Russell confused at crossroads

Russell Investments still needs to figure out what it wants to be when it grows up.

After building a reputation as a top-notch investment consulting firm and a leader in manager-of-managers programs, the Tacoma, Wash.-based firm branched into alternatives.

Now it appears to have lost its way: It disbanded its hedge fund-of-funds operation in 2008 and last month sold private equity manager Pantheon Ventures Ltd. to Affiliated Managers Group Inc. for $775 million.

Stephen Nesbitt, chief executive of Cliffwater LLC, a Marina del Rey, Calif.-based alternatives consulting firm, said that historically, Russell had a reputation as a very good consulting firm, but has to decide what direction it wants to take now.

“It's unclear they know what they want to do,'' he said.

Jennifer Tice, a spokeswoman for Russell, disagreed. She said while Russell has been affected by the financial downturn — like many others in industry — the company is determined to continue its leadership role in providing financial services.

“We are in a whole new environment for financial services firms and we plan to deliver the innovative investment products and services that our clients desire,” she said.

Industry observers say Russell might have been too ambitious in expanding beyond its core expertise of consulting and running traditional multimanager investing strategies for pension funds.

Russell, like other financial companies, had aspired to be a global player in a wide variety of investment products, said Leonard P. Brennan, president and CEO of Rainier Investment Management Inc. in Seattle and Russell's former managing director of individual investment services.

“For any investment organization, that's a difficult challenge,” he said. “My observation is most players are very substantial in a core competency or are a leader in a geographical area. It's hard for a company to dominate in a wide range of products and services.”

There have also been big changes in Russell's work force over the past several years, with its long-time senior management almost completely turning over.

Within the past two years, Craig Ueland, Russell's CEO, was asked to resign, at least 20 other top officials left voluntarily — most after deciding to cash out of an equity ownership program — and the company laid off around 400 employees. The layoffs amounted to about 20% of Russell's 2,000-employee global work force.

Last week, the company disclosed in an employee newsletter that Frank Ryan, the company's chief financial officer, and Terry Berland, its chief of staff, will be departing; Mr. Ryan after two years and Mr. Berland after only nine months. Both had been hired to replace other Russell officials who had left in an earlier round of management changes.

Messrs. Ryan and Berland could not be reached for comment. Russell officials said they do not discuss personnel matters.

(The company may be facing even more turnover at the end of this year. In the fourth quarter, Russell will move its corporate headquarters to downtown Seattle from Tacoma. Former Russell officials say most employees who live in the Tacoma area are not looking forward to the move or making the minimum two-hour round trip commute.)

Just how Russell plans to maintain its leadership role in the new financial world isn't entirely clear.

Andrew Doman, the former McKinsey & Co. executive who was named Russell's president and CEO 13 months ago, has been planning new initiatives, including an expansion of alternative investment advice and research and the introduction of active exchange-traded funds. Russell officials say they also hope to eventually get back into the hedge fund-of-funds business. Yet, at the same time, the company has been retrenching, announcing, for example, the sale of its private equity fund unit last month.

Mr. Doman was unavailable for comment.

Russell officials last week announced plans to increase the firm's global alternative investment consulting business to target the large number of institutional investors interested in private equity, hedge funds, real estate and commodities.

Russell plans to use the expansion of its research and advice capabilities as the first step in getting back into the hedge fund business, said Vic Leverett, managing director of Russell's global alternatives investment team.

“The first step is building up the expertise, the products will come later,'' he said.

Mr. Leverett said expertise in less traditional strategies is becoming increasingly important as investors consider alternative asset classes following the global financial crisis.

The expansion will involve 25 new employees, said Janine Baldridge, Russell's global head of consulting and advisory services.

She said around half of the new employees will work in the global consulting practice and the other half will work for Russell's investment division, providing research on alternative investments for institutional investors.

The two practices now have a combined staff of 50 employees devoted to alternatives, said Ms. Tice, the Russell spokeswoman.

Getting back into the hedge fund business might not be easy for Russell, Cliffwater's Mr. Nesbitt said.

“If you've had serious performance problems or have gone through liquidations, it's hard to re-establish yourself,'' he said.

Mr. Leverett said Russell officials were upfront with their hedge fund-of-funds customers as the company froze redemptions in 2008 and waived management fees.

The hedge fund of funds business, which peaked at $6.8 billion in 2007, had dropped to $4.7 billion in 2008, the most recent number the company would provide.

Mr. Leverett said customers of the hedge fund of funds got at least two-thirds of their money back.

Russell also is still suffering the consequence of an investment in Lehman Brothers Holdings Inc. The firm's supposedly low-risk institutional and retail money market funds had an exposure of more than 5% to securities of Lehman Brothers Holdings Inc.

Its parent, Milwaukee-based Northwestern Mutual Life Insurance Co., agreed to pump up to $764 million into the money market funds fund to prevent the net asset value from breaking the buck by falling below $1. Last year, according to financial statements, Russell paid $27 million in interest on that loan to Northwestern.

And Russell announced last month that it was selling London-based Panetheon Ventures, the private equity fund-of-funds business it bought in 2004 for at least $775 million. Russell officials would not offer a detailed explanation as to why the company was sold. Ms. Tice said Russell will continue to sell Pantheon products.

Ms. Tice said the current estimate is that the transaction will result in an after-tax gain of $365 million for Russell and will be used in part to retire debt owed to its parent arising from the original acquisition of Pantheon in 2004.

Elsewhere, press reports in Australia had quoted Russell officials as saying the company will be launching an active ETF strategy in that country in 2010. A Russell official, who asked not to be identified, said those accounts were accurate and Russell hopes to follow up with introduction of the products in the U.S. sometime after that.

Russell's current problems also are rooted in the company's January 1999 sale to Milwaukee-based Northwestern Mutual, according to five senior officials who have left Russell, and spoke only on the condition of remaining unidentified.

Under the terms of the $1 billion sale, the insurer agreed to let the Russell organization manage its own affairs for 10 years, according to these sources.

Shortly after the agreement ended in 2008, Mr. Ueland, a 25-year Russell employee was ousted. Put in charge on an interim basis was John Schlifske, an executive vice president at Northwestern Mutual. (Mr. Schlifske now is the insurer's president and is scheduled to become its CEO later this year.)

Layoffs last year of 400 employees, ordered by Northwestern Mutual officials, had unnerved many workers at Russell, according to the former senior officials.

“Maybe 5% of the employees (of the firm's 2,000 employees) had to go, but there is a question of whether the layoff had to be so deep,'' said one former senior official.

The former officials noted that Northwestern executives hold three of seven seats on the Russell board to Russell Investments' two. The other two board members also serve on Northwestern's board.

Ms. Tice confirmed that Northwestern has the largest voting bloc on the board but insisted the company was still run independently.

She would not name the board members, saying Russell, as a private company, is under no obligation to disclose the information.