The recent marriage between Merrill Lynch's investment management unit and fixed-income manager BlackRock did more than create a $1 trillion colossus. It would also seem that it has left Morgan Stanley desperately seeking a new mate.
After the long-rumored talks between Morgan Stanley and BlackRock broke down last month - speculation is that the New York investment banker wanted a majority stake in any deal - cross-town rival Merrill swept in and basically offered BlackRock complete control of its asset management unit, as well as access to its coveted retail distribution network. The two companies' international aspirations are also similar.
It was, as Jim Rohr, CEO of BlackRock's former parent, PNC Financial, said, "a perfect fit from the very beginning."
But a deal with BlackRock would have been perfect for Morgan Stanley, too, which is why experts are somewhat skeptical that it will seek another asset manager to shore up its fund units anytime soon.
"There's certainly a possibility that they would go out and grab an asset manager, but what they were really seeking in BlackRock was, yes, a fast-growing asset manager, but also a sound management team and Larry Fink as a successor to John Mack," said Craig Woker, a stock analyst with Morningstar in Chicago.
Mack, Morgan Stanley's CEO, essentially announced an end to negotiations with Fink, BlackRock's vaunted chief executive, earlier this month when he named Zoe Cruz and Robert Scully co-presidents.
"Due to a confluence of factors, more than anything, a BlackRock deal would have been attractive, so it doesn't appear now that they're necessarily looking to build out an asset manager just willy-nilly," Woker remarked.
At the same time, however, Morgan Stanley remains straddled with a slightly underperforming asset management unit, which in addition to its eponymous products includes the Van Kampen lineup of mutual funds.
A snapshot of the Morgan Stanley family of equity funds reveals that 54.84% beat their respective benchmarks in 2005, according to Lipper of New York. Over the last three years, 52.13% beat their benchmarks and going back five years, 45.14% were ahead of their benchmarks. The picture is much brighter inside the much leaner Van Kampen family of equity funds, where 68.42% beat their benchmarks last year. Over the trailing three years, 60% beat their benchmarks, while across five years, 40% were ahead of their benchmarks.
As of Nov. 30, 2005, assets under management or supervision at Morgan Stanley stood at $431 billion, up $7 billion, or 2% from the previous year. Most of that money was on the strength of institutional assets, which were up by $8 billion for the year. Retail assets declined by $1 billion to $199 billion.
A bigger question, Woker offered, might be whether Morgan Stanley shouldn't exit the fund business altogether. Morgan Stanley's chief competitors have now divested themselves of their asset management units - in addition to Merrill's deal with BlackRock, Citigroup swapped its fund business to Legg Mason last year in exchange for the Baltimore money manager's brokerage unit - a sign that the ambitious days of creating financial services supermarkets have officially come to an end.
"That leaves Morgan Stanley as the last big broker to be paired with a big asset manager," Woker observed. "They're looking like the odd man out."
But last year, Morgan Stanley's asset management business accounted for $1.007 billion in pre-tax income, making it one of the bank's most profitable divisions. It also has an impressive retail distribution force of 9,000 brokers.
Nonetheless, selling, spinning off, or swapping its asset management unit would relieve Morgan Stanley of the compliance headache that comes with operating a brokerage business and a fund business. The bank has been saddled with millions of dollars in fines from regulators in recent years for not disclosing to customers that its brokers had incentives to push proprietary products. It's also finding it increasingly difficult to rely on a captive sales force to distribute its funds, a dilemma that's prompted rebranding discussions.
"The situation today is much different than it was five or 10 years ago, when these guys were building up asset management units," said Robert Hegarty, managing director of securities and investments at Tower Group in Boston. "Now anything that remotely resembles a reciprocal arrangement draws the regulators, and they're not achieving the distribution synergies they thought they could."
But that doesn't make Morgan Stanley's fund business any less attractive, he added.
"It's a good cadre of products, but the real question is whether it's a good fit in terms of where we see the industry headed, which is away from the mostly actively managed funds like Morgan Stanley's to a more quantitative process," he said. "The trend is toward an index style of management."
Morgan Stanley appears to be on that very track. Last month, the banker named Michael Feldschuh managing director of its investment management group. A former managing director and portfolio manager at the New York hedge fund Millennium Partners, Feldschuh brought along his team of statisticians and computer scientists to run more process-driven, or quantitative, strategies for the firm. And Mack himself has expressed on more than one occasion his desire to make Morgan Stanley a dominant player in alternative investing, observed Richard Bove, an analyst with Punk, Ziegel & Co. of New York.
"Among the three parts that make up Morgan Stanley's money management operations, the equity side is under incredible regulatory pressure, pricing pressure and distribution pressure," Bove explained, adding that a flat yield curve makes prospects on the debt side of the business equally unattractive.
"Those pressures don't exist on the alternative investment side," he said. "My thought is that Mack will go after that product and will do so piece by piece," Bove said.
The chatter on Wall Street is that FrontPoint Partners, a Greenwich, Conn., hedge fund with $3.6 billion under management, could be the first piece to that puzzle.
Even if Mack were to continue down the road toward a traditional asset manager, Bove doubts Morgan Stanley could afford one. The industry's burgeoning M&A environment has pushed the price of the average asset manager upwards of 22 to 25 times earnings. "If John Mack is smart, he'll forget about money management for a while," Bove added.
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