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Spotting the Bottom in Marsh & McLennan, Alliance

Analysts say the diversified fund company parents might represent good value.

Updated from 8:32 a.m. EST

It's never easy to gamble on troubled stocks, but for investors with a high tolerance for risk, the parent companies of two recent mutual fund casualties could represent compelling value.

Since federal regulators started to point the finger at mutual funds in September, investors have driven down shares of

Alliance Capital Management

(AC) - Get Associated Capital Group, Inc. Class A Report


Putnam Investments'


Marsh & McLennan

(MMC) - Get Marsh & McLennan Companies, Inc. (MMC) Report

amid concern that they could face large fines, shareholder lawsuits and big redemptions.

But a number of analysts say the stocks have been beaten up enough and that now might be a good time to jump in. "The recent pullback in

Alliance represents a duplicative and excessive reaction to recent developments," said Lehman Brothers' analyst Mark Constant in a research note.

Putnam has suffered recently, with customers pulling out $14 billion of assets from its funds in the first week of November, according to an 8K filed Monday. That's on top of roughly $8 billion pulled out by individuals and institutions previously. But the impact to earnings could be modest, according to Prudential Equity Group analyst Jay Gelb. He put the cost to fourth-quarter earnings of a worst-case-scenario, $30 billion reduction in Putnam assets at 7 cents a share.

Arnie Alsin, founder of Alsin Capital Management and contributor to's

subscription sister site


, said Marsh & McLennan has been "clocked over this Putnam mutual fund scandal; too much so, in my opinion."


Securities and Exchange Commission

has said it intends to file charges against Alliance Capital for engaging in an arbitrage strategy known as market-timing. While legal, most funds say they prohibit market-timing because it can increase costs and reduce the profits of long-term fund investors. New York State Attorney General Eliot Spitzer is also expected to file charges against the firm, which Monday morning said the two executives responsible for the company's fund operations had been dismissed.

Putnam has already been charged by the SEC and Massachusetts Secretary of the Commonwealth William Galvin for failing to disclose that two of its managers "engaged in excessive short-term trading of Putnam funds" for their own benefit. The firm has also received a subpoena from the New York attorney general's office.

Since early September, Alliance has fallen 8% and Marsh & McLennan is down about 11%.

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Frustrated analysts point out that Putnam accounts for less than 20% of Marsh's total earnings, down from 45% in 2000. Marsh's insurance unit and its Mercer Consulting business account for 80% of the firm's earnings "and continue to show robust results with upside potential," according to Prudential's Gelb. "As a result, we believe Putnam should not be a meaningful driver of Marsh and McLennan's valuation."

In addition, some say that Charles "Ed" Haldeman, who has replaced Lawrence Lasser as CEO of Putnam, is well qualified to lead a turnaround in the unit because of his vast experience and successful track record.

Deutsche Bank analyst Alain Karaoglan reiterated his buy rating on Marsh this week, saying he expects the news flow to improve. He also said the stock is trading at just 14.2 times 2004 earnings compared to its 10-year average of 18.4.

Lehman's Constant, who upgraded shares of Alliance Friday, said any wrongdoing at that company "would appear to have been relatively benign and isolated" and he expects monetary damages and settlements to be "modest."

"Importantly, we consider the 'franchise risk' and/or potential impact on client cash flows at Alliance to be relatively limited, based on what is knowable today," he said.

Investing in Marsh & McLennan and Alliance Capital might seem risky, but it also seemed risky to invest in brokerage companies when federal regulators were investigating that industry last year.

Merrill Lynch


fell 15% in the space of two weeks when news of Eliot Spitzer's investigation first broke in April 2002. But the stock has rebounded sharply since then and is now trading almost 47% higher than it was when that scandal came to light.

Of course, it wasn't just a settlement with the government that helped these stocks turn around. A significant improvement in the economy and stock market also gave banking stocks a boost and there's no guarantee that Marsh and Alliance will recover as strongly. Indeed, a number of risks remain.

Prudential analyst John Hall said he harbors some concern that there is "another shoe to drop" at Alliance. Some of Alliance's mutual funds like AllianceBernstein Technology and Premier Growth have had extremely high redemption rates, indicating there was "meaningful market-timing," he said.

On Monday, the company said John Carifa, its president, chief operating officer and chairman of its mutual funds unit, resigned as did Michael Laughlin, the chairman of Alliance Capital's mutual fund distribution unit.

While it looks like progress is being made on a settlement, Merrill Lynch analyst Guy Moszkowski said Alliance shares remain expensive at 12.3 times earnings. "We continue to believe that the risks of the unknown outweigh some of the attractiveness of the valuation at this point, at least for the near term," he said.

William Blair analyst Mark Lane conceded that Putnam accounts for less than 20% of Marsh's earnings and he said client defections represent only a small percentage of total assets under management, but ongoing regulatory investigations are likely to be a "negative overhang" for the stock. In addition, he worries that the other segments of Marsh's business, including the insurance and consulting units, are faltering.

"We see improvements within the insurance brokerage moderating, and Putnam and Mercer are falling well short of their historical outperformance relative to their peers," he said.

While client defections, shareholder lawsuits and big fines remain a concern for investors, some say the biggest worry is the potential long-term damage to the firms' reputations. Putnam recognized this in a letter to fund holders, saying, "ethical conduct and investor trust are the foundation of our business."

Putnam has agreed to reimburse fund holders for any losses incurred and has vowed to review independently all controls and procedures. It will also place trading restrictions on its funds.

If investors believe the improper trading was the work of a handful of rogue traders -- as Putnam has suggested -- the damage to credibility isn't likely to be too harsh. But if the investigations ultimately reveal that market-timing was more systemic or that funds were actually engaging in illegal practices like "late trading," the reputation of these firms could be severely tarnished.

Still, Doug Kass, a partner at Seabreeze Partners and a contributor to's

professional investor site

Street Insight

, isn't worried. He believes that the market-timing issue is "endemic to the mutual fund industry" and that no one company is likely to suffer more than another. He likes Putnam, specifically, because it isn't a pure play on the fund industry, unlike Alliance. "This was an ethical lapse," he said. "Putnam is addressing the issues and it's very cheap by historical standards."

While Kass doesn't own Alliance, he said he nearly purchased shares this week because "the whole thing has been blown out of proportion."