Carlyle's challenge

When talent and management come into conflict at a money management firm, they can create a toxic environment that threatens the firm's stability, investment performance and growth.

That is what happened at TWC Group Inc., and it came to a head in 2009 with the firing of Jeffrey E. Gundlach, chief investment officer, and TCW's agreement to acquire Metropolitan West Asset Management LLC to fill the big hole left by his departure.

Now Carlyle Group hopes to revitalize the firm, but it faces a number of challenges. Carlyle announced Aug. 9 an agreement to acquire TCW from Société Générale SA. Carlyle expects the transaction to close by the end of March 2013. It is a move that could strengthen the money management firm, depending on how well Carlyle deals with key issues at TCW. To succeed it will have to address governance, operations and financial issues, including employee incentives.

If it can do so successfully, it may provide guidance for others in the financial service industry.

Financial and management issues were flash points of the internal disputes between TCW and Mr. Gundlach, and eventually caused concern among institutional clients. Contractual and pay issues with Mr. Gundlach were never resolved when he was TCW's CIO, and wound up in a sensational trial.

SocGen, while it was reported to have sold TCW to raise capital to meet banking regulatory issues, appears to have failed to provide oversight of TCW in financial management and organizational issues.

As a result, Carlyle has rebuilding to do. TCW has $130 billion in assets, below the combined $140 billion it and MetWest had at the time of Mr. Gundlach's firing.

In acquiring TCW, Carlyle took a risk of exposure because of the intense scrutiny it will face from institutional clients and potential clients and their consultants. TCW is a prominent money manager, well-known among major pension funds and other institutional investors, some of whom are TCW current, former or potential clients. Some of these investors also invest in the two Carlyle funds that acquired the TCW equity, and even might be investors in Carlyle stock.

Few businesses are required to produce the statistical data and organizational detail that clients and investors use to analyze the performance of money managers. As a result, clients and investors should subject Carlyle's oversight to intense analysis.

The deal will come under scrutiny from the money management industry as well because of its intense competitive nature. Some competitors will likely attempt to recruit talent from TCW. That will raise the stakes in keeping and acquiring talent.

Building a stronger organization is one of the key elements necessary to strengthen the company.

In their criteria for selecting money managers, pension funds generally list at the top organization, structure, personnel, assets under management, resources and investment process. From these elements, when solidly in place, heightened expectations of good performance will flow.

To retain its talent, Carlyle focused on raising the ability of TCW employees to increase their equity interest in the firm to 40% from 17% in return for signing long-term contracts that include lower salaries but larger stock grants.

The move already appears to have had an effect. While TCW continues to negotiate with other equity team leaders, Craig Blum, group managing director of U.S. equities and portfolio manager of TCW's concentrated core equity strategy, agreed to a new five-year contract in exchange for increasing his equity stake in the firm while also receiving smaller up-front cash compensation, according to a report in Pensions & Investments.

However, it's vital that the terms of the compensation, incentives and equity are clear to management and employees alike, something TCW appears to have failed to do with Mr. Gundlach.

Clients and potential clients also must examine the employment contracts. They might spot ambiguities management has failed to see, and stave off the kinds of disagreements that harmed TCW.

If Carlyle is successful, it could become an example for other private equity firms to seek out investment management firms whose organizations might need a makeover.

This article originally appeared in the October 1, 2012 print issue as, "Carlyle's challenge".