As our marketing maven will sometimes point out, it sounds kind of silly when, at meetings with new clients or consultants, I say things like "I've always wanted to be a money manager."
But aw, shucks -- it's kind of true. There is rarely a dull moment; there is always something you don't know and therefore an unquenchable source of inspiration if you are someone driven by innate curiosity; you are generally surrounded by high IQs that are putting your intellect and reasoning skills on the line; and your aptitude for the job is measured in concrete terms. You either are -- or you aren't -- doing well. It is also a vocation that you can pursue for your entire life, and from any locale. You can find and build wonderful relationships with clients that ideally last decades. Oh, and yeah, the pay can be pretty good.
recent lawsuit against
Mercury Asset Management
(now Merrill Lynch Mercury, a division of
), for what is essentially short-term underperformance versus a benchmark, is a frightening development that could have a lot of investment professionals scrambling to update their resumes. It represents not only a potentially ugly turn of events for the entire industry, but it also exacerbates some of the worst practices already creeping into the field, and is yet another anecdotal sign of change looming over the industry.
Mercury, based in the UK, is the largest asset manager in the world, with nearly $260 billion under management. They are a value shop and sometimes compared to
(in what I call the pre-Vinik firing, swashbuckling days) in that they took large positions in underperforming stocks, and sometimes pushed and shoved management to focus on value creation for shareholders. They had a terrific run throughout most of the 1980s and the 1990s.
But similar to the experience of a number of highly regarded value managers, some not-so-funny things have happened in the market over the past few years. The emergence of a Nifty-Fifty focus, momentum analysis, and indexation (both real and closeted) has been an international phenomenon and has contributed to Mercury's ugly relative performance in recent years.
Which brings us to Unilever, which was a client of Mercury from 1987 to their firing in March 1998. They are suing Merrill Lynch Mercury for $165 million, claiming that Mercury was negligent in failing to understand the risks of "underperformance." The money essentially represents a refund of management fees and damages.
Since I am neither a principal of any of the involved parties, nor will either party -- understandably -- relay the juicy details to third parties, I am passing on what has been reported mostly in the
According to several
articles, Mercury was Unilever's best money manager for nine years and all was well. But from January 1997 through March 1998, Mercury underperformed by 10.5 percentage points and things got ugly, with quotes from anonymous sources saying that Unilever pension directors were so angry they were "spitting blood."
So let's get to the issues. Aside from out-and-out-fraud and literally stealing money from a client, is bad performance an offense worthy of a lawsuit?
Let's first define bad performance. There is a substantive difference between a hard-working and ethical investment management firm -- which most are -- that, within the context of its client mandate, delivers poor results relative to his or her peers or/and agreed-upon index, and an investment advisor who makes poor investments grossly different than any reasonable set of
and mutually agreed-upon expectations and loses material amounts of that client's money.
In the former, with all due respect to my peers (and they are entitled to wonder the same things about me from time to time) there is a lot of poor investment decision-making and flawed strategies driven more by marketing than client performance considerations. And as with any human endeavor from sports to film making, results tend to fall along a bell curve, with equal examples of both true brilliance and rottenness wrapped around a whole lot of mediocrity. While I do not personally espouse anything but a striving for excellence, suing anyone for "middling" results is hardly constructive -- and our legal system tends to bear that out. If suing someone for being stupid was legal, can you imagine the effects on our court system?
So suing Mercury for underperformance due to a series of well-intentioned decisions with poor outcomes seems ridiculous on the face of it. According to the
, Unilever's total pension plan underperformed its benchmark by 100 basis points for the five years ending March 1999. While that is a lot of money on a big pool of assets -- and again, this should not construed as an apology for mediocrity -- Unilever has not suffered some grievous wrong in a world where inflation is 2% and investable assets have grown 12.2% annualized for five years.
The Cost of Creativity
A second issue that is perhaps more appropriate for discussion, but is not even worthy of a lawsuit, regards performance dispersion. There is enormous tension in the investment management business between the creation of an unfettered environment where talented people can get together and run money to the best of their respective abilities and the desire to create uniformity so that clients get a standard product with standard results.
The client understandably wants to buy into a firm and its people and receive the best of their abilities, and has a basis to be upset when their portfolio does not do as well as those of the firm's other clients. The investment management "business" has also realized that personal bottom lines can be greatly enhanced by the creation of a uniform product and uniform (albeit sometimes uniformly mediocre) performance -- that nonetheless is eminently marketable to a world that seeks no surprises and whose results and process can be neatly put down on half a page of paper. One of Unilever's gripes was that other MAM clients did better than their portfolio, which is a perfectly respectable gripe and one that should be factored into the hiring or firing of a manager. But what makes it the basis of a lawsuit?
It should be noted that balancing the need for uniformity and creativity is a never-ending issue for the investment-management business, particularly large firms. How do you foster an environment that lets extremely talented people do their thing, but yet reins them in to create a business? Or, if you believe, as I do, that the seeds of contrary thinking produce the best long-term results, how do you allow portfolio manager number nine to buy a stock that he feels strongly should be bought when the other eight feel the opposite? How many businesses, investment or otherwise, run successfully only when there is a uniform consensus? It's a tough issue that is hotly debated (or should be) at every investment firm.
It's All Relative
Which brings us to closet indexing and the investment-management business. The pain of "relative" underperformance has reached unprecedented heights in recent years as there continues to be a stubbornly large gap between the broader market and a very small group of index stocks. Let's take Mercury. Despite any utterances to the contrary at Mercury, you can be sure that there is
pressure for managers to adhere tightly to the performance of their indices, particularly with mother Merrill (who just paid top dollar for the firm) breathing down their necks. And how does one strive to match the performance of a benchmark, particularly when it is capitalization-weighted? You try to replicate the components of the index.
This has been essentially the vicious cycle that active managers around the world are facing. The largest stocks in a capitalization-weighted index do well. This attracts more money into index funds -- which buy more and more of the largest stocks since they are mathematically becoming an increasingly larger part of the index. Which drives the index higher. Which makes value manager portfolios look worse. Which makes clients unhappy and some of those with the thinnest skin fire them (or sue them) and buy index funds ... and so on.
Like all ideas that appear perfectly decent on the surface -- but are mindlessly replicated on Wall Street until there is little value left -- this too shall end. I just hope it does so
Be sure to catch Jeff this weekend when he discusses his favorite stock picks with
on "TheStreet.com" on the
Fox News Channel
. For more information on the show, please see our
Jeffrey Bronchick is chief investment officer of Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value fund. At time of publication, neither Bronchick nor RCB held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at