The stock market carnage of July is putting stress on money management firms, despite some growth in the second quarter.
With the market's slide and investor confidence badly shaken, managers might be looking at another round of staff cutbacks if the market continues to fall, say industry observers.
A majority of the publicly traded money managers tracked by Putnam Lovell Securities Inc., San Francisco, did report increased earnings for the second quarter, even in the face of the sharp stock market decline. Among them are:
* Legg Mason Inc., Baltimore, up 39%;
* BlackRock Inc., New York, up 33%;
* Federated Investors Inc., Pittsburgh, up 23%;
* Affiliated Managers Group Inc., Prides Crossing, Mass., up 19%; and
* Eaton Vance Corp., Boston, up 12%.
Other firms, primarily known for their growth-oriented investment management capabilities, showed declining earnings in the second quarter. They include:
* Stilwell Financial Inc., Kansas City, Mo., which owns Janus and Berger Investments, Denver, down 18%;
* Alliance Capital Management LP, New York, down 16.5%; and
* MFS Investment Management Inc., Boston, which is part of Sun Life Financial Services of Canada Inc., Toronto, down 11%.
At this time last year, money managers were hoping they would be crawling out of the hole by now. Instead, after two of the worst quarters for the stock market in the past decade and a spate of corporate scandals, the hole has gotten deeper.
The Standard & Poor's 500 index fell 15.9% in the second quarter. In July, it was down another 7.8%. The depth and swiftness of the market drop might have taken many by surprise, according to consultants. Even post-Enron, money management firms probably didn't expect this type of decline, said Geoff Bobroff, an East Greenwich, R.I., money management consultant.
"This is a once-in-a-lifetime event," said Ted Disabato, president of Disabato Associates, a Chicago-based investment consulting firm. "We went from the best market ever to one of the worst markets ever."
"We're looking at an environment where additional cuts are required," said Mr. Bobroff. Last year, a number of money management firms made staff cuts, including Janus Corp., Denver; Putnam Investments Inc., Boston; John Hancock Funds, Boston; Fidelity Investments Inc., Boston; and T. Rowe Price Associates, Baltimore. Earlier this year, INVESCO Funds Group, Denver, laid off workers, including three portfolio managers.
Deeper next time?
These cuts primarily affected back office and administrative staff, not investment management or client service. The next wave of cutbacks, precipitated by the summer's steep market decline, could cut deeper into the organization.
"I would hazard a guess that the cuts have not been deep enough," Mr. Bobroff said, because most firms are staffed at higher levels than they were in 1997-'98.
Patricia Ouimet, vice president at Putnam Lovell Securities, said that despite the volatile stock market, money management firms are better positioned today to handle a market downturn than they were a year ago. Firms have been very disciplined in controlling expenses, have taken steps to diversify income streams and are running leaner than in the past. So when it gets to the point where hiring freezes, cuts to non-essential services and bonus reductions aren't enough, money managers will be severely tested.
"If they have to start cutting to the bone, they start cutting into their core businesses, then what do they do?" she asked.
Some firms forced to make deep cuts in investment management staff might not survive, she said, which will lead to more consolidation in the industry and more mergers and acquisitions, particularly for small and midsized firms.
Dana Dakin, managing director at Dakin Partners, a Wilmot Flat, N.H.-based money management consultant, said that if cuts are made to the core of a business - which could be investment management, research, sales, marketing, or client service - then the organization will be weaker and the effects will be felt long term.
"They should avoid that `back-pocket mentality,' " said Ms. Dakin, which is protecting the wealth and compensation of senior executives at the expense of the business. "This is a time when leadership has to make personal sacrifices to protect the future entity."
Where firms decide to trim will be watched closely by consultants and clients, said Ms. Dakin. The first round of cuts, which came last year for many money management firms, was much easier, as the excesses were more obvious. "This time it's a test," said Ms. Dakin.
A couple of years down the road, after the market has recovered, it will be apparent to consultants and clients whether the right cuts were made, as the well-run firms will protect the resources and cut the fat, she said. "In the 1970s, the firms that are great now made the right decisions," she said, citing Capital Research & Management Co., Los Angeles, as one example. But if the decline continues, even the best-run firms may have to "cut to the bone," Ms. Dakin said.
"If the bear market is still around at the end of the year, it's going to take its toll" on money management firms, said Russ Kinnell, senior analyst at Morningstar Inc., Chicago, in terms of declining assets.
Well-positioned
The managers in the best position to handle the bear market are the large, private firms with a diversified collection of assets and services. Mr. Kinnell cites Vanguard Group Inc., Valley Forge, Pa., Capital Research and Fidelity as firms that held up fairly well through the latest period of volatility. They also have benefited from their good relative performance, said Mr. Kinnell.
Vanguard's mutual fund assets fell just 1.4% for the year ended June 30, and Capital Research's mutual fund assets rose 2.1%. Mutual fund assets at Fidelity were down 12% for the same period, but all three firms have seen increased net flows for the first half of 2002 vs. the first six months of 2001, according to Financial Research Corp., Boston.
Peter Smail, president of Fidelity Employer Services Co., the retirement asset management division of Fidelity Investments, said the firm has been successful in generating revenue from services outside investment management, such as its benefits outsourcing business. The firm is looking closely at managing expenses but has not made any decisions on whether staff cuts will be made, he said. "We take a long-term view of our business" and do not make decisions based on reactions to market downturns, he added.
While growth shops are more vulnerable to additional cutbacks, Morningstar's Mr. Kinnell doesn't expect to see cuts to investment staff at the larger growth shops because they already are running pretty lean on the investment side. Firms that will be severely tested are the smaller growth-oriented shops, said Mr. Kinnell.
In this survival-of-the-fittest environment, Mr. Bobroff expects to see increased consolidation and an acceleration of mergers and acquisition activity in the next few years - not so much on the megamerger scale, as has been the case the last couple of years, but more on the midsized and boutique level, he said.
The saving grace for just about everyone would be a rebound in the stock market. "Everyone's hoping that this will work its way out," said Mr. Disabato. "But it's based on hope."
