Outflows still plague active equity firm Rainier

Rainier Investment Management LLC in Seattle, after several years of subpar results, continues to face large net outflows.

Rainier was once a growing firm. Strong performance in Rainier's equity strategies had helped the firm reach almost $19 billion at the end of 2010. But at the end of June, it had $3.8 billion, according to figures from data provider eVestment LLC in Marietta, Ga.

Net outflows were particularly severe in the quarter ended June 30. They reached approximately $1 billion, coming largely from the firm's domestic large-cap equity strategies, company President James. T. Ridgeway said in an interview.

Rainier's large-cap growth strategy saw returns of 12.17% in the 12 months ended June 30, compared with the Russell 1000 Growth index result of 10.56%. But for the three- and five-year periods, the strategy underperformed the benchmark by 10 basis points and 58 basis points, respectively, eVestment shows.

“Assets under management is a lagging indicator of performance, but until you have a sustained recovery, money doesn't come back in,” Mr. Ridgeway said.

Changes in key personnel also have added to Rainier's problems, raising the question of management stability.

Consultants to money management firms say Rainier officials face a difficult road ahead, improved performance or not.

Particularly difficult is regaining the trust of investment consultants to institutional investors, said money management consultant Janie Kass, managing director and co-founder at Margolis/Kass Advisors in San Francisco.

“Once you disappoint a consultant, it might be 10 years before they come back,” she said.

Compounding the situation is the large number of firms that compete with Rainier, said Russell Campbell, CEO of money manager consulting firm, Your Second Opinion LLC in Las Vegas. “There are just too many equity firms out there for anyone to waste time doing business with a firm that is considered damaged goods,” he said.

Mr. Ridgeway said even as performance in Rainier's various equity strategies has improved in 2015, the active management firm also has been fighting an overall trend of investors switching to passive equity strategies.

Active mutual funds saw net outflows of $12 billion in the June 30 quarter, while passive funds saw net inflows of $32.3 billion, data from Lipper Inc. show.

Also, a report from Principal Global Investors and CREATE-Research released last month found the percentage of defined benefit investors that indicated they would use traditional passive strategies rose to 70% from 53% between 2013 and 2015, while among defined contribution respondents, interest in passive equity/bonds strategies rose to 66% from 59%, while actively managed equity and bond funds declined to 47% from 51%.

As part of its efforts to regain assets, Rainier reorganized its domestic investment teams in spring 2013. It ended a team portfolio management approach that assigned investment professionals to monitor different market sectors but had nobody ultimately in charge of making investment decisions. The reorganization installed two separate lead portfolio managers: Mark Dawson for large-cap strategies and James Margard, for small-cap and midcap strategies, Mr. Ridgeway said.

Before the reorganization, everyone on the investment team was referred to as a senior portfolio manager, said Mr. Dawson, a longtime Rainier employee who also was named chief investment officer in 2013.

Mr. Dawson said under the old structure, because no one was in charge, investment team members were sometimes slow to react to changing market conditions in making buy and sell decisions.

“It can be challenging when you want to move money from one area to another area in determining who coordinates that,'' he said, adding the system had worked when the firm was much smaller.

Mr. Dawson also said the overall risk of a particular portfolio, such as having too much of a concentration of stocks in one sector, wasn't analyzed as thoroughly when there no single portfolio manager was in charge. “I think we ended up with too many independent decision-makers, and lost that essential balance between rigorous bottom-up security analysis on the one hand and thoughtful risk control and portfolio decision-making on the other hand,” he said.

Under the new structure, the two investment teams each have several co-portfolio managers in addition to the lead manager, but ultimately the lead manager is in charge.

“Now that we have lead PMs, we know where the buck stops,” he said.

The reorganization also was a factor in the 2013 departures of Peter Musser and Daniel Brewer, two of the firm's 11 voting partners, said Mr. Dawson.

“There were disagreements about how the firm was being managed,” he said. ”Any time a firm goes through a period of underperformance, difference of opinion about how to address that intensifies. And when they intensify, sometimes it is hard to reconcile everybody ... That's just a fact of life.”

The 2013 reorganization was not the first time the firm had change at the top. Rainier also lost its president and CEO, Len Brennan, who resigned in February 2011. Mr. Brennan resurfaced several months later as president and CEO of Russell Investments. Mr. Ridgeway stepped in as Rainier's president but the company also promoted Kurt Polk, who was head of sales, to the CEO spot. Mr. Polk left at the end of 2013.

Two investment consultants, who requested anonymity, said that Rainier's lack of management stability, not just performance issues, has been part of its challenge. They said they would need to see several more years of strong investment performance as well as stable management to recommend the firm again to clients.

But one of the consultants gave Rainier officials credit for reorganizing the investment teams, which he said has helped performance. He said one of his institutional clients still has money invested with the firm, but reduced its $20 million account by half.

Rainier is betting on its newest strategy — international small-cap equity, with $321 million in assets of June 30 — as part of its recovery efforts. The strategy, launched in March 2012, was seeded with $11 million in assets from Rainier. Mr. Ridgeway said investment returns have been strong and with the strategy marking its three-year anniversary in March, there is enough performance data for consultants to consider recommending the firm. He said a major non-U.S. public pension plan invested $135 million in the strategy in March.

The strategy has seen spectacular results. It returned 9.99% for the year ended June 30, vs. its benchmark, the MSCI All Country World ex-U.S. Small Cap index's -3.07%. On a three-year basis, it produced annualized results of 23.4% compared with the benchmark's 12.32%.

Peter Gosselin, co-founder and chief investment officer of Gosselin Consulting Group LLC, Braintree, Mass., is impressed with the strategy.

He said his firm is “very confident” about the abilities of portfolio manager Henrik Strabo, head of international investing at Rainier. Mr. Gosselin said Mr. Strabo has done a good job of finding high-quality international companies for his strategy, using the international equity portfolio skills he honed at other managers including American Century Investments.

Mr. Gosselin has been recommending this strategy to his defined contribution plan clients. He said many other firms' international small-cap strategies have been closed to new investors, meaning there aren't many quality options available for investors interested in the segment. n