Robert Manning took the helm of the nation's oldest fund shop during its darkest hour, but five months removed from its monumental settlement with regulators, it's time to refocus on performance, he said.
With the majority of MFS Investments' legal troubles in the rear-view mirror, now is the time to concentrate on portfolio managers' stock-picking abilities, Manning said. This is an area he knows well, having come from the investment side of the business with a background in distressed debt and junk bonds.
Manning, who took over for suspended CEO John Ballen and President Kevin Parke, grew up at MFS and is a 20-year veteran of the firm. Aside from his role as CEO, Manning is also MFS' president, investment chief and a member of the firm's management committee. Overseeing both the equity and fixed income departments, he is responsible for more than $140 billion in assets under management from more than six million investor accounts.
Manning sat down with Money Management Executive Associate Editors Chris Frankie and Kevin Burke at the firm's plush Boston headquarters overlooking the Charles River to discuss where the firm is finding investment opportunities, how it is retaining talent and paying its managers, and how it is managing its move away from using soft dollars to pay for research.
MME: What is your economic outlook for the coming year?
Manning: We're in an incredible profit cycle right now, which has been discounted by the stock market. We're expecting earnings to be up 25% year-over-year and next year, double-digit growth.
The market trades at 17 times earnings and the small- and mid-cap area has done extremely well, so there's probably going to be a rotation back into large-cap stocks. The problem is that we think the major market moves are behind us, and it's just going to be a stock-picker's market where you're trying to add value through research, which is the hallmark of our company.
We actually think that international equities look relatively cheap when compared to domestic equities, so where we can, in our global portfolio, we're moving more towards international equities. We're particularly interested in continental European companies because our studies show they trade at 60 cents on the dollar versus U.S. companies.
MME: What about returns?
Manning: Our feeling right now is that you probably should expect 8% to 9% returns on U.S. stocks. It'll be choppy here between now and certainly the end of the summer with the election coming up. You're facing a headwind with the Fed potentially continuing to raise interest rates. But, we think that if you do the homework and do the research, there's value in the market, and you can find those companies that are going to grow, beat earnings expectations and go up in value.
Last year's bull market was all low-quality, broken-balance-sheet companies that went up dramatically. Going forward, we think it is going to be the higher-quality companies that can execute and beat earnings estimates that are going to do well. We feel that 04 will have 4% to 4.5% GDP growth. We're looking for 4% next year. So, we're not doomsayers, but we don't think the world's taking off, either. People need to get used to lower equity returns and yields, which is the environment we're going to be in.
We're moving into more cyclical type of companies that we think will do well as the economy continues to expand and just using our research to find more value.
MME: What about inflation concerns?
Manning: We think inflationary issues are temporary. We think normalized inflation is still going to be 2% or less. The Fed really lowered short-term rates way below where they should be, and it has real negative yields at this point in time. So, they just need to get back to a normal Fed funds rate of 2.5% to 3%.
MME: Where do you stand on the proposals to disclose more in-depth portfolio manager compensation information, including revealing managers' personal stakes in the fund and in the company?
Manning: As a company, we think you can't impose the disclosure just upon our industry and not on anybody else's. There's always going to be unique circumstances, and the example we use is: Why would a muni-manager who lives in Massachusetts buy a California muni-fund that they manage?
Where we are on board and believe disclosure is appropriate is to divulge the structure of compensation, which we have done. We have no problem telling people the structure of how people get paid and what the components are that derive that compensation.
At MFS, it is heavily bonus-, incentive comp-driven. We keep our base salaries relatively low, and we want to pay people for performance. Two-thirds of that, on average, is quantitatively driven, mainly focused on portfolio managers' three-year performance numbers, with the one- and the five-year records being of lesser weight. Really, one-third of it is based on our process and our culture--focused on how well people help each other generate investment performance in terms of enhancing the process, working well with each other and creating a collegial environment.
MME: You have expressed concerns about a potential talent drain in the industry if portfolio managers are forced to disclose personal investment information. MFS has also been given a black-eye in the past year from the regulatory probes and settlements. What incentives do people have to stay at MFS?
Manning: We do have a very strong culture here. People work here not only because they can make a lot of money if they do well, but also because they work for a company where teamwork is really encouraged. People treat each other well, and it's a pleasant environment where people enjoy coming to work.
We tend to hire people who don't want to be superstars, who want to work on a team and be a part of something bigger. I've been here my whole career, and I very much believe in the team concept, not the star system.
We also create tremendous dispersion in the bonus. We hold people accountable for their performance, and, unfortunately, if they don't perform, they can't stay here. But, people who do perform can make multiples of their salary in terms of compensation. We like to think we're one of the top shops on the street from an investment point of view, where our best performers get paid in the top quartile in the industry versus their peers.
Lastly, the employees at MFS own 22% of the company in option form or outright in equity. They're aligned long-term with the success of the firm and can grow their wealth through the equity participation in the company.
That's not to say that any person who has great performance isn't going to get wooed away by a hedge fund or some other firm. Occasionally, we may lose somebody. It's a fact of life that successful people are potentially going to leave. So, we create portfolio teams in all the different disciplines so that we really have backup, which allows us to keep continuity in the portfolios over time.
MME: Do you think it's fair to say that at MFS it's back to business as usual?
Manning: Yes. We made some structural changes to the investment department. We restructured the research department. We've made some changes in our portfolio manager positions and moved some analysts into the portfolio management ranks. We really feel that even though we've made these changes, people are settled down and the settlement issues are behind us.
I think the fact that we put our issues behind us quickly and got it out of the way, will end up having been a good decision. From talking to other companies, particularly around town here, those that haven't yet resolved their issues are still experiencing tremendous turmoil. If you look at their asset flows, it is a very different picture than that at MFS.
MME: You agreed to eliminate paying for research using soft dollars. How is that transition coming along, and have you hired new analysts?
Manning: That was just a financial implication for MFS, the advisory company. Between market data and third-party research, we spend about $12 million a year in cash. So we're just writing a check instead of directing brokerage to pay for that.
We're hiring analysts constantly. We're in the marketplace looking for analysts as we speak. It won't affect our research budget from a talent point of view. It's just an additional cost we're going to have to bear at the company, and we have over $1 billion dollars in revenue, so it's not going to kill us to do that. But, we felt we needed to do that to initiate best practices.
MME: Do you think the argument that getting rid of soft dollars will kill independent research firms is valid ?
Manning: I don't buy that argument, no. If third-party research generates value for people, someone will pay for it. Whether we direct brokerage to pay for third-party research or we cut a check, we're only going to do that if we see value in the product.
Third-party research is very, very small here. We spend $3 million a year on it.
MME: You stepped into this role at a crucial time. What has it been like, and what has been your biggest challenge so far?
Manning: I'm working long days, and it's been a challenging environment, particularly emotionally, given everything that has been going on, but the company has settled down, and we're back to business. What I tell people is that we can run the greatest compliance and operating machine in the world, but if we don't have good investment performance, we won't succeed.
Although I'm the new CEO of the company, I have a really strong group of people, who are not investment people, helping me manage the operating environment of the company. I can spend my time on the investment side, which is how I grew up in the business and where I can add the most amount of value.
My goal is to not only get the performance to where it needs to be, but to also ensure all the employees, clients and shareholders here at MFS that we are going to run the company with the greatest amount of integrity and restore our image to where we were prior to all of this stuff.
We are a humble company. We don't get arrogant when things go our way, and we don't hide in a hole when things don't go our way.
MME: The SEC has subpoenaed a number of firms about revenue-sharing arrangements. Have you received a letter from them regarding that?
Manning: We don't comment on what letters we receive from the SEC. I will say that the industry is being looked at with a lot of scrutiny by the regulators, and any big financial institution like ours is going to be involved with all of the things going on in Washington. If we're asked to cooperate, we will give them whatever information they might ask us for.
MME: You spoke about improving investment performance. What other internal goals have you set for the company?
Manning: Our internal goals for the company are to get 75% of our funds above their Lipper category averages. We're working diligently to do that.
Secondly, because we have a new management team in place here, we want to make sure that we get the right structure in place to create an operating environment so that we don't have these problems going forward.
Third is to maintain our market share in all our distribution channels and to get our flows positive and growing into the future. I think if we can accomplish those three things, the company will be financially successful and we will be able to drive value for our shareholders.
But, our primary goal is to get performance turned around on the domestic equity side because we are not where we want to be.
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