers need to focus on performance. BY NIRAJ BHATT
I
n most markets money managers would be ecstatic if assets under management grew by nearly 50 percent in a year. But India is not like most markets. Regulatory reform continues to cloud an otherwise bright outlook for the country’s fund managers. A series of changes designed to reduce costs and increase transparency for mutual fund investors — capped by the abolition last year of entry-load fees — has put pressure on profit margins without, as yet, spurring a big increase in investor demand. With most inflows going into relatively low-margin fixed-income funds, fund management companies are having to cut costs and develop new business lines, such as subadvising for international fund managers, to generate growth. The strategy may be sound, but it may take time to deliver results, industry executives say. “Too many changes have happened too fast, which has slowed down the industry growth for the short term,” says Sundeep Sikka, CEO of Reliance Capital Asset Management Co. Reliance retains its place at the top of the India 20, Institutional Investor’s fifth annual exclusive ranking of the country’s asset managers, but its lead over rivals has narrowed. The firm’s assets grew by 25.8 percent, to $24.5 billion, in the 12 months ended March 31. That lagged the industry’s growth pace, as overall assets rose 47.1 percent to 6.14 trillion rupees ($136.4 bil-
lion), according to the Association of Mutual Funds in India, the industry’s representative body. Assets of the India 20 grew by an even faster 64.7 percent, to $150 billion, reflecting growing concentration in the market. Reliance’s sluggish showing reflected a big decline in the firm’s two money market funds and a slump in sales of new fixed-maturity income funds limited the firm’s growth rate. Other leading firms enjoyed faster growth. ICICI Prudential Asset Management Co. holds on to second place, with $18 billion in assets, up 81 percent for the year. UTI Asset Management Co. gains one place, to third, after its assets rose 89.1 percent, to $17.8 billion. HDFC Asset Management Co. slips one place, to fourth; its assets rose 78.2 percent, to $17.3 billion. Birla Sun Life Asset Management Co. retains fifth place, with $11.9 billion in assets, up 57.5 percent from a year earlier. All of these players are refining their strategies for a new regulatory environment that is deterring the launch of new funds. The industry grew rapidly earlier this decade through a proliferation of new funds. A booming stock market attracted waves of retail investors, while lucrative fee practices, under which fund companies levied as much as 6 percent in initial expense charges and distributors earned a bigger cut for selling new rather than existing funds, encouraged the promotion of new products.
Concerned that those fee practices were encouraging distributors to churn investors from one fund to the next new thing rather than promoting long-term investment, the Securities and Exchange Board of India introduced a number of reforms in recent years. Beginning in 2006 the regulator moved to abolish initial expense charges and required fund companies to meet sales and distribution expenses from entry-load fees, a levy charged for distribution expenses. In 2008, SEBI issued a rule barring fund companies from launching new funds with objectives similar to existing products. The mostrecent change came in August 2009, when the regulator
Serving Investors Regulator says mutual fund fee changes put focus on performance Some Indian fund managers grumble that a regulatory move to ban entry-load fees is hurting the mutual fund industry. Such complaints win little sympathy from Kavasseri Narayanan Vaidyanathan, executive director of the Securities and Exchange Board of India responsible for foreign institutional investors and mutual funds. Vaidyanathan is one of the few officials at India’s market regulator to have significant market experience. He joined SEBI last year after serving as CEO of Alchemy Capital Management, a firm that manages funds for wealthy investors. Previously, he held senior positions at software firm MphasiS, Morgan Stanley Mutual Fund in India and HSBC Holdings. In a recent interview with Institutional Investor Contributor Niraj Bhatt, Vaidyanathan explained his views on why the fee change is good for
banned the imposition of entryload fees, which were 2.5 percent for equity funds and 0.5 percent for most fixed-income funds. Instead, distributors now have to negotiate an advisory fee directly with fund investors. The regulator said it made the change “to bring about more transparency in payment of commissions and to incentivize long-term investment.” Industry executives say the changes will ultimately be good for investors, but it will take some time for retail customers to get used to paying advisory fees rather than having distribution expenses met indirectly through entry loads. “While SEBI is right in theory, the reality is that the manufacturer pays a commis-
investors and, ultimately, mutual fund companies. What has been the regulatory rationale for doing away with the entry load? There was a need to tighten regulation and enhance transparency that will serve investor protection better. The entry load reflected two components: A commission component from the asset management company to the distributor and a fee component from the investor to the distributor, both of which were deducted from the investor’s subscription amount. All that we have said is the investor’s subscription amount will go without any deduction. Whatever the asset management company wants to pay goes from its pocket, and the investor pays the advisory fee from his pocket. Our intent was to make investors conscious of the fees. I am very happy to say that this move has given investors 13 billion rupees ($292 million) of savings in 12 months. To me as a regulator, this is possibly the single-biggest act to realign the equation between the investor and the market. Where does this put India
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FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE THIS MONTH IN FI sion to the agent in most financial products, including even sovereign-guaranteed products,” says Dhirendra Kumar, CEO of Value Research of India, a mutual fund research company. The changes have dramatically slowed the rate of product launches. The industry attracted 362 billion rupees with new fund offerings for the year ended March 31, down from 1.02 trillion rupees the previous year and 1.61 trillion two years earlier. The bulk of the launches continues to come in the fixedincome sector, particularly fixed-maturity plans, closed-end funds with a finite life — typically one to three years — that invest in corporate bonds with the same maturity. Income funds accounted
vis-à-vis other countries? Each country decides its regulatory framework depending on local market requirements. The U.K. market will remove load fees, albeit they have given more time to adjust, as they will do it in 2012. There are a number of other Asian regulators that are in discussion with SEBI on how we went about doing it. Historically, India has adopted global practices, but I don’t think we should feel shy to be a global leader in something. This is done in the interest of the investor, so I don’t think you can fault us on the objective. The proof is that other markets are now certainly engaged in discussions on this. Critics say you could have given more time for adjustments. Regulatory actions are driven by starting a good practice or stopping a bad practice. In India the bad practices had reached huge proportions with high commissions and the churn. In such a scenario I don’t think you need to wait for a good time to stop a bad practice. The sooner you do it, the better it is. The important thing is, was there an adequate consultative process before, and the answer is yes. SEBI also gave
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for 51 percent of industry assets at the end of March, up from 47 percent a year earlier, according to data from AMFI. Equity funds accounted for 28 percent of industry assets, up from 23 percent a year earlier,
but that increase reflected merely the dramatic rise of the Indian stock market rather than fresh inflows from Indian investors. The Bombay Stock Exchange’s benchmark Sensex 30 index soared 80.5 percent in the 12 months ended in March. “The Indian mutual fund industry is actually two different and distinct businesses: retail equity and institutional debt,” says Rajiv Anand, managing director and CEO of Axis Asset Management Co. Equity assets generate fatter profit margins, and fund companies are frustrated by their inability to connect with retail clients at a time of strong growth in the underlying market.“If you remove the stock market appreciation, equity
the market enough time to reorient the process, as there were some changes required to be made in the forms, computer systems, etc. There is a difference in the commission structure of financial products in India. Will the new rules hamper the growth of mutual funds relative to bank deposits or insurance products? In the 1980s banks used to pay commissions for fixed deposits. Notwithstanding the fact that it has been a no-load product for over 20 years, there are queues to invest in the product, and it is the largest savings avenue for most people. So I don’t buy this theory. The second point is that the Indian investor has an intuitive sense, [but] he may not be the most financially literate person to understand complex products of risk and return. That’s why he has a preference for bank deposits, long-term insurance and long-term investments. If we look at the bigger picture, the Finance minister has expressed his desire that all financial products move toward no load. I am sure all regulators will work toward achieving this. Now different regulators will run at different
paces on different products. Investor awareness and mutual fund penetration are both low. Mutual funds have hitherto mimicked the cash equity market, where there are about 12 million to 15 million investors, while mutual funds have about 8 million to 10 million investors. Distribution is highly concentrated in Mumbai and New Delhi. This means our effort has been to sell mutual funds to those who are already in the equity market. The challenge is to open the eyes of the next 10 percent of India — not the top 1 to 2 percent — about the opportunities in mutual funds. That’s where the big market is. My appeal to the industry is to come together and work on growing the denominator. Having joined the Indian fund industry in 1993, what do you make of it now? The industry has gained scale to a reasonable extent. But along with that we have created some issues. There are too many products. Asset management is about scale. You need fewer products that can scale better. So we need the industry to go through a consolidation phase on products. The second issue is that the distribution model is not
“TOO MANY CHANGES HAVE HAPPENED TOO FAST, WHICH HAS SLOWED GROWTH.”
assets haven’t grown since 2001,” notes Value Research’s Kumar. The fund industry’s equity assets amounted to 514 billion rupees in March 2001. Between then and March 2010, the Sensex rose roughly fivefold, but equity assets lagged, rising only fourfold, to 2 trillion rupees. The number of equity fund folios, or accounts, fell by 2.3 million, to 39.4 million, between March 2009 and September 2010. “The reduction in number of equity fund folios is alarming, especially at a time when the stock market is near its all-time high,” says Saurabh Nanavati, chief executive of Religare Asset Management Co., which rises four places, to No. 14, in the India 20.
reflective of Indian sensitivity. Indians prefer dealing with institutions, so banks will always remain preferred distributors. Or they prefer dealing with an agent who represents one exclusive institution like the Life Insurance Corp. of India, which is well respected. I am not sure how much impact this freewheeling agent who represents multiple funds can have on the Indian psyche. The industry needs to think about this distribution channel, and they have to create a distribution channel that works for the asset management companies and not for the distributors. The third issue is that the industry has not kept pace with technology like the rest of the capital market. We are leveraging the available resources, such as allowing mutual fund units to be held in a dematerialized account and the consolidation of accounts by registrars. Apart from that there is some terrific depth of talent. The track records of some fund managers are great stories. And that’s where I would want them to go. In the asset management business, you sell based on track record of performance and service and not on track record of commissions. — N.B.
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O 100 RESEARCH THE INDIA 20 TRADING INEFFICIENT MARKETS UNCONVENTIONAL WISDOM THE F “Despite good performance of equity funds, the industry has not been able to communicate it to consumers,” says Ved Prakash Chaturvedi, who resigned as managing director of Tata Asset Management Co. (No. 10) last month. “That is the challenge.” The shift from entry loads to advisory fees has had a further impact by favoring players with the widest distribution networks, especially banks. Those companies are finding it easier to charge advisory fees to their customers, says Upendra Kumar Sinha, chairman and managing director of UTI Asset Management, India’s oldest fund house, and chairman of AMFI. “Large distributors like banks have gained prominence, while small independent financial advisers have lost market share,” he says. Largely as a result of the reg-
ulatory changes, profit margins in the fund management industry fell to 12 basis points on assets under management in the year ended March 31 from 14 basis points the previous year, Sinha says. The decline is particularly notable considering that 2008–’09 was an exceptionally bad year, with the global financial crisis causing assets to drop by 21.8 percent overall for firms in the India 20. In response to the cost pressures, money managers have been cutting staff and closing offices, particularly outside India’s major cities. “It is sad that the small investor is not being serviced as well as before, and he has missed the recent bull market while foreign institutional investors are making money,” says Reliance’s Sikka. Fund companies are also step-
ping up their efforts to educate retail investors about the advantages of mutual fund investing, reaching more than 29,000 participants in hundreds of meetings between April and July alone. Companies and AMFI, the industry group, are also training IFAs in a bid to make them true advisers rather than mere product-pushers. Reliance has set up its own program, the Edge Learning Academy, and sponsors IFAs to pursue the Certified Financial Planner certification. Money managers are adding new business lines in an effort to spur growth and profits. “Our new areas are managed portfolios and offshore funds,” says Religare’s Nanavati. Similarly, Reliance is boosting its subadvisory business for international fund managers. “We have an advantage,” says Sikka. “The India-focused offshore funds, which are INDIA’S TOP 20 MONEY MANAGERS advised from India, have performed better TOTAL ASSETS UNDER than those that aren’t.” RANK MANAGEMENT ($ MILLIONS) 2010 2009 FIRM 2010 2009 New products are 1 1 Reliance Capital Asset Mgmt Co. $24,523 $19,497 also in the offing. “We have been focusing on 2 2 ICICI Prudential Asset Mgmt Co. 17,994 9,941 capital-protection 3 4 UTI Asset Mgmt Co. 17,816 9,420 funds, asset-allocation 4 3 HDFC Asset Mgmt Co. 17,290 9,701 funds and other hybrid 5 5 Birla Sun Life Asset Mgmt Co. 11,852 7,526 funds such as monthly 6 6 LIC Mutual Fund Asset Mgmt Co. 9,396 4,461 income funds,” which invest up to 90 percent 7 7 SBI Funds Mgmt 8,900 4,441 in debt and 10 to 15 8 8 Franklin Templeton Asset Mgmt (India) 7,135 3,538 percent in equities, says 9 9 Kotak Mahindra Asset Mgmt Co. 5,276 3,087 Naval Bir Kumar, presi10 12 Tata Asset Mgmt 4,683 2,672 dent and CEO of IDFC 11 10 DSP BlackRock Investment Managers 4,627 2,925 Asset Management Co. 12 11 IDFC Asset Mgmt Co. 4,334 2,775 The firm slips one place, to No. 12, in the 13 14 Sundaram BNP Paribas Asset Mgmt Co.1 3,074 1,790 ranking. “We are also 14 18 Religare Asset Mgmt Co. 2,813 1,255 increasing the range of 15 — Canara Robeco Asset Mgmt Co. 2,048 — products for high-net16 20 JM Financial Asset Mgmt 1,776 925 worth investors.” 17 13 Deutsche Asset Mgmt (India) 1,665 1,807 The cost pressures 18 17 FIL Fund Mgmt 1,660 1,257 and regulatory changes may be making life diffi19 16 Principal PNB Asset Mgmt Co. 1,562 1,305 cult for fund managers, 20 15 HSBC Asset Mgmt (India) 1,547 1,762 but they aren’t deterring Assets are as of March 31 of the respective year, converted from rupees using the exchange rate on that date. new entrants. Compa1In October 2010, Sundaram Finance bought out BNP Paribas’s stake in its asset management subsidiary and changed the firm’s name to Sundaram Asset Management Co. nies continue to see
strong fundamentals in India’s solid household savings rate of 23 percent of GDP. With only 8 percent of household savings currently going to mutual funds, companies believe the industry has great upside potential in the medium-to-long term. Over the past 18 months several firms have announced plans to enter the market. In July 2009, Japan’s Nomura Holdings agreed to buy a 35 percent stake in LIC Mutual Fund Asset Management Co., the No. 6 firm in our ranking. Nomura will pay a price that values the business at 2.7 percent of assets. In January, U.S. fund manager T. Rowe Price Group acquired a 26 percent stake in UTI Asset Management at a price that valued UTI at 3.2 percent of assets. Earlier this year U.S. insurer Prudential Financial set up a new fund arm, Pramerica Asset Managers, which launched its first product, a money market offering, in August. In October, BNP Paribas withdrew from its joint venture, Sundaram BNP Paribas Asset Management Co., to concentrate its efforts on Fortis Investment Management, which it acquired in 2009. SEBI had told the French bank it could operate only one mutual fund company. Sundaram BNP Paribas, which has been renamed as Sundaram Asset Management Co., gains one place, to No. 13. Fund companies are learning to live with the new regulations. To succeed, they need to focus on fundamentals — generating strong performance and providing good customer service. As Value Research’s Kumar puts it: “There is convergence of everyone’s interest, and churn has been eliminated. Fund companies do not need to create a large number of products; performing products will pull investors.” •• Comment? Click on the Research tab at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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A 20 RESEARCH TRADING INEFFICIENT MARKETS UNCONVENTIONAL WISDOM THE FUTURIST TH 2010 TRANSACTION COSTS ANALYSIS
Traders Thrive on Life in the Fast Lane Amid the controversy over high frequency traders, transaction costs trend lower still. BY JOHN AIDAN BYRNE
T
he May 6 “flash crash” has put high frequency traders under a harsh spotlight. Many investors contend that these traders, who use high-tech tools to buy and sell stocks in microseconds, put long-term investors at a disadvantage by front-running their orders and fueling market volatility. Such activity merely increases the effective cost of trading for pension funds and other institutional investors, critics say. At a time when investors are struggling to eke out any returns they can get, costs are as important as ever. Fortunately, despite all the controversy about high frequency trading, the evidence suggests that these high-speed, high-volume players continue to put downward pressure on equity transaction costs, not raise them, according to our 14th annual survey of trading costs, conducted for Institutional Investor by New York–based Elkins/McSherry, a subsidiary of Boston’s State Street Corp. The average overall cost of equity trading in the U.S. edged up during the 12 months ended June 30, but that increase largely reflected lower trading volumes and higher volatility, says James Bryson, president of Elkins/ McSherry. The underlying trend in costs is still headed lower, he adds. And costs fell significantly in most international markets. “The concerns about high frequency trading are not justified, because we have seen trading costs falling pretty consistently,” says Jamie Ritchie, director of
capital markets trading at Brockhouse & Cooper, a Montrealbased global agency execution brokerage operating in 39 countries, including the U.S. “Some of that has to do with the high frequency traders.” Average transaction costs for New York Stock Exchange–listed stocks rose 10 percent in the latest period, while costs on the Nasdaq Stock Market were up 16 percent, according to the survey. The U.S., with an overall average cost of equity trading of 19.63 basis points in the period, is no longer the world’s low-cost trading venue. Japan and Sweden share that crown, with an average cost of 18.34 basis points in the period, followed closely by France, at 18.49 basis points. Average transaction costs globally declined 8.1 percent over the past year, to 38.02 basis points. Concern about high frequency trading soared after May 6, when the Dow Jones industrial average plunged nearly 600 points in a matter of minutes and temporarily erased $862 billion in equity value. A report on the incident by the Securities and Exchange Commission and the
“WE NEED TO INTERACT WITH HIGH FREQUENCY TRADERS.”
U.S. TRADING Top investment managers, benchmarked against volume-weighted average price
RANK1
DIFFERENCE VS. E/M UNIVERSE (BASIS POINTS)
INVESTMENT MANAGER 2
1
Pzena Investment Mgmt
2
Arrowstreet Capital
–8.13
3
Jennison Associates
–8.05
4
BlackRock
–6.58
5
Leuthold Weeden Capital Mgmt
–5.06
6
Numeric Investors
–4.74
7
AllianceBernstein
–4.38
8
Deutsche Asset Mgmt
–3.77
9
Jacobs Levy Equity Mgmt
–3.43
Hotchkis and Wiley Capital Mgmt
–2.53
10
–15.29
11
Loomis, Sayles & Co.
–0.89
12
W.P. Stewart & Co.
–0.63
13
Piedmont Investment Advisors
–0.45
14
Manning & Napier Advisors
1.82
15
New Amsterdam Partners
3.65
1Rank is for 12 months ended June 30. 2Includes managers with greater than $1.5 billion in principal traded.
Source: Elkins/McSherry.
Commodity Futures Trading Commission attributed the collapse to a large automated sell order placed by a mutual fund manager, but it added that temporary withdrawals from the market by some high frequency trading firms may have exacerbated the decline. Regulators are weighing whether to impose some curbs on high frequency trading, but with such activity accounting for as much as 70 percent of stock trading volume in the U.S., the prospects of a crackdown appear remote. Investors appreciate the liquidity that high frequency traders bring to the market, but they worry about potentially abusive practices such as pinging stocks, whereby traders rapidly send and cancel successive orders to uncover valuable information about an institutional investor’s position in a bid to gain a trading edge. “If you put in an order and withdraw it immediately, and you have no intention of trading,
that is something that needs to be looked at,” Ari Burstein, senior counsel at the Investment Company Institute, told a conference on market quality at New York’s Baruch College last month. “I think everyone cares about speed,” says Phillip Mackintosh, who heads Credit Suisse’s global portfolio strategy team. “What we don’t want is to put an order into a machine and then find out that the offer you were going to hit is gone.” High frequency trading is less pervasive in Europe, but industry executives expect volume there to continue to grow. Such trading is likely to account for 45 percent of European equity volume in 2012, up from 25 percent currently, according to Aite Group, a financial services consulting firm. “The case against HFT is generally overstated,” Reto Francioni, CEO of Frankfurtbased Deutsche Börse, told the Baruch College conference. For brokers the key to interINSTITUTIONALINVESTOR.COM
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HE CHARTIST CONTENTS INSIDE II TICKER FIVE QUESTIONS PEOPLE THIS MONTH IN FINANCE RAINM U.S. TRADING
U.S. TRADING
Top brokerage firms, benchmarked against volume-weighted average price
RANK1
BROKERAGE FIRM2
Top brokerage firms, benchmarked against arrival price
DIFFERENCE VS. E/M UNIVERSE (BASIS POINTS)
RANK1
DIFFERENCE VS. E/M UNIVERSE (BASIS POINTS)
BROKERAGE FIRM2
1
Fox River Execution Technology
–13.19
1
Fox River Execution Technology
–33.84
2
Liquidnet
–12.10
2
Brockhouse & Cooper
–24.45
3
Agency Trading Group
–11.98
3
Nomura Securities International
–19.08
43
Investment Technology Group
–10.60
4
Deutsche Bank
–14.30
5
Weeden & Co.
–10.60
5
Bloomberg Tradebook
–14.20
6
BTIG
–8.86
6
Knight Capital Group
–14.10
3
7
Source Trading
–8.65
7
Agency Trading Group
–14.09
8
Credit Suisse
–8.21
8
Weeden & Co.
–13.93
9
Goldman, Sachs & Co.
–8.15
9
Source Trading
–13.12
Citigroup
–7.26
10
Guzman & Co.
–8.73
11
Bloomberg Tradebook
–6.92
11
Merlin Securities
–8.48
12
Merlin Securities
–6.49
12
Jefferies & Co.
–2.04
13
Morgan Stanley
–5.87
13
BTIG
–1.84
14
UBS
–5.59
14
J.P. Morgan
–1.15
15
Guzman & Co.
–5.48
15
Liquidnet
–0.94
10
1Rank is for 12 months ended June 30. 2Includes brokers with greater than $7.5 billion in principal traded. 3Rank is based on results before rounding.
1Rank is for 12 months ended June 30. 2Includes brokers with greater than $7.5 billion in principal traded.
Source: Elkins/McSherry.
Source: Elkins/McSherry.
acting with high frequency players is to take advantage of the liquidity that they provide without revealing clients’ positions or trading intentions, executives say. “The liquidity is important to the market, and we need to interact with high frequency traders just like we interact with any other liquidity providers,” says Jonathan Kellnar, president of the Americas business at Instinet in New York. “However, we always need to make sure we are acting in our customers’ best interest. We need to make sure we are not giving up clients’ information or leaving too big a footprint.” Instinet ranks No. 20 in global trading with an average transaction cost, including commissions, fees and market impact, of 4 basis points below volume-weighted average price. The controversy about high frequency trading has led some institutional clients to demand more information about where their trades are executed and the INSTITUTIONALINVESTOR.COM
level of commissions and rebates, which exchanges typically offer to high frequency traders, that are paid, says George Sofianos, who heads up the Equity Execution Strategies group at Goldman, Sachs & Co. in New York. “Their greatest concern seems to be about more transparency on the choice of execution venues,” he says. Goldman ranks fourth among brokerage firms in global trading and ninth among U.S. firms, with an average cost of 17.82 basis points and 8.15 basis points, respectively, below VWAP. By a separate measure, execution relative to arrival price, Goldman ranks No. 14 in global trading, with an average cost of 4.48 basis points below the benchmark. At Brockhouse & Cooper, Ritchie says his firm also worries about information leakage, and the concern extends to parties other than high frequency traders.“You want to use a broker
who has no conflicts of interest with a proprietary trading desk,” he says. As for high frequency trading, he says that although some customers had misgivings, “a lot of our investment manager clients think it is a good thing.” Brockhouse & Cooper ranks ninth in global trading, with an average cost of 16.85 basis points below VWAP. Relative to arrival price, Brockhouse & Cooper ranks No. 2 in U.S. trading and No. 3 globally, with an average execution of 24.45 basis points and 27.23 basis points, respectively, below the benchmark. Both Goldman and Brockhouse & Cooper rank in the top five in more than one cost category. Other firms that also appear in the top five in more than one category include Bloomberg Tradebook, Liquidnet and Fox River Execution Technology. The Elkins/ McSherry data are based on an analysis of more than 11 million trades by 677 brokerages and
nearly 3,000 managers on a universe of 19,669 individual stocks. The challenge of preventing information leakage of customers’ orders and of sourcing liquidity in today’s marketplace has helped fuel the growth of Liquidnet, says New York–based Alfred Eskandar, head of U.S. equities at the firm. Liquidnet, a buy-sideonly dark pool, ranks No. 2 in both global and U.S. trading. Notwithstanding all the fuss over today’s market structure and the role played by high frequency firms, participants need to realize that the basics of trading haven’t really changed, says Alan Hill, chief financial officer of JonesTrading in Westlake Village, California. “Someone is always looking to reap shortterm profit,” he says. The only difference today, he adds, is that “the players have changed, and it’s gotten a lot faster.” •• Comment? Click on the Research tab at institutionalinvestor.com.
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COVER STORY
continued from page 41 using ESG factors to identify investment opportunities, a new pragmatism has kicked in. “Forget about winning the war, let’s just win some battles,”says Goldstein.“Getting people to fundamentally change how they think about investment management is a pretty large task. Getting them to invest in a fund with a proven track record is easier.” Now some foundations are looking at whether to invest in the initiatives they encourage with their grant making. This so-called mission-based investing can help lay the groundwork for a broader approach.“There are some really interesting things happening, lots of community investment across the country,” says Christa Velasquez, director of social investments at the Baltimore-based Annie E. Casey Foundation, which has allocated $125 million of its $2.5 billion in assets to investment funds directly tied into the foundation’s objective: improving the lives of vulnerable children in the U.S. Two years ago, Annie E. Casey was one of three foundations to support the formation of a mission-relating investing initiative at Cambridge Associates, a Boston-based consulting firm that advises more than 800 endowments, foundations and other notfor-profit institutions worldwide. And, in a major breakthrough, a handful of investment consultants are now beginning to take responsible investing seriously. It helps that a group of money managers — Londonbased Generation Investment Management foremost among them — is starting to prove that looking at so-called sustainability issues can be profitable. Outside the U.S. many large investors already take ESG extremely seriously. It has been five years since the Caisse de dépôt et placement du Québec implemented its policy for responsible investing, which, put simply, pledges the $192 billion Canadian sovereign
wealth fund to incorporate ESG principles in its investment approach. “For us, the financial mission and the nonfinancial mission go hand in hand,” says Roland Lescure, Caisse’s Montreal-based CIO.“It is not a duty that we have on top of our financial responsibilities.” Responsible investing is part of Caisse’s core approach, even if the investment impact of some ESG measures is hard to quantify. “It is both a risk management and performance enhancement tool,” Lescure says. For Lescure, a watershed moment was the 2006 launch of the United Nations’ Principles for Responsible Investing. The PRI, which Caisse helped draft, pledges signatories to commit to socially responsible investing. To date, investors representing more than $22 trillion in capital have signed on. “PRI has been much more successful than people expected in terms of its growth and the seriousness with which it now seems to be taken,” says Glen Saunders, a PRI board member and a former guardian of the $11.9 billion New Zealand Superannuation Fund, which integrates ESG into its investing. Not every PRI signatory is as committed as Caisse or the New Zealand fund. One major criticism of the initiatives is that signatories do not have to live up to the pledge or even publicly disclose what they are doing. But Vinay Nair, a former assistant finance professor at the Wharton School of the University of Pennsylvania and an adjunct professor at Columbia Business School, points out that even if only a small percentage of signatories act on their convictions, it will have a material impact on the market value of companies that those investors deem good or bad actors — what he calls the “capital flow” effect. “Some back-of-the-envelope calculations reveal numbers that are quite striking,” Nair says. He estimates that if an additional 5 percent of the total available capital is allocated to sustainability in the equity markets over the next three years, companies that are recognized as “good” will outperform “bad” ones by 3 percentage points annually. Nair is so excited about the opportunity that he has started a New York–based alternative investment firm, Ada Investment Management, to try to take advantage of it. In the developed markets, Ada runs a longonly equity fund and two equity hedge funds, each of which integrates ESG factors into its investment analysis. Ada also runs an internal fund without the ESG factors to track the
incremental impact of these indicators. So far, after two years, the ESG funds are outperforming.“The valuation spread between sustainable and unsustainable companies will continue to widen,” says Nair. The 2008–’09 financial crisis was a major catalyst in reigniting the ESG debate among investors. Public pension funds, sovereign wealth funds and insurance companies realized that although they had long-term horizons, many of the investment decisions they were making, and the decisions being made by the companies in which they had invested, were short term and in some cases highly risky. The behavior of the major financial institutions — their risk-taking and bonus making in particular — struck some nerves. “The financial crisis showed investors we weren’t monitoring the things that really mattered,” says Anne Simpson, senior portfolio manager for global equities at CalPERS and an attendee at the RFK Compass Conference. “If you looked on the boards of the big banks, they checked all of the boxes for good corporate governance. But the crisis told us our reading is superficial.” Kerry Kennedy has been struck by how many public fund fiduciaries have told her they grapple with ESG issues on a daily basis. With states facing huge fiscal shortfalls, officials at public funds “are under pressure to use their resources for the public interest — for instance, funding inner-city real estate developments,” she explains.“Because even though their pension pot of money is much smaller than it used to be, it is still the largest pot of money in the state.” But if a single factor has forced fiduciaries to take ESG matters seriously, it is climate change. “Global warming is an unequivocal and unassailable scientific fact,”says Deutsche Asset Management global head Kevin Parker. “You have to be willfully obtuse to disagree with the fundamental laws of thermodynamics. The only question is, how much carbon can the atmosphere tolerate?” Institutional investors aren’t waiting for an answer. In November 2009 some 20 of them, including CalPERS and the California State Teachers’ Retirement System (CalSTRS), as well as the state treasurers of Connecticut, Florida, Maryland, North Carolina, Oregon and Vermont, sent a letter and petition to the Securities and Exchange Commission contending that climate change had become a material risk and requesting INSTITUTIONALINVESTOR.COM
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commission guidance on what companies needed to disclose about it. Just two months later the SEC issued a groundbreaking decision: For certain companies, climate change is material and should be disclosed. The “E” in ESG had officially become an on-balancesheet risk. But institutional investors, as Kennedy and others argue, ignore the “G” and even the “S” at their peril. “If you decide not to look at ESG issues, then you are deciding not to look at areas of risk,” says CalPERS’s Simpson. IN 2001, HAWAII CAME THE CLOSEST
of any U.S. state to creating a completely socially responsible public pension fund — but that was not very close at all. That year the Hawaii legislature introduced bills proposing that the state’s then–$9.5 billion employees’ retirement fund use SRI screens across its entire investment portfolio. The plan, according to people involved, was opposed by the retirement fund staff and their advisers, and at the end of the year a legislature-commissioned report strongly advised against any kind of SRI screening or shareholder activism. “Mandating institutions, particularly public or quasipublic retirement trust funds, to adopt SRI strategies would be a radical act,” the report said, concluding that there was little to no economic benefit to an SRI approach. Hawaii’s experience highlights the limited way socially responsible investing — the term “ESG” had not yet been coined — was mostly viewed and practiced at the time. Though the concept goes back centuries, socially responsible investing really started in the U.S. and elsewhere with institutions that wanted to avoid certain stocks for religious reasons. By the 1960s, spurred in part by reaction to the Vietnam War, it had grown to include investors making values-based choices. For example, opponents of the war asked investors to dump shares of Dow Chemical Co., the maker of napalm. In a March 2010 research report, the investment consulting firm Callan Associates pointed to the 1985 formation of the Council of Institutional Investors — the first teaming of large institutions to take an activist approach as owners — as a milestone in responsible investing. This coincided with the move to divest from companies doing business in apartheid South Africa. A few years later universities and pension funds INSTITUTIONALINVESTOR.COM
were also looking to divest from tobacco stocks. By 1999 there was more than $2 trillion of SRI assets in the U.S., according to a study by Deutsche Bank. But the bulk of that money largely came from religious institutions or values-based mutual funds, not from defined benefit pension funds and rarely from large foundations and endowments. Socially responsible investing was not anathema to these asset owners; in fact, SRI got integrated into the oversight and management process at most foundations and endowments, says Hutton, who recently announced that, after seven years as CIO, she is leaving Commonfund at the end of this month. “Once you got through the ‘South Africa free’ and the tobacco wars, the rest of the effort has been more focused on executing your policy and doing it in a way that was consistent with your institution,” she explains. But these were not investment discussions — and with good reason. When SRI revolved around screening out stocks, it was very hard to make the case for
ing at environmental issues and sustainable investing — not screening as much as exploring investments that could help the environment and capitalize on the global move toward a more sustainable way of living. In November 2003, Boston-based Ceres — a nonprofit organization that acts as a platform for asset owners, institutional investors and activists interested in environmental issues — and the United Nations Fund for International Partnerships co-hosted an institutional investor summit on climate risk at U.N. headquarters in New York. At that conference, Westly announced that CalPERS and CalSTRS had been directed to figure out how to invest $1 billion in clean-tech and sustainable companies. Westly, who today runs Westly Group, a Menlo Park, California–based clean-tech venture capital firm, is especially proud of that proposal. “At the time, this was viewed as aggressive and potentially risky,” he says. But almost immediately following his announcement at the U.N., other states,
“The amount of venture investing that goes into clean tech is one of the largest single segments of the venture world.” — Steve Westly, Westly Group
it on economic grounds alone. In fact, the numbers argued against responsible investing. In a September 2008 report for CalPERS, consulting firm Pension Consulting Alliance estimated that the retirement fund’s South Africa divestiture program had cost the state $1.86 billion in commissions, market impact and missed investment opportunities. The Florida State Board of Administration divested from tobacco stocks in the 1990s, when that state was engaged in suing the cigarette companies. The SBA, which oversees the state’s $111 billion pension fund, reversed its decision a few years later, an estimated $482 million poorer after investment losses and transaction costs. As a result of figures like these, a whole generation of investment professionals came up through the ranks thinking of SRI as a money loser. But there were more-positive developments happening. Under the direction of then–California treasurer Phil Angelides and then–state controller Steve Westly, CalPERS and CalSTRS began look-
including Connecticut, New York and North Carolina, announced clean-tech venture capital programs of their own. In February 2004, Angelides revealed his Green Wave environmental investment initiative, which included a proposed $500 million combined commitment to clean-tech venture capital by CalSTRS and CalPERS. “It was the beginning of a burgeoning of the asset class,” Westly continues. “The amount of venture investing that goes into clean tech is one of the largest single segments of the venture world today.” This commitment marked a paradigm shift from institutional investors viewing SRI as a negative screening tool to organizations using it to identify investment opportunities. Says Anson, who was CIO of CalPERS at the time and is now managing partner and chairman of the investment committee at $12 billion Menlo Park–based Oak Hill Investment Management: “The question became, How do I find the long-term drivers that have a beneficial or positive impact on
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COVER STORY
performance? That is a much more enlightened way to look at responsible investing. It is consistent with Modern Portfolio Theory.” At the same time that CalPERS and CalSTRS made their clean-tech commitments, each allocated $500 million to environmentally screened equity funds, and CalPERS also created a $5 billion corporate governance investment program. But until recently, few other U.S. fiduciaries followed their lead. CalPERS and CalSTRS have the advantage of being based in a politically liberal state, where officials have long been enthusiastic about such initiatives. They also broadly interpret the fiduciary responsibilities of their pension plans. “Our fiduciary duty is simply that you have to deploy a degree of loyalty, you can’t use your pension to do things that are in your own interest or anyone else’s interest, and you have a duty of care,” says senior portfolio manager Simpson, who oversees CalPERS’s corporate governance program.“People over here usually call this a duty of prudence.” Pension officials in other states have tended to worry that looking at or, worse yet, investing with an eye to ESG factors could violate their fiduciary responsibility — if that is to make as much money as possible for their beneficiaries. It is this kind of misapprehension, Kerry Kennedy says, that has stopped fiduciaries from looking at ESG concerns as important risk factors. Few fiduciaries, for example, paid atten-
sion Fund, and the Netherlands’ ABP have emerged as leaders. In 2004 the Norwegian government set up ethical guidelines and an ethical council to oversee fund management; since then the Norwegian pension plan has taken stands on a whole host of issues, from the use of child labor in the cocoa industry to environmental damage. The Caisse de dépôt et placement du Québec adopted its SRI policy in 2005 as the result of a governance review and consultation with its depositors. For Caisse CIO Lescure, socially responsible investing has economic and risk management benefits, but he acknowledges that the fund also has a social obligation to the people of Quebec. “We do manage public money for public institutions,” he says, and with that comes an obligation to do what the public would want, including acting like a good global citizen. In 2004, stunned by poor returns and criticism of its investments in highly polluting industries, the U.K.’s Environment Agency completely retooled its $2.75 billion pension fund to invest along socially responsible lines. The government-sponsored agency instituted an environmental overlay across its entire pension plan, emphasizing corporate governance and shareholder activism, especially on sustainability issues. Under the new regime, fund performance has improved. Although the plan, like its peers, lost money during the 2008 market melt-
“As a constitutional officer, I clearly have to link any action I take to its ultimate benefit to shareholders.” — Janet Cowell, North Carolina treasurer
tion in 2006 when a BP pipeline in Prudhoe Bay, Alaska, cracked, causing an estimated 200,000 barrels of oil to leak undetected into the winter snow.“It should have been a wakeup call,” Kennedy says. “In the wake of BP’s Gulf Coast disaster, fiduciaries realize that their shareholders cannot afford for them to fail to look at ESG factors when making investment decisions. That lack of attention to ESG has contributed to the crisis that many pension funds find themselves in today.” While ESG stalled in the U.S., it was taking off in the rest of the world. The large Scandinavian pension plans and sovereign wealth funds, such as Norway’s Government Pen-
down, it was up 40.9 percent for its fiscal year ended March 31, 2010. Its top equity manager was U.K.-based Generation Investment Management, which was founded in 2004 by onetime Goldman Sachs Asset Management CEO David Blood and former U.S. vice president Al Gore to practice sustainable investing. Generation returned 54.1 percent during the period, beating its benchmark by more than 10 percentage points. The success of the Environment Agency and others suggests that institutional investors can do better by doing well. As the economic evidence grows, U.S. funds are starting to look at ESG factors seriously. For someone
like Kramer, who joined the board of the New Jersey State Investment Council in 2002 and fought furiously to move the now $70.2 billion state pension fund into alternatives because he believes in the benefits of diversification, incorporating ESG is not a violation of modern investment management; it is an important part of the process. “In theory, stock prices are the discounted value of future cash streams,”explains Kramer, who launched his New York–based hedge fund, Boston Provident Partners, in 1992.“So by definition, corporate practices which aren’t sustainable will ultimately affect stock prices.” ON JANUARY 12, 2009, HER FIRST
full day as North Carolina treasurer, Janet Cowell had an unpleasant task: to announce a 20 percent drop in the assets of the state’s $67 billion pension fund. Worse, because of budgetary pressures, the North Carolina General Assembly had to make the difficult decision not to fully fund the teachers’ and state employees’ retirement plans in 2010. In the face of such challenges, Cowell and her small pension staff decided that one of the ways they could maximize the value of the fund for beneficiaries and North Carolina taxpayers was to incorporate ESG into the state’s investments — but they had to do it carefully. “In North Carolina there is very clear accountability and responsibility toward the beneficiaries,” says Cowell, a former financial analyst. “As a constitutional officer, I clearly have to link any action I take to its ultimate benefit to shareholders. That includes trying to recover monetary value if there has been malfeasance.” Take Massey Energy. For several years, the Richmond, Virginia–based coal mining company resisted an institutional-investorsponsored shareholder resolution requesting that it develop and disclose a strategy for responding to climate change, even after the U.S. Supreme Court ruled in 2007 that carbon dioxide, which is produced when coal is burned, is a pollutant under the Clean Air Act. The investors, which included North Carolina, were also concerned about Massey’s safety record and the makeup of its board. They objected to the fact that one person, Don Blankenship, held both the chairman and CEO positions, and contended that the board was not taking sufficient steps to uphold shareholder interests, especially in areas like health and safety issues. INSTITUTIONALINVESTOR.COM
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Those issues came back to haunt Massey on April 5 of this year, when an explosion at its mine in Raleigh County, West Virginia, killed 29 miners. In the public outcry that followed, North Carolina’s Cowell was one of the leading voices pushing for reform. She and other institutional investors asked shareholders to withdraw support from the three directors with direct oversight of health and safety, but although the explosion occurred just weeks before the annual shareholder meeting, all three board members narrowly won reelection. A shareholder request, submitted by the New York City Employees’ Retirement System, that Massey separate the CEO and chairman positions also failed. Dan Bakal, director of the electric power program at Ceres, which helped organize the institutional investors, says that even though they lost the votes, their fight against Massey is forcing other companies in the sector to act responsibly: “No one wants to be Massey.” In addition, he says, some banks are less willing to lend to the company. For Cowell too, the fight has been worthwhile. “We felt like a team working together, and we are moving in tandem and building some relationships,”she says.“That is a better approach than to try and go out on your own.” Massey recently made progress on the corporate governance front. At a special meeting on October 6, shareholders approved a package of reforms. No longer is a supermajority of shareholders required to amend the company’s bylaws; a simple majority will do. In addition, board members will stand annually for reelection. Shareholders applauded the changes, sending Massey’s share price soaring by more than 30 percent over the next three weeks. As institutional investors put more dollars into emerging markets and companies start doing more business there, the need to incorporate ESG factors into the investment equation becomes increasingly pressing and difficult. “Like it or not, we are involved in emerging markets,” says Caisse de dépôt et placement du Québec CIO Lescure, whose fund currently invests roughly $7 billion directly in those markets.“We have to make sure we know what is going on there.” Emerging-markets companies are unlikely to be as advanced as those in the developed world in terms of corporate governance or environmental issues, Lescure says. “We should have a relative view when evaluating them for potential investment,” he adds. INSTITUTIONALINVESTOR.COM
One way institutional investors are approaching ESG matters in developing economies is by talking to global companies about their supply chains. The Connecticut Retirement Plans and Trust Funds, under the direction of State Treasurer Denise Nappier, has been working with other investors to monitor how companies like Coca-Cola Co. are managing and reporting their water usage. The world’s biggest soft-drink maker uses a huge amount of water, and much of its bottling is done in emerging-markets countries. Many large public pension funds are already directly engaged with human rights issues in emerging markets. In the U.S. more than 20 states have passed laws requesting
are consequences there,” says RFK Center supporter Spilker. Corporate governance is also relatively easy, he adds, because there is usually an obvious link to shareholder value. But when it comes to human rights, the economic benefits are not always clear, and change can be difficult to achieve. Kramer, however, says that just because ESG issues can be hard and complex, and their financial benefits not always quantifiable, investors should not avoid them. He rejects the notion that ESG factors are somehow more amorphous than other aspects of investing, adding that it is a fiction to believe that future return streams are predictable. “Whether it’s the BP oil spill or sub-
“Like it or not, we are involved in emerging markets.We have to make sure we know what is going on there.” — Roland Lescure, Caisse de dépôt et placement du Québec
that their pension funds divest from companies doing business in Sudan, because of the atrocities being committed through genocide in its Darfur region — civil strife that came about in part because of drought-caused migration. Some other state pensions, such as the New York State Common Retirement Fund, have divested voluntarily. Not all public funds support divestiture. CalPERS, for one, is reluctant to divest from companies with operations in Sudan; it believes more good can be done by staying at the negotiating table. Furthermore, many of the companies that do operate in the region are based in China, India or Malaysia. Often these emerging-markets companies are very resistant to shareholder engagement. Dealing with such companies is “one of our most challenging areas, but we’re brainstorming with our members and coordinating with our investor network to achieve greater success,” says Melany Grout, director of the Conflict Risk Network, a group of institutional investors, financial services firms and other stakeholders organized by the Washington-based Genocide Intervention Network. Human rights is by far the hardest issue for investors to justify getting involved in on purely economic grounds, especially in the developing world. “Generally, people have an easier time understanding the environmental stuff, because increasingly there
prime lending, outcomes damaging the public interest can damage beneficiaries,” he explains. “Fiduciaries also have a duty of intergenerational impartiality, which means they have to go through the subjective process of thinking through how social justice or environmental considerations can affect sustainable corporate performance and long-term investment outcomes.” Inspired by the discussions at the RFK Center’s Compass Conference, a group of influential government officials and public pension fund executives — including CalPERS’s Simpson; North Carolina treasurer Cowell; Stanley Mavromates Jr., CIO of Massachusetts’ $44 billion Pension Reserves Investment Trust Fund; and Pennsylvania Treasurer Rob McCord — have been discussing how they and other institutional investors can better integrate an awareness of ESG factors into what they do. They realize that asset owners, their investment staffs and board members, as well as their money managers and even consultants, need to be better educated on the topic. At the urging of these fiduciaries, the RFK Center is in the process of putting together a series of educational sessions to be held around the U.S. In October, Kramer and Tracy Palandjian, a managing director at consulting firm Parthenon Group in Boston and one of the key organizers of the Compass
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Conference, flew to Chicago to meet with fiduciaries and their consultants to talk about the kind of initiatives that are needed. For Spilker, the RFK Center’s position as a human rights organization outside the asset management and investment community enables it to act as an independent, objective mediator of these discussions. Kerry Kennedy and the center’s track record provide legitimacy, and also some useful star power that can bring attention to the cause. (Actors Mandy Patinkin, Vanessa Redgrave and Gloria Reuben attended the Compass Conference.) But it is Kramer’s presence that has really made the RFK Center’s efforts to engage fiduciaries and money managers on the issue of responsible investing successful so quickly. Alan Buerger, CEO and co-founder of Coventry Capital, says he was not remotely interested in attending this year’s Compass Conference when he first heard about it. A Republican, Buerger was skeptical of the
motives behind the gathering, but then he got a call from Kramer. “You can’t say no to Orin; he is very persuasive,” says Buerger. His Fort Washington, Pennsylvania–based firm (the leader in, of all things, the life settlement secondary market) became one of the event’s two lead sponsors. Now Buerger is a believer, talking to asset owners, including insurance firms, corporate pension funds and public funds, about the importance of ESG issues. “It’s Orin’s incredible ability to bring disparate people together, along with his clear understanding of what it means to be a good fiduciary, and his passion and intelligence about these subjects, that makes the whole project work,” Spilker says. Still, there is plenty to be done. Although responsible investing has gained credibility in the past few years, far from every fiduciary is on board with the idea that considering ESG issues should be an important part of what they do. Even the Annie E. Casey Foundation,
which has been one of the more outspoken advocates of mission-based investing, has not adopted a values-driven investment approach across its entire portfolio, as director of social investments Velasquez would like it to do. “It might take having folks like me, or my colleagues at other foundations, moving into the CIO level to bring this to the scale that it needs,” she says. The RFK Center, for its part, is already planning next year’s conference. But Kerry Kennedy is well aware that talk, if not exactly cheap, is relatively inexpensive. She knows that a single annual meeting at her family’s sumptuous summer home each year is not going to be enough. “If we are having the same discussions that we had at the conference this year ten years from now, then we will have failed,” Kennedy says.“But that is not my intention.” •• Comment? Click on Asset Management at institutionalinvestor.com.
AWARD WINNING EDITORIAL AMERICAS
INTERNATIONAL Regulatory Hurdles
Turkey’s IMF Shuffle
Turf battles and new industry PM Erdog ˘ an drags feet on opposition threaten efforts to a standby credit in hopes of reform financial oversight avoiding new fiscal restraints
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What China Wants Beijing flexes its economic muscle in a bid to reshape the international financial system to suit its interests. PAGE 38
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“I don’t think too many people left that conference believing that this was not a business imperative going forward,” says Parker. “I think the skeptics within Deutsche have been silenced.” Starting in 2007, Deutsche introduced ESG factors into the firmwide investment platform that its portfolio managers use to access fundamental financial data, buy-side reports and sell-side earnings estimates and stock ratings. The ESG data includes companies’ energy and water use, waste management, product toxicity and indications as to how well they understand and manage for changing policies around carbon. Parker acknowledges that the “E” represents the bulk of the ESG data offered on the platform, but Deutsche also incorporates material “S” and “G” data: managers can see red flags spurred by child continued from page 48
of the firm. She says this would be in keeping with Aberdeen’s decision in 2007 to join the U.N.’s Principles for Responsible Investment, which pledge signatories to commit to socially responsible investing. Her efforts are likely to get a boost from the performance of the firm’s SRI funds. In aggregate, they have an average annualized return of 3.86 percent for the five years ended in August, handily beating their benchmark, the FTSE world index, which returned 1.50 percent a year. “It’s a good time, on the back of these strong performance numbers, to more fully understand the ESG risks and attributes of more of the companies in which we invest,” Rose adds. But ESG integration isn’t always embraced by portfolio managers and analysts.“ESG is something that is still relatively new for fund managers,” Rose says. “But the tide is turning, since the markets — and clients in particular — are demanding that asset managers understand their investments from a 360-degree point of view.” Another potential problem in integrating ESG at large firms like Aberdeen is that SRI funds may diverge from the rest of the group on certain hot-button issues. An illustration of that chasm is Aberdeen’s stance on its holdings in PetroChina Co., the Chinese oil company that has come under scrutiny from
“We don’t expect our clients to sacrifice performance because they’ve incorporated ESG. They should expect better returns.” — Alexis Krajeski, F&C Investments
labor violations or issues surrounding licenses to operate, and can pull executive pay figures. Aberdeen Asset Management is on the brink of a similar firmwide integration, according to head of SRI research Rose. The firm’s SRI division has been growing at a steady pace since Rose arrived in 2001 following Aberdeen’s acquisition of Glasgowbased Murray Johnstone, where she was an investment writer and web editor. At the end of October, the firm had $1.7 billion across 12 SRI funds, with an additional $8.7 billion in another dozen products that are not traditional SRI funds but require screening based on extrafinancial criteria. Rose is hoping to broaden the ESG research and screening process to the rest INSTITUTIONALINVESTOR.COM
human rights advocates, including Investors Against Genocide, for doing business with the Sudanese government as it continues the war in Darfur. Although Aberdeen’s official policy on its investment with PetroChina is that parent company China National Petroleum Corp. (CNPC) is more of a concern, Rose says her team has failed the stock for the SRI basket because of human rights problems linked to Sudan. “We tell our shareholders, ‘If you’re in our mainstream fund, this is our technical position on it,’” says Rose.“‘If you’re an SRI investor, then we take into consideration the Sudan issue.’ We realize that’s incongruous.” London’s F&C Investments, which caters to both retail and institutional clients, has a
longer-standing commitment to responsible investing than either Deutsche or Aberdeen. The firm was founded by Quakers in 1868 and launched Europe’s first ethical fund in 1984. But of late, F&C, like these other firms, has been considering how to expand the reach of ESG in its offerings. Last year, Boston-based consulting firm Cambridge Associates approached F&C on behalf of a group of institutional clients who were eager to invest in emerging markets, hoping to profit from the outsize economic growth that many analysts are predicting for these countries. But the risks that often accompany emerging-markets businesses in burgeoning industries — lack of government regulation, opaque corporate governance structures, excessive pollution, poor labor relations — had given these investors pause. Working with Cambridge, F&C developed an emerging-markets equities product that, to mitigate risk, integrates a systematic, stock-by-stock inspection of ESG factors. “The fund is meant to be a mainstream approach with a core commitment to ESG that’s embedded in the process,” says Alexis Krajeski, associate director of governance and sustainable investment at F&C. The Emerging Markets ESG fund, which F&C launched on March 1, passes each stock through three filters. The fund’s managers begin by choosing stocks that look to be driving sustainable economic growth in emerging markets or profiting from the positive trends there. The companies that pass what Krajeski calls the alpha filter are then screened for environmental, social and governance risks. Last, those that make it through the ESG test are scrutinized financially. Being strong across the board in ESG but shaky on financial metrics is not going to get a company into the portfolio. “We don’t expect our clients to sacrifice performance because they’ve incorporated ESG,” says Krajeski. “On the contrary, they should expect to get a better return by incorporating ESG.” At F&C about $4 billion in assets is in dedicated ESG strategies like the emergingmarkets fund. But the reach of the ESG analysis doesn’t stop there.“What the governance and sustainable investment team does is help our fund managers really understand where ESG presents risk and opportunity for them,” Krajeski says.“That can be incorporated into any strategy, even if the underlying strategy
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doesn’t obligate the fund manager to look at ESG the way we do in the emerging-markets fund.” For example, Krajeski has worked with the firm’s oil and gas analysts to help them understand which companies have the best ESG performance and which present significant risks. When a portfolio manager’s response is along the lines of “I hear your concerns, but this is a strong investment case,” F&C often turns to its in-house engagement service, called REO, which stands for “responsible engagement overlay.”Through REO, which was introduced in 2000, F&C works with companies in its portfolio to help them move toward ESG best practices. Marathon Asset Management — founded in 1998 by Louis Hanover and Bruce Richards to invest opportunistically in global credit markets — introduced an ESGscreened share class within its flagship hedge fund earlier this year after receiving several client requests similar to those fielded by F&C. The first such request came in early 2009 from a fund-of-funds firm looking for a fixed-income manager that could run an SRI fund for one of its clients, notes chief operating officer Andrew Rabinowitz. Marathon had to say no. At first, Rabinowitz didn’t think much more about the subject, but over the next year Marathon received five or six similar requests, and the firm’s senior management decided it was time to do something.
forum for ESG integration — when it comes to leveraging investor positions to persuade companies to change their ways. As Rabinowitz points out, with a credit investment, the investor controls a crucial life source for a company: access to capital.“If there’s capital available only to those who don’t pollute, for example, it may be a good way to get industries more green,” he adds. THE CATALYST FOR KKR’S DECISION
to embrace ESG came in early 2007, when the New York–based firm teamed up with Texas Pacific Group to acquire Texas power company TXU Corp. At the time, the $45 billion deal was the largest private equity acquisition in history. It also set an internal precedent within KKR for how private equity ESG investing could work. Before KKR’s investment in TXU, several environmental groups, including the Environmental Defense Fund, had protested TXU’s plans to build 11 new coal-fired power plants. Even before the deal was finalized, KKR negotiated on behalf of TXU with EDF and other groups, getting them to agree on a compromise: The new power plants would be reduced to three from 11, and a number of environmental goals and limits, including a cap on carbon emissions, would be imposed on the utility, whose name was later changed to Energy Future Holdings. That collaboration between KKR and
“We aren’t just sitting in New York watching these companies perform. We’re actually engaging with them.” — Elizabeth Seeger, Kohlberg Kravis Roberts & Co.
The firm decided to engage RiskMetrics, which flags companies in Marathon’s Special Opportunity Fund that have some sort of E, S or G issue — those that have been smacked with violations because of pollution or those that are not adhering to labor laws, for example. The companies that fail the ESG screen are put on a restricted list and not included in the SRI share class. Admittedly new to the concept, Rabinowitz calls Marathon’s ESG approach “a starting point.” But as he has grown more familiar with ESG issues, he’s come to believe that fixed income may offer some inherent advantages over equities — still the primary
EDF became the basis of a more formal partnership that the two officially launched in May 2008 with the introduction of KKR’s Green Portfolio Program. In the first year, KKR and EDF worked together on three companies for the pilot project and facilitated a collective $16.4 million in savings for the companies by reducing 25,000 metric tons of carbon dioxide emissions, millions of tons of waste and thousands of tons of paper. Since the collaboration began, Elizabeth Seeger has played a leading role — first for EDF and then for KKR. Seeger, who has an undergraduate degree in environmental studies from the University of Chicago and
an MBA from the Wharton School of the University of Pennsylvania, joined EDF in the summer of 2007 as a fellow in its corporate partnerships program, which engages companies to help them improve their business practices. After the TXU deal, she was one of the first people at EDF to consider what a more permanent partnership between her group and KKR might look like. Once the Green Portfolio was established, she helped manage the program from the EDF side for the first 18 months before moving to KKR early this year to work with its Capstone group of some 50 consultants who advise portfolio companies on ways to improve their operations. KKR announced the Green Portfolio’s second-year results in June: Companies in the portfolio had saved a collective $160 million by cutting out 345,000 metric tons of carbon emissions, 1.2 million tons of waste and 8,500 tons of paper. Dollar General Corp., a leading discount retailer, enrolled in the program in 2009 and, with the help of KKR Capstone specialists, has focused its efforts on improving energy efficiency in its stores and distribution fleet, and on reducing cardboard waste. KKR reports that, to date, Dollar General has eliminated $106 million in costs, reduced its emissions of greenhouse gases by 160,000 metric tons and improved waste efficiency by 75 percent. The Green Portfolio now covers almost a third of the firm’s private equity investments. Seeger says private equity is in many ways a natural fit for this type of ESG integration because of its governance structures, its relationships with its portfolio companies and its focus on creating long-term value in companies. Seeger adds that the longer-term, in-person involvement that the KKR Capstone team brings to its portfolio companies means the firm has more say in suggesting and implementing changes. “We aren’t just sitting in New York watching these companies perform,” she says. “We’re actually engaging with them on the ground.” The ESG effort at KKR doesn’t stop with making portfolio companies greener. Social risk awareness is becoming an increasingly important subject within the firm too. KKR recently partnered with San Francisco–based Business for Social Responsibility, which works with member companies to promote INSTITUTIONALINVESTOR.COM
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sustainability. KKR has also launched a responsible-sourcing initiative that seeks to teach the firm’s portfolio companies more about supply-chain and human rights issues. Half of KKR’s portfolio companies have participated in events focused on the subject of sourcing, including a half-day conference where experts gathered to speak about the issue. Seeger says KKR hopes to hold such conferences in China, where several KKR Capstone professionals are based. Auriel Capital managing director Seitchik says that when he joined the quantitative hedge fund firm 15 months ago, he was intent on instilling in its portfolio managment team the idea that ESG analysis can fit naturally into
and it enhanced the performance by adding about a half percent to an 8 percent return,” he explains. Early next year, Auriel, with support from Trillium, intends to launch an absolutereturn (long-short) equity hedge fund. The fund will fully integrate ESG research, using indicators in each of 23 sectors based on their expected impact on mitigating risk or enhancing return. But Seitchik stresses that while ESG indicators can influence stock selection, it’s important that they “at times get outvoted by traditional financial themes.” He gives the example of Swiss Re, a Zurich-based reinsurance company that promotes sus-
“We’re making the bet that this is such abig area of investment that it will stay with us for at least the next 20 or 30 years.” — Jason Mitchell, GLG Partners
a firm’s existing investment framework.This is particularly true, he notes, for a hedge fund on the lookout for the next great source of alpha. For many years, Seitchik worked at large mainstream investment institutions, like Wellington Management Co. in Boston, where he was an analyst and portfolio manager, and then Deutsche, where he was the London-based chief global strategist (before Parker’s arrival at the firm). In 2004 he decided to focus his career on responsible and sustainable investing and became CIO at Trillium Asset Management, a $1 billionin-assets Boston-based firm dedicated to that approach. Seitchik has introduced Auriel’s portfolio managers and analysts to the idea that ESG research allows them to score companies based on environmental, social and corporate governance health the same way they are already scoring them on traditional valuation and profitability. “In a way, it wasn’t a huge change for Auriel, because we’re always looking for the next thing that might give us a little bit of an edge,” Seitchik says. “It fit very seamlessly into the investment process.” Auriel has been researching an ESG strategy to find out whether it really does add value — and if so, exactly how much. The results have been encouraging, Seitchik says. “When we did the test, we looked at the performance of the portfolio without ESG, and then we did a backtest adding ESG INSTITUTIONALINVESTOR.COM
tainability by developing products related to climate change. The company, however, scores poorly on valuation and investor sentiment. As a result, Auriel is underweight its stock (though Seitchik says he’s less negative on it than he would be without the strong ESG tie-in). By contrast,Amsterdam-based Royal Philips Electronics presents a good short-term trading opportunity and a strong valuation, as well as solid ESG factors such as significant resources devoted to research and development and energy efficiency.“The ESG analysis has increased the size of what was already an overweight position,” Seitchik says. GLG’s Mitchell, for his part, is working to build a strategy that isn’t defined by its inclusion of ESG data but rather uses it as yet another dimension to augment and define a broad-ranging investment process. To illustrate the wider gaze Mitchell’s strategy is taking, the fund he’s overseeing will be renamed the GLG Global Sustainability Fund (from the GLG Environment Fund) at the beginning of 2011. Since Mitchell changed the focus after rejoining GLG earlier this year, the fund has thrived. As of November 1 it was up 7.61 percent for the year, beating its benchmark, the MSCI Europe index, by nearly 300 basis points, even though it has underperformed the index since its launch in 2007. As Mitchell has considered how to best approach GLG’s second incarnation of a
sustainable investment strategy, the lesson learned from the firm’s earlier failure plotting carbon output remains at the forefront of his mind. He says that by focusing solely on companies’ carbon footprints, GLG was missing the point of investing sustainably. “What I’m trying to do as I build this new strategy is look at it from a very Darwinian perspective,” Mitchell says.“What industries and companies will benefit the most from changes that relate to sustainability? Those changes could be greater demand for products like energy-efficient lightbulbs, or they could be regulatory changes for tightening emissions standards. They could come from revaluations of older-economy efficiencies, like if a booming recycling business suddenly has more value because of resource scarcity.” Mitchell’s self-defined task is to find the companies best positioned to profit from global responses to sustainability problems — and at this point, he’s not looking for the cleanest ones. He’s been digging deeply into themes such as social housing, health care provisioning and energy efficiency in countries like China, whose government is devoting massive funds to address these and other issues. He’s added Wacker Chemie, a Munich-based polysilicon producer for the solar industry, to the fund because it is poised to help answer China’s demand for renewable energy; Novo Nordisk, a Danish insulin provider with a 60 percent market share in China that will likely grow on the back of government funds being funneled into health care; and Hong Kong–based Xinyi Glass Holdings, which produces glass products for low-cost housing in China. “We’re making the bet that this is such a big area of necessary investment and regulation, and such a massive trend, that it will stay with us for at least the next 20 or 30 years across a number of sectors — from agriculture to infrastructure to transportation to health care and education services,” he says. “When your strategy is taking into account something as broad as sustainability, your reach extends to all of the facets of life and resources that it affects.” If investors like Mitchell, Seitchik and Parker are right, the impact on the money management industry will be equally everlasting. •• Comment? Click on Asset Management at institutionalinvestor.com.
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continued from page 53 a host of innova-
tions, such as subprime loans, which went to borrowers with the lowest credit scores, and Alt-A mortgages for borrowers who were above subprime but still below prime. There was also a mushrooming variety of adjustable-rate mortgages, interest-only loans and negatively amortizing mortgage loans in which the repayment was less than the interest charged, so the loan amount kept growing ad infinitum. According to Gary Gorton, a finance professor at the Yale School of Management, total outstanding subprime mortgages grew from $81 billion in 2000 to $731 billion in 2006 — 37 percent of private sector mortgage securitizations. Alt-A loans were an additional $765 billion. The same period saw the rise of the collateralized debt obligation, which combined debt such as subprime loans with tranches of other asset-backed securities, like auctionrate securities and credit card debt. The total value of CDOs — which investor Warren Buffett says have so many permutations that “nobody knows what the hell they’re doing” — reached $1.3 trillion in 2007. Wall Street was making such huge fees creating these new securities that it branched out into evenmore-esoteric instruments, such as CDOssquared and -cubed, which were composed of tranches of other CDOs, and synthetic CDOs, which contained credit default swaps, a form of insurance on other debt. When the two Bear Stearns hedge funds collapsed in the summer of 2007, it was an acknowledgement that subprime-backed mortgage bonds had been falling in value for some time. By October of that year, Merrill Lynch & Co. had reported $8 billion in losses in mainly subprime CDOs, with Stanley O’Neal resigning as CEO because of them. Lehman Brothers lost $3 billion on subprime-mortgage-backed securities it held
on its balance sheet in the first half of 2008; it was never able to recover. Academics are still debating the causes of the most recent financial crisis: Lax monetary policy, mispriced risk and improper incentives on Wall Street are just a few of the most frequently mentioned. But some prominent experts are now coming forward to blame the private market securitization process itself for the crash. According to Susan Wachter, a real estate professor at the Wharton School of the University of Pennsylvania, and Adam Levitin, a law professor at Georgetown University in Washington, the housing bubble was the result of two simultaneous developments: the growth of private-label RMBS issuance in the late 1990s and early 2000s, and its expansion into new areas such as subprime, Alt-A loans and adjustable-rate mortgages. According to Wachter and Levitin, the private-label market failed to take adequate account of credit risk — the danger that borrowers would not pay back the loans; this historically had not been a concern with mortgages backed by Fannie and Freddie because they were plain-vanilla fixed 30-year loans and carried an implicit government guarantee. “The process that delivered the information was broken,” Wachter says. “The first basic mistake was that diversification was all that was necessary, but that exposed you to concrete market risk. The second mistake was to rely on the ratings agencies. They were not tracking credit risk or systemic credit risk.” In addition, the speed with which banks processed mortgage securitizations is now coming back to haunt the financial services industry. Loans were not always properly transferred to the trusts, and some did not live up to lenders’ declared criteria, such as income levels or FICO scores. In a research report last month, JPMorgan bond analysts said this problem could force originating banks to take $55 billion to $120 billion in losses on loans they have to repurchase from investors. Some analysts predicted that investors might now challenge the legality of entire securitization transactions and demand all their money back because of the shoddy documentation. The potentially sweeping scope of the crisis was illustrated when the Federal Reserve Bank of New York joined private investors like BlackRock, Neuberger Berman Group and Pimco in demanding that
Bank of America Corp. buy back bad home loans that were part of $47 billion worth of mortgage debt securitized by the bank. BofA said it would oppose the demands. When the housing bubble burst, it wasn’t just mortgage-backed bonds that took a beating. The market for all new asset-backed securities, even those that had no problems associated with their ratings, such as auto loans, fell off a cliff. Many traditional investors, sitting on huge mark-to-market losses in their ABS portfolios, ran for the hills. “Basically, the whole securitization market was in the toilet,” says Guy Cecala, publisher of the closely studied newsletter “Inside Mortgage Finance.” He adds,“There was no confidence in the rating agencies. The market was frozen.” At a hearing on the housing meltdown by the U.S. Senate’s permanent subcommittee on investigations earlier this year, evidence was introduced showing that nearly all of the subprime- and Alt-A-mortgage-backed securities sold during the housing boom had turned out to be worth much less than originally believed and had been downgraded from triple-A to junk status by the ratings agencies. “For a while, everyone made money — banks and mortgage brokers got rich selling high-risk loans, Wall Street investment banks earned big fees creating and selling mortgagebased securities, and investors profited from the higher returns,”Michigan Democrat Carl Levin, the subcommittee chairman, told the hearing.“But those triple-A ratings created a false sense of security. High-risk RMBS and CDOs turned out not to be safe investments.” Faced with the complete seizure of one of the core components of the capital markets, the government stepped in to try to get securitizations moving again. Its first effort was the Term Asset-backed Securities Loan Facility, or TALF, created in 2009. TALF provided $71 billion in loans to investors that posted an asset-backed or commercial-mortgage-backed security as collateral. The New York Fed created a special purpose vehicle to buy collateral if the loans weren’t repaid, but the facility was never used. Although the program was criticized at the time as being too timid, there is no doubt that it jump-started the assetbacked market. According to the Congressional Oversight Panel, TALF provided a hefty 39 percent of INSTITUTIONALINVESTOR.COM
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all auto loan, credit card and student loan securitizations between March and December 2009 — enough to break the logjam. Asset-backed issuance went from a low of $11.3 billion in April 2009 to $24.9 billion in June of this year. Wall Street saw TALF as nothing short of a savior for securitization. “TALF was a hugely successful program,” says the head of securitized products at a large bank. “It was well crafted, targeted a lack of liquidity in the market and gave a backstop to the market that it could sort of spring off of. It became a positive, momentum-building cycle.” In June 2009 the program was expanded to include commercial-mortgage-backed securities. Although only $12 billion in CMBS loans were handled, they too had an effect on the market. “TALF was an important piece to getting the commercialmortgage-backed market going again,” says Mitchell Resnick, co-head of Goldman’s commercial real estate origination and securitization desk. “The Fed really did help thaw the market.” Goldman did the only new CMBS issuance under TALF — though there were later some refinancings — selling $400 million in securities for Developers Diversified Realty Corp., a real estate investment trust. The other government initiative was the Public-Private Investment Program, which
Oaktree Capital Management; RLJ Western Asset Management; and Wellington Management Co. — had raised $7.3 billion in private capital, which was matched by the government. Treasury also provided debt financing, for a total of $29 billion, of which $16 billion has been spent to buy securities. Because of the program’s small size, it’s hard to determine whether PPIP actually did all that much to revive the market. There has been almost no new RMBS issuance. Aaron Bartley, who heads the PPIP program at the Treasury, says the ABX and CMBX derivatives indexes have risen 60 to 90 percent since the program was announced; he sees this as a sign that the secondary market for these securities has gained strength. “[The CMBS market] is beginning to come back, albeit in small steps,” Bartley says. With all this government support, it should be no surprise that the commercialmortgage-backed market has been one of the first to revive, led by JPMorgan’s $1.1 billion deal, which was the largest issuance since the crisis began in 2007. Goldman’s Resnick estimates that there will be $10 billion of new commercialmortgage-backed issuance this year, rising to $25 billion in 2011. But that still is a far cry from the $246 billion issued in 2007. “Investors tend to believe that the loans that they see now are safer than the loans that they
“There is broad agreement that an ABS market is important for the country and the economy.” — Paula Dubberly, Securities and Exchange Commission
was announced in March 2009 and designed to bring private capital back to the market for residential- and commercial-mortgagebacked securities by buying legacy assets from banks. It worked like this: Private investment funds selected by the government received matching investments from the Treasury to buy RMBSs and CMBSs that were stuck on bank balance sheets. The idea was that as demand for these assets rose, even marginally, the market would become unfrozen and new issuance would take place. By June of this year, the nine fund managers — AllianceBernstein; Angelo, Gordon & Co.; BlackRock; GE Capital Real Estate; Invesco; Marathon Asset Management; INSTITUTIONALINVESTOR.COM
saw over the past five to ten years,” Resnick says.“That’s because the amount of leverage that’s being offered is lower than what it was before. It was 80 to 85 percent before, and now you rarely see a lender going above 70 to 75 percent leverage.” So bright do financial services firms see the future of commercial-mortgage-backed securitizations that some banks are once again scrambling to expand into the business. Wells Fargo & Co., for example, which had a CMBS origination business before but not the ability to underwrite the securities, has added a staff of 20 bankers and support personnel to launch an underwriting business. But Wells may be ahead of the curve.
Most Wall Street banks laid off thousands of staff when the securitization markets froze and are just beginning to make hires because of the recent uptick in activity. Goldman and JPMorgan say they aren’t expanding their securitization staffs, which were heavily pruned in the past two years, but Citi is hiring on a small scale. Commercial real estate is not all that’s flowing. The other bright spot in the assetbacked world is auto loan securitization. In September alone, Chrysler Financial issued a $2 billion auto-loan-backed bond and Nissan Motor Co. sold a $1.3 billion security, its first since March 2009, with record-low yields. There was also a $1 billion bond from Ford Motor Credit Co., a $750 million issuance from German automaker BMW and a $700 million deal by AmeriCredit Auto Receivables Trust. Two types of ABSs have suffered since the financial crisis: bonds backed by credit card receivables and student loans. While the number of credit cards is up, card balances have declined sharply, so there is less product to finance. In addition, because major banks have huge deposits on which they pay little interest, they prefer to keep their credit card receivables on their balance sheets because they make a hefty profit on the interest rate spread. Nonetheless, on September 13, Deutsche Bank and JPMorgan managed to sell a $600 million bond backed by credit card receivables for the credit card issuer Discover. One big concern, though, is the Financial Accounting Standards Board’s 2009 rulings known as FAS 166 and 167, which basically prohibit banks from taking off-balance-sheet treatment for securitizations. In the past, large banks used securitizations to get assets off their balance sheets and improve their capital ratios. That meant banks didn’t have to hold as much capital, because the loans were considered a risk to the investor. Now, however, banks can sell 70 to 80 percent of a transaction and still have to hold regulatory capital against the assets. Under the new standards, if a bank has control over the assets, such as servicing the loans, or if it has retained some of the risk, it has to consolidate the assets. “I think it will fundamentally change a lot of how securitizations are done,” says Tom Deutsch, executive director of the American Securitization Forum, which represents both issuers and
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investors in asset-backed securities. Henceforth, he adds, Wall Street banks may opt to be servicers or owners of risk, but not both. “Because the advantage of helping to improve your capital ratios is no longer there, there’s a question in many chief financial officers’ minds about whether the economic benefit of securitization is what it used to be,” explains Paul Jablansky, Stamford, Connecticut–based senior strategist for RBS Securities. At a time when the cost of a college education is becoming prohibitive for many families, student loan securitizations have dropped dramatically — from $67 billion in 2006 to just $12 billion this year — but that is not because of the financial crisis. As part of the Obama health care package, Congress shut down the Federal Family Education Loan Program, in which commercial lenders lent to college students with a federal subsidy (a total of $55 billion in 2008), because of concerns that banks were making too much money on the deals. Over a 35-year period, as the cost of a four-year education skyrocketed, millions of students benefited from the program’s Stafford loans, but most new loans will now be made directly by the Department of Education, so there will be a much smaller market for private loan securitizations. THE FINANCIAL CRISIS LEFT MANY
in Washington feeling blindsided by Wall Street’s excesses; it should be no surprise that politicians and regulators alike have set out with a mixture of anger and missionary zeal to rein in what they see as irresponsible behavior. Barney Frank, the Democratic chairman of the House Financial Services Committee, predicts a “third age of American finance” in which the government slaps “restraints” on securitization much the same way it did on trusts and the stock market in earlier days. The Dodd-Frank financial regulation bill, which was finally signed into law in July, has an entire section devoted to “improvements to the asset-backed securitization process.” In addition, other provisions of the law change the way that ratings agencies can work in the future; this will have a direct bearing on how ABSs are issued. The Securities and Exchange Commission, perhaps the regulator most chastened by the huge investor losses in mortgage-backed securities during the financial crisis, is now
writing regulations that will implement Dodd-Frank’s sweeping calls for reform. In addition, in April the SEC proposed its own substantial rewrite of Regulation AB, its rules for asset-backed securities, designed to increase the amount of information in investors’ hands. Both sets of rules aren’t expected to be finalized until the middle of next year. Paula Dubberly, deputy director in the SEC’s division of corporation finance, says the government is trying to ensure that securitization doesn’t cause another crisis. “There is broad agreement that an ABS market is important for the country and the economy,” she explains. “That’s why the proposals were so sweeping.” Among the biggest changes is a requirement that securitizers — meaning Wall Street underwriters — retain a 5 percent piece of the credit risk in any transaction. The govern-
reason for the financial crisis was that investors didn’t have enough information or time to study what was available. The new rules propose a five-day waiting period before an investor can buy a new bond issue. They also call for a huge increase in the amount of information disclosed about underlying loan pools. Auto loan ABSs, for example, would have to disclose details about every loan in the pool, even though a typical securitization might include 100,000 loans. ABS issuers would also be required to review the bundled assets in the collateral to make sure the loans all meet the representations of the issuer, and to disclose to investors the results of that review, as well as any thirdparty due diligence. Another, more controversial, rule proposed by the SEC would require the CEO of the securitizer to certify in writing that the
“There are a lot of investors who are now doing a fair amount of their own due diligence.” — Karen Weaver, Seer Capital Management
ment contends there were too many instances where securitizers sold investors pools of loans that turned out to be worth far less than originally thought. The belief is that by forcing the deal makers to hold a portion of the credit risk, they will be more careful about what they sell. “Retention is a logical response and certainly makes sense,” says DLA Piper’s Borod. “What you are trying to do is make someone accountable where before they were packaging mortgages and selling them and not caring what was inside the packages. If you tell those people, ‘You’ve got to have skin in the game,’ then that should have some impact.” The rule contains a number of exemptions, including bonds backed by qualified residential mortgages. The SEC may add other exemptions. The agency also has to decide if the 5 percent credit retention will be “horizontal,” meaning the underwriting firms must retain a slice of the lowest-rated tranche of a security, or “vertical,” which would entail forcing them to own a section of each of the many tranches in a deal: 5 percent of the senior triple-A-rated tranche, an equal portion of the double-A piece and so on. The SEC is convinced that part of the
pool of loans is able to pay out to investors as described in the prospectus. Critics maintain this would create a new and unnecessary legal liability for the securitizing firm. Adding to the uncertainty, the FDIC on September 27 jumped the gun on the SEC and announced its own new securitization regulations, which are called Safe Harbor rules. In the past, the Safe Harbor rule guaranteed that if a bank became insolvent, the FDIC would not seize the collateral in the firm’s securitization pools to protect the depositors. Now, however, the FDIC says that under the Safe Harbor rule it can take control of the collateral. This may make securitizations by deposit-taking banks less attractive to investors. “Basically, Safe Harbor creates an uneven playing field between U.S. banks and nonU.S. banks,” says the ASF’s Deutsch. In addition, the new rule requires U.S. banks to retain a 5 percent vertical slice of the credit risk, which may put it at odds with the SEC’s own rule on credit risk retention under Dodd-Frank. The FDIC’s ruling takes effect on January 1, well before the SEC even finishes drafting its regulations. Predictably, Wall Street is not enthusiastic INSTITUTIONALINVESTOR.COM
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about all the changes, though no one will say so on the record. One investment banker moans privately: “I don’t think they realize that some of the things they are proposing will have a negative effect quite opposite to what they wanted to take place. If they make the rules too difficult to be involved in the business, you won’t be involved in the business, which means there is one less lender out there, rates will go up, and borrowers won’t have as much access to credit.” For example, on the question of retaining skin in the game, the banker says that holding credit risk indefinitely is expensive and that some firms may exit the business rather than submit to the new rule. Of all the actors in the housing crisis, few came in for more criticism than the ratings agencies, which were widely accused of issuing favorable ratings on subprime mortgage debt solely in hopes of drumming up new business from the issuers. In response, Washington is trying to rein them in on several fronts, and the agencies themselves are taking steps to rehabilitate their image before a final regulatory decision is made. “The commission has been clear, and the government as a whole is trying to get rid of the reliance on ratings,” says the SEC’s Dubberly. The Dodd-Frank bill, for example, removes all requirements for investmentgrade ratings from all sections of U.S. law. It
even though there is virtually no private-label RMBS issuance taking place at the moment. Moody’s has beefed up three parts of its analysis: an originator assessment that reviews the lender’s policies and procedures; a third-party review that requires a due-diligence firm to look at every loan in the pool to see if it is consistent with the lender’s guidelines; and an examination to make sure each loan is consistent with federal and state regulations about such things as truth in lending — this should reduce the problem of no-doc loans that was so prevalent before the crisis. Linda Stesney, head of the primary RMBS ratings group at Moody’s, says the agency is also looking at the “representations and warrants” an originator makes when securitizing a loan, such as whether all the loans in the pool are current and meet regulatory guidelines.“Although we have reviewed R&Ws as part of our overall evaluation of transactions in the past, our updated review criteria more specifically address the aspects of R&Ws that we believe improve transparency, data integrity and accountability,” she says. At Standard & Poor’s, a AAA rating now reflects economic stress on a level with the conditions of the 1929 Depression, according to structured ratings chief Jacob. Securitizations are compared against an “archetypical” loan pool so that investors can see how
“Without standardization, it’s impossible to interpret the information — you simply can’t do statistical analysis.” — Susan Wachter, Wharton School
also calls on the SEC to create, after a twoyear study, an oversight board to choose which ratings agencies will grade each bond. One regulatory innovation adopted earlier this year requires issuers of assetbacked securities to set up a web site for each new issuance, with complete details of the transaction. The web site is then open to all ratings agencies, even those not hired to rate the deal, in an effort to spur competition in the ratings market, now dominated by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. For their part, the ratings agencies have made substantial changes in the way they evaluate securities, particularly mortgages, INSTITUTIONALINVESTOR.COM
new issues might differ from the norm. In deliberating whether to bestow a AAA rating, S&P assesses whether bonds backed by an archetypical prime pool have a paper cushion equal to 7.5 percent of the total loan pool that can be exhausted before investors take losses — this is double the size of the previous cushion.“The level of credit enhancement to achieve various ratings categories has been increased, transactions are less levered, and loss assumptions are more severe,” Jacob says. In addition, if a so-called scenario analysis shows that the rating might shift quickly, the security can’t receive a AAA rating. “Taking stuff through the ratings agencies is a very challenging process right now,” says
one investment banker. “The response time is much slower, their staffing levels are a lot lower, and the whole thing just takes a lot longer than it used to.” The change in attitude was evident in how the agencies approached the only new residential mortgage issue of the year, the $238 million Sequoia deal issued by Redwood Trust, a California real estate investment company. Moody’s gave Sequoia a Aaa rating, but S&P, while it issued a lengthy analysis of the deal, did not give it a rating, presumably because the credit cushion was below the new 7.5 percent AAA requirement. That difference of opinion didn’t deter investors: The Sequoia deal was five times oversubscribed, despite the poisoned reputation of RMBSs these days. What made the difference? According to Redwood COO and CIO Brett Nicholas, the fact that the originator and servicer of the loans were separate from the sponsor was part of the allure. Also, Redwood kept the bottom 6.5 percent tranche, meaning it would take the first losses if any of the loans were not repaid. One effect of the crisis is that more firms are doing their own due diligence and relying less on the opinions of the big ratings agencies. Karen Weaver, who as an analyst at Deutsche Bank was one of the first to recognize the calamity emerging in the subprime market, says investors have become more savvy and need the ratings agencies less.“Historically, the securitization product attracted investors looking for very highquality assets, who in many cases didn’t feel it was necessary to do a lot of their own independent analysis,” says Weaver, who is now head of market strategy and research at Seer Capital Management, a New York investment firm with $300 million under management. “Having gone through the wrenching of the past few years, we now have a different investor base, which doesn’t rely on the ratings agencies as much. There are a lot of investors who are now doing a fair amount of their own due diligence.” This has led to a concentration of investors in asset-backed securities at large fixedincome investment firms with budgets big enough to include dedicated research staffs. “Oh God, no, we don’t rely on the ratings agencies,” says Pimco’s Gross.“The obvious fact is that our common sense has proven much more valuable than their computers, so we match our common sense and computers
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against their computers, and it comes out to the plus side.” There is also a growing business niche for companies that can assess the risk of securitized assets in better ways. Durham, North Carolina–based asset manager Smith Breeden Associates, for example, has developed sophisticated computer models of mortgage-backed securities that it uses to advise pension funds and other investors on which securitized bonds make good investments. “We’ve had a lot of inquiries from investors who quite frankly didn’t know what they owned, and we’ve been able to provide advice on valuation and risk and even helped investors work out their positions,” says Jeffrey Wheeler, a Smith Breeden portfolio manager who focuses on assetbacked securities.
in 2008, there is still no promise that their bonds have the full faith and credit of the U.S. behind them) to eliminating them and putting mortgage securitizations entirely in private hands. Even the sharpest critics of Fannie and Freddie, however, concede that there is no quick fix. Raphael Bostic, assistant secretary for policy development and research at the Department of Housing and Urban Development, says the Obama administration is still kicking around ideas on how to keep the housing market vibrant if Fannie and Freddie’s role changes. That includes whether to continue some sort of government guarantee for housing loans. “It’s important that private capital be engaged in the marketplace, and some of that may come through private-label securities and some may come through public,” Bostic
that would convey more information to the investor. “There has to be more standardization of information,” she says. “Without standardization, it’s impossible to interpret the information — you simply can’t do statistical analysis.” She proposes that residential mortgages be limited to just three flavors: a “Neapolitan” concoction of plain-vanilla 30-year fixed-, plain-chocolate 15-year fixed- and two types of strawberry shortterm adjustable-rate loans. Whatever new methods and innovations are adopted, the new securitization market is sure to be smaller in scale than it was just three years ago. “It’s going to be smaller bite sizes,” says attorney Borod, who also teaches securitization at Boston University. “The market is going to have to grow back brick by brick by issuing more smaller deals, maybe $200 million to $300 million instead
IN AUGUST, PIMCO’S BILL GROSS TRAV-
eled to Washington in a role that was a departure for the outspoken bond guru. Treasury Secretary Timothy Geithner had invited him to a White House conference to discuss the future of Fannie Mae and Freddie Mac. Geithner himself called for weaning the markets away from government programs and letting the private sector get back in the business of financing mortgages, from which it is now almost entirely excluded. Although Gross might have been expected to call for a quick return to private sector financing of mortgages — after all, he says he is a staunch Republican, and privatelabel securitizations offer a much higher interest rate for the benefit of Pimco’s many bond funds — he confounded his listeners by calling for the government to basically take over the residential mortgage market. His reason? Private sector mortgages, by requiring large down payments, are priced beyond the means of most home buyers and would have disastrous consequences for the housing market. “We need the government until it becomes obvious the public begins to believe that housing has a decent foundation,” Gross says. “We need a number of years in which the confidence can begin to come back.” There has been a vast variety of suggestions for reforming Fannie and Freddie, ranging from combining them into a new agency with an explicit government guarantee (even though the once-semiprivate firms were taken over by the government
“Investors tend to believe that the loans they see now are safer than the loans that they saw over the past five to ten years.” — Mitchell Resnick, Goldman Sachs Group
says. “But at the current stage, we haven’t ruled anything out as a possibility.” Even if Fannie and Freddie are successfully reformed, Seer Capital’s Weaver doubts there will ever be a return to the kind of privatelabel securitization that took place in the past decade.“We’re never going to have that volume of raw material, and we’re never going to have that total risk transfer that begets more origination,” she says. One idea for restarting the private mortgage market is to force Fannie and Freddie to reduce the limits on so-called conforming loans. During the financial crisis the limit was raised from $417,000 to $729,000 in expensive areas of the country, crowding out the private sector for all but the biggest loans. “Lowering the conforming maximum would sure help,” says Lawrence White, a professor of economics at New York University’s Leonard N. Stern School of Business. “That opens the market to the private sector more and is one of the necessary steps in reforming Fannie and Freddie.” A proposal to make the private-label mortgage market less risky comes from Wharton’s Wachter, who suggests the creation of standardized mortgage products
of $1 billion to $2 billion. Let the investors take the time to understand the deals, and grow it back gradually.” Though innovation will be a crucial and necessary part of the effort to restore the economy’s vigor, the market has learned the hard way that some financial breakthroughs are as dangerous as they are clever. Such innovations as CDOs-squared and synthetic CDOs are probably never going to be revived and won’t be missed by anyone. The rule changes proposed by the SEC and the new regulations required by Dodd-Frank are steps in the right direction of reassuring investors that the excesses of the past will not be allowed to be repeated. The danger, of course, is that the rules will become so burdensome that the costs of securitization won’t be competitive with those of other forms of financing. That would be unfortunate, because with more than $5 trillion in private debt outstanding, securitization has a proven track record as one of the most efficient methods of raising capital. •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
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continued from page 57 ing that the bank
failed to disclose the extent of Merrill’s losses before shareholders voted to approve the deal. Earlier this year, New York State Attorney General Andrew Cuomo sued Bank of America, Lewis and former CFO Joseph Price for allegedly failing to inform shareholders of Merrill’s losses. Moynihan, 51, seemed an unlikely choice to lead Bank of America. Born in Marietta, Ohio, he is the sixth of eight children of a DuPont chemist and his wife. He attended college at Brown University in Providence, Rhode Island, and the University of Notre Dame Law School. After earning his law degree, he returned to Providence, where he joined the firm Edwards Angell Palmer & Dodge. His energy and drive impressed his first boss, Duncan Johnson. “He will work
Charlotte-based bank, initially put in charge of the combined company’s wealth management unit and later running its investment banking operations. When Merrill CEO John Thain took control of the combined group’s investment banking and wealth management operations after the 2008 merger, Moynihan found himself without a position. Unwilling to move his family to Wilmington, Delaware, where he’d been asked to run the bank’s credit card operations, he gave his notice and prepared to leave the bank.At the urging of some board members who were determined not to lose Moynihan, Lewis stepped in and appointed him Bank of America’s general counsel. “I’ve always thought of myself as a person trying to do what the company needs me to do,” Moynihan says. In the chaotic months following the Merrill deal, Moynihan held three different management positions, heading consumer and small-business banking, global corporate banking and investment banking. When Lewis announced his intention to retire, he initially favored Gregory Curl, then the bank’s chief risk officer, as a successor, but the board ruled out Curl because of questions over his role in the Merrill deal. The board approached Robert Kelly, CEO of Bank of New York Mellon Corp., only to be
“His grasp of business issues was eyecatching. He could think beyond the transaction, which is unusual for some executives, especially lawyers.” —Terrence Murray, former CEO, FleetBoston
around the clock if that’s what it takes to get a project done,” Johnson says. Moynihan caught the attention of Terrence Murray, then chief executive of FleetBoston, while working on acquisitions for the Boston-based bank in the early 1990s. “His grasp of business issues was eye-catching,” Murray says. “He could think beyond the transaction, which is unusual for some executives, especially lawyers.” Murray invited Moynihan to join Fleet in 1993 as an associate general counsel. He soon rose to become head of corporate strategy and later head of wealth and investment management. When Bank of America acquired FleetBoston in 2004, Moynihan was one of a handful of Fleet executives to thrive at the INSTITUTIONALINVESTOR.COM
turned down. Finally, the board offered the CEO post to Moynihan.“Many of you know him because he’s been in so many different jobs,” Lewis quipped when he announced Moynihan’s appointment to employees at a town hall meeting in Charlotte last December. “Hopefully, he will be in this job much longer than the last three or four.” The new CEO inherited a chastened institution. Federal regulators had forced several changes on the board, which officials believed was too beholden to Lewis and lacked sufficient experience. Only five of the 13 directors who selected Moynihan as CEO held their positions before 2009. The new members included Robert Scully, a former Morgan Stanley executive; Donald Powell,
a former chairman of the Federal Deposit Insurance Corp.; Susan Bies, a onetime member of the Federal Reserve System’s board of governors; D. Paul Jones Jr., former chairman and chief executive of Compass Bancshares; and William Boardman, onetime chairman of Visa International. Spurred by regulatory pressure, the revamped board has moved to strengthen risk management, transforming an assetquality committee into a more focused credit committee and establishing an enterprise risk committee to oversee risk, capital and liquidity management. “Historically, the bank has been dominated by strong managers and a weak board,” says D. Anthony Plath, an associate professor of finance at the University of North Carolina’s Belk College of Business in Charlotte. “It’s nowhere near what its culture, history and tradition were in the Storrs, McColl and Lewis years.” Charles (Chad) Gifford, a former FleetBoston executive and a board member since 2004, sees the changes as part of a broader trend in the industry postcrisis. “This is less a commentary on Bank of America than on the world we live in right now, but I believe boards now and going forward must be more focused on areas like realistic strategy and risk management,” Gifford says.“We’ve got to be absolutely comfortable asking questions.” Moynihan moved quickly to resolve regulatory problems and position the bank for an anticipated economic rebound. In February, BofA agreed to pay a $150 million fine to shareholders to settle the SEC charges stemming from the Merrill Lynch deal. The settlement, which Judge Jed Rakoff of the U.S. District Court for the Southern District of New York characterized as “halfbaked justice at best,” doesn’t prevent nearly a dozen other civil lawsuits related to the merger from moving forward. In June, BofA agreed to pay $108 million to more than 200,000 Countrywide clients to settle claims by the U.S. Federal Trade Commission that the mortgage lender had charged excessive fees to struggling home buyers. Moynihan has sold nonbanking assets to fulfill a $3 billion capital-raising commitment, part of its TARP repayment. In May, Bank of America completed its sale of institutional asset manager Columbia Management to Ameriprise Financial. The bank also announced the sale of its stakes in Banco Santander’s Mexican unit and Itaú Unibanco
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BANKING
Holding, Brazil’s largest private bank. The three sales helped BofA generate $1.9 billion in aftertax gains. Other divestitures are expected, including Balboa Insurance Group, which BofA acquired through Countrywide. The new CEO made a few senior management changes, notably promoting Bruce Thompson, head of the bank’s global capital markets unit, to replace Curl as chief risk officer. For the most part, however, Moynihan is relying on Lewis’s management team to turn the bank around. His key lieutenants include Thomas Montag, a 22-year veteran of Goldman Sachs Group whom Thain recruited to Merrill in 2008 and who heads Bank of America’s global investment banking and markets operations, and Sallie Krawcheck, former Citigroup CFO and Smith Barney chief, who runs the bank’s wealth and invest-
the first half of this year, but Bank of America Merrill Lynch also gained market share. In the past 18 months, Montag’s division has hired about 800 people overseas — half of them in Asia — in investment banking, capital markets and sales and trading. “Our greatest opportunities for growth are clearly overseas,” Montag told II last year. He can point to some early successes. In March, Bank of America Merrill Lynch served as joint global coordinator for the $11 billion IPO by Dai-ichi Mutual Life Insurance Co. of Japan. In July the unit acted as lead manager for Mizuho Financial Group’s $8.82 billion share sale. Those deals helped lift the unit to third place as an IPO underwriter and seventh in investment banking revenue in Asia in the first nine months of this year, according to statistics compiled
“A company of this size whose business is primarily serving U.S. consumers isn’t going to escape what’s going on in the U.S. economy.” —Richard Bove, Rochdale Securities
ment management business, including Merrill Lynch’s brokerage unit. Other key executives include Desoer, who oversees the home lending and insurance unit; David Darnell, who heads the global commercial banking unit; and Anne Finucane, the bank’s chief strategy officer and a former FleetBoston colleague of Moynihan’s. Moynihan appointed Joe Price, the bank’s former CFO, to run consumer and small-business banking, and recruited Charles Noski, a former chief financial officer at Northrop Grumman Corp. and AT&T Corp., to serve as CFO. Executives say they’ve been impressed by Moynihan’s energy and management style, which gives division heads considerable autonomy to run their businesses. At an off-site meeting with top staff in London in March, Moynihan “took the time to meet people, took time to look at issues. People came away feeling really good about him as the CEO,” says Krawcheck. “It’s early days, but we like the fact that he’s one of the hardest workers we’ve ever met.” One of the most notable successes so far under Moynihan has been the revival of the Merrill franchise. Most investment banks enjoyed strong profit recoveries in 2009 and
by Dealogic. The bank had ranked 13th and 12th, respectively, a year earlier. In September, Bank of America Merrill Lynch acted as joint global coordinator and book runner on a $70 billion secondary stock offering by Brazil’s Petroleo Brasileiro, helping the bank rise to second place in Latin American equities from fifth a year earlier. Overall, the bank edged ahead of JPMorgan to rank first in global debt in the first nine months of this year; it ranked fourth in global equities, with a share of 5.8 percent, and fifth in M&A, with a share of 5.3 percent. Montag has also stabilized his ranks of investment bankers after some early departures in the tumultuous months after the Bank of America acquisition. Sam Chapin and Todd Kaplan, who left Merrill Lynch as the firm was being sold, returned in February as executive vice chairmen for global banking. Two months later, Montag recruited Christian Meissner, a key European deal maker for Nomura Holdings and a former senior banker at Lehman Brothers and Goldman Sachs, to come on board to head investment banking for Europe, the Middle East and Africa. Andrea Orcel, one of Merrill’s chief rainmakers in Europe, was tapped
recently by Montag to spearhead the bank’s international push as president of emerging markets excluding Asia. In addition to positioning his unit for growth, Montag has been reshaping his business to fit the new regulatory environment. In September, Bank of America Merrill Lynch announced it was laying off 20 to 30 proprietary traders to comply with the socalled Volcker rule of the Dodd-Frank Act, which restricts banks’ abilities to bet their own money on the markets. Krawcheck’s wealth and investment management business is also key to Moynihan’s growth ambitions, which aim to exploit synergies between Bank of America’s retail banking network and Merrill’s big brokerage operations. “There are just more arrows in the quiver,”says Krawcheck. Branded as Merrill Lynch Wealth Management, Krawcheck’s unit boasts 15,340 financial advisers and 1,400 wealth advisers.They directed customers to 171,690 banking products in the year to mid-September, a 60-fold improvement over a year earlier. Bank of America’s retail network, meanwhile, ramped up brokerage referrals threefold, to 271,498, over the same period. That was only scratching the surface. BofA’s affluent banking customers hold more than $7 trillion in assets at other financial institutions, while Merrill Lynch customers hold $500 billion in deposits at other banks, bank research shows. One key target for Krawcheck is growing the bank’s share of the $2.7 trillion market for 401(k) retirement assets in the U.S., a market that is expected to grow to $3.8 trillion by 2014, according to Cerulli Associates in Boston. Krawcheck’s business oversees more than $400 billion in retirement assets, including $81.5 billion in 401(k) plans. New retirement assets grew 383 percent in the 12 months ended in mid-September, to $10.8 billion. Among recent wins, Legg Mason agreed to buy its 401(k) and nonqualified deferred compensation services from the bank. “I guarantee you our 401(k) business will be one of the biggest in the country” in the next ten years, says Moynihan. In retail banking, Moynihan is playing defense rather than offense. His top priority is to restructure Bank of America’s sizable deposit business and recapture the revenue lost as a result of regulatory changes.“The value of the branch system and core deposits isn’t worth
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much in a low-interest-rate environment,” says Nancy Bush, an independent bank analyst at NAB Research in New Jersey. “That will change when the federal funds rate moves.” Moynihan is responding to margin pressures by seeking to migrate less-profitable deposit activities away from the bank’s 5,900 branches to electronic platforms. Automated transactions are growing by more than 8 percent a year, while teller transactions are declining at a 5 percent pace. Bank of America has invested heavily in automated technology. Nearly 13,800 of the bank’s more than 18,000 ATMs allow customers to feed cash and checks directly into the machine without an envelope or deposit slip and receive an image of their deposit on their receipt. Over the next 12 months, Bank of America will reset its entire product line, increasing account balance minimums and introducing monthly fees, Moynihan said at the September investor presentation. BofA’s termination of overdraft fees was a critical piece of the puzzle: About 10 percent of bank customers were paying 70 percent of overdraft charges, and account closings had grown by 18 percent in the previous year, equal to the number of new accounts. “We made a decision last summer to repair a customer franchise that was starting to leak customers badly,” Moynihan told analysts in October. Retail customers can now select the types of services they want, including a prototype e-banking account launched in August that allows customers to bank for free, regardless of their balances, if they use electronic channels and receive their statements online. Moynihan also has been working to fix the bank’s credit card business. The card division posted a loss of $5.5 billion last year, a dramatic drop from 2007, when the unit earned $4.3 billion — about a third of the bank’s total profits. Net charge-offs peaked at 12.13 percent of balances in the third quarter of 2009, the highest of the six major U.S. card issuers, a group that includes American Express Co., Capital One Financial Corp., Citigroup and JPMorgan; the charge-off rate declined to 9.12 percent in the quarter ended in September. The bank continues to reduce credit card balances, which amounted to $183.3 billion at the end of June, a 20 percent decline from the start of 2008. Housing represents by far the biggest challenge facing Moynihan and his team. When it bought Countrywide, Bank of America took INSTITUTIONALINVESTOR.COM
on a company that had lent heavily in California and Florida at the height of the housing bubble. Today fully 1.3 million of the bank’s 14 million mortgages are at least 60 days past due, including 200,000 on which borrowers have made no payments in two years. Losses at the bank’s home lending unit widened to $3.84 billion in 2009 from $2.48 billion a year earlier, and the unit racked up a further $3.95 billion in red ink in the first nine months of this year. Net charge-offs for the home loan and insurance unit totaled $8.77 billion over the past five quarters. Desoer, the executive charged with fixing the bank’s mortgage mess, says changing the corporate culture at Countrywide is essential for turning around the business. “At Countrywide only one value could be articulated consistently: winning. And it was the concept of winning at all costs,” she tells II. “The concept of balance performance didn’t exist.” Bank of America has shifted staff and added contract workers to handle the modification of troubled mortgages. The
end of September, about half of them from government-sponsored entities. The letter last month to Countrywide Home Loans Servicing by attorneys for BlackRock, MetLife, Pimco and the New York Fed — demanding that Bank of America fix problems with $47 billion of mortgage securities within 60 days or buy them back — has fueled speculation about potential mortgage buybacks.“It has definitely added uncertainty to companies with high exposure to mortgage repurchases,” says Compass Point’s Gamaitoni. Bank of America’s litigation expenses increased by $380 million in the past quarter, and more lawsuits are on the way. On October 15, the Federal Home Loan Bank of Chicago sued BofA, along with dozens of other financial institutions, including Citigroup, Goldman Sachs and Wells Fargo, claiming that offering documents for $3.3 billion in private-label mortgage-backed securities were inaccurate and contained critical omissions. Similar lawsuits have been filed by the
“At Countrywide only one value could be articulated consistently: winning. And it was the concept of winning at all costs.” —Barbara Desoer, Bank of America Home Loans
bank now employs nearly 20,000 workers in default management — almost twice the staff it had at the start of 2009. The bank had modified 700,000 mortgages by the end of September, almost 90 percent through inhouse plans and the remainder through the government-sponsored Home Affordable Modification Program. Provisions for credit losses, which amounted to $7.3 billion in the first nine months of the year, are expected to remain high as private investors and monoline insurers join government-sponsored agencies in demanding that Bank of America buy back troubled mortgages. Just how big the buyback problem may become is anybody’s guess. Bank of America, Countrywide and Merrill Lynch sold $2.1 trillion in mortgage securities, mostly between 2004 and 2008, with just over half sold to government-sponsored agencies, including Fannie Mae and Freddie Mac. That’s more than any other big financial institution sold. BofA reported outstanding buyback claims of $12.88 billion at the
Federal Home Loan Banks of Seattle and San Francisco. On October 18,Bank ofAmerica announced it would restart foreclosure proceedings on 102,000 properties in the 23 judicial states. “The teams reviewing data have not found information which was inaccurate”and could affect the status of foreclosure, Moynihan told analysts on BofA’s earnings call the next day. He promised to vigorously contest buyback claims, saying,“We’re going to make sure that we’ll pay when due, but not just do a settlement to move the matter behind us.” For analyst Nancy Bush, the latest foreclosure problem only underscores the tremendous challenges Bank of America and its chief executive continue to face.“Brian Moynihan is not going to fix in a year what took 20 years to build and mess up,” she says.“There’s a lot of rebuilding to do. This is going to take three to five years before you can really take a look and see if he’s tackled them.” •• Comment? Click on Banking & Capital Markets at institutionalinvestor.com.
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THE 2010 LATIN AMERICA EXECUTIVE TEAM
continued from page 63 nitudes over 6 on
the Richter scale. Extensive topographical work was required to realign equipment and to assess small but noticeable changes in the configuration of the sites.” The company estimated damage to its facilities at more than $170 million. To add to the urgency, when news of the quake was reported, pulp prices surged as investors and analysts predicted a supply shortage. CMPC’s executive team knew they had to get production up and running quickly, to capitalize on the price increase and maintain the company’s expansion efforts and stunning surge in profits; the month before the quake, the company had reported that fourth-quarter profits had jumped 94 percent
quickly by further aftershocks measuring 6.7 and 6.0,” Llanos recalls.“Many office buildings in Santiago were evacuated that day. We carried on and completed that call with an extended question-and-answer session.” Llanos says shareholders were concerned about the lasting effect of the earthquake on the company’s facilities. “We let them know that damage to the mills and infrastructure was not serious, but the recovery would take days, weeks or even months, depending on the particular mill situation.” Some of the facilities were back in operation within a week after the disaster; all were operational within two months — a time frame that exceeded most analysts’ expectations. “It was a great achievement for all of our operating and maintenance crews,” says Llanos, with understandable pride. “We learned many valuable lessons from this experience and have improved our emergency operating procedures, equipment standards and building requirements.” With the company in full swing, Llanos and his associates could turn their attention back to the expansion strategy they embarked upon in 2009. Last December the company acquired Brazil-based Fibria’s Guaíba unit in a $1.4 billion deal that vaulted CMPC to
“The high-frequency pitch I heard reminded me of the 1985 earthquake, but soon I realized that this was a bigger one.” — Luis Llanos Collado, Empresas CMPC
over the previous quarter, to $123.3 million, owing to soaring demand. Llanos knew they had to get the word out that CMPC was down — for a while — but certainly not out. “Board members and key shareholders were well informed of the first assessment during day No. 2 after the quake, and on a daily basis afterwards,” Llanos says. “There were also press releases that were made public during the week after the quake.” As if to underscore the precariousness of the situation, a major aftershock disrupted one of the company’s conference calls. “On March 11 we held a conference call related to our 2009 financial statement. While [investor relations director María Trinidad Valdés Monge] was addressing the management discussion of the fourth-quarter results, a 6.9 Richter aftershock broke out, followed
the No. 2 pulp producer in the world (behind Fibria). To finance the deal, CMPC issued $500 million in new bonds and $500 million in new shares and borrowed some $400 million from Brazilian and Chilean banks. “This acquisition was made in the middle of the crisis, but it’s in economic downturns that opportunities arise,” says Llanos, who has been CFO since 2004. “Fortunately, we had a healthy balance sheet that allowed us to close the transaction.” The consolidation of the Guaíba assets in Brazil will increase CMPC’s hardwood capacity to 450,000 tons a year and enable it to increase annual pulp production to 1.75 million tons. Guaíba was CMPC’s second acquisition last year; in April 2009 the company bought São Paulo–based tissue producer Melhoramentos Papéis.
“From a strategic point of view, these deals sealed CMPC’s entry into Brazil, which improves our ability to serve global customers,” he says. “Having pulp-production facilities on both sides of South America also increases our economies of scale in forestry, operations and logistics.” Analysts agree. “CMPC has a top-notch management team,” declares Josh Milberg of Deutsche Bank Securities, who leads the topranked team in Pulp & Paper on this year’s Latin America Research Team. “We believe management’s strength and acumen are evident from the moves it’s made to expand outside Chile. Its decision to acquire Fibria’s Guaíba unit last year was very bold because of the magnitude of the investment involved — the $1.4 billion deal is the largest foreign acquisition in the country’s history. At the same time the deal was very compelling from a strategic standpoint, offering the company a foothold in Brazil and a means to expand pulp capacity longer term, taking into account Chile’s lack of available land.” Llanos, who has been with the company in various positions since 1986, has worked hard to maintain CMPC’s impressive balance sheet. Sales for the 12 months through June topped $3.7 billion, with earnings before interest, taxes, deprecation and amortization of $889 million (an ebitda margin of 24 percent), $2.2 billion of net debt and $565 million in cash. “These figures reflect a very strong cash flow from operations, which arises as a result of a consistent and coherent capital investment program,” Llanos says. CMPC works to achieve a ratio of net debt to ebitda of less than 2.5 and to have sufficient cash on hand to allow the company to pay the next 18 months’ debt and expenses, Llanos says.“All of these measures have been recognized by the investor community and are reflected in the terms of our financing,” he adds, noting that CMPC’s BBB+ credit rating from Standard & Poor’s and Fitch Ratings is one of the highest in its industry. The Matte Group, which is controlled by Chile’s billionaire Matte family, holds 55 percent of CMPC’s shares and appoints five of the company’s seven board members; the remaining shares are held by investors large and small. Llanos estimates that he devotes one quarter of his time to addressing the needs of these investors. “Because of the regional expansion proINSTITUTIONALINVESTOR.COM
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cess that we have experienced during the past few years, we have experienced a higher demand for attention from investors and requests for more frequent interaction and thorough coverage,” he observes. CMPC has a three-member IR team, but Llanos notes that all employees are expected to support investor outreach initiatives. “I am keen on involving line managers to explain their business to investors,” he says. “It helps our people get a grasp on investors’ sensitivities and also conveys a more colorful representation of what we are doing.” CMPC has also focused efforts on increasing the number of analysts who provide coverage.“We now have more than 20 financial institutions issuing reports about CMPC,” Llanos says, and he expects that figure to rise in the coming year as the company continues to expand throughout Latin America. “There is huge growth potential in the pulp and paper industry, due to low per-capita paper and paper products consumptions,” he explains.“As soon as the region’s per-capita income grows, there is going to be a higher demand for our products, presenting us with a horizon full of challenges and opportunities.” Llanos hints that more acquisitions may be in the offing, possibly elsewhere in the region. “CMPC is always looking for opportunities that match our strategy in each of our business lines,” he says. “Geographically, we have a focus on Latin America, which we believe has strong growth potential.” Taking advantage of opportunities throughout the region has also helped Cementos Argos, the highest-ranked Colombian company on the Latin America Executive Team, weather the economic downturn. Next month the company’s Panamanian subsidiary will begin work on a three-year, $65 million contract to rebuild locks on the Panama Canal — a job for which Cementos Argos began aggressively bidding more than a year ago, as its business opportunities in the U.S. were drying up, according to CFO Ricardo Andrés Sierra Fernández. The hit the company took in the U.S. was a hard one, with sales of its ready-mix cement and other products plummeting 50 percent since 2007. “The situation in the U.S. has been challenging for the whole industry,” says Sierra, noting that many construction projects have ceased to move forward or have been abandoned altogether, owing to excess capacity, weak demand and a decline in INSTITUTIONALINVESTOR.COM
THE 2010 LATIN AMERICA EXECUTIVE TEAM:
BEST IR PROFESSIONALS commercial property Listed here by sector are the executives who rated highest when rates, among other buy- and sell-side analysts were asked to pick the leading factors. “We had to IR Professionals in their domains. make a lot of effort Sector Buy Side Sell Side internally, especially Aerospace, Ronald Domingues, Roberto Antônio in terms of our cost Transportation Multiplus; Mendes, structure,” he says. & Industrials Miguel Aliaga Gargollo, Localiza Rent a Car; Grupo Aeroportuario Leonardo Porciúncula Despite the dearth del Pacífico1 Gomes Pereira, of new cement and Gol Linhas Aéreas Inteligentes1 concrete orders in the U.S., Argos has Agribusiness Luiz Felipe Jansen de Luiz Felipe Jansen de Mello, Cosan Mello, Cosan been able to keep its Banking & Financial Alfredo Egydio Setubal, David Ricardo Suarez, head above water Services Itaú Unibanco Holding Grupo Financiero better than many Banorte of its peers, thanks Luciana García, Cement —2 to the company’s Empresas ICA; & Construction Eduardo Rendón, strong financial situCemex1 ation and some good Consumer Goods Mariana Rodríguez de Paula Picinini, decision making & Retailing García, Lojas Renner Wal-Mart de México on Sierra’s part. For example, the BogotáElectric & Other Antonio Previtali Jr., Gustavo Estrella, Utilities Tractebel Energia CPFL Energia based finance head Food & Beverages Juan Fonseca, Juan Fonseca, made sure to match Fomento Económico Fomento Económico up Argos’s long-term Mexicano Mexicano capital investitures Health Care José Roberto Borges José Roberto Borges Pacheco, OdontoPrev Pacheco, OdontoPrev with its long-term financing, to prevent Metals & Mining Roberto Castello Branco, Tarcisio Beuren, Gerdau Vale committing shortOil, Gas Marcelo Faber Torres, Enrique Ortega Prieto, term cash to long& Petrochemicals OGX Petróleo e Gás Mexichem term investments. Participações “Even though debt Pulp & Paper Andrea Fernandes, André Luiz Gonçalves, is a good source of Suzano Papel Fibria Celulose e Celulose funding for growth, Real Estate Michel Wurman, Hans Christian we are always cauPDG Realty Schroeder Jung, tious and conservaCorp. GEO tive when considering Technology, Media Daniela Lecuona Torras, Carlos Raimar new investments,” & Telecommunications América Móvil Schoeninger, Vivo Participações explains Sierra, CFO 1Tie. since 2005.The com2No IR Professional met the minimum vote requirement. pany restructured its debt in September 2009 so that “the compounded average its stake in an investment holding company, maturity of our outstanding debt outflows Grupo de Inversiones Suramericana, for 260 billion Colombian pesos ($1.4 billion). — principal plus interest — is five years.” Another safeguard: Argos’s nonoperating The latter transaction allowed Argos to assets can be easily divested if the necessity report a consolidated net profit of 461 bilarises. “We have an investment portfolio lion pesos in the first nine months of this year, which is worth more than $3 billion,” he says. a leap of 73 percent (in local currency terms) “We also have a land bank and coal assets over the comparable period in 2009. Sierra also says he is committed to keeping that can be used as a source of funds.” In fact, the company has already taken down distribution costs, and he regularly steps to spin off its noncore assets, to improve conducts supply-chain management analysis profitability. In April 2009, Argos sold its El in search of ways to do that. U.S. business Hatillo and Cerro Largo coal concessions volume is performing in line with company and related logistics to Vale for roughly expectations, he adds. $373 million; and earlier this year it sold “We have seen the price of cement reduced
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THE 2010 LATIN AMERICA EXECUTIVE TEAM THE 2010 LATIN AMERICA EXECUTIVE TEAM: BEST IR COMPANIES
U.S. and its impact on Argos. “They try to compare our situation to players Sell Side in the industry in Cía. de Concessões the U.S., and they Rodoviárias are worried,” Sierra says. “But once the Cosan U.S. question is Itaú Unibanco Holding taken away and they focus on Colombia, Cemex they understand the Lojas Renner potential growth of Latin American CPFL Energia markets. We spend a lot of time discussing Marfrig Alimentos projects in ColomOdontoPrev bia and across the Vale Caribbean.” Petróleo Brasileiro In August, Argos began production at Fibria Celulose a new plant in CartaPDG Realty gena, Colombia. The company’s $400 milVivo Participações lion investment in the cement production facility will expand Argos’s capacity by almost 20 percent annually. “This will be very important for our future numbers, as it took us almost four years to finish the project,” Sierra says. The Cartagena plant will also play a crucial role in the Panama Canal project, thanks to its capacity expansion of up to 3 million tons per year and its strategic location: It is less than one day away from Panama by ship. Moreover, Argos’s business in Colombia — which accounts for 50 percent of its total revenues — is heating up. Governmentsponsored infrastructure projects have driven up demand, with sales in the company’s ready-mix unit up 40 percent year to date through September. “We are having an infrastructure boom in Colombia, which should continue for the next three years,” Sierra says. Areas of focus include ports, residential construction and roads — all projects in which Argos is looking to participate. “We will definitely see many more projects coming in the future,” he adds. One big change that Sierra anticipates — along with many other market participants — is for Colombia’s credit rating to be restored to investment grade, an improvement that could come as soon as next year. Colombia’s credit rating was downgraded to
Listed here by sector are the companies that rated highest when buy- and sell-side analysts were asked to pick the outfits that provide the best investor relations. Sector
Buy Side
Aerospace, Transportation & Industrials
Localiza Rent a Car
Agribusiness
Cosan
Banking & Financial Services
Itaú Unibanco Holding
Cement & Construction
Cemex
Consumer Goods & Retailing
Lojas Renner
Electric & Other Utilities
CPFL Energia
Food & Beverages
Brasil Foods
Health Care
OdontoPrev
Metals & Mining
Vale
Oil, Gas & Petrochemicals
OGX Petróleo e Gás Participações
Pulp & Paper
Fibria Celulose
Real Estate
PDG Realty
Technology, Media Vivo Participações & Telecommunications
10 to 15 percent in some markets, and that immediately affects the ready-mix price,” he says. “All the cost-cutting efforts you do internally can not make up for those fast price reductions. Even though we are doing a lot, it’s not well reflected in our numbers.” Indeed. In a July conference call with investors to discuss performance for the first half of the year, CEO José Alberto Vélez Cadavid noted that revenues had declined 18.5 percent, to 1.5 billion pesos, compared with the same period one year earlier. However, he also pointed out that, over the previous six months, consolidated assets increased by 1 percent, to 14.8 billion pesos; liabilities decreased by 8 percent, to 4.5 billion pesos, and shareholder equity gained 5.3 percent, to 10.3 billion pesos. Sierra says his team understands the importance of keeping money managers informed, especially when times are tough — as they are now.“Our IR director is always in direct contact with shareholders, investors and analysts,” he says, estimating that he spends 15 to 20 percent of his time on investor relations, including meetings with investors and quarterly conference calls. “We make lots of effort to communicate our specific situation to shareholders.” The concern he hears most frequently from investors is about the situation in the
junk status in 1999, when an economic crisis decimated the country’s financial sector. “Recently, the different rating agencies have improved the outlook for Colombia — a good sign to get us to investment grade in the near term,” he says. “If that happens a lot of foreign funds will come to Colombia. They can’t invest today because we don’t have investment-grade status, but that could change soon. So far, 17 different banking institutions have been trying to find executives to open offices here. We have not seen that before.” Despite the difficulties of the past two years, Sierra remains upbeat. “The growth prospects of our company are very strong in the Colombian and Caribbean markets,” he says. “The recession defeated us in the U.S., but Colombia and the Caribbean are performing well and are balancing out our situation in the U.S.” Not that he’s giving up hope regarding the U.S. market. “We are conservative, and we think our business in the U.S. will have a tough time in 2011, but we expect to see some recovery by 2012,” Sierra says. “We established long-standing relationships with customers in the U.S., in terms of credit and technical support, and our most important relationships were with customers who suffered the most” from the economic downturn. Nonetheless, Sierra says, he is confident that, when the crisis passes, Argos will be well positioned to serve those customers again. Waiting for a crisis to pass is something with which Raúl Jacob is all too familiar. Manager of financial planning and investor relations for Southern Copper Corp., the Peruvian subsidiary of Mexico-based mining behemoth Grupo México (and the topranked Peruvian company in our survey), Jacob spent the better part of the past three years updating shareholders on developments involving striking miners at Grupo México’s operations in Cananea, Mexico. “It’s not the best narrative you can have,” Jacob acknowledges. The Cananea mine had represented 26 percent of Grupo México’s copper-mining capacity.“We had no production from this unit since the time of the crisis, which certainly did not make things easier,” Jacob adds. Friction between the company and the union can be traced to the early 1990s but intensified in 2005, after Grupo México set aside $55 million in a trust account as INSTITUTIONALINVESTOR.COM
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part of an agreement with the union when the company was privatized. Soon after, the union took control of the trust, and before long the Mexican government accused labor leader Napoleón Gómez Urrutia of fraud and embezzlement. He fled to Canada, claiming to be a victim of political persecution for calling attention to unsafe working conditions in the company’s mines. In July 2007 more than 1,000 union workers seized possession of the Cananea mine as a show of solidarity with their leader (who was reelected to his post twice while he lived in self-imposed exile) and in demand of safer working conditions. They vandalized parts of the facility and brought production to a shuddering halt, says Jacob, 50. “It was hard for us to transmit the message to shareholders that fighting with the union to the finish was good, and some shareholders became discouraged as the conflict dragged on for so long,” he explains. “However, the quality of the company’s assets was such that investors decided to stick with us.” Ensuring that loyalty meant keeping investors informed. “We communicated to our shareholders constantly,” says Jacob, who is based in Lima. He made a point of expressing the company’s confidence that it would prevail in its battle against the union without making it appear that Grupo México was engaged in a Goliath versus David showdown. “It was a delicate situation,” he recalls.“We had to explain to shareholders that the reason we wanted to finish any relationship with this union is because we wanted to have these assets developed back at full capacity again.” Southern Copper also set up a phone line and e-mail address exclusively to handle investor inquiries about the strike.“I personally read all the e-mails that came through,” says Jacob. He also took phone calls, set up one-on-one meetings and made presentations.“Shareholders always knew what was going on and the progress the company was making on the legal front,” he adds. The legal struggle lasted until February 11 of this year, when a Mexican Federal Court ruled in favor of Grupo México and allowed the company to terminate its contract with the workers. The union’s appeal was dismissed in April by the Mexican Supreme Court, which ended the legal process, and in June police removed the miners from the site. (Gómez Urrutia was acquitted of fraud and embezzleINSTITUTIONALINVESTOR.COM
ment charges by a Federal District court, and a warrant for his arrest was dismissed.) At the same time that Jacob was working to shift shareholders’ attention away from the strike and toward the company’s plans for growth and increased output, the global economy was melting down. Copper prices plunged from a 2008 precrisis average of $3.62 a pound to $1.56 by the first quarter of 2009, he says, and demand for copper slipped 7 percent last year. “We had to adjust to new circumstances in which cash flow control was extremely important to maintain the company’s longterm progress,” he adds.“However, we knew that because of the low cost structure that characterizes Southern Copper, the firm would be able to generate cash flow despite the low metal prices we had in 2009. And, consequently, we were able to move on with our projects — but at a slower pace.” Once the court case with the miners was settled, the company immediately began
copper projects, such as the Tia Maria greenfield and the brownfield expansions of La Caridad, Toquepala and Cuajone. It also provided an opportunity to have a more balanced capital structure between debt and equity.” Analysts say the company’s record speaks for itself.“Southern Copper has consistently been one of the top performers in the Latin American mining sector over the last few years,” says one sell-side equity researcher. “The company has been very diligent in returning cash to shareholders, having one of the highest dividend yields in the industry. It is now preparing itself for its next big step, after solving very difficult conflicts with labor unions. The focus is now on growth, as the company is willing to monetize its longlife reserves by doubling its capacity over the next five to seven years.” Although he acknowledges the lingering effects of the global recession, Jacob is equally optimistic about Southern Copper’s prospects.“Demand is not growing as strongly as it
“It was hard for us to transmit the message to shareholders that fighting with the union to the finishwas good.” — Raúl Jacob, Southern Copper Corp.
repairing the damage to the mine. Two units, representing 30 percent of Cananea’s capacity, were up and running by September, and the company expects to have the mine at full capacity — producing some 180,000 metric tons of copper a year — by February. In the meantime, Southern Copper is working on significantly expanding its operations and expects to double its production within the next four years, from about 500,000 metric tons a year to more than 1 million. “We think we can further increase it by 50 percent by the end of the decade — that is our strong plan for organic growth,” Jacob notes. To help finance some of that long-term growth, the company in mid-April issued $1.5 billion in debt, $400 million in ten-year bonds at 5.375 percent and $1.1 billion in 30-year notes at 6.75 percent. “We believed that was an excellent moment to tap debt markets and had an excellent response: The deal was oversubscribed by six times the supply,” Jacob says. “The bond offering was a way to fund the resources we needed to go ahead with future
did three or four years ago, but we still expect to see positive growth,” he says. “We believe our company is the best copper play for investors. We are doing our job on the operational side, and there is a strong potential for growth and value creation for shareholders.” Despite the turmoil of the past few years, Jacob says, Southern Copper has learned some valuable lessons:“We now understand how to more clearly transmit information and explain our case.”In September, he adds, the company completed the overhaul of its web site, making it more accessible so that “investors can understand very quickly who we are, how we operate and where we want to go together.” Making sure investors know where a company is going — and keeping them informed every step of the way — is a hallmark of corporate excellence, one that money managers say is readily apparent in the actions and initiatives undertaken by the members of the 2010 Latin America Executive Team. •• Comment? Click on Research at ins institutionalinvestor.com.
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RO 100 THE INDIA 20 TRADING
INEFFICIENT MARKETS UNCONVENTIONAL WISDOM THE
Navigating Sideways
stock prices are Japan, where stocks have fallen driven in the long more than 80 percent from the Forget buy and hold. Investors run by two factors: late 1980s to today. If the U.S. need to adjust their strategies to earnings growth (or economy fails to stage a comemake money in a market likely to decline) and priceback with at least some nominal have little long-term direction. earnings expansion earnings growth over the next BY VITALIY KATSENELSON (or contraction). decade, what started sideways Though economic in 2000 will turn into a bear fluctuations are market, as high valuations are responsible for already in place. short-term market I should mention the role volatility, long-term interest rates and inflation play market cycles are in market cycles. They are seceither bull or sideondary to psychological drivways if the economy ers, but important. They don’t is growing at a close cause the cycles but help shape their duration and stocks’ valuto average rate. ations. For instance, if interest Prolonged bull FOR THEU.S. STOCK markets start with belowrates and inflation had not been market, the past ten scraping low single digits in the average P/Es and end with years have earned the above-average ones. This late ’90s, the bull market would title “the lost decade.” vibrant combination of P/E have ended sooner and at lower The next ten years expansion and earnings P/Es. The higher inflation and probably will not be growth — which doesn’t have interest rates that are around much different: The market to be spectacular, just more or will likely set record highs and less average — brings terrific multiyear lows, but index inves- returns to jubilant investors. tors and buy-and-hold stock Sideways markets follow collectors will find themselves bull markets. As cleanup guys, not far from where they started. they rid us of the high P/Es We are in a Cowardly Lion caused by the bulls, taking them market, whose occasional down to and actually below the bursts of bravery are ultimately mean. P/E compression — a staoverrun by fear that leads to a ple of sideways markets — and subsequent decline. earnings growth work against Every long-lasting bull marthe corner will take their toll each other, resulting in zero (or ket of the past two centuries on the duration and P/E of this near-zero) price appreciation (and we had a supersized one market too. plus dividends, though this is from 1982 to 2000) was folIn sideways markets you as achieved with plenty of cyclical lowed by a sideways market an investor need to adjust your volatility along the way. that lasted about 15 years. The strategies: Bear markets are the cousins • Become an active value Great Depression was the only of sideways markets, sharing exception. Despite common half of their DNA: high starting investor. Traditional buy-andperception, secular markets valuations. But whereas in side- forget-to-sell investing is not spend a lot of time in bull or ways markets economic growth dead but is in a coma waiting for the next secular bull market sideways phases, and roughly softens the blow caused by P/E to return — and it’s still far, far an equal amount in each. They compression, during secular visit the bear cage only on very bear markets the economy is not away. Sell discipline needs to be rare occasions. there to help. The U.S., however, kicked into higher gear. • Increase your margin of This doesn’t happen because has never had a true, longsafety. Value investors seek the market gods want to play lasting bear market like the one a margin of safety by buying a practical joke but because investors have experienced in
“ ”
LINA CHEN
Bursts of bravery are overrun by fear.
INSTITUTIONALINVESTOR.COM
stocks at a significant discount to protect them from overestimating the “E.” In this environment that margin needs to be even more beefed up to account for the impact of constantly declining P/Es. • Don’t fall into the relative valuation trap. Many stocks
will appear cheap based on historical valuations, but past bull market valuations will not be helpful again for a long time. Absolute valuation tools such as discounted cash flow analysis should carry more weight.
• Don’t time the market.
Though market timing is alluring, it is very difficult to do well. Instead, value individual stocks, buying them when they are cheap and selling them when they become fairly valued. • Don’t be afraid of cash.
Secular bull markets taught investors not to hold cash, as the opportunity cost of doing so was very high. The opportunity cost of cash is a lot lower during a sideways market. And staying fully invested will force you to own stocks of marginal quality or ones that don’t meet your heightened margin of safety. What if a sideways market isn’t in the cards? If a bull market develops, active value investing should do at least as well as buy-and-hold strategies or passive indexing. In the case of a bear market, your portfolio should decline a lot less. •• Vitaliy Katsenelson is CIO at Investment Management Associates in Denver and author of the upcoming Little Book of Sideways Markets. Comment? Click on Global Markets at institutionalinvestor.com.
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INEFFICIENT MARKETS
UNCONVENTIONAL WISDOM THE FUTURIST THE CHARTIST C
LINA CHEN
Attack of theTraders
by the innovation and growing The flash crash revealed a market system highly vulnerable dominance of high frequency trading. to cyberterrorists armed with One of the more sophisticated algorithms. startling pieces of BY RODERICK JONES news to come out of the flash crash is the geographic shift in trading. Wall Street is no longer the heart of the U.S. financial market, nor is London’s Square Mile the epicenter of the U.K. market. The data and trading compoTHE RECENT nents of the financial systems release of the longare now centered in New Jersey awaited government and Essex, respectively. report on the May 6 Does this mean that the “ring “flash crash” highof steel” surrounding the City lighted one specific of London or the New York trade as the catalyst for a series Police Department presence of chain reactions, accelerated outside the Big Board can be by computer algorithms, that scaled back or eliminated? Not whipsawed the market. While entirely, as both market centers the report goes a long way are still symbolic targets. But toward explaining the events it might be a good idea to of that afternoon, it doesn’t move some of these protective begin to address the systemic resources to the data centers weaknesses of the market, supporting critical financial highlighted by the nearly 600systems. Although the security point drop in the Dow Jones of the data centers has no doubt industrial average in a matter of been considered at some length, minutes — and the Dow’s even resulting in bomb-proofing faster recovery. and improved data protection, To an observer of global it would be surprising if all security risk, the flash crash vulnerabilities surrounding the looked like a horrific new way staffing of these sites have been fully explored. to cause economic, political and social damage. Although The potential cyberwar elethe crash played out in the U.S., ment of high frequency trading the systems that underpinned it is a fascinating area of future are being used globally and are security risk — not only for currently seeing their greatest financial markets but also for growth in Asia. The rise in the the countries that host them. use of high-speed technology One of the fundamental conand reactive algorithms to cerns with the system becomes conduct a variety of market apparent when examining functions is driven in part what has been described as the INSTITUTIONALINVESTOR.COM
democratization of trading. In short, the use of technology allows companies to offer trading platforms at very low cost to anyone by locating their services in data centers alongside the exchanges themselves. For a small amount of capital, anyone can connect an algorithm to a financial market from anywhere. It remains fundamentally unclear who is responsible for conducting reallife due diligence on the traders tying into the financial system. Much political noise is devoted to which people are allowed to enter a country, but little thought is put into who is tapping into the financial system. Anonymity, of course, is not a crime. And it has taken a while to understand what, if anything, a rogue algorithm could do if introduced into
“
It is entirely possible for a government to sponsor this kind of market manipulation.
”
a particular market. Clearly, the ability to crash the entire market would make for a spectacular attack if the events of May 6 could be replicated, but this seems unlikely. However, further examination suggests that a kind of denial-of-service attack could be discretely aimed at particular nodes in the financial system, as evidenced by the practice of using algorithms to bombard a
market with buy and sell offers to slow it down enough to create a financial arbitrage opportunity elsewhere. It’s not that far-fetched to imagine a terrorist creating a number of algorithms that could act in concert as a denial-of-service attack against financial exchanges. On a larger scale, the order by mutual fund firm Waddell & Reed to sell $4 billion in index futures contracts, which is being blamed for setting off the May 6 crash, will not have escaped the notice of national governments interested in exerting financial pressure on their opponents. The size of this trade may be beyond the ability of smaller groups to execute, but it is entirely possible for a government to sponsor this kind of market manipulation against its international opponents. In fact, there is a long history of using financial manipulation to gain diplomatic and even military advantage; the weakness of a massively networked system relying on trading algorithms can clearly be exploited during times of international tension. The ability to crash or negatively impact financial markets would be an incredible cyberwarfare tool. For this reason, the flash crash should be examined further through the lens of security risk to ensure that the vulnerabilities and opportunities are well understood. •• Roderick Jones is CEO of Concentric Solutions International, a San Francisco–based security risk management company. Comment? Click on Exchanges & Trading at institutionalinvestor.com.
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THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER FIV
Abandoned Housing Where are the big, bold ideas for rebuilding mortgage finance? BY JEFFREY KUTLER
A FEW WEEKS
after President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law, Treasury Secretary Timothy Geithner hosted a public conference on the future of housing finance. Dodd-Frank had punted on that subject. Geithner was hoping to jumpstart a policy discussion on the moribund $10 trillion home mortgage sector and prepare a Treasury Department review of the U.S. mortgage finance agencies Fannie Mae and Freddie Mac requested by Congress. Geithner kicked off the August 17 gathering with a speech reviewing the histories and missions of the governmentsponsored enterprises and how they had exacerbated “the general race to the bottom” that precipitated the financial crisis. He outlined options for fixes that will inevitably involve continued federal intervention even as, in his words,“we begin the process of weaning the markets away from government programs and make room for the private sector.” Geithner acknowledged that “there is no clear consensus
yet on how best to design a new system.”While industry groups have drafted blueprints and broadsides, few advocate any kind of clean, let alone radical, break. Some have put forward what systems engineers would call point solutions, specifically targeted at, say, tightening the lax regulatory standards for mortgage brokers or using the powers of the new Consumer Financial Protection Bureau to police lender abuses. Such solutions are, by definition, not all-encompassing. Yet magic bullets may be unrealistic to expect for a system that seems to have broken down from one end to the other, from credit judgments to securitizations to the foreclosure processes that many banks recently suspended as improprieties came to light. Clifford Rossi, Tyser teaching fellow at the Center for Financial Policy of the University of Maryland’s Robert H. Smith School of Business, estimates that mispriced risks and perverse incentives have caused the U.S. housing market to be 30 percent overbuilt, an overhang that will take years to work through. “The situation is not getting better in the housing market — it’s getting worse,” UBS mortgage finance analyst Thomas Zimmerman said in a recent panel discussion at the American Enterprise Institute for Public Policy Research, in Washington. “It is not tenable to leave
in place the system we have today,” Geithner asserted in August. But how bold will, or can, the Obama administration be with a divided Congress? “The really big idea would be creating a large, private secondary market for the bulk of mortgages, relying on privately set prices without the effects of government intervention,” says Alex Pollock, a former president of the Federal Home Loan Bank of Chicago and now a resident fellow at the AEI. Pollock’s view, representative of that think tank’s free-market bias, has the fresh appeal of simplicity. Pollock, among others, has also suggested that, instead of tweaking the existing system, the U.S. learn from the more-restrained housing finance approaches of Canada,
“ ”
It is not tenable to leave inplace the systemwe have today. — Treasury Secretary Timothy Geithner
Denmark and other countries that came through the downturn better than the U.S. did. At the opposite pole, William Gross, founder and co–chief investment officer of Pacific Investment Management Co., raised eyebrows during Geithner’s August session when he suggested “full nationalization.” Elaborating in his September letter to clients, Gross said it is too late to turn back now that Fannie and Freddie are wards of the state
and 95 percent of mortgage originations are governmentguaranteed. Taxpayers may still be bearing systemic risk, but, Gross wrote, “Having grown accustomed to a housing market aided and abetted by Uncle Sam, the habit cannot be broken by going cold turkey into the camp of private lending.” Between those positions, it would be hard to find common ground for compromise, unless the objective is to transition over time from one to the other. The University of Maryland’s Rossi — who has held credit and risk management posts at Citigroup, Countrywide Financial Corp., Washington Mutual, Fannie Mae and Freddie Mac — advocates a transition, but by “holistically” addressing the ills of the home-sale market along with those of financing. He will spell out in a forthcoming white paper his goal of “getting government completely out of it,” accompanied by such innovations as a covered bond market to supply mortgage liquidity. He would even put the mortgage-interest tax deduction on the table, steering the $100 billion-plus in additional annual revenue toward supporting first-time home buyers. Politically unpopular, perhaps even impossible, but this may be just the kind of “fundamental change” that Geithner says the administration wants to embrace. •• Jeffrey Kutler is editor-in-chief of Risk Professional magazine, published by the Global Association of Risk Professionals. Comment? Click on Risk/Tech/Regulation at institutionalinvestor.com. INSTITUTIONALINVESTOR.COM
LINA CHEN
UNCONVENTIONAL WISDOM
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WISDOM THE FUTURIST THE CHARTIST CONTENTS INSIDE II TICKER
INDEX OF ADVERTISERS Allianz . . . . . . . . . . . . . . . . . . 6
Daiwa . . . . . . . . . . . . . . . . . 11
Sungard . . . . . . . . . . . . . . . 35
Arab Bank . . . . . . . . . . . . . 36
Deutsche Bank . . . . . . . . . 27
Thomson Reuters . . . . . . . . . 4
Bank of America Merrill Lynch . . . . . . . Cover 4
GE . . . . . . . . . . . . . . . . . . . . . 21
Zagat . . . . . . . . . . . . . . . . . . 70
I Shares . . . . . . . . . . . . . . . . 49
FOCUS SERIES
ITG . . . . . . . . . . . . . . . . . . . . 79
Stable Funds Report .... 64-69 Aviva Metlife New York Life
Barclays Capital . . . Cover 2 Bloomberg . . . . . . . . 3, 29, 31 BNP Paribas . . . . . . . . . . . . 23
Principal Global Investors . . . . . . . . . . Cover 3
Columbia Management .. 33
Prudential . . . . . . . . . . . 13, 47
Commerzbank . . . . . . . . . 17
RBC . . . . . . . . . . . . . . . . . . . . . 9
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VENTIONAL WISDOM THE FUTURIST
THE CHARTIST
CONTENTS INSIDE II TICKER FIVE Q
$20,000
LONDON
ISTANBUL
TAIPEI
SHANGHAI
$5,000
CAPE TOWN
PRAGUE
ATHENS
$10,000
SINGAPORE
MUMBAI
TOKYO
$15,000
HONG KONG
WORRIES THAT FAST-
MOSCOW
Hot economies offer cool deals.
U.S. dollars per square meter
NEW YORK
Property Chic growing China and India may face a housing bubble similar to the debacle that devastated Japan’s economy two decades ago seem overblown. In fact, despite a ramp up in prices for property in Shanghai and Mumbai, the cost of housing is far pricier in places like London, New York, even Moscow, based on the Global Property Guide’s study of housing cost per square meter. To put that in perspective, a square meter of property in Shanghai costs about $5,000, compared to more than $15,000 in nearby Hong Kong and $20,000 in London. Tokyo, once the world leader in property inflation, has fallen behind Moscow, a telling sign of the times. Those seeking blazingly good housing deals should look to Istanbul or Cape Town. Of course, don’t let the word get around, else prices will start creeping up. — The Editors
PROPERTY PURCHASING PRICE
Moscow
London Prague
Tokyo
Athens Istanbul
New York
Shanghai Hong Kong
Mumbai
Taipei
NIGEL HOLMES
Singapore
Cape Town Source: BCA Research (www.BCAresearch.com). INSTITUTIONALINVESTOR.COM
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