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Street Wants Action on Morgan Stanley Funds

Bankers and analysts push elaborate fixes for the investment bank's asset management unit.

Morgan Stanley's

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ability to stay calm on the topic of its struggling asset-management unit is making Wall Street hyper.

After two megadeals for mutual fund groups this year, one of which featured Morgan Stanley as an also-ran, would-be advisers are getting creative with plans for the bank's investment group. One tactic being floated calls for Morgan to follow the pack and spin off the assets to mutual fund manager

Franklin Resources

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But Morgan Stanley will hear no such talk, at least when it comes to selling the business. Of late, the big securities firm has stubbornly defended the asset-management division, saying it believes in the business and will make small acquisitions to help build it up.

Asset-management groups are increasingly the problem children of Wall Street investment houses. After a series of conflict-of-interest investigations that stopped firms from pushing their own mutual fund products, brokers are reluctant to sell funds with their own names on them. For some, dealing with the issue just hasn't been worth it.

"The problem is that retail investors have a long memory," said Brad Hintz, research analyst at Sanford C. Bernstein & Co. "So brokerage firms are having a hard time selling their own products."

When run well, fund units are an extremely lucrative way for banks to level more volatile revenue streams in other divisions, such as banking and trading.

Goldman Sachs

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, for one, has a model that works, whereby asset management enables it to take on more risk in other areas -- something Wall Street likes.

The way the market sees it, Morgan Stanley has two options: sell the investment business to someone else, or try to find a way to recapture some previously missed opportunities. Morgan Stanley has stubbornly defended its commitment simply to modify its current course. One missed chance the company is trying to address is in the alternative investments group.

"Goldman built business on alternative assets and used its prime broker business to help," Hintz said. "Morgan Stanley is the No. 1 prime broker, but it has never leveraged the prime broker business. It would be the perfect fund-of-funds manager."

The firm's most recent comments have centered on a desire to beef up alternative investments. On Thursday,

learned that the asset-management team will bring over a group from the proprietary trading desk in Morgan Stanley's institutional equity division. In January, Morgan hired Michael Feldschuh from Millennium Partners to run process-driven strategies in a step to stack top management in the group.

The company also has a relationship with a hedge fund run by Barton Biggs, founder and former chairman of Morgan Stanley's asset-management business, to provide strategies for the group. On the first-quarter earnings call, Chief Financial Officer David Sidwell said that the firm plans on adding individuals and small teams and making small acquisitions to help build out the high-margin alternative-investments business -- moves that might position it to compete with Goldman Sachs.

But overhauling a group internally is timely and expensive, and it requires more than one or two small acquisitions.

"The asset-management business at Morgan Stanley can be fixed, but the problem is that none of these businesses can be fixed quickly," Hintz said. "It took Goldman Sachs about four years to build up its business."

For that reason, some of Wall Street's biggest firms have already decided to cut their mutual fund divisions loose.


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, for one, spun off its asset-management division to

Legg Mason

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in an asset swap last year. In February,

Merrill Lynch


sold control of its group to


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Morgan Stanley was also reportedly pursuing a deal with BlackRock, but it decided to walk away because it didn't want to give up control of the business, according to analysts' assessments at the time. Merrill was willing to cede control of the unit, collecting in return a big chunk of BlackRock stock and rights to almost half the revenue stream created by the merged fund outfit.

Morgan Stanley's intransigence on the control issue could get harder to defend if the company is unable to reverse the fortunes of its fund group soon. In the first quarter, the asset-management group was an obvious underperformer. It was the only division to post flat revenue growth vs. the same period in 2005, and revenue was down 22% from the fourth quarter of last year.

In the meantime, the market is getting antsy. Merrill Lynch's research analyst Guy Moszkowski outlined a plan this week intended to extricate Morgan Stanley's asset-management unit from what he called a "thorny dilemma." According to Moszkowski, the brokerage should sell the asset-management division to Franklin in return for a 29% stake in the company. The deal would value Morgan Stanley's $442 billion in assets under management at between $10 billion and $13 billion.

In return for giving Morgan Stanley a stake, Franklin Resources would gain access to Morgan's Van Kampen name and would more than double the number of four- and five-star-rated equity funds. Franklin would also gain scale with a combined $927 billion in assets under management, which would position it to better compete with the newly formed BlackRock.

The deal would be 5% accretive to Morgan Stanley's earnings per share and would produce a gain while a releasing $1 billion of goodwill on the books, Moszkowski argued. For Franklin, the deal could be up to 13% accretive if it could eliminate 11% in costs, something that Moszkowski believes is possible.

Moszkowski acknowledges that the deal might not be the "right deal for either party. But we think Morgan Stanley might eventually reconsider its 'control' stance given potential benefits." And although the analysis might not be a perfect fit, it does highlight a very important theme: Wall Street may not be patient through Morgan Stanley's asset-management restructuring.

"Mack's team is committed to the business, and I tend to be a believer," Hintz said. "But Mack isn't a magician, and it's going to take time."

For now, Morgan Stanley's stock price may be enough to appease the market. Shares in the company have risen to a recent quote of $64.25 from a low of $47.66 about a year ago, a 34.8% increase. Investors are confident in John Mack's plans for the company, and other issues -- namely the continued staffing changes in the M&A business -- have kept the criticism focused elsewhere.

But through the coming quarters, the asset-management business is sure to be closely watched. And as long as results in the group are stale, Morgan Stanley's stubbornness may not be worth it.