Institutional Investor - 07 Jul 2009

Europe’s Best CFOs A resurgence of the Hong Kong’s Chris have cut costs and put their sukuk market raises hopes that Gradel has grown Pacific firms in a position to profit Islamic finance could benefit Alliance into one of Asia’s during economic hard times from the banking crisis hedge fund stars

INTERNATIONAL

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S ALTERNATIVES NERD ON THE STREET

CONTENTS INSIDE II TICKER PEOPLE FIVE QUESTIO FEATURES

22 CAPITAL MARKETS

Last Man Standing BY RICH BLAKE

Technological changes and weak markets threaten floor traders like Vincent Farina, but the veteran broker says a human touch still adds value.

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SPECIAL REPORT THE CLIMATE CHALLENGE

Climate change poses growing risks to the environment — and the economy. We examine how investors are looking to profit from cleanenergy technologies.

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Winds of Change BY JEREMY LOVELL

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From Smokestacks to Greenbacks

“JUST BECAUSE SOMETHING IS FASTER AND CHEAPER DOESN’T MEAN IT’S BETTER.”

BY KATIE GILBERT

38 ASSET MANAGEMENT

Manning’s Method BY JULIE SEGAL

MFS is on the rebound thanks to CEO Robert Manning’s team-based approach.

42 ISLAMIC FINANCE

Can Islamic Finance Profit from the Crisis? BY HUGO COX

Islamic banks and the sukuk market may benefit from the West’s financial disarray.

48 HEDGE FUNDS

West Meets East

BY HENRY SCOTT STOKES

Chris Gradel and his team at Pacific Alliance Group scour Asia for mispriced assets.

VOLUME XXXIV, NO. 6 • INTERNATIONAL EDITION

JULY/AUGUST 2009

RESEARCH and RANKINGS

••

54 The 2009 Brazil 20 Limited exposure to equities muted the impact

58 Europe’s Best CFOs Earnings guidance is out, cost controls are in, as

of the financial crisis on Brazil’s top money managers. BY LESLIE KRAMER

European financial chiefs steer their companies through the recession. BY WILLIAM BOSTON

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CONTENTS INSIDE II TICKER PEOPLE FIVE QUESTIO DEPARTMENTS

BGI chief Blake Grossman says the cultures of BlackRock and BGI have some common elements

OPENING

• Ticker BlackRock says BGI was worth every cent • Paulson’s Midas touch • An SEC fraud cop on learning from Madoff • Expect a flurry of fines • People Faces in finance • Five Questions For David Einhorn • New Zealand freezes pension contributions • Did II Say That? What we said about “swinging funds” in 1967 CAPITAL

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RAINMAKERS

Banker to the Banks BY HEIDI MOORE

17 SCORECARD

Hunting in a Difficult Year J.P. Morgan grabs the lead in M&A by advising buyers in a lean market.

When facing chaotic markets, nervous investors and a wrathful government, Morgan Stanley investment banker Jonathan Pruzan was well prepared.

18 MARKETS

16 DONE DEALS

Established stock exchanges are trying to compete with a growing flock of upstarts. .

Cash for Clunkers BY STEVEN ROSENBUSH

For General Motors the road to insolvency has been littered with unhappy shareholders, but the automaker’s bankruptcy financing is one sweet deal.

Trading Titans Fight Back BY CHARLES WALLACE

19 CEO INTERVIEW

Not Playing Around BY CLAUDIA DEUTSCH

Mattel CEO Robert Eckert guides the toy company through the trials of recession.

INVESTING

62

THE BUY SIDE

Staying the Course BY MICHAEL SHARI

America’s Largest Overseas Investors remain committed to international growth, despite a sharp setback in 2008.

64 INEFFICIENT MARKETS China Recovery Doesn’t Add Up

BY EDWARD CHANCELLOR

Beijing’s stimulus plan risks aggravating the economy’s imbalances.

66 ALTERNATIVES

Survivor Benefits BY IMOGEN ROSE-SMITH

A relatively prosperous hedge fund firm picks up the remains of a fading rival.

MISCELLANEOUS 3 Inside II 68 Nerd on the Street

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NTRIBUTORS INSIDWALL THE STREET CONTENTS INSIDE II TICKER PEOPLE FIVE QU www.iimagazine.com

EDITOR William H. Inman INTERNATIONAL EDITOR Tom Buerkle AMERICAS EDITOR Michael Peltz ART DIRECTOR Nathan Sinclair MANAGING EDITORS

Thomas W. Johnson (Production, Research) Tracy Tjaden (International, Online) INTERNATIONAL EDITION LONDON BUREAU Loch Adamson (Chief) ASIA BUREAU Allen T. Cheng (Chief) CONTRIBUTING EDITORS Vita Bekker (Tel Aviv), Lucy Conger (Lima), Craig Mellow

INSTITUTIONAL INVESTOR.COM EDITOR James Johnson ASSISTANT WEB EDITOR Michelle Tom ASSISTANT MANAGING EDITOR Steve Rosenbush (Wall Street, Corporate Finance) SENIOR EDITORS Steven Brull (Los Angeles), Karl Cates, Jane B. Kenney (Editorial Research) SENIOR WRITERS Frances Denmark, Michael Shari STAFF WRITERS Imogen

Rose-Smith, Julie Segal

SENIOR ASSOCIATE EDITOR Tucker Ewing ASSOCIATE EDITORS Denise Hoguet, WeiQing Lu (Research Specialists),

Carolynn B. Tetro SENIOR CONTRIBUTING EDITOR Len Costa SENIOR CONTRIBUTING WRITERS Pam Abramowitz,

Hugo Cox, Mary D’Ambrosio, Katie Gilbert, Udayan Gupta, Fran Hawthorne, John Hintze, Jonathan Kandell, Sara Kandler, Donald Kirk, Janice Koch, Leslie Kramer, Ellen James Martin, Scott Martin, Ben Mattlin, Nick Rockel, Jan H. Schut, Harvey D. Shapiro, Mike Sisk, Jinny St. Goar, Miriam Stickler, Henry Scott Stokes, Paul Sweeney, Stephen Taub ASSISTANT TO THE EDITOR Elizabeth Simroe SENIOR COPY EDITOR Ingrid Accardi COPY EDITORS Monica Boyer, Catheryn Keegan, Elizabeth Ungar, Melissa Wohlgemuth DEPUTY ART DIRECTOR Diana Panfil ART DEPARTMENT Katie Constans, Israt Jahan, John

Risk Raconteur “ Irreversibility dominates decisions ranging all the way from taking the subway instead of a taxi, to building an automobile factory in Brazil, to changing jobs, to declaring war. ” — Peter Bernstein, Against the Gods: The Remarkable Story of Risk Imagine if banks had ignored subprime temptations, Lehman Brothers had survived or Bernie Madoff’s schemes had unraveled sooner. Such possibilities — irreversibly vanished now — were the stuff of routine supposition for Peter Bernstein, a master interpreter of the complex world of probabilities and risk. Peter, who passed away in June, was much more than that to this magazine. Working with founder Gil Kaplan, he generated ideas that nurtured the fledgling Institutional Investor. He later founded the acclaimed Journal of Portfolio Management, a small publication that thought

big, explaining academically rigorous topics from quantile regression to clairvoyant value teases. (See Bernstein tribute, www.iijpm.com.) Peter was that rarity, an economic scholar who wrote with the flair and precision of a great novelist. And he had a delightful sense of humor. “The world would be a dull place,” he wrote in his landmark risk study, Against the Gods, “if people lacked conceit and confidence in their own fortune.” Fortunately for us, good writing mattered to Peter. He told stories simply, without pretense, building on strong verbs, always in the active voice. There was a power and elegance in simplicity. Big things can be accomplished with small words. He admired Winston Churchill, no small accomplisher, who wrote that “short words are always best, old words best of all.” If ideas could not be clearly stated so they could be understood, they were probably not good ideas in the first place.

— WILLIAM H. INMAN, EDITOR [email protected]

MEMO

Miliczenko, Frannie Ruch

TO: Asset Managers RE: Expand Your Institutional Investor Networking

CREATIVE CONSULTANT

Institutional Investor is proud to offer these two conferences to a limited number of asset managers.

James Crombie INSTITUTIONAL INVESTOR, 225 Park Avenue South, New York, NY 10003; (212) 224-3300; Fax: (212) 224-3171. www.iimagazine.com London Bureau: Nestor House, Playhouse Yard, London EC4V 5EX, U.K.; (44-207) 303-1703; Fax: (44-207) 303-1710 Hong Kong Bureau: 17/F, Printing House, 6 Duddell Street Central, Hong Kong; 852-2912-8030; Fax: 852-2801-7009 © 2009 Institutional Investor, Inc. (ISSN 0192-5660) No statement in this magazine is to be construed as a recommendation to buy or sell securities. Neither this publication nor any part of it may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system, without the prior written permission of Institutional Investor magazine. For reprints and Web links, contact: Dewey Palmieri (212) 224-3675; Fax: (212) 224-3563; e-mail: [email protected]. Printed by Cadmus Specialty Publications, Richmond, Virginia, U.S.A. For customer service inquiries please call (800) 945-2034; Overseas: (212) 224-3745; Fax: (615) 377-0525. FOUNDER Gilbert Kaplan

European Investment Roundtable

16-18 September 2009 t Vier Jahreszeiten Kempinski t Munich, Germany

Network with an exclusive audience of over 50 senior investment executives from major European public and corporate pension and insurance funds.

Asia/MidEast Government Funds Roundtable 18-19 November 2009 t The Raffles Hotel t Singapore

Meet 60+ senior officials of government investment funds in Asia and the MidEast including sovereign wealth funds, country pension funds and central banks. Register today as space will be limited at both events to ensure investor to manager ratios greater than 1 to 1. To Register or for attendee lists, programs and more information, please contact Kristin Zammit at [email protected] or +1 212 224 3063.

Itaú Unibanco

Blazing A New Trail Itaú Unibanco puts its Latin American asset management expertise to work on global ambitions

D

emosthenes Madureira de Pinho Neto is a man on a mission, just eight months after South America’s largest financial institution - Itaú Unibanco - was created from the merger of two of Brazil’s leading privately owned banks. “Seizing the similarities in investment philosophy between the two original asset managers, we’ve just finished getting both teams under one roof,” says the head of Itaú Unibanco’s new asset management company from his São Paulo office. “Now we’re looking to consolidate our place as the Latin American specialist investment manager with a relevant presence in all Latin American markets – one that has its own personality and identity in a huge financial group.” Pinho Neto has the advantage of tackling this ambition from an enviable position. The merger between Itaú and Unibanco – first announced last November – created not only the largest bank in the southern hemisphere with assets valued at R$632.7 billion at year-end 2008 but also the sixth The merger largest bank in the Americas. between Itaú Still, size isn’t the whole story. Last and Unibanco year, financial institutions in the group were named Best Brazilian Bank by created the sixth largest Euromoney (for the 11th consecutive year) and Global Finance magazines and the bank in the country’s best asset manager by the local Americas. Exame magazine. This year, the FT voted it the Most Sustainable Bank across Emerging Markets. The asset management company’s current team – picked from the cream of the crop from both firms – is unrivaled in its depth of experience in the Brazilian market and is expert in covering other Latin American countries including Chile, Argentina, Uruguay, Paraguay and, most recently, Mexico. Itaú Unibanco has the largest buy side equity team in Brazil, composed of 10 portfolio managers and 14 analysts who take a fundamental bottom-up approach to investing to optimize longterm returns. The size and knowledge base of the team allow

the company “to offer not just the most diversified strategies among asset management companies in Brazil, but also the ability to provide unparalleled service to investors who want to know not just where their resources are being allocated but what strategies are being employed and why,” says Walter Mendes, the head of equities strategies. Itaú Unibanco is also the leader among the private sector asset managers in all client segments in Brazil. “We are the first choice of Brazilian clients, so why should this be any different for foreign investors?” points out Bruno Stein, head of international business development for asset management. “This is why leading global asset managers have chosen us as sub-advisors and managers of their Brazilian and Latin American portfolios.” Net portfolio investments of foreign investors into Brazilian equities and fixed income markets already has reached more than US$5.3 billion this year. Itaú Unibanco, the leading privately owned asset manager in the region with US$130 billion under management as of May this year, had US$2.0 billion of net inflow from foreign investors in the same period. Investor Interest Aided by Falling Rates It helps that Brazil has emerged from the global financial crisis with its financial system largely intact, aided by 15 years of macroeconomic stability, an under-leveraged financial system, and a highly regulated and robust banking system that has not been afflicted with subprime mortgage problems. This has spurred a wave of new investment in Latin America’s largest economy even as the global crisis deepened late last year, and not just from the traditional strongholds of US and Europe. “Now, we’re seeing a lot of investors from the Middle East as well as Asia, particularly Japan and South Korea,” says Marcelo Fatio, the head of international distribution of Itaú Unibanco. ““This may show that the decision of opening offices in different locations outside Brazil was the right one. Now we are part of this flow.” Itaú Securities has offices in

Itaú Unibanco Team

Demosthenes Madureira de Pinho Neto

Alexandre Zakia Albert

Paulo Corchaki

July/August 2009 • Institutional Investor Sponsored Statement

Walter Mendes

Bruno Stein

Marcelo Fatio

New York, London, Tokyo, Hong Kong, and Dubai. Brazil is increasingly perceived today as one of the strongest emerging market economies even among its BRIC (Brazil, Russia, India and China) peers. “China has stayed at the top of the heap of the BRICs, but Brazil is becoming far more important in relative terms,” says Fatio, pointing to Brazil’s stable political system, abundant natural resources and burgeoning domestic market. “We have been participating in several RFPs for mandates from US endowments, foundations and pension funds around the world” adds Stein. So far this year, the Bovespa index has risen 67.81 percent in US dollar terms. Aiding the rise in The bank’s equities is the Central Bank’s aggressive long-short interest rate-cutting program that has hedge fund, trimmed Brazil’s Selic interest rate to historic lows of 9.25 percent as launched in of June. The fall in interest rates will the midst spur a migration to equities from local of a financial investment funds that have traditionally crisis, is a parked 85 percent of assets in fixed top performer. income and were as high as 90 percent fixed income at the end of 2008, says Paulo Corchaki, Director and CIO of Itaú Unibanco’s asset management unit. “This is a trend that is inevitable and structural.” Adds Alexandre Zakia Albert, head of asset management for institutional clients: “Brazilian investment funds could double their participation in equity funds in the next two to three years. In an industry that today is valued at US$700 billion, this means that US$140 billion could be directed into equities as investors move more funds out of plain-vanilla funds into hedge funds or multi-strategy funds.” Stellar Performance, Diverse Products For international investors, Itaú Unibanco offers a diverse range of traditional and boutique products including offshore Brazilian long-only equity funds and fixed income funds set up in Luxembourg, as well as Cayman Island-domiciled hedge funds that rival small boutique hedge funds in their sophistication and performance. For example, the bank’s long-short hedge fund – launched last August in the eye of the financial crisis – saw gains of 5.75 percent in US dollar terms through December last year, at a time when the Bovespa index saw losses of a staggering 57.7 percent. In the 10 months since its inception, the fund has been up 3.93 percent, outperforming the Bovespa index, which slipped by 30 percent in US dollar terms in the same timeframe. Another top-performing product has been Itaú Unibanco’s fund of hedge funds, which gained 15 percent in US dollar terms in the first five months of this year. The fund, one of the longest-running

funds of its kind, was begun in 2005 but built upon research that monitored 100 percent of the roughly 1,000 funds in the country for more than a decade. Currently, the fund of funds team invests in more than 150 portfolios, and the team also runs an incubator fund of funds for emerging hedge funds managers. “Itaú Unibanco is a full-service provider in Brazil,” says Stein. “That allows it to offer managed accounts that can replicate any of its domestic strategies for foreign investors. The bank can also set up any type of advisory model related to Brazilian investments.” Investor appetite has been robust for these products since the fourth quarter of 2008, with US$5 billion raised from international investors as of May this year. Cases include fixed income and thematic equity long-only funds distributed locally in Asia, Europe and North America for retail and institutional investors. Ahead: More Global Allocation of Assets to Brazil Though Brazil is likely to emerge from the current crisis in good shape, Pinho Neto warns against excessive optimism. “It’s ironic that Brazil is now much more solid than many industrialized countries in terms of its fiscal and financial situation, but I think international investors are overlooking some potential problems that may occur, such as the quality of government expenditures,” he says. Perennial Brazilian problems such as infrastructure and much-needed tax and social security reform must be addressed in coming years or Brazil will find its competitive edge blunted. That said, the most compelling Brazil trends today are woven into a story that started in 2006, as falling interest rates began to fuel the growth of consumer credit to Brazil’s rising middle class. While the global financial crisis has interrupted this story momentarily, Brazil’s economy is likely to grow at 4 percent from 2010 onward, or double the rate of developed economies, according to the International Monetary Fund. Moreover, says Stein, “if you believe the emerging market story, and the shift of Brazil to a key emerging market, then we’re still at the very beginning of the cycle of money being allocated here on a global scale. A lot of investors are still not accessing the market using local expertise, but this will certainly change as the increase of the weight of the asset class forces more resources to be dedicated to Brazil and local managers continue to outperform global managers.” CONTACT INFORMATION

Bruno Stein +55 11 3073-3161 [email protected]

Institutional Investor Sponsored Statement • July/August 2009

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OPENING

July/August 2009 News and views from the world of finance

Barclays Global Investors CEO Blake Grossman (left) worked with BlackRock COO Susan Wagner and president Robert Kapito to hammer out the deal to create a $2.7 trillion giant

FROM LEFT: DANIEL ACKER/BLOOMBERG NEWS; MIKE SEGAR/REUTERS; BRENDAN MCDERMID/REUTERS

MONEY MANAGEMENT

scramble for liquidity, the conditions were ideal for Fink, one of the most powerful CEOs in the U.S., to snap up the troubled U.K. bank’s money management business at a discount and create a $2.7 trillion-inassets financial titan that would dwarf its competition and control more cash than the U.S. Federal Reserve. Yet by some accounts, the $13.5 billion that Fink agreed to pay for Barclays Global

THE PRICE IS RIGHT DID BLACKROCK PAY TOO MUCH TO BECOME THE WORLD’S LARGEST MONEY MANAGER? BlackRock chief executive Laurence Fink has a well-deserved reputation as a shrewd deal maker. So this spring, when Barclays was desperate for money, markets were still reeling from the financial crisis and investors were redeeming funds in a mad

Investors was anything but a bargain.“BlackRock is paying full price for BGI,” says Robert Lee, a research analyst at Keefe, Bruyette & Woods in New York. Lee values the cash portion of the deal at 11.1 times San Francisco–based BGI’s estimated pretax earnings for 2010, the first full year after the deal is expected to close. That’s in line with the multiple for asset management firms before the market meltdown, which was ten to 12 times earnings. Considering that such shops have sold at steep discounts in

recent months and that many, including Bank of America’s Columbia Management, have languished on the market, the question is: Did BlackRock pay too much? The team that pulled the deal together says the price was right and defends the $3 billion in debt they assumed to buy the business.“We need the scale to support the global presence that we think is going to be required,” says Susan Wagner, chief operating officer of BlackRock. Scale is no longer a problem. BGI gives BlackRock the reach

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it needs to keep costs down and expands its global footprint at a time when the money management industry is desperate to tap new markets like India and China. The combined firm’s arsenal will include a wide range of products across the risk spectrum. “BlackRock is one of the few, if not the only, firms that have the breadth of product to accomplish this,” says Joseph Hershberger, a managing director at Credit Suisse Securities, a lead adviser for BlackRock on the deal. “Except for Pimco, nothing of this quality has ever traded.” The new BlackRock Global Advisors will oversee everything from stocks, bonds and money market instruments to passive and alternative investments, for both institutional and retail investors. BlackRock’s top executives say the big prize was iShares, BGI’s exchangetraded funds business, but Fink wanted to get his hands on the rest of its huge passive portfolio as well. The $325 billionin-assets iShares has been on a tear — Jes Staley that industry J.P. Morgan Asset Management heavyweights say shows no sign of letting up. “Fink has bought the ‘secret sauce’ for the next generation of the mutual fund,” says Donald Putnam, managing partner at merchant bank Grail Partners. Between 2004 and 2008, iShares’ assets

“

This deal becomes a strategic gut check for the major money managers.

”

John Paulson is moving into gold stocks

INVESTING

GOING FOR GOLD PAULSON EXERCISES HIS MIDAS TOUCH John Paulson, king of the subprime short, has become a goldbug. His metamorphosis can be traced to the first quarter of this year, when the New York–based hedge fund manager moved roughly 44 percent of the $9 billion in U.S. equities he had held in Paulson & Co. into exchange-traded funds specializing in gold-mining stocks and related companies. This included $2.8 billion for an initial stake in SPDR Gold Trust. Not only was that his largest equity holding, but it also made Paulson the ETF’s biggest shareholder. His stake exceeded that of the nextlargest investor by five times. A similar fund — Market Vectors Gold Miners ETF — accounted for nearly $638 million of Paulson’s assets at the end of the first quarter, making it his fourth-largest

grew at a 26 percent annualized rate, compared with 2 percent for BGI’s overall business. Experts estimate iShares’ profit margin to be as much as 90 percent, not counting distribution and other costs. Robert Kapito, president of BlackRock, won’t reveal margins but claims the 90 percent figure is on the high side. He does say the potential is huge: “There will be significant growth in the ETF business.” ETFs can also easily cross borders. “If you’re talking to a family in Switzerland, France or Cincinnati, you’re dealing with different regulatory regimes,” notes Putnam. “ETFs have the potential to level that playing field.” There’s upside as well in

equity holding. Individual mining companies Kinross Gold Corp. of Canada and South Africa–based Gold Fields also ranked among his top-ten holdings. Paulson was even more aggressive on the gold front in the second quarter. On June 1 he boosted his stake in Johannesburg-based AngloGold Ashanti to 12.1 percent, mostly through his Advantage Plus Master fund. The 53-year-old manager has also filed with the Securities and Exchange Commission an intention to launch both onshore and offshore versions of the Paulson Gold Fund. The moves are a clear indication that Paulson, who made a name for himself — as well as nearly $6 billion — by shorting the subprime mortgage market early in the credit crisis, is worried about inflation. His strategy has already paid off to some degree. Most of Paulson’s funds, which currently control about $36 billion in assets, were up by 4 to 14 percent this year through the end of May. This despite a money-losing April, when Paulson was hurt by a bad short on U.K. bank Barclays after having made big bucks earlier in the year betting against British banks. He is also looking to move into private equity and recently told clients he was raising money for the Paulson Real Estate Recovery Fund. “We believe that there will be many opportunities in distressed real estate, as borrowers default and capital becomes scarce,” Paulson wrote in a year-end letter. “Investing near the trough of this cycle should provide superior riskadjusted returns while providing an inflation hedge.” There’s life, perhaps, in the real estate sector too. — STEPHEN TAUB

the defined contribution space, as ETFs are likely to increase their penetration into the 401(k) market. The deal will make BlackRock the fourthlargest manager of DC assets, says Douglas Sipkin, an analyst at Pali Capital. BGI also adds strength to BlackRock’s non-ETF passive fund management. “There’s been a fairly large movement to passive because of the volatility in the stock market in the last couple of years,” notes Kapito. With the acquisition, BlackRock’s passive portfolio climbs from $45 billion to an estimated $1.05 trillion. But being a giant is no easy task — integration may be the most serious risk hanging over

the combined firm. “The big question is what happens to the culture of BGI, the investment teams that have driven its success over the years,” says Scott Powers, CEO of State Street Global Advisors, one of BGI’s close competitors in indexing and ETFs. The cultures of BGI and BlackRock are similar in that both are strong quant managers, but there are also key differences, says Blake Grossman, CEO of BGI, which was Wells Fargo’s asset management arm before Barclays acquired it in 1996. The firm had already developed its academic bent, adopted from nearby Stanford University, where Grossman was a protégé of Nobel Prize–

BLOOMBERG NEWS

BlackRock Global Advisors Golden Opportunity

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SIDE II OPENING TICKER PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS

PAPER: RICHARD MEGNA

SEC Crackdown Brokerage Fines

winning economist William Sharpe; today BGI is still packed with researchers who hold Ph.D.s in mathematics and economics. BlackRock’s work environment, by contrast, is entrepreneurial and grew out of the expertise Fink gained in the brokerage industry in the early years of structuring mortgage products in the 1970s. It became more corporate when the firm merged with Merrill Lynch Investment Managers in 2006. “Larry’s drinking his own Kool-Aid when he says there is only one culture at BlackRock,” says Putnam. “The critical culture question becomes how the individual teams will be integrated, and Larry is no better than anybody else at that.” Then there are the financial risks. BlackRock is sandbagging itself with $3 billion in debt, about $1 billion of which it plans to repay from existing lines of credit while seeking short-term loans from other lenders, one of which is Barclays. In June, citing refinancing risk, Standard & Poor’s cut BlackRock’s counterparty credit rating to A+/A-1 from AA-/A-1+, with a negative outlook. Grossman predicts that the deal will have a “transformational” impact on the industry, possibly triggering a wave of consolidation. Many concur. “Passive investing is going to have a role in the institutional market and the consumer market,” says Jes Staley, CEO of J.P. Morgan Asset Management.“This deal was less about the financials — it becomes a strategic gut check for the major money managers.” — Julie Segal and Michael Shari

REGULATION

THE SEC FIGHTS BACK A TOP COP SAYS IT’S TIME TO GET PAST THE MADOFF HORROR As one of the U.S. Securities and Exchange Commission’s longest-serving cops on the beat, Robert Plaze has seen his share of booms, busts and frauds. In an exclusive interview, he tells Institutional Investor how the agency is tightening rules to prevent future scams like the Bernie Madoff swindle. The SEC’s reputation was tarnished by its failure to detect a $50 billion-plus Ponzi scheme despite detailed warnings from investigator Harry Markopolos. Criticism of its faulty oversight has spurred the agency to take action, and Plaze, 53, is helping to lead the charge. As associate director of the SEC’s Division of Investment Management, the division’s No. 2 official and chief rule writer, Plaze recently proposed an amendment that would require investment advisers who maintain custody of client assets to undergo more-stringent reviews, and

occasional surprise exams, by outside accountants. Regulators believe that Madoff’s combined role as custodian and fund manager enabled him to pull off his scam. Plaze presented the draft regulation at a recent meeting of the five SEC commissioners led by chairman Mary Schapiro, who opened it to public comment until July. Plaze also detailed a new SEC reporting system, the Investment Adviser Registration Depository, that generates spreadsheets listing, for example, every firm that fails to properly inform the agency of changing or terminating its accountants. “In the past when we’ve seen fraud,” Plaze said during remarks at the SEC hearing, “an accountant is nowhere is in sight.” He spoke to Contributing Writer Rich Blake recently in Washington. Institutional Investor: Is the custody measure a direct response to the Madoff case? Plaze: Yes. When Mary Scha-

piro came to office, she asked our division for options on what the SEC could do to

The SEC’s Robert Plaze is focused on controls

strengthen custody controls. How many investigations into money management frauds are under way now?

I can’t comment on ongoing investigations. But it’s clear that even a few lawbreakers can cause tremendous damage. The people I talk to are terribly upset by what happened. After you get past the horror and the breast-beating, then you have to really focus on your core responsibility: identifying the controls that can prevent it from happening again. How does the IARD work?

All advisers report information to us electronically in the IARD. We want to amend the form to capture more information — better information — to lengthen our regulatory reach and leverage our existing resources. If we can identify people who are not in complicontinued on page 12

REGULATION

A FLURRY OF FINES IN THE FORECAST For all the rhetoric about beefing up oversight of the money management business, there are signs that enforcement may actually be sliding. The Financial Industry Regulatory Authority, which oversees U.S. broker-dealers, fined firms and individuals roughly $35 million in 2008, down 55 percent from $77.6 million in 2007, according to a report by Atlanta-based law firm Sutherland Asbill & Brennan. To be fair, last year was FINRA’s first full year in operation — it was created in July 2007 through a merger of the National Association of Securities Dealers and the regulation, enforcement and arbitration arm of the New York Stock Exchange. The report compares FINRA’s total 2008 fines to the combined published levies from the NYSE and NASD in 2007. Simple integration pains likely played some role in the 2008 dip in punitive fees, but experts say it was the calm before the storm. “It does not take a genius to predict that actions will be substantially higher than in the past,” says John Hewitt, a partner in the financial services practice of McCarter & English in New York. “Given the credit crisis, we expect activity to pick up considerably.” When they’re making money investors tend not to file complaints with regulators. And because there’s typically a one-year lag between the time a complaint is filed and when a penalty is levied, it looks like FINRA could be heading for a banner year. — S.T.

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KER OPENING PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS SCORECAR

PEOPLE MAKING THE MOST OFA CRISIS; HONG KONG EXCHANGE TAPS NEW CEO Michael Holmberg, the founder of Newberry Capital Management in Chicago, closed down the distressed-debt investment shop recently, returned assets to its mainly institutional clients and joined the Windy City office of the fixed-income operation of Neuberger Berman Group, bringing his team of four veteran bond managers with him. Holmberg, 48, will manage publicly traded senior secured debt of companies in default, a market he says is worth about $225 billion. By hiring him, New York–based Neuberger, the former investment management division of the bankrupt Lehman Brothers Holdings that successfully staged a management buyout less than six months ago, seems to be making the most of the U.S. financial crisis by expanding into an asset class that’s drawing investors. “From where we sit that is a compelling market opportunity,” Holmberg says. — Michael Shari

HONG KONG HUB Hong Kong Exchanges and Clearing is strengthening its ties to Beijing by tapping JPMorgan Chase & Co.’s point man in China as its new CEO. The appointment of Charles Li Xiaojia, who starts in October, marks the first time the exchange will have a CEO who was born on the mainland. He replaces Paul Chow Manyiu, a Hong Kong native who strengthened HKEx’s position as a global financial hub, with

the exchange consistently ranked in the top three globally for initial public offerings for the past three years. From January to mid-June of this year, HKEx listed eight IPOs — raising $1.6 billion, second only to the New York Stock Exchange’s volume, according to research firm Dealogic. Beijing-born Li, 48, earned a doctorate of jurisprudence at Columbia University and then worked as a lawyer on Wall Street in the 1990s. Li became president of Merrill Lynch in China before taking over as chairman of JPMorgan in China in 2003. He’s reputed to have strong ties to senior officials, especially those at the China Securities Regulatory Commission. “Li built up significant relationships in the

Chinese government over the years,” notes Albert Louie, a risk management consultant in Beijing. — Allen T. Cheng

LAWYER TO LEADER When Eric Doppstadt joined the Ford Foundation nearly 20 years ago as an in-house counsel to the investment team, he wasn’t planning to abandon the law and pursue a career in portfolio management. But 14 years after switching from a legal to an investment role — a transition he made with the help of his mentor, then-CIO Linda Strumpf — Doppstadt assumes responsibility for the $9.2 billion endowment as Ford’s new CIO. Guiding the nation’s second-largest private foundation by assets under management through turbu-

lent securities markets will be no mean feat. The 49-year-old is confident, however, that with Ford’s cash reserves and liquidity, he will be able to take advantage of some of the pricing dislocations in the months ahead. What he won’t do is emulate his mentor’s legendary passion for scuba diving with sharks in the open ocean. “All I can say is that there are enough predators in the financial world,” he quips. “I prefer to spend my leisure time doing things that don’t involve risking my life.” — Loch Adamson

ASIAN ALLIANCE Anthony Miller, a private equity manager in Asia over the past two decades, will now be mining for gems among distressed assets in Japan for Hong Kong–

CHARLES LI: NELSON CHING/BLOOMBERG NEWS

DISTRESS POTENTIAL

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RD MARKETS CEO INTERVIEW CAPITAL MARKETS COVER STORY ASSET MANAGEMENT ISLAMIC FI Counterclockwise from upper left: Neuberger Berman taps Michael Holmberg, Charles Li Xiaojia joins HKEx, Eric Doppstadt takes on a new investment role at the Ford Foundation, Anthony Miller joins Pacific Alliance, Bob Treue manages Barnegat, Jack Perkowski launches a PE fund, Josh Ellis investigates at the U.K.’s Serious Fraud Office

the managing partner, says, “China is rising, but its growth is still embryonic.” JFP will focus on the environmental technology, health care, distribution-logistics, retail, value-added manufacturing and financial services industries. Perkowski, who penned Managing the Dragon: How I’m Building a BillionDollar Business in China, published last year, began his career on Wall Street in 1973 and started Asimco, which boasted sales of $600 million last year, in 1994. — A.T.C.

TECHNO TRACKER

based Pacific Alliance Group. In June the Chicago native assumed the post of president and CEO at Pacific Alliance’s new Japan subsidiary. He’ll be investing up to $200 million in real estate and distressed assets in the coming 12 months, and as much as $1 billion over five years.“Many institutional investors invested in Japan, and many are leaving,” notes Miller, 52.“The most attractive [plays are] real estate and distressed real estate.” Miller was president of the RCG Japan unit of New York–based multistrategy hedge fund firm Ramius before joining Pacific Alliance, which has $3 billion in assets spread among hedge funds, private equity and real estate (see “West Meets East,” page 48). — A.T.C.

RIDING THE WAVES The difficult money-raising environment is déjà vu all over again for Bob Treue, CEO of Hoboken, New Jersey–based Barnegat Fund Management. Soon after he set up his hedge fund in November 1998, LongTerm Capital Management collapsed, spooking investors. “Everyone was scared,” Treue, 40, tells II. As a result, he was unable to attract fresh money until March 2000 and ran the fixed-income hedge fund with $500,000 of his own cash. In 2001 three global investors put in a combined $25 million, which Treue used to create a new offshore fund that he capped at $500 million two years later. Last year’s market turmoil pushed assets down to just over $200 million, after the

fund fell 37 percent. Barnegat is up 81 percent this year through May 31, and its assets have rebounded to $413 million. — Suzy Kenly

SHIFTING GEARS Jack Perkowski, a former Wall Street banker who founded the largest foreign-owned autoparts maker in China, has started a private equity firm in that country. Using some of his own money and that of a few partners, the former chairman and chief executive of Beijingbased Asimco Technologies launched JFP Holdings in March. The new firm will assist foreign companies in finding co-investors in China, as well as help Chinese companies lock onto acquisition targets abroad. Perkowski, 60, who is

Like a latter-day Eliot Ness, Josh Ellis enjoys nothing better than a good investigation — especially one where he can flex his skills in forensic accounting and track down bad guys by tracing their electronic footprints. The technologist will get a chance to do just that as the first-ever chief information officer for the U.K.’s Serious Fraud Office, an independent government department that prosecutes cases of complex deception. In an economic downturn, the incidence of fraud tends to rise, especially in financial services, making his role as head of a team of techsavvy investigators in the SFO’s digital forensic unit critical. The former regional director of forensic services for PricewaterhouseCoopers in Central and Eastern Europe is excited about returning to the U.K. to help tackle white-collar crime. “People can be remarkably astute and slick in how they perpetuate a crime,” Ellis notes. “But an astonishing number of them are technologically illiterate, so they don’t do a good job of covering their tracks.” You have been warned. — L.A.

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OPLE OPENING FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS SCORECARD MAR-

continued from page 9 ance by simply running a report on this system, then we can better deploy our resources. You’ve mentioned dusting off an old proposal related to public pension funds. Can you expand on that?

The Municipal Securities Rulemaking Board has a regulation, G37, that prohibits broker-dealers and underwriters from making contributions to people who are in a position to select them as bond underwriter. In 1999 the commission proposed standards that would have extended G37 to investment advisers registered with the SEC. If you make a political contribution to a state or local official who’s in position to influence the awarding of a pension fund advisory contract, then you would be disqualified from managing that municipality’s money for two years. Schapiro has called on the division to look at that proposed rule with an eye to making recommendations this summer.

“

Even a few lawbreakers can cause tremendous damage.

What has changed the most about the SEC since you arrived?

In October 1987, on Black Monday, we were at work all day and didn’t know what was going on. We — Robert Plaze SEC didn’t have computers back then, and nobody had a TV in his or her office. It wasn’t until someone’s wife called up after the market had closed that anyone here knew we were in the middle of a crash. Now if something’s going on, we know immediately. We have a market-watch room down the hall and around the corner where we can go and see the screens. — Rich Blake

”

Greenlight Capital CEO David Einhorn is shorting Moody’s

risky variableand fixed-rate bonds and other fixed-rate instruments helped fuel the crisis by allowing businesses to borrow excessive capital. He bluntly announced that his firm was shorting Moody’s Investors Service, explaining, “If your product FIVE QUESTIONS FOR DAVID EINHORN is a stamp of CREDIT COP approval where your highest rating is a curse David Einhorn, founder to those who receive it and of $5 billion-undershunned by those who are management New York supposed to use it, you have hedge fund firm Greenlight a problem.” Einhorn recently Capital, has become a spoke to Institutional Invesfamiliar and provocative tor London Bureau Chief — if often prickly — speaker Loch Adamson about the at the annual Ira W. Sohn ratings agencies and their Investment Research Confer- power to stifle any attempt ence. The fabled gathering at reform. brings together some of the 1 Why target Moody’s? best investment managers to support a foundation, named Einhorn: I felt that talking about a pure-play American for a Wall Street trader who rating firm would be more died of cancer at 29, that funds treatment for kids with interesting to the audience, but I don’t believe Moody’s the disease. ratings are worse than those In a prescient speech of Standard & Poor’s or delivered at the conference Fitch Ratings. last year, Einhorn warned that Lehman Brothers Hold- 2 Do you buy Moody’s claims that it is taking steps to manage ings was overexposed to conflicts of interest and toxic assets and urged regulators to force it to recognize improve the quality of its ratings? losses and raise capital. They did not. Less than four What else can it say? Rating agencies’ misbehavior is at months later, Lehman colthe center of the financial lapsed. At this year’s event, problem, and the Securities in late May, the 40-year-old Einhorn called on regulators and Exchange Commission showed last year that this to dismember the “governwas not the result of innoment-created oligopoly” cent mistakes. That said, the of credit rating agencies, basic problems are strucwhose inflated grades for

tural to the credit rating oligopoly and the issuerpays system and cannot be fixed through symbolic internal steps. 3 If triple-A ratings were apportioned more judiciously, wouldn’t the U.S. government be due for a downgrade?

When giving a triple-A-rated entity too much cheap credit, there is a risk to lender and borrower alike. Sovereign issuers are certainly not exempt from that hazard. 4 Given the enormous political interest in maintaining the status quo, how can regulators fix the rating process?

Elimination of the rating agency oligopoly and issuerpays system is one of the crucial distinctions between claiming a reform agenda and actually reforming the system. But the administration’s proposal announced on June 17 doesn’t eliminate the rating agencies or the issuer-pays system or break the oligopoly. So it is probably not a good, genuine reform. 5 How would you deal with the problem?

We don’t need rating agencies as part of the official process. The market evaluates credit every day and often ignores what the rating agencies say, so we could do fine without them. The situation is analogous to equity research; it should become an investordriven process. I can go to Bank of America today and ask its analysts their opinions about certain stocks, and they’ll either tell me or I can read their research. If people want to hire rating agencies to help them assess credit, they can and they should. But I don’t think agencies are needed.

DANIEL BARRY/BLOOMBERG NEWS

Market Regulation Brokerage Fines

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STIONS OPENING DID II SAY THAT? RAINMAKERS DONE DEALS SCORECARD MARKETS CEO INTE Public Pensions

NEW ZEALAND

of NZ$134 billion. New Zealand, which earns foreign currency from tourism and exports of meat and dairy products, ranks alongside Estonia and Greece at the bottom of the savings ladder among countries in the Organization for Economic Cooperation and Development. Household net savings as a percentage of disposable income is –3.8 percent, more than 9 percentage points lower than the OECD average of 5.4 percent. (U.S. households save, on average, 2 percent of income.) Critics say the move by New Zealand sends the wrong message to a population nursing a hangover from a debt-fueled spending binge. “Ten years — that’s a long time, that’s a lot of funding,” says Martin Lewington, New Zealand business leader at Marsh & McLennan Cos.’ Mercer subsidiary. When the budget moves back into surplus, “there will be other calls on the national purse.” Latvia plans to cut pension payments by 10 percent, as part of painful budget measures aimed at winning the next tranche of a US$10.4 billion

PAPER: RICHARD MEGNA; BILL ENGLISH: MARK COOTE/BLOOMBERG NEWS

PENSION SUSPENSION HAPPY TO BORROW AND SPEND, NEW ZEALAND BALKS AT BORROWAND SAVE New Zealand has joined nations including Latvia and Ireland in putting a spotlight on pension payments in the wake of soaring budget deficits. Comparing the South Pacific country’s behavior to “a person trying to save money by using their credit card,” Finance Minister Bill English suspended contributions to a fund established to help meet the retirement needs of future generations. “Shifting money from one jam jar to another does not make you wealthier,” English tells Institutional Investor. “We don’t have surpluses to put into the fund.” He plans to suspend annual contributions of about NZ$2 billion (US$1.3 billion) to the New Zealand Superannuation Fund for at least ten years starting with the 2009 budget, leaving NZ$13 billion invested in global stocks and fixed interest. The fund amounts to about 10 percent of New Zealand’s GDP

Finance Minister Bill English suspended pension contributions

International Monetary Fund package as its economy slumps. In Ireland, the government is transferring ailing public sector pension funds into the National Pensions Reserve Fund, creating a future cost for taxpayers. English projects a deficit of NZ$12 billion for next year. In addition to suspending pension contributions, he has deferred tax cuts that were slated for the next two years. His steps helped steer New Zealand away from a credit rating downgrade. Standard & Poor’s lifted the outlook on the AA+ rating to “stable” from “negative” on the day the budget was announced. The credit crisis and simulta-

DID II SAY THAT?

’67

WHAT WE SAID ABOUT “SWINGING” FUNDS

APRIL 1967 — The roots of the current economic crisis may be traced back to the late 1960s. That’s when the financial industry’s emphasis on capital preservation gave way to a new credo of risk and reward. The shift was captured in the second issue of II in a story by one of the magazine’s first editors, George Goodman, the journalist, author and public television personality better known as Adam Smith. In “Performance: The New Name of the Game,” Goodman wrote that the term “performance” has “come to mean a kind of investment policy that seeks rapid appreciation, leaving dividends, safety and diversity behind. . . . The effect is to downgrade the preservation of capital as a goal.” As Richard Jenrette, a founder of investment bank Donaldson, Lufkin & Jenrette, noted in the same article, this trend away from capital preservation included pension funds “so large that only a small fraction [of them] has to change direction to give a whole new tone to the investment scene.” How many dollars have been sacrificed at the altar of performance over the past 42 years? Too many, at least for such market players as New York–based Cantillon Capital Management, a $4.5 billion asset manager that told its clients on June 17 that it was closing two hedge funds and shifting assets into safer long-only vehicles.

neous recession in the world’s biggest economies exacerbated the impact of high interest rates and a record-high New Zealand dollar, which sapped export returns. The central bank has slashed interest rates to a record low and the kiwi dollar has returned to nearer its long-term average. The global credit squeeze has hurt a nation where property has been the most popular investment, typically financed via mortgage funds sourced overseas. During the property boom of the early 2000s, New Zealanders felt wealthier and ramped up their credit card debt on consumer goods. The current account deficit sits at 8.5 percent of GDP, up from 4.8 percent in 2003–’04. If payments had continued, the fund — designed to meet 20 percent of the nation’s pension payments — would have been worth NZ$124 billion by 2031, when it was to begin making payments. Now there will be a NZ$37.5 billion shortfall. — Jonathan Underhill Comment? Let us know what you think: [email protected].

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TICK

Morgan Stanley North American financial institutions group co-head Jonathan Pruzan says market perception has a way of becoming reality

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E

KER PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS SCORECARD MARKE

CAPITAL

NOAH KALINA

EVEN BEFORE THE OBAMA ADMINISTRATION SUBJECTED

19 major banks to stress tests this spring, Jonathan Pruzan and his colleagues in Morgan Stanley’s financial institutions group were working on how to help lenders replenish their equity coffers. Last summer, Morgan Stanley created a team of about 20 people, including bankers as well as professionals from fixed income, structured finance and equity capital markets, that began meeting three times a week to brainstorm. It was led by Pruzan, the co-head of North American FIG, and two key senior colleagues, John Esposito and Taylor Wright. In May, when the results of the stress tests were announced and the banks were ordered to raise capital, Morgan Stanley sprang into action. The playbook developed by Pruzan and his group included overnight deals, which are pulled together quickly to take advantage of sudden market opportunities; marketed deals, which are sold over a period of days; and “dribble-outs” — quiet, steady block trades in which a bank can sell as much as 10 percent of its monthly stock volume. “We were advising all our clients to be ready at a moment’s notice,” says Pruzan, 41. The results have not been too shabby. As of June 22, Morgan Stanley had surged to No. 2 in bank equity deals for the year, up from No. 9 at the same time in 2008, according to Dealogic. The firm has advised 11 U.S. banks on raising $11.98 billion in equity capital, just behind Goldman Sachs Group, which has advised 12 banks on $12.11 billion in such deals. Pruzan led the Morgan Stanley team that generated $2.7 billion for U.S. Bancorp, $1.7 billion for BB&T Corp., $1.6 bil-

lion for SunTrust Banks and $750 million for Fifth Third Bancorp. The firm moved fast in every case. About one fifth of Fifth Third’s dribble-out had been completed when a sudden burst of investor demand set Morgan Stanley running to sell the remaining $600 million through block trades on June 1. The head of Morgan Stanley’s equity syndicate, Mohit Assomull, gave the sale order over the squawk box at 4:20 in the afternoon. By 5:00, Pruzan had called Fifth Third to let it know there was buying interest for more than $1 billion. Pruzan grew up in New York City, but well outside the world of Wall Street. His father and grandparents worked in the garment industry. Pruzan followed the lead of his two brothers, who worked at McKinsey & Co. and Goldman Sachs, respectively, in the swaggering, deal-making era of the late 1980s. Pruzan joined PaineWebber & Co.’s financial institutions group in 1990, the year he graduated from Tufts University with a degree in political science and economics. His first job was as an analyst When facing chaotic working for James Kilman, a markets, nervous investors banker whom Pruzan helped and a wrathful hire at Morgan Stanley last government, Morgan year to head its specialty Stanley investment finance advisory group. banker Jonathan Pruzan Pruzan moved to Morgan was well prepared. Stanley from PaineWebber BY HEIDI MOORE in 1994. He advised on a flurry of bank deals, from the seminal merger of Chase Manhattan Corp. and Chemical Banking Corp. to Deutsche Bank’s purchase of Bankers Trust Co. to Bank of America Corp.’s acquisitions of FleetBoston Financial and LaSalle Bank Corp. In 2006 he was promoted by Derek Kirkland, then head of FIG and now a senior adviser at Morgan Stanley, to oversee its U.S. group. Pruzan took up his new post last year just in time for the biggest bank crisis in more than 70 years.“One of the lessons is that market perception becomes reality,” he notes. “You might not agree with it, but it’s best to accept it and move on.” GMAC Financial Services chief finance officer Rob Hull has appreciated that no-nonsense view as Pruzan has helped the finance company wrest its independence away from General Motors Corp. “Jon has been able to distill strategic options when they’ve not been easily discernible,” Hull says. ••

Banker to the Banks

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Cash for Clunkers For General Motors the road to insolvency has been littered with unhappy shareholders, but the automaker’s bankruptcy financing is one sweet deal. BY STEVEN ROSENBUSH

A

S GENERAL MOTORS CORP.

drove into a financial ditch, its trip to bankruptcy court was greased by $33 billion in loans from the U.S. Treasury and from Export Development Canada, a state-owned enterprise. Such loans to bankrupt companies, known as debtor-in-possession financing, can be notoriously expensive. Rates, including fees, reached as high as 20 percent in February and generally remain in the low to mid-teens. GM won’t be paying nearly market rate on its credit, though. The U.S. and Canadian governments, which will own a combined 70 percent of the new auto company expected to emerge from bankruptcy, perhaps as early as July, have provided it with some of the cheapest

DIP financing in history. Neither the company nor the Treasury would comment on the details. The Treasury referred all inquiries from Institutional Investor about the cost of the loan to GM, which in turn addressed questions by referring II to its 166-page DIP filing. The document includes a formula for calculating the floating-rate loan. According to that formula, the nondefault rate for the bulk of the deal has a floor of about 5 percent. The rate is calculated by adding LIBOR or 2 percent — whichever is higher — to a base of 3 percent. “The interesting question is whether the rate on the DIP loan was lower than appropriate,” says S. David Cohen, professor of law at Pace Law School in White Plains, New York, who is writing a book on the GM bankruptcy. GM filed for protection on June 1, reporting assets of $82.3 billion and liabilities of $172.8 billion. Based on assets it’s the fourthlargest bankruptcy filing in U.S. history, after those of Lehman Brothers Holdings, Washington Mutual and WorldCom. The reorganization will be financed with $19.5 billion that the Treasury issued earlier this year and $30 billion that it will issue later. That $49.5 billion, along with $9.5 billion from the Canadian EDC, which provides credit to exporters, will be rolled into $59 billion in equity in the reborn company. Most of the funds have been distributed, in the form of about $15 billion in bridge loans and the $33 billion DIP financing. Only one other company has been able to negotiate DIP funding at such a low rate. That’s bankrupt automaker Chrysler Group, which secured $3.3 billion in DIP funding from the U.S. government. Other recent bankruptcies financed by private lenders have been much more expensive. Lyondell Chemical Co., which filed for bankruptcy protection in February, is paying 13 percent in interest and 7 percent in fees to lenders. Shopping mall operator General Growth Properties, which filed for Chapter 11 protection this spring, secured $400 million in DIP financing from half a dozen investment companies in early May with a rate of LIBOR plus 12 percentage points. At the end of June, most DIPs still had rates of LIBOR plus 10 to 14 percentage points. General Motors’ DIP loan was arranged with the help of William Repko, head of the restructuring practice at Evercore, the New York–based investment bank founded by former Clinton administration deputy Treasury secretary Roger Altman. According to an affidavit, Evercore was paid $25 million for its work on the deal. Repko declined comment. Weil, Gotshal & Manges provided legal counsel for GM. GM will derive a competitive advantage from its cheap government financing, asserts Dan Ikenson, associate director of trade policy at the Cato Institute, a libertarian think tank in Washington. “No one else has access to capital at that rate,” he says. Allows Pace Law School’s Cohen: “It is a significant advantage for GM. But at the same time, GM is giving up control.” DIP lending is a lucrative business for private investors. But it’s not clear how much return taxpayers will see on their DIP financing, which will be converted into equity in the new GM. If the new owners, including the U.S. and Canada, can’t operate GM in the black or sell it for a profit, the return on the DIP loan could be zero. •• Comment? Click on the Capital Markets tab at iimagazine.com.

BARRY FALLS

ERS CAPITAL DONE DEALS SCORECARD MARKETS CEO INTERVIEW CAPITAL MARKETS COVER ST

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DEALS CAPITAL SCORECARD MARKETS CEO INTERVIEW CAPITAL MARKETS COVER STORYASS

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leadership of the U.S. mergers and acquisitions market. At a time when buyers are hungry for capital, J.P. Morgan Securities, backed by the balance sheet of corporate parent JPMorgan Chase & Co., was able to grab first place from rival Goldman Sachs Group. J.P. Morgan worked as a lead adviser on four of the ten biggest deals completed during the past 12 months. In each

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Deutsche Bank rises a notch. It was a co-lead adviser on two of the ten largest deals of the past year and a lead adviser on the spin-off of Time Warner Cable from Time Warner. The $35.8 billion deal closed on March 9.

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J.P. Morgan rises by advising buyers like Wells Fargo, which bought troubled Wachovia for $12.67 billion in a deal that closed on December 31, beating out Citigroup in a bidding war.

GLOBAL M&A REVENUE (VALUE $ MILLIONS)

Bank of America holds steady by helping itself. It used its own investment bank as a co-lead adviser on its $18.53 billion acquisition of Merrill Lynch, which closed January 1.

case, it represented the acquirer. Goldman Sachs was a lead adviser on six of the ten top deals, but always on the side of the targeted company. J.P. Morgan had a 9.06 percent share for the 12 months ended June 26, up from 8.53 percent for the comparable period of last year, according to research firm Dealogic. Goldman Sachs had an 8.61 percent share, down from 10.41 percent during the year-ago period. M&A activity for the past 12 months fell 40 percent, to $760.3 billion, a far cry from the $1.5 trillion level of the previous year. ••

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ARD CAPITAL MARKETS CEO INTERVIEW CAPITAL MARKETS COVER STORY ASSET MANAGEMENT

Established stock exchanges are trying to compete with a growing flock of upstarts. BY CHARLES WALLACE

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ASDAQ OMX GROUP’S SHARE

of the U.S. equity trading market is in serious decline. Since the beginning of the year, the New York– based institution, the largest U.S. exchange by share volume, has seen its piece of the pie plummet by 6 percentage points, to 21 percent, thanks to competition from dark pools and electronic communications networks. ECNs and dark pools are both alternative trading platforms, the chief difference being that the former display prices and the latter do not. These increasingly potent rivals have forced incumbents such as Nasdaq to respond with similar products of their own. “It’s fair to say that we’re feeling the pain,” says Brian Hyndman, senior vice president for transaction services for Nasdaq OMX. The exchange is not alone. NYSE Euronext saw its market share drop to 14 percent this April from 15 percent in December 2008.The two exchanges have had to defend themselves against more than 40 dark pools, electronic venues where institutional investors can trade large orders anonymously. Broker-dealers have increasingly been bypassing exchanges to execute trades using their own dark pools, a process known as internalization, which reduces transaction costs. In addition to dark pools, Nasdaq and NYSE Euronext face stiff competition from ECNs like Jersey City–based Direct Edge, which is owned by Citadel Derivatives Group, Goldman Sachs Group, International Securities Exchange Holdings, J.P. Morgan Securities and Knight Capital Group. Nasdaq is fighting back. Last month it introduced two new types of electronic flash trading that it hopes will help it reclaim some of the institutional trader business it has lost. The first, INET Flash, beams an order on the exchange’s proprietary data network to its broker-dealer customers and dark pools, where it is flashed for 500 milliseconds; if the order goes unexecuted, it is canceled. The second type, known as Routable Flash, checks Nasdaq’s proprietary data network of broker-dealers for an execution; if none is found, the order can either be canceled or routed back to the public exchanges. Flash orders are already generating 60 million to 70 million trades daily. (Nasdaq OMX trades more than 2 billion shares a day overall.).

In addition to Nasdaq, the Kansas City, Missouri–based BATS exchange last month introduced BOLT, a flash-trading system intended to protect its market share — 9.6 percent in April — from further incursions by ECNs. NYSE Euronext has chosen to mount a legal challenge. In a letter to the Securities and Exchange Commission, says NYSE Euronext executive vice president Joseph Mecane, it complained that flash trading is “creating a two-tiered market, with some participants having privileged access to orders and information.” SEC chairman Mary Schapiro announced that her agency would be “taking a serious look at what regulatory actions may be warranted in order to respond to the potential investor protection and market integrity concerns raised by dark pools.” According to Adam Sussman, head of research at TABB Group, a New York–based market research and consulting firm, Nasdaq’s current market share is a far cry from the 30 percent it once enjoyed. Meanwhile, dark pools have seen their portion rise, going from 6 percent in December 2008 to 7 percent in April; in the same period that of ECNs climbed from 9 percent to 12 percent. Although share trading has become a low-margin, highvolume business, some dark pools owned by big brokers have an advantage because they don’t charge anything to trade off the exchange. Direct Edge has been particularly successful in attracting business, with a proprietary enhanced-liquidity program that takes orders from a private network of 25 to 30 broker-dealers. “This is a critical issue for the exchanges, because Direct Edge has been such an effective competitive weapon,” notes Justin Schack, a market structure analyst at Rosenblatt Securities in New York (and a former Institutional Investor editor). Beyond developing its flashtrading products, Nasdaq is expanding in Europe, where a similar battle is shaping up between the long-standing — Mary Schapiro, SEC exchanges and newcomers like Nomura Holdings’ dark pool, Chi-X. “We are the most competitively priced of the dark pools in Europe at the moment,” asserts Charlotte Crosswell, president of Nasdaq OMX Europe. The hope is that by coming to market early, the exchange will gain the kind of advantage that dark pools have achieved in the U.S. ••

“

The SEC will be taking a serious look at what regulatory actions may be warranted in order to respond to market integrity concerns raised by dark pools.

”

Comment? Click on the Capital Markets tab at iimagazine.com.

JOSHUA ROBERTS/BLOOMBERG NEWS

Trading Titans Fight Back

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ARKETS CAPITAL CEO INTERVIEW CAPITAL MARKETS COVER STORY ASSET MANAGEMENT ISLAM

I’ve ever seen. Could the whole industry really be in trouble?’” Eckert, 54, says. He moved quickly to gird the company, based in El Segundo, California, for the slowdown. Eckert laid off almost 1,000 people late last year and cut prices on many toys before the holiday rush. Still, the recession hit hard. Sales declined by 11 percent in the fourth quarter from the same period a year earlier, to $1.94 billion, and earnings tumbled 46 percent, to $176.4 million. Toy companies tend to do badly after the holidays, but this year’s first quarter was particularly gruesome. Mattel’s revenue dropped 15 percent, to $785 million, reflecting decreased toy sales and the translation effects of a stronger dollar. International sales, which generate roughly half of the company’s revenue, were down 23 percent, with the dollar accounting for 13 percentage points of the decline. Mattel posted a $51 million loss, compared with a yearearlier loss of $46.6 million. Its stock closed at $15.79 on June 17, down from a 52-week high of $21.95 on August 11. The company did receive one boost this spring, when a federal judge upheld a 2008 ruling that awarded Mattel $100 million in damages and gave it control of rival MGA

Not Playing Around Mattel CEO Robert Eckert guides the toy company through the trials of recession.

BRENDAN SMIALOWSKI/BLOOMBERG NEWS

Robert Eckert, CEO of Mattel, is hopeful that the economy will maintain its current level of activity throughout the year

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BY CLAUDIA DEUTSCH

OBERT ECKERT, CHIEF EX-

ecutive of Mattel, the world’s biggest toy marketer, remained relatively sanguine as the U.S. economy weakened last year. He knew that, historically, even the most cashstrapped adults have been inclined to spring for a Barbie doll or a Hot Wheels car for their kids at the holiday season, when as many as half of all toys are sold. “People will self-sacrifice if they have to, but they don’t want their children to realize that times are tough,’’ Eckert notes. Yet when the global economy went into free fall in the fourth quarter of last year, following the collapse of Lehman Brothers Holdings, Eckert finally felt his share of angst. Industry numbers show that domestic toy purchases fell 5 percent from the same period of the previous year. “I remember thinking, ‘This is the worst number

Entertainment’s Bratz line of dolls, which was based on drawings by a former Mattel employee. Eckert met recently with Institutional Investor Contributing Writer Claudia Deutsch and discussed how he plans to manage his way through the economic downturn and other challenges facing the company. Institutional Investor: Do you see any signs that the current recession is abating? Eckert: I won’t say the industry is optimistic, but we’re hopeful that

the economy can hold at the current level between now and the end of the year. We’re not seeing positive news, but we’re finally seeing the absence of constant negative news. For a couple of months, all we kept seeing was more bad news, record unemployment, record profit declines — I’m hopeful that we’ve leveled off. Long term, history has proved that recessions end.

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KETS CAPITAL CEO INTERVIEW CAPITAL MARKETS COVER STORY ASSET MANAGEMENT ISLAMIC F

capitalize on the relationship between moms and kids — in one case through nutrition, in the other through education and entertainment.

How important was the Bratz victory?

Winning that case was important on principle — the people who design toys here should know that we will protect what is ours. If you design a toy here, we want to make sure that this company gets the benefit.

In fact, the advent of digital games and the Internet has broadened Barbie’s appeal. Our sweet spot used to be five-year-olds, because as girls got older, they didn’t want to be caught playing with dolls. But now we’ll get eight-year-olds or even older girls visiting Barbie.com and Barbiegirls.com and playing with the doll online. So the Internet has let us double Barbie’s life span with girls. Boys can now play with Hot Wheels online too. Even Fisher-Price, our line for infants to four-yearolds, has gone interactive. You can plug its newest exercise bike for three-year-olds into a TV set, and as kids pedal they can also play learning games on the video screen. In 2007, Mattel had to recall some toys that were made in China, because they turned out to be unsafe. Yet you still do most of your manufacturing in China, Indonesia and Thailand. Why should parents believe that it won’t happen again?

“

The Internet has let us double Barbie’s life span with girls. Boys can now play with Hot Wheels online too.

”

We reorganized the company in 2007 for just that reason. We have teams of safety engineers who report directly to me. We created the job of senior vice president for corporate responsibility, who also reports to me. And we’ve strengthened our testing protocols and added more redundant checks. It’s a lot harder for anyone to circumvent our rules for how you make a Mattel toy, and it’s a lot harder for a defective toy to get through our system. Mattel owns and operates many of its plants in China. Since you feel so confident of your testing protocols, wouldn’t it be easier, and even cheaper, to simply hire local manufacturers to make toys?

It’s a question of volume and a toy’s life span. We’ve made Barbies for decades — we’re way up the experience curve. And we make maybe 600 million Hot Wheels cars every year, so we know how to design and manufacture them at highest quality standards at lowest costs. But we’ll usually use outside plants to make new toys. It’s a fluid system — we constantly review each toy to see if it should be made in a Mattel plant or a vendor plant. You were running Kraft Foods when Mattel asked you to be its chief in 2000. Why didn’t Mattel promote from within, or at least tap another toy industry executive?

Mattel had fallen on hard times. It had spent $3.5 billion to buy an educational software company called the Learning Co. It lost lots of money. The board held existing management responsible for that decision and was ready for change. Kraft and Mattel are in incredibly similar businesses. Both

Well, we immediately sold the Learning Co., for virtually nothing. And we got rid of Mattel’s cultural silos. The company had been structured so that groups were competing instead of cooperating. There was a manufacturing organization that worried about processes, a distribution group that worried about shipping, a sourcing organization that bought toys or parts from other plants and so on. You couldn’t make a fully informed decision on whether to make or buy a toy, for example, because manufacturing and sourcing had different interests. We now have a system where a group is responsible for making and distributing specific toys, not carrying out specific functions. And we instituted some real management training and development programs. I guarantee that when I finally leave, the board will have good internal candidates to consider. Mattel has always emphasized the value of good corporate citizenship. Are philanthropic giving and the green movement luxuries that Mattel can afford in this economy?

As I’m talking to you, I’m drinking plain tap water from a cup that says it’s made of compostable corn. The difference is, I had to consciously change my behavior. The younger generations fully understand the interplay of the planet and profits. The point is, greener can be cheaper. We’ve gotten rid of a lot of excess packaging, and we’ve gotten more efficient at utilizing space in shipping containers so that we can ship more toys per trip. We just remodeled our design center. It’s now lit by skylights. It’s a friendlier place to work and a lot more fuel-efficient. Have you had to cut back on philanthropy?

When I joined this company in 2000, we were losing $1 million a day and we still fulfilled a $25 million commitment we’d made to the UCLA medical school. Tough times come and go, but we don’t renege on our commitments. Our rule has traditionally been to give 2 percent of pretax profits to charity. That won’t be a huge number this year, so we’re relaxing the rule to maintain our giving levels. Charities have told us that if we can be predictable, they can build infrastructure around us, so maybe we’ll change the rule to 2 percent of profits over the past five years or so. And what about executive pay? Has Mattel relaxed the rules on that as well?

My compensation dropped 38 percent in 2008. I don’t have a company car anymore, and Mattel didn’t pay bonuses to executives. Mattel walks the walk when it comes to pay for performance. •• Comment? Click on the Capital Markets tab at iimagazine.com.

BRENDAN SMIALOWSKI/BLOOMBERG NEWS

Iconic brands like Hot Wheels and Barbie have served Mattel well over the years, but they must seem old hat to today’s Internet-savvy kids. Are you developing a Barbie equivalent for the Internet age?

So what needed to be fixed at Mattel, and how did you fix it?

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Vincent Farina of Farina and Associates has spent more than four decades working on the floor of the New York Stock Exchange

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CAPITAL MARKETS

Last Man

Standing?

Technological changes and weak markets are threatening the livelihoods of the NYSE’s dwindling band of floor traders. But veteran broker Vincent Farina is determined to carry on. By Rich Blake

PHOTOGRAPHS BY MICHAEL EDWARDS

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CAPITAL MARKETS

E

EACH WEEKDAY JUST BEFORE 8:00 A.M., VINCENT FARINA

arrives at his office on the tenth floor of 20 Broad Street in lower Manhattan, upstairs from the New York Stock Exchange. He pours himself a cup of coffee, reads his e-mail and checks the overnight markets on his Bloomberg Terminal. Then at about 9:00 a.m., half an hour before the opening bell, Farina goes down to his firm’s station on the NYSE trading floor and greets the six other members of his trading crew. For most of his 40-plus-year career, Farina would spend the bulk of the trading session on the floor, personally executing his clients’ most sensitive orders. In recent years, though, as the Big Board and its customers have shifted more and more of their orders to faster, electronic trading systems, Farina has been heading back upstairs earlier and earlier. On a recent Friday morning, with no orders to handle, he was back at his desk by 10:45 a.m. “Slow today?” asked Farina’s sole upstairs employee, daughter Danielle, who oversees operations and administration. “Slow would be nice,” sighed a frustrated Farina, glancing up at a television tuned to CNBC. Farina has seen plenty of ups and downs since he first stepped onto the exchange floor as a clerk in the mid-1960s. From the ending of fixed commissions on May Day in 1975 to the October 1987 stock market crash to the tech stock bubble of the late ’90s to the attacks of September 11, 2001, the 61-year-old broker has lived and traded through tumultuous events at the heart of the U.S. financial system. But technology now threatens to do what bear markets, recessions and terrorists failed to do in the past: end a way of life for Farina and his dwindling cohort of floor traders. “The buy side wanted fast, cheap execution,” Farina tells Institutional Investor. “Well, they got it. Now everything is algorithms, crossing networks, dark pools. Humans have been almost completely replaced by machines. I keep waiting for the market to realize the upside of having a human involved in the process. For a throwback like me, that’s my only hope.” These days fewer and fewer traders share that hope. As recently as December 2005, the floor was home to 1,244 equity members — specialists, now called “designated market makers,” and brokers — and 2,087 clerks, according to the exchange. Today there are 442 equity members and 627 clerks. Farina and Associates is one of the last of the NYSE’s independent floor brokerage houses, firms once known as “$2 brokers” because of the fixed per-trade commission they used to charge. The number of independents has fallen to fewer than a dozen from 50 or more two decades ago, Farina estimates.

“I’m not averse to technology – I just think The floor is a victim of technology. Electronic exchanges such as longtime rival Nasdaq Stock Market and recent upstart BATS Exchange have siphoned off much of the activity from the floor by creating ultrafast trading networks. The NYSE responded to the pressure in 2006 by acquiring an electronic exchange of its own, Archipelago Holdings; the following year it snapped up Euronext, the multinational European exchange that had itself gone largely electronic, to create holding company NYSE Euronext. Now, of the roughly 6.5 billion shares of U.S.-listed stocks that change hands each day, the NYSE handles only about a third of the total, according to industry estimates. Even for NYSE-listed stocks, the exchange has a market share of just 42 percent, according to its most recent statistics. A substantial percentage of the volume that does make it to the floor, moreover, is executed via a single click on NYSE Arca without the need for two human beings — a floor broker and a specialist — to interact. Floor brokers accounted for just 5 percent of overall volume in April, exchange data show. Determined to keep swimming against the tide, Farina makes sure that his floor team is equipped with state-of-the-art systems for

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Vincent Farina on the floor of the once-congested New York Stock Exchange, where machines now outnumber people and floor traders fight for survival

this trend toward the machines has gone too far.” — Vincent Farina, Farina and Associates

carrying out smarter and faster executions. They use an expensive, powerful order management system called Mixit that gives them access to practically every liquidity venue on the planet. “I’m not averse to technology — I just think this trend toward the machines has gone too far,” Farina says.“People who fought for these changes used to say that the guys on the floor picked them off. Do they really think the guys upstairs running those dark pools aren’t picking them off? People want transparency — you get that here on the floor, not in a dark pool.” GROWING UP IN THE BENSONHURST SECTION OF BROOK-

lyn, then largely a working-class Jewish and Italian neighborhood, Farina knew exactly how he wanted to spend his days: as a longshoreman, like his father, Vincenzo. A first-generation Italian immigrant, Vincenzo worked brutal hours unloading freight cargo on Piers 57 and 59 on the West Side of Manhattan. “He always worked Monday through Saturday, and sometimes Sunday,”Farina recalls.“There were even times when he worked for several days on the docks without leaving — eight hours on, four hours off — until a ship was emptied.”

Grueling as that life was, the younger Farina wanted in. “When I graduated high school in 1964, I asked my dad when I could start down on the docks, and he told me in his broken English, ‘No way, son, you gonna work in an office!’ ” So Farina, at 17, found a summer job as an office boy in the Rockefeller Center offices of brokerage firm Bache & Co. He transcribed handwritten tickets into a ledger, fetched coffee — “basically anything that needed doing,” as he puts it. After a year’s active duty in the U.S. Army Reserves, Farina came back to New York and to his old job at Bache. He also worked nights as a bouncer at a nightclub in Queens, where he met his future wife, Lorraine.“I checked her ID, and the rest is history,” he says. One of Bache’s office managers assigned Farina to the floor of the NYSE, where the action was. Bob White, who at the time oversaw Bache’s floor operation, helped him make the transition, and eventually, Farina landed a job as a clerk at now-defunct brokerage firm Lockwood Peck. Later he moved to E.H. Stern & Co., which would become Lasker, Stone & Stern. Lasker Stone comprised three units: a commission-based broker-

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age, a specialist group and a proprietary arbitrage desk. “When I started clerking on the floor, we sent handwritten trading slips upstairs using pneumatic tubes,” Farina says. “Later we used big computer punch cards — that was considered modern.”In December 1974, Farina became a licensed floor broker, which allowed him to trade directly in the market. Farina’s supervisor was a no-nonsense, widely admired trader named Bobby Oscher. Nicknamed “Bobby O,” Oscher was Lasker Stone’s head of execution and worked under Bernard (Bunny) Lasker, an arbitrage legend and a former chairman of the NYSE. (Lasker was the “bunny” invoked in Martin Siegel’s infamous Boesky-era quip, “Your bunny has a good nose.”) Oscher, a fellow Brooklynite, became Farina’s mentor and role

and Farina maintained a small but loyal client base. But business, he says, has never been the same. Still, whereas some of his contemporaries have taken to watching DVDs during business hours, Farina soldiers on, staying as positive as he can. “You have to try to do your best,” he explains.“I’ve watched a lot of guys throw in the towel. I’ve chosen to stick it out. We have long-standing clients who rely on us.” Farina realizes that if he is to stay in business, he and his team have to find a way to convince traders and portfolio managers that certain large or time-sensitive orders are better handled by human traders. “Just because something is faster and cheaper doesn’t mean it’s better,” notes daughter Danielle, a Villanova University graduate who clerked several years for specialist firms Van der Moolen Holding and Spear, Leeds & Kellogg before joining the family business last year. (Vincent’s other daughter, Nicole, doesn’t work there, though her husband, Billy Sachs, does, as a floor broker.) She adds, “We give our traders access to all the same technological tools as anybody upstairs, but ultimately, what we bring to the table is superior service, the comfort and security of knowing an order is in good hands and that it’s going to get done.” The human touch can come in handy at other times also.“Machines malfunction,”Vincent Farina likes to point out. Now and then his phone rings because somebody’s automated system has gone down. “Not too many guys can figure out an arb-spread trade with pen and pad,” he notes. “Everybody talks about customer service and best execution, but Vin takes it personally,”says Christopher Crotty, 40, a veteran floor trader of convertible securities who joined Farina five years ago from a competitor.The NYSE member firms, broker-dealers and small to midsize money managers that deal with the firm do so because “they trust us,” he asserts.“In some ways the Street hasn’t changed after all these years. Guys still want to know exactly who they’re trading with.” Guys like Choset. During one recent session the arbitrageur had a 35,000-share order he considered time-sensitive because of possible “headline risk,” as he puts it.“I called down to the floor to make sure that Vin was in the crowd and that he would personally handle the order,” he recalls. Farina sprang into action. He thought about using an algorithm but instead decided to break the order into small lots and trade it directly on the floor. Within half an hour the deal was done. “I’m not averse to the modern way of trading,” Farina says.“But at heart, you can say, I’m old school.” It’s an open question whether floor traders can continue to survive, considering the onward march of technology. But Farina is determined to carry on. “This is the kind of market where the people who know what they are doing — who have been through tough times — can add value,” he says.“I love this business. It got into my blood when I was young, and it’s still there.” ••

“You have to try to do your best. I’ve watched a lot of guys throw in the towel. I’ve chosen to stick it out. We have long-standing clients who rely on us.” — Vincent Farina, Farina and Associates

model. Together they handled orders for many of the biggest, bestknown Wall Street traders during the heyday of merger arbitrage. “If, at the start of the day, I wanted to sell 95,600 shares by the end of a session, there were two guys on that floor — and I mean only two guys — I would trust with the order,” notes Warren Choset, a pioneer on Merrill Lynch & Co.’s risk arbitrage desk in the mid- to late 1970s who currently works at New York hedge fund firm Havens Advisors. “Bobby and Vinny. No one else. And believe me, for Vinny to be mentioned in the same breath as Bobby O — both in terms of market skills and integrity — that’s saying a lot.” In 1980, at the age of 53, Oscher was diagnosed with pancreatic cancer. He went into the hospital and never left. His sudden passing was a tough loss for the firm, and for Farina. “He taught me the business,” he says. “Not just how to trade, but how clients, their needs, always came first.” By the end of the fast and furious ’80s, Bunny Lasker was looking to slow down and trade just his own capital. Lasker Stone split in 1989, with Donald Stone taking the specialist piece and Farina taking the brokerage business, injecting his own capital and forming Farina and Associates with ten employees in January 1990. He enjoyed some great years in the ensuing decade (“I made enough to put two daughters through college,” he says) but continued to face obstacles, most formidably the introduction of decimal pricing, a major market structure change that was ordered by the Securities and Exchange Commission in the late ’90s and put into effect at the NYSE in the summer of 2001. The new rule “killed us,” insists Farina. “A hundred price points, as opposed to eighths or sixteenths, made it harder for guys like me to make money and easier for the machines, so we lost large orders.” Increased volume slightly offset the drastic narrowing of spreads,

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COVER STORY

SPECIAL REPORT GLOBAL WARMING

Climate Challenge The

C

Climate change poses growing risks to the environment — and the economy. As governments negotiate a successor plan to the Kyoto Protocol, we examine how investors are addressing these risks (page 28) and looking to profit from a new generation of clean-energy technologies (page 32).

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COVER STORY

SPECIAL REPORT GLOBAL WARMING

As countries step up efforts to combat climate change, investors are increasingly looking to exploit the opportunities — and minimize the risks — of a low- carbon future.

Winds Change of

By Jeremy Lovell

Is climate change the next new thing in investing? The issue of global warming is moving up the political agenda as the Obama administration pushes for the introduction of a cap-and-trade scheme to limit U.S. carbon emissions and governments around the world seek to reach a new agreement by the end of this year to contain greenhouse gases. There is no guarantee that these initiatives will succeed, especially in the short run. But climate change promises to exert a growing influence on investment decisions, from whether to fund the development of alternative-energy sources like wind and solar power to how to value the big carbon-emitting industries like automobiles, steel and utilities. “Technology is something that has impacted every single industry on the planet,” says Jan Babiak, global head of climate change and sustainability services at Ernst & Young. “Lowcarbon transformation is very similar. Every industry, every household, every government, every country, every part of society will be impacted by it.” Some 800 funds worldwide, managing $95 billion, focus on climate change or clean energy, according to New Energy Finance. The London-based consulting firm, along with DB Climate Change Advisors, an arm of Deutsche Asset Management, recently surveyed more than 100 institutional investors managing a total of more than $1 trillion and found

ILLUSTRATION BY BRIAN STAUFFER

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COVER STORY

that 75 percent of them expected to increase investments in clean energy by 2012. Recent programs undertaken by many countries to restart their economies are giving an added boost to the sector. Deutsche estimates that $106 billion of the U.S.’s $787 billion stimulus package is earmarked for spending on energy conservation, renewable energy, mass transit, a smart energy grid and related areas. The European Union has committed $60 billion to similar initiatives. To be sure, investment opportunities in climate change depend significantly on the price of energy. The surge in oil prices to more than $145 a barrel last year made many alternative-energy sources economically viable and conservation measures compelling. Carbon’s impact on corporate bottom lines dwindled when oil prices collapsed, though. The HSBC Climate Change index, which tracks about 350 stocks that are expected to benefit from climate change, outperformed the MSCI World index by more than 60 percentage points between January 2006 and May 2008, but it gave up most of its gains over the following five months. The rebound in oil prices to $70 a barrel in recent months promises to provide a fresh impetus. More and more, governments are seeking to impose rules curbing carbon emissions at national, sectoral and even corporate levels through measures ranging from cap-andtrade plans to energy-efficient building requirements to vehicle exhaust limits. The EU led the way, with the introduction of its Emissions Trading Scheme in 2005. Australia and New Zealand are also considering cap-and-trade systems to limit carbon emissions. In the U.S., where Congress is debating such a program as part of an energy bill, ten Northeastern and Midwestern states have already The return of the U.S. as an active participant has invigorated global introduced carbon trading and negotiations on combating cliemission limits under the Regional mate change, but just months ahead of the talks’ supposed Greenhouse Gas Initiative. deadline, governments remain far “When a price gets put on apart on targets for reducing carcarbon, what we do for a liv- bon emissions — and on who ing is going to be important in should pay the enormous tab. The United Nations Climate bringing capital to solutions,” Change Conference will gather says Kevin Parker, CEO of environment ministers from more Deutsche Asset Management in than 190 nations in Copenhagen New York. Deutsche, which sees in December in an effort to agree climate change as a megatrend on a successor plan to the Kyoto Protocol, the 1997 accord that that will have a major effect on called for reducing global carbon investment activity in coming emissions to 5 percent below 1990 decades, drew attention to the levels by 2012. Kyoto has been honored more issue in June by launching a in the breach than in the obsercarbon counter — a real-time vance. Although the Clinton indicator showing the estimated administration signed it, the U.S. levels of greenhouse gases in the Senate refused to ratify the pact, atmosphere — on a giant bill- and the Bush administration effectively discarded it. Developing board outside New York City’s nations, most significantly China, which last year surpassed the U.S. Pennsylvania Station.

Climate Talks Heat Up Nations remain divided on details of a new global pact.

Carbon trading volume rose 37 percent in the first quarter of this year from the previous quarter, to 1,927 million tons, but the value of those trades declined by 16 percent, to $28 billion, reflecting weaker energy prices, according to data from New Energy Finance. “Climate change has hit first in companies that have significant direct emissions — particularly in Europe, because of the Emissions Trading Scheme — so we are talking about utilities, steelmakers, cement and so on,” says F&C Investments associate director Vicki Bakhshi, who covers the oil and gas and insurance industries for the London-based money management firm and heads its climate change program. “Every equities analyst worth their salt who is analyzing one of these companies will, as a matter of course, incorporate carbon emissions as part of their evaluation.” Rory Sullivan, head of responsible investment at Insight Investment Management in London, argues that it is misguided to assume that the size of a company’s carbon footprint equates directly to its climate risk and ability to profit from climate change — and, therefore, to its share price. “Where climate change or carbon liabilities are material, it is already in the numbers,” he asserts. “The really interesting issue is the strategic one — to what extent are companies looking further into the future and looking at their supply chains? That is where it is less clear-cut. It is an open question as to how much investors are really analyzing those issues at the moment.”

as the world’s biggest emitter of carbon dioxide, aren’t covered by the agreement. A hardening scientific consensus about the risks of climate change has given an impetus to the Kyoto follow-up negotiations. The scientists at the Intergovernmental Panel on Climate Change warn that unless urgent action is taken to halt and reverse the buildup of carbon dioxide and other greenhouse gases in the atmosphere, average world temperatures will rise by between 1.8 and 4.0 degrees Celsius (3.2 to 7.2 degrees Fahrenheit) by the end of the century, causing species extinctions, rising sea levels and dramatic changes in rainfall and storm patterns. President Barack Obama, who advocates a U.S. cap-and-trade system to contain carbon emissions, has vowed to push for a deal at Copenhagen. U.S. negotiators have so far offered to reduce the country’s emissions to 1990 levels by 2020 — in effect a 15 percent cut from current levels — and then slash them by 80 percent by 2050. The European Union, among the most enthusiastic backers of Kyoto, is almost on track to achieve its target of an 8 percent decrease by 2012. The bloc has already agreed internally to bring emissions to 20 percent below

1990 levels by 2020 and has offered in the UN talks to raise that target to 30 percent. China and India blame the developed West for causing the climate problem and insist that those nations should lead the way in cutting greenhouse gases — and foot the bill for efforts by developing countries. China, which aims to achieve GDP growth of 8 percent this year and relies mostly on carbon-intensive coal for its energy, has refused to offer any emissions reduction targets in the global talks. Yvo de Boer, the chief UN official at the talks, acknowledges that ministers are unlikely to reach a detailed agreement in December. Still, he hopes for a framework deal that includes tough emissionsreduction targets for developed countries, binding commitments by major developing nations to take action on emissions and sources of long-term financing to promote cleaner technologies. Michael Zammit Cutajar, the Maltese diplomat chairing the negotiations, is optimistic about the Copenhagen talks despite a lack of progress in preparatory meetings in Bonn last month. “This is like the evolutionary process in reverse,” he notes. “The Big Bang comes at the end. We hope it is going to be a very big bang.” — J.L.

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A recent report by the Carbon Trust, an indea long-term environment where the cost of carbon pendent agency set up by the British government to is likely to be higher and there will be political and advise businesses on climate change, underscored policy imperatives to reduce emissions, and what the potential for carbon to have a big impact on that means for them,” explains David Russell, cocorporate valuations. The report focused on seven head of responsible investment at the fund. global sectors, with a current combined market USS is currently talking with a company in India value of some $7 trillion, where it said that climate about plans for the possible introduction of carchange regulation had the potential to either generbon emission regulations in that country. “We are ate new profits or impose new costs. For example, asking the company how it is looking at this issue in the aluminium sector, it said, companies that over the next ten, 15, 20 years, where infrastructook early action to reduce their carbon footprint ture developed now will be around for potentially could increase their market valuations by as much decades; how they are factoring in the implications as 30 percent, whereas those that did not risked of a cost of carbon and emission reductions, or the physical impacts of climate change, into their seeing their valuations drop by 65 percent. For developments now,” says Russell, who declined to the auto industry the range extended from +60 percent to –65 percent; in building materials the identify the firm. Tom Curtis potential value change ranged from +80 percent — Although some organizations are taking steps DB Climate Change Advisors to –20 percent. to limit their carbon footprints, others are doing “In most cases, carbon is just one factor among more talking than acting.“Companies are starting to many in an investment decision,” points out Tom market themselves around their environmental perCurtis, global co-head of DB Climate Change Adviformance,” notes Seb Beloe, director of responsible sors. “A lot of it comes down to data, and that is investment at Henderson Investments in London. getting better all the time. We are starting to get to “Three or five years ago, that wouldn’t have hapthe point where an investment manager can start to quantify the pened. The need to look behind the message has always been there, carbon exposure.” but it is much more of an issue now.” Some of the best potential investments may be in the U.S., accordHenderson has avoided investing in corporations whose green ing to a recent research report by Joaquim de Lima and Vijay Sumon, spin it deemed to be well ahead of commercial reality, says Beloe. quantitative equity analysts at HSBC in London. (That’s ironic, given One such case is Japan’s GS Yuasa Corp. The company’s share price the U.S.’s checkered history in the debate about climate change.) soared recently after it drew attention to its production of lithium ion “The U.S. now has an opportunity to become the engine for batteries for electric cars, but Beloe point out that the overwhelming growth in climate change investing,” they wrote. The U.S. accounted majority of GS Yuasa’s output is lead acid batteries. And despite the for 18 percent of global climate revenue last year, and that figure has fact that Brazil’s Cemig is part of the Dow Jones Sustainability index, been growing at a compound annual rate of 26 percent since 2004 Henderson has steered clear of it as well because of its involvement even though the country did not ratify the Kyoto Protocol or enact in a controversial dam in the Amazon. federal climate change legislation. Henderson is also prepared to lobby businesses for changes in The report identifies energy efficiency and low-carbon energy behavior. Beloe cites the case of China’s Suntech Power, a maker production — in particular solar power — as key potential growth of solar power equipment whose share price tanked last year after sectors, because they are the biggest beneficiaries of the Obama the Washington Post reported that the company was dumping its administration’s economic stimulus package. It also highlights waste on farmland. Henderson prodded Suntech to address the potentially key drivers of activity, such as the need to smarten the issue, and it responded by putting tough environmental clauses in its supply contracts. electricity grid and improve the energy efficiency of buildings. Investors need to keep a close eye on regulatory and political Analysts at Deutsche forecast that investment in clean energy, energy efficiency and other climate change sectors could hit $650 bil- developments. Ernst & Young estimates that 250 pieces of major lion a year over the next 20 years, up from $150 billion in 2007. climate-related legislation have been introduced around the globe “We are actively engaging in developing the low-carbon technolo- in the past year alone. The outcome of the United Nations talks in gies,” says Curtis.“We are also quite excited about energy efficiency. Copenhagen this December could also have a significant impact on We think it is low-hanging fruit.” Deutsche believes that the most markets in the short term. But whatever happens in coming months, promising investment targets are makers of insulation and smart the effect of climate change on the market is likely to grow. meters as well as developers of new window technology, all of which “We are well positioned for whatever happens at Copenhagen,” increase energy efficiency in buildings; low-carbon transportation, says Henderson’s Beloe. “If it succeeds, then tougher targets will such as electric car technology; and renewable energies like solar come in over a shorter time period. If Copenhagen fails to come up and wind power. with a strong agreement, international renewable companies would The Universities Superannuation Scheme, the second-largest be hit, and some of the carbon traders would definitely be hit. But U.K. pension fund, with £23 billion ($38 billion) under manage- it is not going to derail the whole thing.” •• ment, takes carbon emissions into consideration when making Comment? Click on International Markets at iimagazine.com. investments. “We look at how companies are managing a shift to

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We are starting to get to the point where an investment manager can quantify the carbon exposure.

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COVER STORY

SPECIAL REPORT GLOBAL WARMING

The alternative-energy sector has suffered along with the broader economy of late, but patient money managers see profits on the horizon as the quest for environmentally friendly sources of power generation intensifies.

From

Smokestacks to

Greenbacks By Katie Gilbert

Last summer, as the price of oil was peaking at more than $145 a barrel, legendary oilman T. Boone Pickens Jr. emerged as an unlikely clean-energy pitchman. The 81-year-old investor was trumpeting a novel plan to build a wind farm in his home state of Texas that would produce 4,000 megawatts of electricity, enough to power 1.3 million homes, which he figured would free up natural gas to run cars more cleanly and help slake Americans’ seemingly unquenchable thirst for foreign oil. Just a few months earlier, Pickens had put his money where his mouth was: His Dallas-based company, Mesa Power, paid $1.5 billion for 667 General Electric Co. wind turbines, slated for delivery in 2011 and expected to generate 1,000 megawatts of clean energy. By 2014, Pickens reckoned, the additional turbines he needed would be in place and the initiative, dubbed the Pampa Wind Project, would be fully operational. Unfortunately for Pickens, gale-force economic winds began blowing in the wrong direction. Credit markets, the lifeblood of large-scale alternative-energy projects, all but locked up. Difficulties in finding a grid to distribute the farm’s electricity and the plunge in oil prices, which sapped investor interest in the project, also created unexpected problems. Pickens was soon compelled to declare his timetable unrealistic. The feisty Texas billionaire isn’t the only alternative-energy investor whose plans have been disrupted by market turbulence. Although the sector attracted $155 billion in capital in 2008, up fourfold from 2004, investment flows fizzled in the second half of last year as the credit crisis intensified, according to data from London-based research

ILLUSTRATIONS BY BRIAN STAUFFER

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COVER STORY

firm New Energy Finance. From the second quarter of 2008 to the first quarter of 2009, asset financing dropped by nearly 60 percent, to $11.5 billion. Venture capital and private equity investments fell by more than half, to $1.8 billion. And public market investment fell off a cliff as valuations collapsed: The WilderHill New Energy Global Innovation index, which tracks 85 clean-energy companies with market caps north of $100 million, fell 61 percent last year, far outpacing the 38.5 percent drop in the Standard & Poor’s 500 index. “There are going to be good companies with promising technologies that can’t get financing,” says Brian Fan, senior director of research for Cleantech Group, a research firm in San Francisco. Even so, the economic shakeout may ultimately prove to be healthy. “The downturn has felt terrible — in the long run it’s likely essential,” says Russell Read, former chief investment officer of California Public Employees’ Retirement System, who left the pension fund in 2008 to co-found C Change Investments, a private equity firm based in Cambridge, Massachusetts, that invests in clean-energy companies. The current economic environment reminds him of the early 1980s, which marked a major turning point for several emerging industries and ushered in roughly two decades of sustained growth. “I believe we’re at such an inflection point today,” explains Read, who expects the alternative-energy sector to be among the biggest beneficiaries. The fundamentals underlying investor interest are hardly a passing fad. Global warming, once the province of obscure scientific debate, has become a mainstream concern, driven by a growing consensus that the world’s dependence on fossil fuels isn’t ecologically — or economically — sustainable. This consensus has sparked new entrepreneurial ferment in the energy sector and attracted a variety of name-brand investors, including venture capital powerhouse Kleiner Perkins Caufield & Byers, which in late 2007 teamed up with Generation Investment Management, a money management firm co-founded by former vice president Al Gore, to “find, fund and accelerate green business,” and Khosla Ventures, a venture capital fund run by Sun Microsystems co-founder and Kleiner Perkins alum Vinod Khosla. Many other investors in the venture capital, private equity and hedge fund arenas have followed their lead in search of profit. Now a wave of government stimulus money is poised to wash over the alternative-energy industry. Of the $2.6 trillion in funds pledged by the Group of 20 nations to revive their faltering economies, roughly $400 billion is earmarked for alternative-energy projects, according to Cleantech. The $787 billion U.S. stimulus package, which will funnel more than $70 billion into alternative energy, is the largest national outlay in absolute terms, slightly outpacing China’s $67.2 billion in “green stimulus.” Signed into law by President Barack Obama on February 17, the spending package allocates $11 billion for modernizing the electricity grid, $6.3 billion in grants to help local governments increase energy efficiency, $2.5 billion for energy-efficiency and renewable-energy research and $500 million for training workers in renewable-energy-related fields. The stimulus package also offers a 30 percent investment tax credit to alternative-energy manufacturers and homeowners who install energy-efficient technology. Observers expect renewable-energy mandates to also spur growth in the sector. Late last year the European Union finalized a binding

commitment to generate 20 percent of its power from renewable sources by 2020. In the U.S. the American Clean Energy and Security Act was passed by the House of Representatives in June. The legislation mandates an 80 percent cut in U.S. greenhouse gas emissions by 2050 and requires electricity providers supplying more than 4 million megawatts of power to produce at least one fifth of it from renewable sources by 2020. It also establishes a cap-and-trade system that grants emissions allowances to companies, which can then trade them. The legislation now faces a contentious battle in the Senate, where several other climate bills are also being crafted. “Environmental regulation is the new alpha,” asserts Peter Fusaro, chairman and founder of energy consulting firm Global Change Associates, based in New York City, and founder of the Energy Hedge Fund Center, a Web site that maintains a directory of hedge funds investing in the alternative-energy sector. “The regulatory certainty provides the financial certainty, and then a lot more people deploy capital in the sector.” There are some promising signs that the worst of the downturn may be over. Even though investment has slowed dramatically, 2008 marked a tipping point: For the first time power capacity projects sourced from clean energy attracted more capital than did fossil fuel technologies ($140 billion versus $110 billion). In addition, investment flows may have bottomed out. In early June, New Energy Finance reported that second-quarter global clean-energy investments had already outpaced those in the previous quarter. The jump in activity was fueled in part by successful secondary stock offerings worth $2 billion from a number of leading companies, including Denmark’s Vestas, the world’s largest maker of wind turbines, and SunPower Corp., based in San Jose, California, which develops solar energy technology. Pickens, for one, is ready to get back to work on his wind project, although the plan has been “scaled back and put into phases,” says Ray Harris, Mesa Power’s president and CEO. General Electric has agreed to delay delivery of the wind turbines, but Harris won’t say

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when he expects them to be up and running. Still, he is working with GE to look for other, smaller wind projects around the U.S. to support together. Notes Harris,“We’re seeing lots of projects out there in need of turbines and in need of capital.”

Alternative energy

first burst into the U.S. consciousness in the wake of the OPEC oil embargo in 1973. The sector got a boost a few years later when the journal Foreign Affairs published an influential essay by a young physicist and environmentalist named Amory Lovins, who articulated a vision of what he called a “soft energy path” — a future where renewable resources would replace the U.S.’s “hard energy path,” defined by its reliance on foreign fossil fuels and nuclear power. Jimmy Carter, elected president a year after Lovins’s essay appeared, embraced these ideas. In a televised speech on the energy crisis, wherein he laid out his plan to create the U.S. Strategic Petroleum Reserve and the U.S. Department of Energy, Carter famously called for shared sacrifice and conservation, but he also vowed to harness “permanent renewable-energy sources, like solar power.” Two years later he installed solar panels on the roof of the White House and unveiled a plan to power 20 percent of the U.S.’s electricity needs using renewable sources by the year 2000. But as the oil shocks receded and Ronald Reagan entered the White House, Carter’s clean-energy policies — along with the White House solar panels — were dismantled. Over the next couple of decades, the nascent solar and wind power industries went through a series of booms and busts as tax incentives came and went. At the same time, according to researchers at Resources for the Future, a Washington think tank, the deregulation of natural gas and oil, the falling costs of conventional energy production and the competitiveness of the world petroleum market all contributed to a decline and stabilization in oil prices, which hindered the adoption of alternative-energy technologies. Even so, a consensus was building among scientists and policymakers that global warming posed a threat to the environment, culminating in the creation of the Kyoto Protocol, which was adopted in 1997 and became legally binding in 2005. The climate pact imposed limits on emissions of carbon dioxide and other harmful gases, marking a watershed moment even though the U.S. was notably absent from the list of signatories, with the Bush administration arguing that the agreement was flawed. (The U.S. will be at the table this December, however, when signatories are supposed to agree on a successor plan to the Kyoto Protocol at a United Nations confab in Copenhagen.) Large corporations also led the charge. A few months after the Kyoto Protocol took effect, GE rolled out its “ecomagination” initiative, vowing to decrease pollution generated by its products and increase spending on clean-technology research and development. That same year retailing giant Wal-Mart Stores unveiled an ambitious plan to “green up” its operations, promising to spend $500 million a year to reduce greenhouse gases by 20 percent within seven years, shrink energy use in its stores by nearly a third and double the fuel efficiency of its truck fleet in ten years, among other goals. With eco-conscious governments and corporations eager for new technologies, investors leapt into action. In 2005, $60 billion in new capital was dedicated to the alternative-energy sector, a 73 percent

jump from 2004 and nearly three times the average increase over the previous two years. “There was a recognition by entrepreneurs and investors that we had a couple of big problems to solve,” says Cleantech’s Fan.“How do we wean ourselves off coal for power generation? And how do we reduce our dependence on oil for transportation?” The still-fledgling solar sector was among the biggest beneficiaries of this newfound interest. In several European countries, most notably Germany, solar power got a lift from the adoption of “feed-in tariffs,” which require an electric utility to spread the higher cost of renewable energy across its entire customer base, making switching to clean-energy sources cost-effective for end users. Germany’s Q-Cells, today the largest producer of photovoltaic cells, went public in 2005 with backing from New York–based Good Energies, a private equity firm focused on renewable energy that oversees $2.4 billion. Over the next two years, growing political and environmental awareness and plentiful investment capital yielded a veritable cleanenergy boom. In 2007 investment in the sector jumped to $148 billion, more than double the total just two years earlier. That same year 19 percent of all new power capacity added globally came from renewable sources, nearly twice the level in 2005. Even though investment in alternative energy began slowing in the second half of last year as the financial crisis heated up, 2008 was still a banner year. Wind energy, the most mature alternative-energy source, attracted $51.8 billion, including nearly half of all the asset finance capital deployed in the sector last year. Solar energy, which is slightly less mature, attracted $33.5 billion in venture capital and private and public equity. Through last summer capital was plentiful: William James, co-founder and co–managing director of RockPort Capital Partners, a clean-tech venture capital firm in Boston, says that when his firm set out in mid-2008 to raise a new fund to invest in alternative-energy technologies, it intended to shut the door at $400 million but instead took in $453 million.“We could have raised $700 million or $800 million, we were so oversubscribed,” he says.

Capital may be a lot

scarcer these days, but investors are undeterred. James, for one, has seen tough times before: When he and his five co-founders launched RockPort in 2000, the term“clean tech” hadn’t yet been coined. All of the partners had backgrounds in energy, renewable power or commodities finance and were inspired to invest in the sector by the growing environmental consciousness sweeping Europe at the time. They decided to focus their capital and know-how on three areas: energy and power, advanced materials, and process and prevention technologies — and branded their niche “anchor technology.” Not only did the name not stick, it also failed to inspire interest from institutional investors. “If we went to any endowments or big investors, they would say, ‘No, this is never going to work; we’re not believers in the green movement,’” recalls James. But the partners stayed with it, ultimately growing their firm to $850 million in capital as their enthusiasm caught on in the investment community. Today the firm ranks with Kleiner Perkins and Khosla Ventures as one of the most active cleanenergy investors, with the bulk of its money in solar and wind power. In 2008, for instance, the firm invested in Fremont, California–based Solyndra, which has developed photovoltaic systems that are cheaper and more powerful than rival solar technologies. Specialty firms aren’t the only big players that have been attracted

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COVER STORY

to the sector. Bryan Martin, co-head of the U.S. private equity unit at D.E. Shaw & Co., a global hedge fund firm that oversees $30 billion across a variety of strategies, says that his group dedicates about one third of its time to alternative-energy investing and has been active in the sector for more than five years. Martin welcomes what he sees as a return to a more rational environment.“The fast money and the hype are not always helpful,” he notes. Although D.E. Shaw also invests in the public equities, debt and convertible bonds of alternative-energy companies, Martin believes that private financing offers the most attractive risk-adjusted returns. His team focuses on finding projects that offer a bigger payoff because they appear difficult to execute. “We try to do the work to understand whether the difficulties can be overcome,” he explains. A case in point is a wind farm project that D.E. Shaw recently agreed to finance on Maui in Hawaii, where energy must be shipped in and is thus relatively expensive, helping make wind power attractive. The project hadn’t yet been financed because locals feared that the turbines would imperil Hawaii’s state bird, the nene. But the firm studied the geese’s flight patterns and determined that the species wasn’t prevalent enough near the proposed site to be at risk. D.E. Shaw is a big backer of wind power in both Hawaii and the lower 48. The firm is an investor in First Wind, a Newton, Massachusetts–based wind energy company. Among its 36 projects in ten states, First Wind recently completed $375 million in financing for a 200-megawatt wind venture in Utah that will supply electricity to Southern California. Another of D.E. Shaw’s portfolio companies, Deepwater Wind, is focused on developing offshore wind farms in markets where it is difficult to construct new power plants. “This is not a traditional leveraged buyout where one can work on a deal for six months, close and own a big company,” points out Martin, reflecting on the challenges of financing large-scale wind energy projects. “It may take three to five years to develop.”

Gaps in market prices and imbalances in supply and demand are what attracted Boston-based Denham Capital Management to the alternative-energy sector. Riaz Siddiqi, managing partner at the $4.3 billion private equity firm, says he was drawn to the profit that could be made from what he calls a “value-dislocation paradigm.” The South African energy market is a case in point. Last year the supply of coal energy in that country hit a wall and South Africa was forced to cut industrial energy consumption by as much as 15 percent. In late 2008, sensing an opening for renewable power, Denham Capital invested in BioTherm Energy, a South African company that builds and operates renewable- and clean-energy projects. BioTherm converts waste gases from industrial processes into electricity, which can be sold or fed back into the national power grid, and plans to build a number of small power plants in South Africa in the coming years. Like Denham Capital, C Change is looking to profit by backing technologies that can shift consumption from traditional to renewableenergy sources. Co-founder Read first became interested in alternative energy during the Carter era, when he was in high school and studying photovoltaics, which focuses on converting sunlight into electricity, a cornerstone of the solar industry. Read ultimately pursued a career in finance but has returned full circle to his earlier passion. C Change is looking to invest from $20 million to $80 million in alternative-energy

companies and hopes to take an active role in the engineering and development of the underlying technologies. The goal, Read says, is to help portfolio companies scale up and achieve critical mass. Last November, C Change announced its first major investment, in a firm called NC12, which formed a joint venture with an as-yetundisclosed utility company to convert coal and petroleum coke from oil refineries into natural gas using a proprietary process that is essentially free of harmful emissions. When the final phase of the project is completed in 2012, the facility will produce the equivalent of 7 percent of current U.S. natural-gas imports, according to C Change. The firm is also positioning itself as an adviser to cities and on green projects worldwide. For example, it is in discussions with the South Korean Ministry of Knowledge Economy about partnering to create a private equity vehicle that will help internationalize the country’s technologies and bring the most promising non-Korean technologies to the nation, whose heavy industries have an intense demand for energy and materials. Read says that C Change will likely invest several hundred million dollars in South Korea–related projects over the next few years.“We are looking at similar arrangements with local partners in other regions,” he adds. Smaller hedge funds have gotten into the clean-energy investing game too. The Energy Hedge Fund Center lists 97 pure-play funds that invest primarily in the space. Rob Romero, founder of Connective Capital Management, a hedge fund that oversees $108 million in assets, 40 percent of which are dedicated to alternative energy, says that the sector’s volatility plays to hedge funds’ strengths. In 2001 a voice mail company that he had co-founded, eVoice, was sold to America Online, and he began exploring venture capital opportunities in alternative-energy technologies such as solar power and advanced batteries. “What I found was that with venture you can only go long,” explains Romero, who founded Connective Capital in 2003.“Frankly, many of the things that I saw I would rather have shorted.” In October 2007 he launched the Connective Capital Emerging Energy fund, which focuses solely on alternative energy. The small fund, which manages just $7 million and is still being incubated internally, lost 21.4 percent last year, versus a 3.6 percent gain for the firm’s flagship fund. Still, the new fund has rallied in 2009, climbing 10.3 percent in the first five months of the year. Romero says that Connective Capital’s investments in wind turbines and solar technology have been the most fruitful. For example, his position in Nasdaq Stock Market–listed A-Power Energy Generation Systems, which supplies wind turbines to China, has more than tripled since he bought the stock in March, although the shares fell after worsethan-expected first-quarter results were released in June. To the casual observer alternative energy may appear to exhibit all the foibles of a textbook boom-and-bust industry, taking off as investor excitement catches fire only to overextend itself and crash. But many longtime industry observers see the current downturn differently, as a mere blip on the road to wider acceptance of alternativeenergy technologies — and bountiful profits for early backers.“Some thought the sector was going to blow up and go away,”notes RockPort Capital’s James. “But it’s our guess that clean tech is going to eclipse other spaces like information technology and biotech.” •• Comment? Click on International Markets at iimagazine.com.

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ASSET MANAGEMENT

Manning’s

Method

r

Eighty-five years after it launched the first mutual fund, MFS is on the rebound thanks to CEO Robert Manning’s team-based approach to performance.

By Julie Segal

PHOTOGRAPHS BY CHRISTOPHER CHURCHILL

OBERT MANNING KNOWS ALL ABOUT HANDLING

crises. When the veteran fund manager was promoted to CEO of MFS Investment Management five years ago, the Boston-based firm was reeling from years of bad leadership and performance. MFS, the 15th-largest U.S. mutual fund manager, with $150 billion under management, had invested heavily in growth and technology stocks in the late 1990s only to be pummeled by investor redemptions when the tech bubble burst. Then MFS got caught in the market timing scandal of 2003, which cost the firm $225 million and the loss of two top executives, CEO John Ballen and president and CIO Kevin Parke. Manning, 45, a veteran MFS analyst and portfolio manager, vowed to turn the company around by overhauling the investment process and instilling a more disciplined culture of performance. He abandoned the firm’s reliance on star managers and instituted a system based on teamwork, research and careful diversification rather than big bets. The aim was to balance performance with safety: MFS funds would seek to consistently beat their benchmarks rather than take on large, risky positions that might pay off in a big way but could also generate hefty losses. The CEO’s method has worked handsomely. MFS, a unit of Canadian insurer Sun Life Financial, ranked fourth among fund companies Robert Manning has empowered MFS’s analysts and portfolio managers to move quickly

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ASSET MANAGEMENT

in asset-weighted performance last year, behind State Farm Mutual in 2008, to $186 million, and its operating profit Funds, Northern Trust Corp. and State Street Corp., according to margin slipped 6 percentage points, to 30 percent. research company Lipper. The firm’s analysts recognized trouble By contrast, BlackRock posted a 48 percent decline early on in the subprime mortgage market, and its fund manag- in pretax profits in 2008. ers sold stocks with heavy mortgage exposure well before the “MFS has a strong culture, and Manning has equity and credit markets tanked. As of April 30, Morningstar helped the organization get its confidence back,” had awarded either four or the maximum five stars to 62 percent says John Casey, chairman of investment manageof MFS’s retail assets, up from 33 percent a year ago. Only Pacific ment research firm Casey, Quirk & Associates. Investment Management Co. has higher ratings, with 70 percent “We might see behemoths like BlackRock/Barclays of its assets enjoying four or five stars. Fully 94 percent of MFS’s Global Investors try to be all things to all people, but institutional separate accounts beat their benchmarks during the there’s room for an MFS that picks its spots.” three-year period ended March 31, 2009. Now, with markets having suffered their worst losses in decades, N AN AGE WHEN FINANCE SPANS THE Manning wants to exploit MFS’s track record and put his firm back on a growth path. He is beefing up its team of 49 portfolio managers and globe, Manning stands out as a small-town 75 analysts, particularly in overseas markets, where the firm now has boy who made good without ever really the majority of its equity exposure. He is also broadening distribution leaving home. One of three children, he to include more brokerage firms and independent advisers, as well as grew up in a modest one-story house in Methuen, working with advisers to help them build their businesses and gener- Massachusetts, a working-class former mill town ate leads. The executive is confident that MFS can thrive by gaining about 25 miles north of Boston. The first in his market share even at a time when poor stock performance and a weak family to go to college, he attended the University economy have led many retail investors to pull back from equities. of Massachusetts in nearby Lowell, majoring in “You don’t often get to stress test what you built. But we got that technology and computers. In 1986 he married his stress test, and it worked,” Manning told Institutional Investor in a high school sweetheart, Donna, now an oncology recent interview. “We really rebuilt this company to withstand the nurse at Boston Medical Center who takes care of highest level of pressure, and the firm separated itself from the pack.” terminally ill patients. Manning has remained a Manning’s strategy is nothing if not bold. The financial crisis loyal supporter of UMass. He was appointed to the dealt a blow to many leading names in the mutual fund business. board of the Massachusetts state university system Firms such as Legg Mason, OppenheimerFunds and Putnam by then-governor Mitt Romney in 2006 and was Investments have struggled with poor performance and have been elected chairman — a position he still holds — in cutting staff and support for advisers. Even stalwarts like Capital 2007. Robert Pozen, the MFS chairman, who served Research & Management’s American Funds have suffered investor as secretary of economic affairs under Romney, introduced Manning to the former governor. defections and laid off employees. Manning joined MFS straight out of university, There are no guarantees that Manning will succeed, but his plan is in tune with the risk-averse attitude of today’s shell-shocked at the age of 20, working as a cable-television and investors, analysts say. “Over the past few years, distributors have steel analyst in the company’s junk bond group. In his spare time been seeking investments managed by teams rather than stars,” he went to night school at Boston College and earned an MBA in says Aaron Dorr, managing director at Jefferies Putnam Lovell. finance. He rose through the ranks at MFS, working on a fund that “They don’t want performance to be possibly hijacked by one invested in distressed debt, becoming chief strategist of fixed income manager, who could get hit by a bus or decide to and ultimately head of fixed income in 2001. Just like the mill town where Manning grew up, leave. Following this major downturn a lot of retail MFS enjoyed a rich heritage but had fallen on hard and institutional money will be up for grabs over the times in recent years. It launched the first mutual fund next 12 to 24 months. It will be a performance story. — Massachusetts Investors Trust — in 1924 and in If MFS has the performance, it will be a winner.” subsequent decades developed a reputation for steady Manning has already had a fair degree of success if staid returns. The company thrived in the 1990s by in diversifying MFS, increasing exposure to fastbetting heavily on technology and growth stocks, and growing overseas markets and building up its instiits performance attracted plenty of investors eager to tutional business. At the end of March, 57 percent partake in the boom. MFS boasted $147 billion in of the firm’s assets were retail and 43 percent instituassets at the end of 2000. The firm was whipsawed by tional, compared with an 80-20 split in 2001. MFS had 34 percent of its assets invested in international the tech bust at the start of this decade, however, and stocks, 28 percent in U.S. stocks, 26 percent in fixed saw investors flee to rivals with more consistent perincome, 10 percent in balanced funds and 2 percent formance, such as American Funds and the Vanguard Group. The market-timing scandal, in which MFS in money markets. By contrast, it had 73 percent of allowed hedge funds to trade in and out of its mutual its assets in U.S. stocks as recently as 2001. — John Casey funds to the disadvantage of long-term investors, The company’s net income declined 29 percent Casey, Quirk & Associates

i

“

MFS has a strong culture, and Manning has helped the organization get its confidence back.

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U.S. investment chief Michael Roberge sees a “historic opportunity” for MFS to use its improved investment returns to grab market share

compounded the damage. Assets had dwindled to $113 billion by the end of 2002. After the firm settled charges with regulators, former CEO Ballen and CIO Parke resigned; the company also paid a $50 million fine and $175 million in restitution to investors and cut its management fees by $125 million over five years. When Manning took the top job in February 2004, MFS’s assets had recovered to some $140 billion, but morale remained low. He insisted on taking over a combined role of CEO and CIO, a move that underscored his belief that MFS needed to change its investment process if it was to recover.“Separating yourself from the investment side as a CEO of an asset manager is not only dangerous, I think it’s disastrous,” he says. “MFS prides itself on the ability to manage other people’s money, and my greatest skill, having grown up as an investment person for 25 years, is on the investment side.” Manning also surrounded himself with a cadre of trusted colleagues. He tapped Robin Stelmach, who had been director of fixed-income quantitative research, as chief operating officer, a new position to help oversee the firm and its infrastructure. And he lured back Maria Dwyer to serve as the firm’s chief regulatory officer; she had been with MFS in the early 1990s but had left to become president of Fidelity Funds. “We’ve got our team in place. We’ve figured out what we’re

good at. And given our performance, we’ve got a historic opportunity,” says Michael Roberge, head of U.S. investments. In overhauling MFS’s investment procedures, Manning wanted to retain the firm’s traditional strength in stock selection while eliminating its reliance on star portfolio managers, which had allowed stock pickers to gun for performance without adequately taking account of risk. He assembled teams of portfolio managers to oversee funds so investment decisions would reflect multiple opinions, rather than an individual’s gut instinct. He also elevated the role of the firm’s analysts, creating a career track in eight sectors and basing compensation on the success of their stock choices. “Analysts were almost like second-class citizens to portfolio managers,” he says.“We wanted a foundation of having a very seasoned, experienced analyst follow a sector for years and years and pick the best securities that the firm could use in all portfolios.” Manning supplemented bottom-up stock picking with quantitative tools. The company tracks how managers generate returns and makes sure that portfolios are weighted to an index and aren’t overly concentrated in particular sectors or individual stocks. The aim is for returns to be a function of good stock selection rather than sector, currency or macroeconomic bets. The new approach proved its mettle as credit markets started to deteriorate in early 2007. When HSBC Holdings announced a big jump in loan-loss provisions because of its exposure to U.S. subprime mortgages in March of that year, a team including Boston-based financials analyst Kevin Conn, London-based financials analyst Florence Taj and fixed-income analyst Gerald Pendleton took it as a signal that worse was to come. They called for MFS funds to adjust by dumping holdings of mortgage lenders, including Fannie Mae and Freddie Mac, and commercial banks with big subprime positions and by focusing financial exposure in safer areas, like custody banks. “When you get into a stressed environment like we’ve had, things begin to move quickly,” says Manning.“If you’re not talking to the credit person in the financial area about what’s going on with the banks and understanding what’s on their balance sheets that can trigger problems for the equity value, and conversely things on the equity side that can affect the credit, you won’t be making good decisions in portfolios for clients.” Analysts say Manning’s shift in strategy is appreciated by many investment advisers. “Intermediaries, whether pension consultants or brokerage firms, talk about hot returns, but in the end they are interested in dependability and reliability,” says Casey. Manning is now looking to sustain growth at MFS. He is not keen on acquisitions, notwithstanding all the industry talk of consolidation in the aftermath of BlackRock’s decision in June to purchase Barclays Global Investors. “We don’t see how one would fit,” he says of potential acquisitions. “We might acquire assets if they are attractively priced, but our focus has been on maintaining our culture and on organic growth, and acquisitions present challenges to that.” Manning believes MFS’s revamped infrastructure is capable of managing up to $300 billion in assets, more than twice its current total. Achieving that won’t be easy, but the CEO is up for the challenge.“I’m programmed for that environment. I grew up a scrappy kid. Nothing ever came easy.” •• Comment? Click on International Markets at iimagazine.com.

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ISLAMIC FINANCE

Can

Islamic finance

Islamic banks and the sukuk market have been hit by the economic downturn, but the sector may benefit from the West’s financial disarray.

finance from an obscure niche into a mainstream alternative, the industry has suffered its first major setback. The market for sukuk, or Islamic bonds, tanked last year, as the global economic slowdown hit the Gulf region hard and forced governments to bail out many lenders, including Islamic financial institutions. These problems, although very real, haven’t diminished bankers’ enthusiasm about the sector’s long-term prospects. Indonesia and Bahrain have issued major new sukuk in recent weeks, raising hopes for an imminent rebound in issuance. Islamic banks and mutual funds are expected to continue to grow at a rapid rate in the Gulf, driven largely by increasing customer demand and the region’s expanding wealth. And new initiatives, such as efforts to develop Islamic mortgages for home ownership in Saudi Arabia, promise to broaden the industry and enable banks to diversify their income streams. Perhaps just as important, bankers say, the global financial crisis promises to boost the Islamic sector by prompting investors to look for alternatives to now-tarnished conventional Western banking products and institutions. “The financial crisis has challenged the assumption that conventional financial solutions are the most desirable,” says

LEFT TO RIGHT: CHARLES CROWELL/BLOOMBERG NEWS; DIMAS ARDIAN/BLOOMBERG NEWS

A

FTER A DECADE OF GROWTH THAT TRANSFORMED ISLAMIC

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profit from the crisis?

LEFT TO RIGHT: GOH SENG CHONG/BLOOMBERG NEWS; VICTORIA HAZOU/BLOOMBERG NEWS

By Hugo Cox

Hussein Hassan, head of structuring MENA for Deutsche Bank.“Many experts in the conventional space are looking seriously at alternative approaches. The principles of Islamic finance look very strong.” Spurred by the Middle East’s oil-fueled economic growth and fast-rising wealth, the trickle of money into Islamic finance products has become a flood. Bankers at State Street Corp. estimate that the industry has grown at a compound annual rate of about 15 percent over the past five years, with total assets under management at Islamic institutions now exceeding $600 billion. Before the 2008 slump in the sukuk market, issuance had grown more than sixfold in recent years, from $5 billion in 2004 to $33 billion in 2007, according to Moody’s Investors Service. The Gulf has also witnessed an explosion in the number of Islamic banks, whose assets totaled a combined $60 billion at the end of last year. The United Arab Emirates, which had only two Islamic banks as of 2002, Dubai Islamic Bank and Abu Dhabi Islamic Bank, now boasts six after the launches of Al Hilal Bank, Emirates Islamic Bank, Noor Islamic Bank and Sharjah Islamic Bank. In Saudi Arabia — the largest market for Islamic products after Iran — the National Commercial Bank, the country’s largest lender with 250 billion riyals ($67 billion) in assets, started out as a conventional bank in 1953 but has expanded its retail Islamic banking services aggressively in recent years. The industry has tapped into genuine demand for products that adhere to shari’a, the Islamic law that prohibits the payment of interest and bars investment in companies that are involved with alcohol, tobacco, gambling, pornography

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ISLAMIC FINANCE

or speculation. Islamic finance can’t escape the laws of economics, Disagreements about what constitutes an Islamic product are though. Much of the industry is based on real estate, and values in likely to persist because of the decentralized nature of Islam. Judgthe Gulf have suffered from the global recession and the bursting of ments about shari’a compliance are typically made by a board of local property bubbles. at least three religious scholars employed by the issuer. Such judgThe impact on the sukuk market has been particularly severe. ments about how to apply the Koran are always open to debate. Global issuance of sukuk fell by more than 50 percent last year, to In the six-nation Gulf Cooperation Council — which includes $15 billion, reports Moody’s, and the supply of new paper slowed Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab dramatically in the first half of 2009. There were only four sukuk Emirates — countries impose an almost universal ban on shortissues, worth a total of $5.4 billion, in the first six months of this year, selling, revolving credit cards and overdraft facilities. However, according to data provider Dealogic. In addition, spreads on out- those products are permitted in Malaysia, where a more relaxed standing issues have widened dramatically. Spreads over LIBOR on interpretation of shari’a prevails. In some instances variations exist the HSBC/DIFX sukuk index increased to a peak of more than 1,200 even within the GCC. Total-return swaps are well established in the basis points in February; although those spreads came down to less than 800 basis points in May, they are still three times as high as a year ago. At the heart of the problem is the dependence of sukuks on the regional real estate market, which has been hurt by overbuilding and the fallout from the global credit crunch.“The majority of sovereign and corporate ijaras were backed by real estate assets to finance the construction boom in countries like the UAE, so at the heart of the widening spreads and falloff in demand for sukuks was the stark correction in these markets,” explains Mariam Boulbol, an Islamic fund specialist at HSBC Global Asset Management in London. An ijara is a commonly used sukuk structure that resembles a lease agreement and can be used to finance property or equipment. The collapse of the sukuk market was followed by HSBC Amanah’s Mukhtar Hussain (left) and State Street’s Rod Ringrow the first major default in May, when Investment Dar Co., an Islamic financial institution that is one of Kuwait’s largest asset UAE and Bahrain, but when several banks tried to introduce the managers, failed to make payments on its $100 million global sukuk. product in Saudi Arabia in 2007, shari’a boards there refused to The company, which recently completed the £479 million ($790 million) approve it. Although the boards deemed the swap structure itself to acquisition of U.K. performance car company Aston Martin, is still in be legitimate, they ruled that the basket of stocks from which a swap talks with bankers and investors regarding Investment Dar’s restructur- derived its return was not screened for shari’a compliance. ing. It was the region’s first default of a large public Islamic instrument. Notwithstanding these differences, the industry is making progA dispute about the legitimacy of certain sukuk structures has ress in developing common standards. The AAOIFI and the Islamic also undermined confidence in the market. In February 2008 the Financial Services Board, based in Kuala Lumpur, have helped recreligious board of the Accounting and Auditing Organization for oncile accounting and regulatory standards across different jurisdicIslamic Financial Institutions, a Bahrain-based shari’a standards tions and worked to develop international best practices. AAOIFI’s setter, ruled that two sukuk structures — musharaka and mudaraba sukuk standards are now accepted by Bahrain, Jordan and Sudan, — violated shari’a principles because they contained repurchase with Qatar and Pakistan likely to sign up soon. In Malaysia, Asia’s guarantees. Such guarantees are deemed contrary to the Koranic largest market for Islamic products, the government has centralized principle that investors should share in the profits or losses of any the process of certifying that products are shari’a-compliant. venture they back, rather than make money through usury. “There has been considerable progress around the standard language The ruling shook confidence in the sukuk at a time when the market used over sukuks,”notes Mukhtar Hussain, CEO of Dubai-headquarwas already reeling from the impact of the global credit crisis and tered HSBC Amanah, the Islamic subsidiary of HSBC Holdings.“Banks, economic slowdown. “Suddenly, people are talking about shari’a scholars and regulatory bodies are pulling together so that over the next risk — the risk that the product you thought was shari’a-compliant year, I think, we’ll see real strides toward a common standard.” Bankers hope the two recent sukuk offerings by Indonesia may turn out not to be,” explains Rushdi Siddiqui, global head of Islamic finance at Thomson Reuters in New York. and Bahrain signal a broader recovery in the market. In April the Data show the extent of the damage. Issuance of musharaka, a Indonesian government raised $650 million with its first dollartype of profit-sharing joint venture that was the most popular sukuk denominated sukuk, a five-year offering that was priced to yield structure, with more than $12 billion of new offerings in 2007 — about 720 basis points over U.S. Treasuries. Book runners Barclays declined by 83 percent in 2008, and issuance of mudaraba, another Capital, HSBC and Standard Chartered Bank claimed that the offertype of profit-sharing, dropped 68 percent, according to Moody’s. ing was well oversubscribed, with orders totaling $4.7 billion. In

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Bahrain • Chicago • Dubai • Malaysia • Turkey

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ISLAMIC FINANCE

June, Bahrain issued $750 million of five-year sukuk priced at 340 basis points over Treasuries. Investor subscriptions for the offering totaled $4 billion, according to HSBC Amanah, which managed the issue along with Calyon and Deutsche Bank. Sovereign issues are likely to continue to dominate the flow of issuance, bankers say. GCC governments have committed to spending some $1.3 trillion on infrastructure over the next five years, according to Moody’s, and they will look to finance a chunk of that with sukuk. Many bankers, including HSBC’s Boulbol, believe that issuance during the second half of this year will exceed total 2008 volume. Anticipating the resurgence of these markets and a continued narrowing of spreads, leading Western banks are looking to launch

After the financial crisis we saw a lot of market makers and investors from the region repatriate assets to the GCC. — Rossana Abueva Bank of New York Mellon

sukuk funds. In July, HSBC Global Asset Management launched a $100 million closed-end sukuk fund for UAE and Saudi investors. The market for Islamic equity mutual funds also continues to grow strongly. Consulting firm Booz & Co. predicts that 925 Islamic mutual funds will exist worldwide by the end of this year, more than double the number in 2006. This is one product area that stands to reap clear benefits from the financial turmoil in the West. Islamic mutual funds screen out stocks that aren’t shari’a-compliant. Doing so means excluding stocks of Western financial institutions because they charge interest. The absence of such financial holdings is a major reason that the Dow Jones Islamic Market index, which consists of more than 2,500 stocks in 50 countries, has outperformed the Dow Jones world stock index over the past five years, declining 4 percent over the period compared with a loss of 8 percent for the conventional index. The tenets of Islamic investing — lower leverage, transparency, no speculation — are particularly attractive in the wake of the global meltdown. “After the financial crisis we saw a lot of market makers and investors from the region repatriate assets to the GCC,” says Rossana Abueva, head of global conventional debt strategy and product management at Bank of New York Mellon in London. Thanks to the surge in oil prices in recent years, the number of people in GCC countries with liquid assets in excess of $50,000 grew at a compound annual rate of 6 percent from 2003 to 2007, according to accounting firm Ernst & Young. And those individuals are allocating more wealth to the region. Consulting firm McKinsey & Co. reports that the percentage of the Gulf’s private wealth that is invested in the region, rather than in U.S. or European markets, say, has risen to 25 percent from 15 percent in 2002. Islamic banks have also suffered from the credit crisis less than many of their conventional rivals. Shari’a prohibits Islamic institutions from investing in companies that charge interest or engage in significant leverage — typically defined as debt amounting to more

than a third of the firm’s stock market value. Consequently, they have avoided investments in financial stocks and in such complex securities as collateralized debt obligations, which are at the heart of the global financial crisis. Certainly, several Islamic banks have faced major problems, some requiring government bailouts. The most notable are Dubai’s two largest mortgage lenders, Amlak Finance and Tamweel. The two banks are in the process of being merged and restructured under the supervision of the UAE government. Other regional Islamic lenders, such as Bahrain-based Gulf Finance House, Emirates Islamic and Dubai Islamic, have continued to see significant losses this year because of investment hits and bad loans. Bahrain-based Gulf International Bank has posted losses of $1.1 billion during the past two years because of exposure to U.S. banks and a large book of asset-backed securities. In March the bank sold $4.8 billion of toxic assets — roughly two thirds of its entire investment portfolio — to the six GCC governments that own it. Kuwait’s Gulf Investment Corp. and Bahrain-based Arab Banking Corp. have also suffered heavy losses from subprime investments. The difficulties of such conventional Middle Eastern institutions help to bolster the image of Islamic banks and the wider Islamic finance industry, in the eyes of many local investors. If the industry is to benefit, however, it needs to make considerable progress in managing market, liquidity and credit risk, bankers say. In particular, banks must develop an expanded range of shari’acompliant risk management instruments such as derivatives, which are virtually nonexistent. “Funding and liquidity risk are among the most critical issues for Islamic financial institutions now,”notes Rod Ringrow, head of State Street’s Doha, Qatar–based Islamic finance division. Secondary markets for Islamic products are few, owing to a combination of shari’a limits on reselling and the relative scarcity of products like sukuk. In addition, Islamic banks typically aren’t allowed to invest in fixed-income instruments for Treasury management. Islamic institutions also need to diversify their asset base to control credit risk. Most of these firms’ assets are highly concentrated in real estate, private equity and commodity investments. “Credit risk at Islamic institutions is still high. All products must be backed by tangible assets to be shari’a-compliant; for many banks that means real estate,” explains Emmanuel Volland, senior director of financial institutions ratings at Standard & Poor’s Paris office.“Dubai Islamic Bank, with over 30 percent of its assets in real estate, is not exceptional.” Some hope for industry diversification comes from the prospect of mortgages being legalized in Saudi Arabia — currently the region’s second-largest market for Islamic products. The Saudi Consultative Council recently approved a draft of the long-awaited mortgage law that will allow banks to help finance homeownership for the first time. The Kuwait Financial Centre, an asset management and investment banking outfit, estimates that a Saudi mortgage law, if enacted, would increase demand for residential property by as much as 50 percent over the next five years. The challenges are significant. But given the rapid growth of the past decade or so, most bankers are confident that the market will continue to expand. •• Comment? Click on International Markets at iimagazine.com.

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HEDGE FUNDS

West By Henry Scott Stokes

Chris Gradel and his team at Pacific Alliance Group in Hong Kong have delivered consistently strong returns by scouring Asia for mispriced assets and other opportunities.

CHRIS GRADEL IS A ROMANTIC AT HEART

— at least when it comes to office buildings. For the past seven years, the co-founder, managing partner and chief investment officer of Hong Kong–based Pacific Alliance Group has been operating his growing hedge fund empire from St. John’s Building, an unremarkable 22-story rectangle of glass and steel in the city’s Central business district that is overshadowed by much newer and taller towers. As other hedge fund managers in Hong Kong have flocked to such glitzy buildings as the 62-story Cheung Kong Center, whose tenants include U.S. multistrategy giant Eton Park Capital Management, Gradel has stuck with St. John’s, where he started his firm in July 2002 with just $10 million in assets and a lone secretary, subletting a single room. “We have a slight sentimental attachment,” says Gradel, 37, whose firm now occupies three floors, has $3 billion in assets under management and employs 120 people spread among its original Hong Kong headquarters and posher digs in Beijing, Shanghai and Tokyo. “We also don’t like following the crowd in anything that we do.” No one can accuse the Ulster-born Brit of following the crowd. Unlike most of the big multistrategy shops and smaller hedge fund managers that have rushed into Asia this decade and made largely long-only bets on its promise of rapid economic growth, especially in China, Gradel and his team at Pacific Alliance have placed a

PHOTOGRAPHS BY PHILIPP ENGELHORN

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MeetsEast Chris Gradel doesn’t like to bet on the direction of the market

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HEDGE FUNDS

decidedly directionless wager on the region. Although they are generally bullish on Asia’s long-term prospects, it doesn’t matter to them whether markets there go up or down. In true hedge fund fashion, they scour their world for mispriced securities, identifying innovative ways to arbitrage them or catalysts to unlock their value. During its short lifetime, Pacific Alliance has invested in everything from listed closed-end country funds trading at deep discounts and nontradable Chinese C shares to asset-backed loans and distressed debt. The approach seems to be working: Gradel’s flagship $1.45 billion Pacific Alliance Asia Opportunity Fund has a net annualized return of 27.71 percent since its inception through May of this year. That’s more than twice the 12.24 percent annualized return for the Eurekahedge Asia ex-Japan hedge fund index during the same period and a whopping five times the 5.14 percent return for the MSCI AC Far East ex-Japan index. Pacific Alliance’s performance during the recent turbulence has been even more impressive. For all of 2008 the Asia Opportunity Fund was up 7.64 percent, trouncing the Eurekahedge index, which fell 26.45 percent, and the MSCI index, which plummeted 54.48 percent. “Anybody who was up last year was doing something right,” says Robin Eggar, head of communications and public affairs at Winton Capital, a $15 billion London-based hedge fund firm. “These guys [at Pacific Alliance] were smart to have found a niche where the holes were obvious, and they exploited it while others stood by idly.” Gradel has profited by operating away from the crowd. But the real secret to his success has been his knack for identifying talent — a skill he developed as captain of boats for his college rowing club at Oxford University — and his decision early on to emphasize local expertise in building his team. Pacific Alliance’s investment process depends on it, as Gradel and his fellow portfolio managers and analysts do their own on-the-ground research to generate investments; they don’t want to rely on bankers or other intermediaries for ideas. “That was critically important last year, when many hedge funds lost a lot on poorly structured syndicated investments brokered by the banks,” Gradel notes. All of Pacific Alliance’s 32 hedge fund investment professionals have extensive experience in Asia. Some, like managing director Ian Zheng, Gradel’s first hire, grew up and went to school there. Others, like COO Derek Crane, a Brit, have spent most of their careers in the region. The combination of homegrown and imported talent has helped Gradel — who studied economics and engineering at Oxford before getting a more practical business education in the employ of American industrialist Robert Pritzker — navigate the often murky world of Asian markets. Gradel himself has spent most of his adult life in Asia. He first came to China in the mid-’90s to run a factory that Pritzker’s company, the Marmon Group, was purchasing from the Chinese government. In 1999 he moved to Hong Kong as a consultant for McKinsey & Co. It was there, two years later, that he met Horst Geicke, a former president of the German Chamber of Commerce in Hong Kong, who owned trading and manufacturing businesses in China and Vietnam. The two hit it off, and Geicke provided half of the seed capital for Pacific Alliance. In return he got one-third ownership of the management company and the title of nonexecutive chairman (both of which he retains today). The other $5 million came from Millennium Management, the

now nearly $12 billion New York–based multistrategy giant run by Israel Englander, where Gradel worked for three months in 1999 before starting his job at McKinsey. Millennium went on to invest as much as $150 million with Pacific Alliance and to own 20 percent of its management company before Gradel bought back half its stake in 2007 and the rest this year. Under Gradel’s leadership, Pacific Alliance blossomed almost overnight into a major player in Asian markets, dealing in hedge funds, private equity and real estate. With $1.45 billion in hedge fund assets as of April 1, it is the seventh-biggest hedge fund firm headquartered in the region, according to Alpha’s latest Asia 25 ranking, up from No. 12 a year ago and No. 19 in 2007. Working closely with managing directors Zheng and Eddie Hui, Gradel oversees the firm’s hedge fund investments, the majority of which are in China. “I spend practically all my time on the hedge fund,” he says. “I manage the fund.” Entrusting the firm’s other investment activities to members of his team has allowed Gradel to focus his energies on the hedge fund. Managing partners Allan Liu and Rachel Chiang head up Pacific Alliance’s 50-person private equity group, which has invested a total of $1 billion in 34 deals , including China’s first leveraged buyout. Patrick Boot, a managing director who Gradel recruited in 2007, is in charge of the firm’s $300 million in Chinese real estate investments. Pacific Alliance also owns 55 percent of VinaCapital Group, which Geicke and Gradel co-founded in 2003 with Don Lam to invest in real estate, private equity and other ventures in Vietnam. VinaCapital CEO Lam manages the firm’s now $1.7 billion in assets largely independently from Pacific Alliance. Gradel has had his headaches. In September 2006 his firm successfully listed on London’s AIM exchange a $275 million closed-end fund that follows the same investment strategy as the flagship hedge fund. The Pacific Alliance Asia Opportunity Fund Limited (not to be confused with the limited partnership of the same name) soared by 60.86 percent in 2007, lifting its assets to $407 million, but last year it suffered an 18.31 percent loss, while the more diversified hedge fund made money. Following a recent vote by shareholders, Gradel wrapped the closed-end fund back inside the limited partnership. GROWING UP IN NORTHERN IRELAND, CHRIS GRADEL GOT

a firsthand view at a young age of the repercussions of political conflict. His parents had moved from Germany to Ballymena, a loyalist stronghold, in 1970, the year before he was born, and Gradel remembers watching from the school playground as dense smoke occasionally rose over the small industrial town, signaling that the Irish Republican Army had just set off a car bomb. In 1977 an IRA terrorist broke into his house and tried to kill his father, who ran an Irish subsidiary of a German company.“I slept through the whole thing,”says Gradel, who lived in

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a year on the factory floor to see for yourself how it works,’” Gradel recalls. Gradel soon found himself in Cedar Bluff, a 1,000person town in rural Virginia, working for a company that made coal-mining equipment. One of his first jobs was to count all the bolts on each type of machine in the factory.“It was mind numbing,” says Gradel, who recalls thinking at the time, “So this is why I got a degree from Oxford.” After a year Pritzker sent him to China, which was auctioning off old state-owned factories to all comers, including Westerners. Gradel was put in charge of a plant that Marmon was buying from the government — a ramshackle operation that made conveyor belts for coal mines. The plant was located in Tangshan, a city of 3 million people about 100 miles east of Beijing. Gradel — who at the time didn’t speak any Chinese — spent six months there, modernizing the operation and improving safety procedures. He also got officials from the city and the local Communist Party to approve Marmon’s request to build two new factories on green-field sites. “That was terrific experience,” says Gradel, who went on to spend six months in Tianjin and two years in Beijing working for Marmon. “I gained an understanding of the motivations of people in government and the restrictions under which they operate. I also learned that confrontation is not going to work in China.” In late 1998, Gradel told Pritzker (who by then was getting on in years; he would retire in 2002) that he was leaving Marmon, and he accepted an offer from McKinsey to join its Hong Kong office. Before starting his new job in spring 1999, Gradel headed to New York Allan Liu (far left) and Rachel Chiang head up the private equity team; Eddie Hui (second from right) at the invitation of Robert Knapp, a classmate of his works closely with Gradel on hedge fund investments; Derek Crane oversees the firm’s operations at Oxford, who was managing a portfolio for Millennium. Gradel worked at Millennium for three months, Northern Ireland until the age of 15, when his father changed jobs and learning the basics of arbitrage from Knapp, who was impressed by how moved the family to Loughborough in the Midlands region of England. quickly his friend picked up the subtleties of hedge fund investing. Gradel’s own fighting instinct showed itself at Oxford, where, as “I had thought Chris was unusual the day he accepted a job to an undergraduate, he took up rowing for New College, one of the 38 work for a coal-mining company,” says Knapp, who rowed with schools that make up the university.“When I started I had no idea that Gradel for three years at Oxford.“Chris is really good at finding out rowing takes so much time and involves such tremendous pain,”says what is going on.” Gradel, who manned all eight oars — at one time or another — for By the time he arrived at McKinsey, Gradel knew he had little the eight-man crew and was named captain of boats his senior year interest in a consulting career. Still, he says, his three years at the firm by the New College Boat Club in recognition of his leadership and taught him discipline and trained him to analyze companies. He also competitive spirit. widened his circle.Among those he met in early 2001 was Hong Kong He graduated from Oxford in 1994 with an honors degree in resident Geicke, a German-born entrepreneur and owner of a family engineering, economics and management. Given his résumé he could manufacturing business. “Chris is extremely bright, very clear and have easily gotten a job with a top bank or company in the U.K., straight,” Geicke says.“He has always had a sense of what will work.” but he chose to work for Pritzker, whom he had met when Pritzker By spring 2002, Gradel was eager to leave McKinsey and set up his was a visiting lecturer at Oxford. Pritzker had built Chicago-based own investment shop. He approached Knapp and Geicke. Marmon Group into one of the largest privately held companies in Knapp flew to Hong Kong to learn more. Gradel suggested that the U.S. and offered to launch Gradel’s career by throwing the young they go to Shanghai, China’s foremost commercial city, with its man into the deep end. famous waterfront, the Bund, and crowds of people, so Knapp could “Bob said,‘Before you run any of my businesses, you have to spend see the opportunity for himself. Stunned by the sheer electricity of

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“

When we got back to Hong Kong, Chris and I immediately began the process of getting out ofanything to do with equities.

Shanghai, Knapp agreed that China had great investand by the beginning of this year was using rental ment potential. On his return to New York, Knapp proceeds to pay back interest and principal. proposed to his colleagues that they offer Gradel seed At their height, bridge loans accounted for nearly financing. “The go-ahead came from Millennium 70 percent of Pacific Alliance’s hedge fund portfolio, and from Horst on the same day,” Gradel recalls. helping Gradel to preserve and grow his investors’ Pacific Alliance launched that July, investing in capital in 2008. This year he expects asset-backed exchange-traded closed-end country funds selling, lending to fall to 25 percent of hedge fund assets, as in some cases, at a 40 to 50 percent discount to their the loans roll off and companies that borrowed from net asset value, and then taking activist positions to Pacific Alliance refinance them with cheaper bank close the discounts. The next year, Gradel expanded loans, thanks to the government’s 4 trillion–yuan ($584 billion) stimulus package. Gradel is redirecting his portfolio into distressed debt and other securities, that money into closed-end funds, which are once again looking for market dislocations that had created trading at sizable discounts, and broader distressed mispricings. By 2005, Pacific Alliance was managing opportunities driven by financial deleveraging, hedge $300 million and had 12 hedge fund staffers. That — Eddie Hui, Managing Director, fund redemptions and the capital flow out of Asia. year, when China announced stock market reforms Pacific Alliance that would convert nontradable C shares held by LATE LAST YEAR, GRADEL CAUGHT A MORNstate-owned companies into publicly traded A ones, ing flight from Hong Kong to Tokyo.Although he had Gradel instructed his team to buy as many as possible. never done much business in Japan, he liked what he “Having a large investment team on the ground, with was being told about a certain deal there. Staying at the each member having his own significant network, we were able to quickly cast a wide net when searching for C shares,” he Grand Hyatt Tokyo, Gradel met with Katsuya Takanashi, chairman explains.“The money we made was a function of how many people and CEO of Secured Capital Japan Co., a publicly traded real estate management company with $5.7 billion in assets. Secured Capital has a we could muster.” Pacific Alliance earned about 300 percent in 2006 on the C shares great investment track record, but it was struggling to refinance an existtrade (the Asia Opportunity Fund was up 45.6 percent overall that ing convertible bond. Such were the times. With the system in default, year). By the middle of 2007, however, the C shares had all been perfectly creditworthy companies were unable to obtain financing. Pacific Alliance invested $30 million in a convertible bond that converted into publicly traded ones, the discounts on closed-end funds were largely gone and distressed-debt investments were drying gives the firm as much as a 40 percent stake in Secured Capital, which up, as most of the world was still awash in credit and equity markets is listed on the main board of the Tokyo Stock Exchange. were flying high. “It was a terrific deal for Chris,”notes Jon-Paul Toppino, president That fall, Gradel took the entire company — by then spread and CIO of SCJ Investment Management Co., a subsidiary of Secured among Beijing, Hong Kong and Shanghai — to the luxurious Grand Capital that manages several Japanese real estate funds. Hyatt Tokyo in the fashionable Roppongi district for two days of “The investment was attractive financially but also strategically, as formal and informal meetings. On the second day, he gathered all it gives us a foothold in the Japanese market,” Gradel says.“Secured the investment professionals in a private conference room to talk Capital has a distressed-debt-servicing team, which will give us more about what they were seeing in the markets. The general view was depth when looking at Japanese distressed-debt opportunities.” Gradel inked the deal with Secured Capital in late March, just as he that Chinese equities, which had hit an all-time high in October 2007, were overvalued and that Asian markets in general were overpriced. was getting ready to open an office in Tokyo. In June he hired Anthony After everyone spoke Gradel asked people to vote by a show of hands Miller to run the Japanese operation. Miller, who had been president of New York–based multistrategy fund Ramius’s RCG Japan unit, on what the firm should do. “Overall, the vote was about 70–30 in favor of caution,” says had brokered the Secured Capital deal with Pacific Alliance. He was managing director Hui, who has 20 years of experience in Hong Kong. already a member of the firm’s four-person investment committee, “When we got back to Hong Kong, Chris and I immediately began the which approves all loans and other structured deals and includes process of reworking the portfolio, getting out of anything to do with Gradel, COO Crane and chief credit officer Philip Skevington. equities where we could. That is how we escaped the crash in 2008.” Pacific Alliance’s entrée into Japan is the latest example of Gradel’s Last year Gradel and his team focused on making loans in China, investment style. The Oxford graduate has no crystal ball, he says, but where credit was virtually nonexistent, as the government had been is inclined to be opportunity-driven. That, in part, is what has drawn attempting to slow the economy’s then–double-digit economic him to Asia, where markets are less efficient and transparent and where growth. “We saw asset- and share-backed lending as an attractive every few years capital rushes in and then just as quickly rushes out. Asked where he expects Pacific Alliance to be in a decade, Gradel opportunity to weather the storm,” Gradel explains. The bulk of the investments were short-term bridge loans made to responds: “Certainly, I do not want to gobble up the rest of the property developers like Beijing-based Zhonghong Group. In April world. I don’t have that amount of ambition.” Nor will he need it. 2008, Pacific Alliance provided $92 million in financing for the com- Asia appears to present a world of opportunity perfectly suited to pany to complete a shopping mall in a well-established residential his investment style. •• area of Beijing. Zhonghong, which is paying a 32 percent annual Comment? Click on International Markets at iimagazine.com. interest rate on the 18-month loan, put up the mall as collateral

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INSIDE: EUROPE’S BEST CFOS

The region’s top financial executives find innovative ways to protect margins through the crisis. Page 58

Brazil’s Biggest Money Managers Low exposure to equities helped many asset managers avoid the brunt of last year’s 41 percent stock market plunge. Page 54

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UNDS RESEARCH THE BRAZIL 20 EUROPE’S BEST CFOS THE BUY SIDE INEFFICIENT MARKETS ALTE

B

ECONOMIC THEORY OF RELATIVITY

Brazil’s top money managers saw the assets under their control tumble by 21 percent last year, in dollar terms. In ordinary circumstances a decline that steep would be cause for alarm. But these are extraordinary times, and such a drop can be cause for celebration when compared with the 41 percent plunge of the nation’s benchmark index. Investor aversion to equities helped cushion the stock market’s blow for the firms in the Brazil 20, Institutional Investor’s second annual ranking of the country’s top money managers (right). Many people will probably continue to favor fixed-income securities, even though interest rates have dropped and Brazilian stocks are more attractively priced than they have been in years. It’s hard to argue with a strategy that works. Conservative strategies are also the order of the day in Europe, where leading financial executives have abandoned earnings guidance and embraced aggressive capital management (see “Europe’s Best CFOs,” page 58). Not long ago, a finance chief would have been assailed for failing to provide earnings estimates, but in this economic environment, such projections are unhelpful — relatively speaking. — Thomas W. Johnson

Managing Editor Thomas W. Johnson Senior Editor Jane B. Kenney Senior Associate Editor Tucker Ewing Associate Editors Denise Hoguet WeiQing Lu Carolynn B. Tetro Cover photograph by Rich Press/Bloomberg News

THE 2009 BRAZIL 20

Brazil Breathes a Sigh of Relief

Limited exposure to equities muted the impact of the financial crisis on Brazil’s top money managers. BY LESLIE KRAMER

B

razil’s asset managers are breathing a bit easier these days. As of mid-June the nation’s benchmark Bolsa de Valores, Mercadorias & Futuros Bovespa index had climbed 43.6 percent off its March low, which represented a 50.7 percent plunge since its May 2008 high. Jittery investors, both foreign and domestic, yanked money out of the market on concerns that the financial crisis roiling developed countries would stop Brazil’s booming economy in its tracks. “It appears that the worst is over,” says Demosthenes Madureira de Pinho Neto, São Paulo–based head of asset management and executive director of financial institutions at Itaú Unibanco, the firm created through the merger, completed in March, of Banco Itaú, Unibanco Holdings and Unibanco–União de Bancos Brasileiros. Brazil is emerging from the global meltdown ahead of many other countries for one simple reason: “We did not have a banking crisis, and that makes all the difference,” says Madureira, pointing out that not a single Brazilian bank failed. Owing to a strict regulatory framework that precludes them from leveraging assets to the extent that their counterparts in the U.S. could — and did — Brazilian banks are generally healthy and well capitalized. “It’s interesting that we just found that out after the crisis,” Madureira notes with a chuckle. Although worldwide financial turmoil caused a sickening 41.2 percent drop in the BM&F Bovespa index in 2008, the effect on Brazil’s top money management firms was muted because only a small portion of their total holdings is in equities, thanks to high interest rates that make fixedincome instruments more attractive to investors. At BB Gestão de Recursos, which repeats in first place on the Brazil 20, Institutional Investor’s second annual ranking of the nation’s leading

managers, stocks account for only $19.5 billion of the firm’s $105.2 billion in total assets under management. That total is down 15.5 percent from one year earlier, in dollar terms; in local currency terms BB Gestão de Recursos and several other firms saw their assets under management increase in 2008. The real fell 24.5 percent against the dollar last year. Caixa Econômica Federal, which rises one spot to take second place, saw its assets under management slip 12.4 percent in 2008, to $76.3 billion; of that total, only $2.8 billion is in equities. Had the Itaú Unibanco merger been completed by yearend 2008, the combined firm would have secured the No. 2 spot (the position Banco Itaú held on its own last year), with $95.4 billion in total assets, but only $8.2 billion in stocks. As it is, Banco Itaú slips one rung to third place, with $73 billion in assets (25.9 percent less than a year earlier), $7.5 billion of which is in equities. In fourth place again this year is Bradesco Asset Management, whose assets under management slid 23.7 percent last year, to roughly $64 billion. Less than 10 percent of that total is in stocks. Robert John van Dijk, the firm’s director superintendent, says the avoidance of equities turned out to be a smart move for Brazilians. “If we consider the negative performance of the Bovespa in

“WE DID NOT HAVE A BANKING CRISIS, AND THAT MAKES ALL THE DIFFERENCE.”

2008, and the small decrease in the total assets of Brazilian funds, we can conclude that the impact of the international crisis in Brazilian funds was very low,” says van Dijk, who is based in São Paulo. Total assets of the Brazil 20 fell just 21 percent last year. Although the crisis appears to be over, at least in Brazil, it was not without its harrowing moments. “We saw high risk aversion from banks in terms of lending and huge uncertainty about how each sector in Brazil would be affected,” notes São Paulo–based Alcir Freitas, who directs equity research coverage of the banks and financial services sector at Itaú Securities. “Money flow suffered, credit was squeezed, and access to lending became very restricted deeply into the fourth quarter of 2008.” The Brazilian Central Bank’s Monetary Policy Committee swung into action as soon as government figures showed that the economy had stumbled. In January, after the Brazilian Institute of Geography and Statistics reported that Brazil’s real gross domestic product growth had contracted by 3.6 percent in the October-toDecember period compared with the third quarter, the committee slashed the benchmark Selic interest rate by a full point, to 12.75 percent, in an effort to increase liquidity and stimulate growth. The Selic has since been cut three more times, with June’s full-point reduction bringing the rate to its lowest level on record, 9.25 percent, even though Brazil’s GDP contraction of 0.8 percent in the first quarter was much slower than many economists had expected and seemed to suggest that the recession would be short-lived. José Luiz Rosenberis Cunha, Caixa’s portfolio management superintendent, predicts that the rate will remain low, by Brazil’s standards (the Selic topped 40 percent a decade ago), at least through next year. Although reducing interest rates encourages borrowing and helps promote consumer spending and corporate growth, he says, this approach also puts Brazil’s money managers in the uncomfortable position of having to reconsider the fees they charge — 2 percent is currently the norm — because the lower the rate, the lower the nominal gain and the bigger the impact of the fee on the investor’s account balance. Bradesco’s van Dijk agrees. “When the interest rate was 20

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ERNATIVES NERD ON THE STREET CONTENTS INSIDE II TICKER PEOPLE FIVE QUESTIONS DID II SAY

BRAZIL’S TOP 20 MONEY MANAGERS RANK

FIRM

2008 BRAZILIAN PORTFOLIO MIX ($ MILLIONS)

TOTAL ASSETS UNDER MANAGEMENT ($ MILLIONS)

EQUITIES

FIXED INCOME

CASH & EQUIVALENTS

ALTERNATIVE INVESTMENTS

2008

2007

1

1

BB Gestão de Recursos1 (Rio de Janeiro)

$105,197

$19,538

$85,659

—

—

—

2

3

Caixa Econômica Federal (São Paulo)

76,275

2,778

24,105

$ 882

—

$48,509

3

2

Banco Itaú2 (São Paulo)

73,094

7,530

31,913

23,498

—

10,153

4

4

Bradesco Asset Mgmt (São Paulo)

64,231

5,780

42,405

12,182

—

3,865

5

7

Santander Asset Mgmt3 (São Paulo)

34,375

2,248

14,538

10,040

—

7,548

6

6

HSBC Global Asset Mgmt (São Paulo)

23,847

925

13,491

202

—

9,2294

7

9

22,314

621

9,643

3,472

$120

8,459

8

5

Unibanco–União de Bancos Brasileiros2 (São Paulo) UBS Pactual Asset Mgmt5 (Rio de Janeiro)

16,525

2,352

10,467

2,122

—

1,584

PROPERTY

9

13

Banco Safra de Investimento (São Paulo)

11,006

979

5,406

4,621

—

—

10

17

BNY Mellon ARX Investimentos6 (Rio de Janeiro)

10,014

6,270

32

997

—

2,716

11

15

Votorantim Asset Mgmt (São Paulo)

8,908

167

4,459

12

12

Credit Suisse (São Paulo)

8,666

475

1,534

1,363

86

5,208 4,100

4,282

Credit Suisse Hedging–Griffo Asset Mgmt

6,082

97

436

1,363

86

Credit Suisse (Brasil)

2,584

378

1,098

—

—

1,108

13

11

BNP Paribas Asset Mgmt Brasil (São Paulo)

8,580

1,991

3,237

223

21

3,107

14

10

Western Asset Mgmt (São Paulo)

8,289

813

4,809

2,667

—

—

15

18

SulAmérica Investimentos (São Paulo)

5,739

199

4,163

41

—

1,335

16

16

Opportunity Asset Mgmt (Rio de Janeiro)

4,898

3,529

27

175

72

1,095

17

—

Gávea Investimentos (Rio de Janeiro)

3,979

45

—

—

—

3,934

18

—

1,775

100

1,675

—

—

—

1,238

—

—

—

—

1,238

1,084

827

—

—

—

257

19

—

Icatu Hartford Administração de Recursos (Rio de Janeiro) Quest Investimentos (São Paulo)

20

19

Schroder Investment Mgmt Brasil (São Paulo)

All assets are as of December 31, 2008, and where necessary are converted from reais using the exchange rate on that date. Ranks in 2008 were based on assets as of September 30, 2007. 1Rank in 2008 was for Banco do Brasil Administradora de Ativos, which in July 2008 changed its name to BB Gestão de Recursos.

2In November 2008, Banco Itaú, Unibanco Holdings and Unibanco–União de Bancos Brasileiros agreed to merge. The deal closed at the end of March, and the combined firm is Itaú Unibanco. 3Rank in 2008 was for Santander Asset Management. In July 2008, Banco Santander acquired the Brazilian operations of ABN Amro Holding; ABN

Amro Asset Management was No. 8 last year. 4HSBC Global Asset Management’s alternative investments include balanced funds. 5UBS announced in April that it will sell its Brazilian financial services business, UBS Pactual; the transaction is expected to close sometime this summer.

6Rank in 2008 was for BNY Mellon Asset Management Brasil, which acquired ARX Capital Management in January 2008; the combined firm is BNY Mellon ARX Investimentos.

percent, a management fee of 2 percent represented only 10 percent of the Selic reduction in the fund return. But when the Selic rate reaches 10 percent, the same fee represents a loss of 20 percent,” he explains. “We have savings accounts that yield TR plus a 6 percent fixed coupon, without management fees and without income tax, which means that funds with high management fees yield less than savings accounts.” (TR, or taxa referencial, is the rate used to determine yields on passbook accounts; it is based on the average 30-day yield on certificates of deposits issued by Brazil’s top banks and is adjusted monthly.) Instead of lowering their fees, some fixed-income portfolio managers will choose to chase yield,

according to Itaú Unibanco’s Madureira. “In the past it was very easy to manage a fixed-income mandate, because you could invest everything in government bonds and get a decent yield,” he says. Madureira predicts that fund managers will move from plainvanilla investments to more complex securities, such as derivatives, to boost return and justify what now appears to be a disproportionately high fee. The low Selic rate may also motivate some investors to allocate more money to Brazilian equities. “It will be a gradual process, but people are starting to realize that if they want more return, they have to take more risk — and that makes the stock market a more attractive investment,” says Madureira.

Brazilian investors had been moving toward equities when the financial crisis hit. The trend began in the middle of the decade, when the BM&F Bovespa index was racking up gains of 26.5 percent in 2005, 34.2 percent in 2006 and 43.6 percent in 2007 (in local currency terms), then it reversed in the fall of 2007 as investors grew worried about collateral damage to Brazil’s economy from the crisis unfolding in the U.S. and other developed markets. The share of money allocated to Brazilian equity funds reached 15.5 percent of the total market in 2007, a record, before dropping back to 10 percent last year, according to Brazil’s National Association of Investment Banks. By last month it had inched up to 11 percent.

Caixa saw its percentage of equities under management fall from 20 percent of its portfolio in mid-2007 to less than 4 percent by year-end 2008, Cunha says; as of last month, it had climbed back to roughly 10 percent. However, that figure reflects recent stock market gains as well as inflows, he notes. Bruno Pereira, who left UBS Pactual and joined Rio de Janeiro– based asset management firm Leblon Equities in January, says pension funds and retail investors will look more seriously at equities as they watch the returns of their fixed-income investments drop below the yield of savings accounts. “Commercial banks have to face the challenge of developing products that are suitable to the retail segment, and this will gradually

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UNDS RESEARCH THE BRAZIL 20 EUROPE’S BEST CFOS THE BUY SIDE INEFFICIENT MARKETS ALTE

EQUITY ALLOCATION DROPS AT BRAZIL’S BIGGEST MONEY MANAGEMENT FIRMS 2008

RANK

1

FIRM

BB Gestão de Recursos (Rio de Janeiro)

TOTAL ASSETS UNDER MANAGEMENT ($ MILLIONS)

2007

EQUITIES ($ MILLIONS)

EQUITIES AS A PERCENTAGE OF TOTAL ASSETS (%)

TOTAL ASSETS UNDER MANAGEMENT ($ MILLIONS)

$105,197

$19,538

18.57%

$124,458

EQUITIES ($ MILLIONS)

$31,610

EQUITIES AS A PERCENTAGE OF TOTAL ASSETS (%)

25.40%

2

Caixa Econômica Federal (São Paulo)

76,275

2,778

3.64

87,024

7,622

8.76

3

Banco Itaú (São Paulo)

73,094

7,530

10.30

98,637

16,966

17.20

4

Bradesco Asset Mgmt (São Paulo)

64,231

5,780

9.00

84,230

10,604

12.59

5

Santander Asset Mgmt (São Paulo)

34,375

2,248

6.54

29,542

3,652

12.36 5.58

6

HSBC Global Asset Mgmt (São Paulo)

23,847

925

3.88

35,865

2,001

7

Unibanco–União de Bancos Brasileiros (São Paulo)

22,314

621

2.78

26,357

1,883

7.15

8

UBS Pactual Asset Mgmt (Rio de Janeiro)

16,525

2,352

14.23

31,337

6,442

20.56

9

Banco Safra de Investimento (São Paulo)

11,006

979

8.90

12,241

2,119

17.31

10

BNY Mellon ARX Investimentos (Rio de Janeiro)

10,014

6,270

62.61

10,537

8,664

82.22

11

Votorantim Asset Mgmt (São Paulo)

8,908

167

1.88

10,366

232

2.23

12

Credit Suisse (São Paulo)

8,666

475

5.48

13,639

1,891

13.86

6,082

97

1.59

7,788

545

7.00

Credit Suisse Hedging–Griffo Asset Mgmt

2,584

378

14.63

5,851

1,346

23.00

13

BNP Paribas Asset Mgmt Brasil (São Paulo)

Credit Suisse (Brasil)

8,580

1,991

23.21

15,087

4,703

31.17

14

Western Asset Mgmt (São Paulo)

8,289

813

9.81

14,344

1,387

9.67

15

SulAmérica Investimentos (São Paulo)

5,739

199

3.47

7,587

433

5.70

16

Opportunity Asset Mgmt (Rio de Janeiro)

4,898

3,529

72.05

9,982

6,919

69.31

17

Gávea Investimentos (Rio de Janeiro)

3,979

45

1.12

4,288

121

2.82

18

1,775

100

5.65

2,296

158

6.87

19

Icatu Hartford Administração de Recursos (Rio de Janeiro) Quest Investimentos (São Paulo)

1,238

—

0.00

339

—

0.00

20

Schroder Investment Mgmt Brasil (São Paulo)

1,084

827

76.27

2,881

2,217

76.96

lead to additional structural changes in the mutual funds industry and open more room for independent asset managers,” says Pereira, who was the top-ranked analyst in Banking & Financial Services on II’s 2008 All-Brazil Research Team and leader of the first-place troupe in Financial Institutions on the 2008 Latin America Research Team. Some structural changes are already occurring, as a wave of

merger and acquisition activity washes over Brazil’s financial landscape. In addition to the ItaúUnibanco merger, Bank of New York Mellon Corp. acquired ARX Capital Management in January 2008 and merged it with subsidiary BNY Mellon Asset Management Brasil to form BNY Mellon ARX Investimentos. Banco Santander acquired ABN Amro Holding’s Brazilian operations when it joined Royal Bank of Scotland Group and

HOW THE RANKING WAS COMPILED Institutional Investor’s second annual ranking identifies Brazil’s top 20 fund managers by assets. São Paulo– based Researcher Milena Mazzola Moreti compiled the ranking under the guidance of Senior Editor Jane B. Kenney, using data from questionnaires filled out by the institutions themselves. II refined this data through followup faxes, e-mails and telephone calls. All figures are in millions of dollars, as of December 31 of the respective year, and where necessary were converted from reais.

Fortis in the €72 billion ($98.3 billion) buyout of the Dutch bank, the biggest such deal in history, which closed in July 2008. That same month, BB Gestão de Recursos changed its name from Banco do Brasil Administradora de Ativos to emphasize its asset management operations. And in April UBS announced it would sell its Brazilian financial services unit, UBS Pactual, to BTG Investments, a Rio de Janerio–based boutique founded by André Esteves, a former Banco Pactual managing partner who had sold the firm to UBS in 2006. The $2.5 billion deal is expected to close sometime over the summer. Some industry observers believe the M&A activity will have only a minor impact on the money management business in Brazil, where the top ten firms already control 88 percent of the assets. However, Madureira says it could pose problems for smaller, independent entities if institutional investors choose to consolidate their invest-

ments. “There will still be niche players focused on equity mandates, long and short hedge funds and private equity, but there may be some consolidation in those sectors as well,” he explains. For the moment, investors and money managers seem more concerned with finding out if the current market rally is sustainable. Caixa’s Cunha believes it is. He predicts that the Bovespa index will end the year up 20 percent and gain an additional 25 percent in 2010, as Brazil’s economy begins picking up steam and investors look to equities — attractively priced after last year’s rout — for returns they can no longer get from fixedincome instruments. Itaú Securities’ Freitas is also optimistic. “The recovery will not be a V shape,” he says. “It will be slow but, on a relative basis to other countries’, not that slow.” •• Comment? Click on the Research tab at iimagazine.com.

PAPER: RICHARD MEGNA

All assets are as of December 31 of the respective year and where necessary are converted from reais using the exchange rates on those dates.

RESEARCH

&RANKINGS In Depth Coverage & Analysis

December/January: The Power 50 • Best of the Buy-Side • Best Hotels by City February: All-Europe Research Team March: America’s Most Shareholder-Friendly Companies • U.S. Investor Relations • Emerging EMEA Research Team • Country Credit Ratings April: America’s Best CEOs • All-Japan Research Team • Best of the Buy-Side Europe May: Hedge Fund 100 • America’s Best CFOs • All-Asia Research Team • Europe’s Most Shareholder-Friendly Companies • European Investor Relations June: Latin America Research Team • All-Russia Research Team • Europe’s Best CEOs • Russia’s Top Business Leaders July/August: II 300 • Brazil 20 • Europe’s Best CFOs September: All-America Fixed Income Research Team • All-Brazil Research Team • Online Finance 40 • All-China Research Team • Asia 100 • Country Credit Ratings • Global Custody October: All-America Research Team • China 20 • Online Finance 30 November: Euro 100 • India 20 • Japan’s Best CEOs • Best Hotels by City

ADVERTISE US: Christine Cavolina ~ [email protected] Europe: Spencer Wicks ~ [email protected] Asia: Wendy Gallagher ~ [email protected] Caribbean/Latin America: Craig Leon ~ [email protected] Africa/Latin America: Lorna Solis ~ [email protected] Online: Michael Feinberg ~ [email protected]

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EUROPE’S BEST CFOS

Investors Cheer Candor, Caution

Earnings guidance is out, cost controls are in, as European financial chiefs steer their companies through the recession. BY WILLIAM BOSTON

I

nvestors typically look to a company’s chief financial officer for guidance about its earnings outlook. But in the midst of this recession, many of Europe’s top CFOs are openly acknowledging that the future is as clear as mud. “We pride ourselves on being pretty good with our forecasting,” says Robin Freestone, CFO of U.K. publishing company Pearson. “But this year we’ve stopped giving guidance on sales and margins because it’s too difficult to get that accurate.” That stance, which would have invited swift punishment from the

“NOW WE INTEND TO BE FAST IN TAKING OPPORTUNITIES.” — Dieter Wemmer Zurich Financial Services

market in years gone by, wins acceptance from investors in these volatile times. Instead of focusing obsessively on earnings targets, shareholders are looking for candor from CFOs about business developments, cost control and capital management. Such actions build the credibility that is vital to maintaining confidence in hard times. Freestone has certainly delivered. While many companies gorged on cheap credit during the boom years, Freestone reined in borrowing and slashed Pearson’s ratio of debt to earnings before interest, tax, depreciation and amortization by more than half since 2000, to 1.7 last year. That prudence is a major reason investors voted Freestone No. 1 in the Media sector in Institutional Investor’s seventh annual ranking of Europe’s Best CFOs. “At the time when everyone was leveraging, Freestone never went to

extremes,” says Andreas Wagenhäuser, analyst with Deka Investment in Frankfurt. Some CFOs built credibility by tackling problems in ways that prepared their companies for an economic downturn. Joseph Kaeser of Siemens, who ranks first in Electronic & Electrical Equipment, helped the German company recover from a bribery scandal by spearheading a restructuring that aims to generate €1.2 billion ($1.7 billion) in annual cost savings by next year. Nicolas Dufourcq of Cap Gemini, No. 1 in Technology/Software, helped the consulting firm rebound from a big loss four years ago by tightening financial controls and expanding the group’s presence in India. Companies that maintained discipline in the go-go years now find themselves in a position to capitalize on the weakness of competitors. At BNP Paribas, CFO Philippe Bordenave, a former markets chief, helped limit the growth of the firm’s investment banking unit and minimized its exposure to U.S. subprime mortgages and other shaky assets. When turmoil shook the European banking industry after the collapse of Lehman Brothers Holdings last year, he led a team that struck a deal with the governments of Belgium and Luxembourg to acquire control of Fortis while taking on few of its toxic assets. Bordenave was also quick to take advantage of the recent thaw in credit markets to raise €23 billion of BNP Paribas’s €30 billion funding requirement for 2009 by early June. Zurich Financial Services has avoided complex financial derivatives in recent years and focused on its core insurance business. In April its Farmers Group subsidiary snapped up the auto industry unit of troubled rival American International Group for $1.9 billion. As Zurich CFO Dieter Wemmer, winner in Insurance, puts it, “We came through the crisis fairly well, and now we intend to be fast in taking opportunities.”

Philippe Bordenave BNP Paribas Age: 55 Year named CFO: 2000 Number of employees: 173,188 2008 earnings: E3.0 billion ($4.2 billion) Compensation: Undisclosed

B

eing chief financial officer of one of Europe’s major banks through last year’s financial crisis was a demanding job; doing that job while helping to close the acquisition of a troubled European lender was even more daunting. Yet Philippe Bordenave has met the challenge with panache, helping BNP Paribas — France’s largest bank by profits and market capitalization — emerge from the crisis with its standing and market share enhanced. BNP Paribas was a harbinger of the credit crisis. The bank’s decision, in August 2007, to suspend withdrawals from two investment funds exposed to U.S. subprime mortgages was one of the first signs that the crunch would have global repercussions. Bordenave’s strong financial markets background — he headed the bank’s global markets division before becoming

“WE ARE AT THE BEGINNING OF THE ECONOMIC CRISIS. THE RECESSION IS DEEPENING.” — Philippe Bordenave BNP Paribas

CFO — enabled him to confront the challenges head-on. BNP Paribas disclosed its limited direct exposure to the subprime market in its third-quarter results that year and alerted investors to a sharp rise in counterparty risk — a problem that would not become widely apparent until the deterioration of monoline insurers and the near collapse of Bear Stearns Cos. last year. “We were the first ones to mention that,” Bordenave says, referring to counterparty risk. “There were not many CFOs who understood what that meant.” BNP Paribas’s relative strength enabled it to pounce last October when the Belgian and Luxembourg governments sought a buyer for Fortis, the banking and insurance group that was brought down by subprime investments and its top-ofthe-market purchase of part of ABN Amro. Bordenave, who for years has screened potential acquisition targets so BNP Paribas could move quickly, led a team that inspected Fortis’s books over a weekend and reached a purchase agreement with the governments. Although that deal was blocked by minority shareholders, who claimed it undervalued Fortis, BNP Paribas held its ground and struck a broadly similar accord in March to pay €3 billion in shares for control of Fortis’s banking operations and €1.4 billion for one quarter of its insurance business; crucially, the governments agreed to take 90 percent of any losses on Fortis’s holdings of structured products. That protection, and the share-based payment — “We couldn’t afford to harm our tierone ratio” — made the acquisition, which closed in May, attractive, Bordenave says. Bordenave remains cautious on the banking outlook. Although U.S. banks are racing to repay government capital received under the Troubled Asset Relief Program, he has no plans to buy back the €5.1 billion in nonvoting shares that the French government bought in March. “The worst of the financial crisis is behind us,” he says. “But we are at the beginning of the economic crisis now. The recession is deepening.” Investors appreciate Bordenave’s candor and conservative approach. “I always feel he tells me how he really feels about the environment,” says an analyst at one U.S. fund manager.

ILLUSTRATIONS BY NATHAN SINCLAIR

IL 20 RESEARCH EUROPE’S BEST CFOS THE BUY SIDE INEFFICIENT MARKETS ALTERNATIVES NER

37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22

RD ON THE STREET CONTENTS INSIDE II TICKER PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINM

Joseph Kaeser Siemens Age: 52 Year named CFO: 2006 Number of employees: 430,000 2008 earnings: E5.7 billion ($8.3 billion)* Compensation: E3.5 million ($5.0 million)*

PHOTO OF JOSEPH KAESER: THORSTEN JOCHIM/BLOOMBERG NEWS

M

any CFOs have been tested by the financial crisis. Joseph Kaeser came to it battle hardened. Kaeser, a veteran Siemens executive, thought he had the best job in the world when he took over as CFO in May 2006. Instead, he immediately found himself on the front lines of a scandal over alleged bribes that company executives had paid to win orders. The affair forced the resignation of chairman Heinrich von Pierer and the early departure of CEO Klaus Kleinfeld in 2007. Kaeser spent most of the next two years overhauling the company’s internal controls and cooperating with German and U.S. investigations into the alleged payments. In December the company pleaded guilty to U.S. charges of circumventing internal controls and violating the Foreign Corrupt Practices Act and agreed to pay a total of $800 million in fines and restitution to settle criminal and civil charges;

“KAESER INTRODUCED A MORE RIGOROUS SYSTEM OF FINANCIAL TARGETS.” — Christian Frenes TIAA-CREF

it also paid €596 million in fines to settle German legal investigations. “It was a question of whether or not the company would keep its license to do business,” says Kaeser. “Siemens could not afford to fail.” In addition to addressing legal matters, Kaeser ramped up a corporate restructuring that Siemens had initiated in 2005. The plan consolidated 13 business divisions into three — energy, health care and industry — which it subjected to strict financial targets. The company sold unprofitable or peripheral businesses such as its stake in Fujitsu Siemens Computers and a nuclear power alliance with France’s Areva.And Kaeser set a target of cutting costs by €1.2 billion a year by next year by reducing Siemens’s 1,800 legal entities around the world to fewer than 1,000.“This is about streamlining, making sure there is only one M&A department in the company, not 15, as we used to have,” he says.“It is to make sure there is only one clear chain of command at the accounting level and the reporting level.” Analysts appreciate the CFO’s tough controls. “Kaeser introduced a much more rigorous system of financial targets that lead to financial discipline at the group level, which is something you don’t often see in companies in continental Europe,” says Christian Frenes, a New York–based analyst at U.S. pension fund manager TIAA-CREF. *For the fiscal year ended September 30, 2008.

Europe’s Best CFOs Listed here by industry and sector are the 28 finance chiefs who scored the highest when Institutional Investor asked portfolio managers and buy-side equity analysts to choose the topperforming CFOs in their domains. BASIC MATERIALS

Chemicals Metals & Mining

Klaus Kühn, Bayer Vesa-Pekka Takala, Outotec

CONSUMER

Autos & Auto Parts Beverages Food Producers

Holger Härter, Porsche Malcolm Wyman, SABMiller Pierre-André Terisse, Groupe Danone

Household & Personal Care Products Luxury Goods

Colin Day, Reckitt Benckiser Group Jean-Jacques Guiony, LVMH Moët Hennessy Louis Vuitton Darren Shapland, J. Sainsbury Dariusz Pachla, LPP

Retailing/Food & Drug Retailing/General ENERGY

Oil & Gas Utilities

Ashley Almanza, BG Group Gregor Alexander,1 Scottish and Southern Energy; Nicholas Luff,1 Centrica

FINANCIAL INSTITUTIONS

Banks Insurance Property

Philippe Bordenave, BNP Paribas Dieter Wemmer, Zurich Financial Services Peter van Rossum, Unibail-Rodamco

INDUSTRIALS

Aerospace & Defense Electronic & Electrical Equipment Engineering & Machinery

Alessandro Pansa, Finmeccanica Joseph Kaeser, Siemens Hans Ola Meyer, Atlas Copco

PHARMACEUTICALS & HEALTH CARE

Biotechnology

Health Care

Pharmaceuticals

Andrew Oakley,1 Actelion; Ronald Scott,1 Basilea Pharmaceutica Lawrence Rosen,1, 2 Fresenius Medical Care; Stephan Sturm,1 Fresenius Erich Hunziker, Roche Holding

TECHNOLOGY, MEDIA & TELECOMMUNICATIONS

Dieter Wemmer Zurich Financial Services Age: 52 Year named CFO: 2007 Number of employees: 60,000 2008 earnings: $3.0 billion Compensation: Undisclosed

A

s rival insurers were chasing higher returns by investing in exotic financial instruments, Dieter

Media Technology/Semiconductors Technology/Software Telecommunications Equipment Telecommunications Services

Robin Freestone, Pearson Pierre-Jean Sivignon, Royal Philips Electronics Nicolas Dufourcq, Cap Gemini Richard Simonson, Nokia Corp. Gervais Pellissier, France Télécom

1Tie. 2In March 2009, Fresenius Medical Care announced that Lawrence Rosen would resign from the board and step down as CFO; the date of Rosen’s departure was not specified.

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IL 20 RESEARCH EUROPE’S BEST CFOS THE BUY SIDE INEFFICIENT MARKETS ALTERNATIVES NER

Wemmer, CFO of Zurich Financial Services, stuck to his knitting. The decision to stay focused on the company’s core insurance business has paid off. In April, when troubled American International Group was obliged to put its U.S. Personal Auto Group up for sale to reduce its massive debt, its Swiss competitor scooped up the business for $1.9 billion. The deal transformed Zurich’s U.S. subsidiary, Farmers Group, into the third-largest property-andcasualty insurer in the country. It also demonstrated how Zurich can wield its financial strength to grow through selective acquisitions, says Wemmer. “In the current market there will be opportunities coming as more people become willing to sell at reasonable prices,” he notes. Not that Zurich has been immune to the economic downturn. Its net income fell 47 percent last year, to $3 billion, and dropped 75 percent year-over-year in the first quarter, to $362 million. The declines reflect both weaker underwriting performance and reduced earnings on investments. With many companies cutting back on insurance expenses, Zurich’s general insurance arm — the p/c unit that generates roughly 60 percent of premium income — posted a 12 percent drop in first-quarter payments, to $9.8 billion. Market declines knocked the value of Zurich’s average invested assets down to $176.7 billion at the end of March, off 10 percent; investment income plunged 62 percent, to $816 million. “We lost a substantial amount last year, especially on our bond portfolio,” says Wemmer. Zurich is acting on several fronts to offset the impact of the crisis. Wemmer, considered a candidate for the top job when CEO James Schiro retires at the end of

this year, says the company has reduced its investment exposure to stocks, credit instruments and short-term bonds, preferring to put money into long-term, high-grade corporate bonds. He says the insurer does not invest in derivatives, and it avoids complex instruments. “We take risks, but on the insurance side,” he says. The company has also pushed through price increases of 1 to 2 percent on insurance policies for businesses. In light of the increased possibility of corporate failures, “balance sheet protection is getting expensive,” Wemmer says. And the company froze salaries this year to keep a lid on costs. Zurich is already reaping rewards from its cautious investment strategy, according to Christoph Bieri, an analyst with Credit Suisse Private Banking in Zurich. “This put them in a better position than some of their competitors going into the crisis,” he says. “This strong position should help them gain market share from weaker players.”

Robin Freestone Pearson Age: 50 Year named CFO: 2006 Number of employees: 33,584 2008 earnings: £292 million ($423 million) Compensation: £957,000 ($1.4 million)

ZURICH’S “STRONG he European and U.S. econoT mies are deep in recession, and POSITION the media business is reeling, but wouldn’t know it from looking SHOULD HELP you at publishing powerhouse Pearson. The company, a major educational THEM GAIN publisher and owner of the Financial Times newspaper and Penguin MARKET books, reported a 15.6 percent increase in sales last year, to SHARE.” £4.8 billion, and a 2.8 percent rise — Christoph Bieri Credit Suisse

to its CFO, Robin Freestone. When many companies were loading up on cheap debt a few years ago, Pearson was conspicuously restrained. “There was a lot of investor pressure to leverage up all the way into the middle of 2007,” Freestone says. “We resisted that temptation and didn’t overborrow, and when we go to debt markets now, our ratings are worth something.” The company did increase its net debt to £1.46 billion at the end of last year from £973 million in 2007 as a result of purchases, including that of educational testing company Harcourt Assessment for $635 million, and the pound’s weakness, which inflated the value of the company’s dollar-denominated debt. Still, Pearson’s ratio of debt to earnings before interest, tax, depreciation and amortization fell to 1.7 in 2008 from 3.9 in 2000. Looking ahead, Pearson is embracing the digital transformation of media. A few years ago the company began developing digital education products, such as its MyLab series of online instruction products, which now boast 4.1 million users in the U.S. Pearson is also bullish about the prospects for electronic reading devices, such as Amazon.com’s Kindle. “We are making sure that all our major works and all new books are available on Kindle and other e-readers,” he says. “Keeping products available digitally is a must; it’s not an option.”

in earnings. No small amount of credit for the company’s robust health goes

Nicolas Dufourcq Cap Gemini Age: 46 Year named CFO: 2004 Number of employees: 91,621 2008 earnings: E451 million ($636 million) Compensation: Undisclosed

O

ver the past five years, Cap Gemini has transformed itself from a loss-making also-ran in the

race for a piece of corporate information technology budgets to a strong — and profitable — global competitor. But Europe’s largest IT consulting group by revenue isn’t immune to the recession that has gripped much of the rest of the industrialized world. “The financial crisis hit us in January,” says Nicolas Dufourcq, the Paris-based company’s chief financial offider. Dufourcq immediately ordered a round of belttightening based on projections that revenue would fall by 2 percent this year. He imposed a hiring freeze, implemented a program to cut procurement costs by €18 million this year and ordered executives to hold tough against customer demands for lower prices. “Cost-cutting has been heavy, and it allows us to protect the margins of the group,” says Dufourcq, who adds that he is comfortable with analyst estimates that Cap Gemini will achieve an operating profit margin of 7 percent this year, down from 8.5 percent in 2008. Dufourcq has been open with investors and analysts about the company’s outlook, although he has not given any earnings guidance for the second half of this year, saying it is difficult to project earnings in the current environment. His cautious approach goes over well with many shareholders. “They aren’t hiding behind the trees,” says Luc Mouzon, an analyst at Crédit Agricole Asset Management in Paris. “They are one of the few companies giving us lots of details about their cost base, contracts and what’s going on in the market.” Dufourcq’s disciplined financial control is a major reason for Cap Gemini’s turnaround in recent years. The company posted a €534 million loss in 2004, when it was still reeling from the dot-com bust and the postmillennium drop in IT spending. Last year it reported a 2.5 percent rise in net income, to €451 million, on revenue that was flat, at €8.7 billion. Cap Gemini has also been expanding its presence in India, catching up with such rivals as IBM Corp. and Accenture in that important IT service market. The company expects to have more than 40 percent of its employees in India by the end of the decade, a greater percentage than in its home market of France. •• Comment? Click on the Research tab at iimagazine.com.

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NCE THE BRAZIL 20 EUROPE’S BEST CFOS

INVESTING THE BUY SIDE INEFFICIENT MARKETS

INSIDE:

MICHAEL KIRKHAM

U.S. INVESTORS KEEP FAITH WITH FOREIGN MARKETS Page 62 CHINA’S ECONOMIC RECOVERY MAY NOT BE WHAT IT SEEMS Page 64 FORTRESS PICKS UP THE PIECES OF A FORMER RIVAL Page 66

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CFOS INVESTING THE BUY SIDE INEFFICIENT MARKETS ALTERNATIVES NERD ON THE STREET CO

Gregory Johnson is expanding Franklin Templeton’s network

Staying the Course

America’s Largest Overseas Investors remain committed to international growth, despite a sharp setback in 2008. BY MICHAEL SHARI

WHEN U.S. INVESTORS BE-

gan to sour on American stocks in late 2007, fund managers were only too happy to lead them into more-buoyant overseas markets, and build up their own international business in the process. Then the collapse of Lehman Brothers Holdings spread financial panic around the world, hitting most international equities — particularly those of emerging markets — even harder than U.S. stocks. Although the global sell-off nipped talk of decoupling in the bud, it hasn’t diminished the interest of U.S. asset managers in overseas markets. Consider T. Rowe Price Group. In April the Baltimore-based fund manager eliminated 288 positions as part of a companywide initiative to reduce costs in the face

of the market downturn. But only nine of those layoffs involved employees outside the U.S., because the firm regards foreign markets as key growth areas in the long term. Market declines drove the firm’s non-U.S. assets down 42 percent last year, to $39.92 billion, but some of that lost ground was regained in the first quarter, thanks in part to strong net inflows of $4.5 billion — most of which was channeled into non-U.S. strategies. “That snapped back very smartly,” says Edward Bernard, the fund manager’s vice chairman in charge of marketing and distribution, noting that just over half the new money came from institutional investors. “The institutional business outside the U.S. is growing faster because we are underrepresented there.” Other leading fund management firms, including Capital Group Cos., Franklin Templeton Investments and Invesco, have maintained their international efforts even as they have cut back in the U.S. in recent months, executives say. Barclays Global Investors, the world’s largest fund manager, has also seen a strong rebound in its international business. The San Francisco–based firm, which agreed to be acquired by BlackRock in June, attracted $92 billion in net inflows in the first five months of this year. BGI’s extensive global reach was one reason it was such an attractive acquisition target, according to BlackRock COO Susan Wagner. “We did have very healthy flows into global mandates during the first handful of months this year,” says BGI CEO Blake Grossman, although he declines to disclose the percentage of inflows allocated to nonU.S. strategies. Stronger performance helped draw investors, he says. For example, BGI’s International Tilts strategy, managed by

“

Cheng, the Institu- Minder firm’s chief investment tional officer for active equibusiness ties, outperformed the outside MSCI EAFE index by basis points in 2008 the U.S. 17 after underperforming is grow- that benchmark for ing developed international markets by 277 faster points in 2007. because basis The recovery in we are international strateunder- gies is welcome news for U.S. fund managers. repreForeign markets had sented been a major source of there. growth, and the firms — Edward Bernard T. Rowe Price Group

”

were whipsawed by last year’s abrupt decline in those markets — and the investor withdrawals that ensued. The MSCI EAFE index declined 45.1 percent in 2008, in dollar terms, a worse performance than that of the Standard & Poor’s 500 index, which was down 38.5 percent. Investors were spooked, triggering a net outflow of $60.43 billion from nonU.S. equity and fixed-income mutual funds and exchange-traded funds, according to Financial Research Corp. in Boston; billions more were withdrawn from separately managed accounts. It was a stark departure from the bounty of 2007, in which investors poured $229.37 billion into non-U.S. funds, according to FRC. The 50 biggest U.S.-based managers of non-U.S. stocks and bonds, which make up Institutional Investor’s annual ranking of America’s Largest Overseas Investors, saw combined foreign holdings fall by 38.6 percent last year, to $4.79 trillion. The robust growth rates of 21.9 percent in 2007 and 29.6 percent in 2006 were a distant memory. BGI, which has placed No. 1 on the list every year since 2000, fared better than most of its rivals in 2008, with its global assets falling by 27.3 percent, to $728.84 billion. Those holdings accounted for 47.6 percent of BGI’s total assets, roughly the same share as in the previous year.

41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26

ONTENTS INSIDE II TICKER PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS

THE LARGEST U.S.-BASED MANAGERS OF NON-U.S. SECURITIES NON-U.S. SECURITIES

Other firms were less fortunate, particularly in global equities. State Street Global Advisors, which stays at No. 2, saw its non-U.S. assets fall 33.7 percent, to $439.12 billion. That represented 30.5 percent of the Boston-based firm’s total assets under management, or 3.1 percentage points less than a year earlier. The pressure point for SSgA was nonU.S. equities, where assets plummeted by 39.6 percent, to $328.53 billion.“Active equity has been an area where we have seen outflows,” says SSgA CEO Scott Powers. Non-U.S. fixed-income assets fell only 6.9 percent, to $110.58 billion, as a new management team made improvements to SSgA’s active fixedincome investment processes, says Mark Marinella, executive visce president and global fixed-income CIO of SSgA. Franklin Templeton Investments, which repeats at No. 7, suffered a fall in equity assets but enjoyed an increase in fixed-income assets outside the U.S. The San Mateo, California–based firm’s total non-U.S. assets fell by 39.7 percent, to $197.84 billion, mainly reflecting lower valuations as opposed to outflows. Its non-U.S. fixed-income assets rose by 17.6 percent, to $54.65 billion, boosted by strong net flows into its mainstay, institutional Global Fixed Income strategy. Emerging markets have rebounded strongly in the first half of this year, but it could take some time before many U.S. investors that bailed out of those markets venture back in. “The U.S. investor hasn’t seen anything like this kind of decline,” says Gregory Johnson, CEO of Franklin Templeton. “That’s a big concern: Is the trust still there?” Johnson is betting that it is. In February and March this year, Franklin opened new country offices in Malaysia and Mexico, acquired a stake in an asset manager in Vietnam and increased an existing stake in an asset management firm in Dubai. •• Comment? Click on the Investing & Trading tab at iimagazine.com.

RANK 2008

FIRM

TOTAL NON-U.S. AS ASSETS PERCENTAGE OF EQUITIES ($ MILLIONS) TOTAL ASSETS ($ MILLIONS)

$728,841

FIXED INCOME ($ MILLIONS)

TOTAL ASSETS UNDER MANAGEMENT ($ MILLION)

1

Barclays Global Investors

$447,455

$281,386

$1,529,849

2

State Street Global Advisors

439,116

30.50

328,534

110,582

1,439,577

3

Capital Group Cos.

333,231

34.64

312,271

20,960

962,034

4

AXA Group

299,520

48.79

232,322

67,198

613,863

5

BlackRock

266,060

20.35

182,295

83,765

1,307,151

6

Fidelity Investments

225,294

18.84

203,234

22,060

1,195,514

7

Franklin Templeton Investments

197,841

47.53

143,193

54,648

416,203

8

J.P. Morgan Asset Mgmt

167,132

14.75

121,355

45,777

1,133,232

9

47.64%

Legg Mason

158,800

22.79

21,235

137,565

696,694

10

Goldman Sachs Group

138,625

18.50

38,806

99,819

749,249

11

Bank of New York Mellon Corp.

127,715

15.07

95,561

32,154

847,527

12

Allianz Global Investors of America

114,023

14.40

7,297

106,726

791,891

13

Invesco

103,000

28.84

82,640

20,360

357,200

14

Morgan Stanley Investment Mgmt

100,295

23.99

71,938

28,357

418,131

15

Wellington Mgmt Co.

93,530

22.29

66,004

27,526

419,627

16

Northern Trust Global Investments

75,476

13.51

55,919

19,557

558,830

17

Prudential Financial

73,079

16.24

14,049

59,030

449,857 234,630

18

ING Group

65,901

28.09

18,638

47,263

19

MassMutual Financial Group

64,088

23.54

41,235

22,853

272,201

20

Old Mutual Asset Mgmt

63,520*

25.48

39,756

23,764

249,279

21

Lazard Asset Mgmt

62,384

78.80

53,382

9,002

79,165

22

Ameriprise Financial

60,089

31.16

30,512

29,577

192,846

23

Vanguard Group

57,533

6.76

52,656

4,877

851,341

24

Sun Life Financial

53,014

35.89

45,304

7,710

147,733

25

Grantham, Mayo, Van Otterloo & Co.

52,806

61.59

48,368

4,438

85,733

26

Dimensional Fund Advisors

47,974

43.17

38,972

9,002

111,125 357,733

27

TIAA-CREF

44,646

12.48

26,991

17,655

28

Brandes Investment Partners

40,684

76.84

40,684

—

52,944

29

T. Rowe Price Group

39,924

14.45

32,760

7,164

276,300

30

Artio Global Mgmt

39,581

87.56

39,581

—

45,204

31

Natixis Global Asset Mgmt

37,770

18.95

17,152

20,618

199,346

32

Principal Global Investors

33,081

16.68

12,530

20,551

198,318

33

Putnam Investments

32,104

30.46

18,072

14,032

105,409

34

Mondrian Investment Partners

31,271

98.56

26,118

5,153

31,729

35

Bridgewater Associates

28,830

42.76

—

28,830

67,430

36

Arnhold and S. Bleichroeder Advisers

25,354

82.92

25,354

—

30,578

37

Dodge & Cox

24,746

17.28

24,746

—

143,178

38

California Public Employees’ Retirement System

23,833

21.69

23,833

—

109,896

39

Affiliated Managers Group

23,344

22.84

23,280

64

102,228

40

Thornburg Investment Mgmt

21,475

63.72

21,475

—

33,702

41

GE Asset Mgmt

19,577

20.71

16,075

3,502

94,517

42

Nuveen Investments

18,630

16.42

17,743

887

113,444

43

Northern Cross Investments

18,383

97.10

18,383

—

18,933

44

LSV Asset Mgmt

17,605

43.60

17,605

—

40,375

45

Artisan Partners

17,362

56.78

17,362

—

30,577

46

Baillie Gifford Overseas

16,682

95.49

16,647

35

17,469

47

Teacher Retirement System of Texas

16,425

28.51

12,673

3,752

57,610

48

BNP Paribas Investment Partners

15,896

46.68

5,432

10,464

34,056

49

New York Life Investment Mgmt Holdings

15,626

9.81

5,200

10,426

159,213

50

Silchester International Investors

15,409

100.00

15,409

—

15,409

*Includes assets in consultation arrangement.

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SO FAR, CHINA HAS PROVED

to be remarkably resilient in the face of America’s Great Recession. Doomsayers predicted that its economy would collapse as U.S. imports contracted, yet it continues to expand rapidly. Even the World Bank now expects growth in China’s real gross domestic product this year to be within a whisker of Beijing’s official target of 8 percent. The Shanghai stock market has exploded, and the country’s appetite for raw materials is rekindling speculative fervor for commodities. The nation’s giant, 4 trillion yuan ($585 billion) stimulus package is boosting car and home sales and encouraging hopes that consumer demand will drive future economic expansion. Still, doubts persist. Because it is based on rampant credit growth and fails to address deep structural flaws in the economy, China’s resurgence may be vulnerable to weaknesses similar to those demonstrated by the U.S. during the recovery that Alan Greenspan engineered after the technology sector bust. “The bullish group-think on China is just as vulnerable to massive disappointment as any other extreme of bubble nonsense I’ve seen over the last two decades,” Albert Edwards, a global strategist at Société Générale, wrote in a note to clients in June. Edwards points out that electricity output — one of the few pieces of reliable macroeconomic data to come out of the country — has been declining. Industrial profits and exports are also contracting sharply. The key question surrounding China’s future prosperity is whether the country can wean itself from its dependence on exports and on massive investment growth. Yasheng Huang, an economics professor at the Massachusetts Institute of Technology’s Sloan School of Management and author of Capitalism with Chinese Characteristics, dismisses the notion that rising domestic consumption can offset declining exports. During the past two decades, Beijing’s economic policies have deliberately discouraged small businesses in rural areas, according to Huang. “In the 1990s foreign direct investment, national champions, massive infrastructure developments and urban renewal

China Recovery Doesn’t Add Up Beijing’s stimulus plan risks aggravating the economy’s imbalances. BY EDWARD CHANCELLOR were elevated to the top of the economic policy agenda,” he writes. The nation’s rapid growth appears to testify to the success of Beijing’s policy. Impressive new airports in Shanghai and Beijing and the construction of numerous splendid office buildings in both cities provide visual confirmation of China’s arrival as an economic superpower. But appearances can be deceptive, notes Huang. Much of the economy is still controlled by the state. Although the investment share of GDP has approached 50 percent in recent years, the role of the private sector has contracted. State-owned enterprises receive the bulk of bank credit at the expense of small businesses, which are forced to borrow (at usurious rates) outside the official banking system. Foreign investors benefit from tax cuts that give them an advantage over indigenous entrepreneurs.

This policy of suppressing private businesses in favor of state-controlled national champions and foreign exporters has had profound consequences. In recent years, China’s 500 million rural workers (two thirds of the total workforce) have watched their income share of GDP drop below 50 percent, whereas households in Shanghai and other cities have seen their pay go up, Huang has found. Income inequality in China has climbed to Latin American levels. Education and health services in rural areas have been squeezed to pay for such expensive infrastructure projects as Shanghai’s 300-miles-per-hour Maglev train. In Huang’s view, Shanghai is a Potemkin village: Vastly impressive to foreigners, its gleaming modernity deflects attention from the backwardness of the countryside, where the bulk of the population lives and works. Rural illiteracy has climbed as resources have been diverted to urban development. Excessive spending on infrastructure, combined with restrictions on the private sector, has contributed to a decline in China’s productivity, according to Huang. Although GDP data point to a high Chinese savings rate, Huang suggests that much of the saving has been done by the government, which achieved large budget surpluses in the boom years. Household savings are largely concentrated in the richest section of the population. The discouragement of small-scale businesses, poor rural income growth and low savings among most of the population — half of whom earn less than $2 a day — all speak against the notion that China can switch rapidly from an exportand investment-driven growth model to one based on expanding consumer demand. Where does the stimulus plan figure in all this? Chinese auto sales, after all, climbed by 9 percent in May, boosted by tax cuts.

BARRY FALLS

SIDE INVESTING INEFFICIENT MARKETS ALTERNATIVES NERD ON THE STREET CONTENTS INSIDE

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E II TICKER PEOPLE FIVE QUESTIONS DID II SAY THAT? RAINMAKERS DONE DEALS SCORECARD M

Subsidies to rural consumers have spurred sales of household appliances. Overall retail sales were up 15 percent for the same month. However, as China watchers know only too well, such macro data can be misleading. Government purchases account for a substantial part of “retail”sales.Value-added tax receipts have diverged from sales figures, suggesting that the government has been playing a large role in generating consumption. Far from shifting China’s economic growth onto a new flight path, the stimulus package is exacerbating chronic industrial overcapacity, asserts Michael Pettis, a professor of finance at Beijing University’s Guanghua School of Management. “The massive expansion of credit and investment,” Pettis writes in his irreverent blog, China Financial Markets (mpettis.com), “is simply more of

the same set of policies which have pushed China ever deeper into the Asian development model,” a model that involves channeling subsidized capital into investment and export-oriented manufacturing capacity. Bank loans, which surged by an incredible 15 percent in the first quarter of this year, are largely going to state-owned enterprises to boost investment. Even such sectors as shipbuilding and steel production, which suffer from overcapacity, are receiving fresh investment capital. In a repeat of U.S. president Herbert Hoover’s misbegotten policies at the onset of the Great Depression, Chinese companies are being instructed not to lay off workers. Most of the stimulus money will be spent on infrastructure that, as Huang points out, is already excessive. Pettis fears that long-term consumption growth could be suppressed if

loans turn sour and the government is forced to bail out the banking system. This year, Beijing has shown that it can pull the levers to generate rapid economic growth in a fashion that Western policymakers can only envy. However, as Pettis points out, the Chinese economy remains dependent on exports and the trade surplus continues to rise. The giant stimulus, in his view, is a massive “gamble on the duration of the global slowdown.” Unless the worldwide economy picks up shortly, Beijing may well find that all its vast infrastructure spending has achieved is to dig the Chinese economy into an even deeper hole. •• Edward Chancellor is the author of Devil Take the Hindmost and a senior member of GMO’s asset allocation team.

AWARD WINNING EDITORIAL AMERICAS Kevin Parker is remaking Deutsche Asset Management, pushing into alternatives: Can he make money?

Bob Greifeld gets Nasdaq back in the global game of market consolidation with two very different deals

DEC 2007/JAN 2008

The cost of equity trading keeps sinking, and so does the NYSE’s market share. Why investors are happy

EUROPE The Wallenberg family holding company enjoys new prosperity by investing like a private-equity player

Moscow rules: Ignoring the credit crunch, investment banks vie for talent as they bid for Russian supremacy

ASIA Central banks open the money spigots in an effort to prevent the credit crisis from spinning out of control

Central banker Meirelles maneuvers to keep Brazil’s inflation in check and its impressive growth on track

Top analysts overcome cost pressures to meet their clients’ demands: the All-America Fixed-Income Research Team

Georgia’s Gurgenidze insists that the conflict with Russia won’t delay reforms or hold back the economy

SEPTEMBER 2008 WWW.IIMAGAZINE.COM

NOVEMBER 2007 WWW.IIMAGAZINE.COM

DECEMBER 2007/JANUARY 2008 WWW.IIMAGAZINE.COM

INTERNATIONAL EDITION · EUROPE

PAGE 42

Institutional Investor FRANCE AND LAGARDE THE POWER 75 DUBAI’S BANKING CHAMPION RUSSIA’S INVESTMENT BANKING BATTLE

All’s Wells

Can new CEO John Stumpf keep profits booming at consumer savvy Wells Fargo despite the mortgage crisis?

WORLD ECONOMIC FORUM SPECIAL REPORT

An exclusive interview with France’s Lagarde The Power 75: The movers and shapers of global finance Dubai bids for banking dominance in the Gulf

IMF-WORLD BANK SPECIAL REPORT SOVEREIGN WEALTH FUNDS NORWAY’S SLYNGSTAD TAKES AN ACTIVIST TURN BANKERS FLOCK TO THE GULF AND ITS RICHES

Inside China

Investment Corp.

La Belle

France

In an exclusive interview, Chairman Lou Jiwei explains how he aims to “maximize returns” and “be a good public citizen” while turning China’s sovereign fund into one of the world’s leading investors. PAGE 60

Finance Minister Christine Lagarde is driving ambitious reforms as part of President Nicolas Sarkozy’s goal to restore French confidence — and influence in the world. PAGE 36

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KETS INVESTING ALTERNATIVES NERD ON THE STREET CONTENTS INSIDE II TICKER PEOPLE FIV

Survivor Benefits

A relatively prosperous hedge fund firm picks up the remains of a fading rival. BY IMOGEN ROSE-SMITH slow shuttering of New York–based D.B. Zwirn & Co. came in late May, when its investors approved the transfer of about $2 billion in assets to crosstown rival Fortress Investment Group. It’s a move that makes sense for Fortress in part because some of the holdings are similar to what the publicly traded alternative-investment firm already owns. Had the assets gone in a fire-sale auction, as they could have if Zwirn had been forced into bankruptcy, they might have fetched lower prices, driving down the value of assets held by Fortress. For example, both firms, according to a former Zwirn employee familiar with them, were lenders to radio-station chains Inner City Broadcasting Corp., based in New York, and Pappas Telecasting Cos., based in Visalia, California. Other investments on the books of both firms, according to the former employee, include loans made through Summitbridge National Investments, a Denver-based lender to small companies, and Petrobridge Investment Management, a Houston-based lender to oil and gas properties. After a run of redemptions last year, managing partner Daniel Zwirn began closing the D.B. Zwirn Special Opportunities Fund, which at its height — in October 2006 — had more than $5 billion in assets. Zwirn’s main strategy was direct lending to middle-market companies, meaning his portfolio was highly illiquid. In the midst of the credit crisis, the wind-down didn’t go well. By November 2008, according to the proxy proposal for the transfer of management to Fortress, “certain substantial investors had expressed a desire for changing the manager.” Fortress had first looked at striking a deal

with Zwirn as early as April 2008, but it did not make an outright bid until November. Goldman, Sachs & Co. and Blackstone Group were among the other firms looking at the portfolios, according to an industry source. In the transfer that closed in late May, Fortress paid $51 million for what was left of the D.B. Zwirn Special Opportunities Fund. Neither firm would comment on the transaction, but Peter Briger Jr., the president of Fortress, told investors on a conference call shortly after the transfer that the firm had acquired the assets because it “could tie all aspects of the purchase together.” Fortress had more expertise in the —Scott Johnson Zwirn holdings than GasRockCapital did rivals, largely because it had some

“

If investors have a choice, they do not want to be unloading their portfolio today.

”

of the very same assets in its Drawbridge Special Opportunities funds. Briger said that he anticipated that the workout would take four to five years. Fortress will need the time. Now, for example, it is very difficult to sell asset-backed loans made to oil and gas companies. And both Fortress and Zwirn still hold paper lent to companies through their joint ventures with Petrobridge, according to sources familiar with the deal. “If investors have a choice, they do not want to be unloading their portfolio today,” explains Scott Johnson of GasRock Capital, a Houston-based competitor of Petrobridge’s. Johnson points to the recent double whammy of a drop in commodities prices and the ongoing credit crisis: “If investors can hold out one or two years, until a better point in the cycle, they may well come out ahead,” he notes. And although its assets have shrunk considerably — to $26.5 billion today from $32.9 billion at the beginning of 2008 — Fortress is in much better shape to wait around than Zwirn is. ••

GEORGE BATES

THE LATEST STAGE IN THE

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J U LY / A U G U S T 2 0 0 9

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FFICIENT MARKETS ALTERNATIVES

NERD ON THE STREET

CONTENTS INSIDE II TICKE

Math, Machines and Wired Markets

SYNTHETIC COLLATERALIZED DEBT OBLIGATION (SCDO)

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BY DAVI D LEINWEBER (author of Nerds on Wall Street: Math, Machines and Wired Markets, John Wiley & Sons) The upper panel is a simplified schematic of a synthetic collaterized debt obligation based on various sources who for some reason seem reluctant to have their original work further exposed. The lower panel, taken from an actual U.S. patent for a “User -Operated Amusement Apparatus for Kicking the User’s Buttocks” is a nonsimplified schematic of the effects of SCDOs on the world’s financial system. FOR MORE ILLUSTRATIONS, COMMENTARY AND TO JOIN THE DISCUSSION,VISIT IIMAGAZINE.COM

RICHARD MEGNA

Booting Up

Ukraine’s consumer boom continues to attract foreign banks even as rising inflation threatens to crash the party

Europe’s Best CEOs stay focused on the bottom line to survive the credit crisis and a weakening economy

Marfin’s Vgenopoulos marshals elite backers in a bid to create a southeast European business empire

Restoring

Munich Re

CEO Nikolaus von Bomhard has turned the giant German reinsurer around. Now he must battle activist investors over his plan to expand in primary insurance. PAGE 38

Europe’s top CFOs combine financial acumen and a firm grip on operations to steer through market turbulence

Rebuilding Invesco: How Russia’s business leaders Martin Flanagan brought defy global economic woes a chaotic fund group back and keep their feet on the to order, and profitability gas in a drive to expand

The Asian Development Bank focuses on the private sector to narrow the region’s yawning income gaps

As Brazil’s banking market booms, domestic leaders Itaú and Bradesco are leading the way forward

Special Report: Coping with the credit crisis, from the Federal Reserve to major pension plans

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With the credit crisis and recession worries battering stocks, top analysts keep their nerve and provide clear insights. Introducing our 2008 All-Japan Research Team.

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PAGE 116

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Banking on Insurance Michael Diekmann has restored profits

at Germany’s Allianz. Can he unload troubled Dresdner Bank unit and win investors’ favor? PAGE 34

GROUND BREAKING JOURNALISM

AWARD WINNING EDITORIAL 



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Argentina’s banks benefit from an economic boom, but President Fernández keeps on calling for cheaper credit

Can Banco del Sur and Chávez challenge the United States — and Venezuela’s neighbors?

Investor favorites: Europe’s most shareholder-friendly companies pursue clear strategies and plain talk

India’s promise continues to lure the world’s biggest investment banks despite recent market turmoil

Switzerland’s private banks look for opportunity in the turmoil afflicting the country’s two banking behemoths

Improved straits: Taiwan’s new president reaches out to China to build political and economic bridges

Argentina’s banks profit from an economic boom, but President Fernández calls for cheaper loans

Class-action lawyers turn up the heat on the 401(k) industry, seeking damages for excess costs

America’s Best CFOs: Taking on more strategic roles while tackling the punishing credit crunch

Where is the love? Find out in our annual ranking of the most shareholder-friendly companies in America

Bright lights, big tickets: Homespun brokerage Edward Jones heads to the city for growth

Is the New York Stock Exchange’s new management team getting ready to sweep the floor clean?

Can a hedge fund thrive in Tokyo? Asuka Asset Management bets on diversification to overcome a harsh climate

OMV’s bid to create an Austro-Hungarian energy giant meets a nationalist backlash from MOL Group

Medvedev promises to boost spending, but Putin’s heir risks upsetting Russia’s fragile economic stability

The Asian Development As Brazil’s banking market Korean shareholders unite? Bank focuses on the private booms, domestic leaders National Pension Corp. lays sector to narrow the region’s Itaú and Bradesco are down a marker by challengyawning income gaps showing the way forward ing Hyundai and Doosan

The

Bank of

Chávez

Natixis

Goes Global

With Banco del Sur, Venezuela’s socialist president pushes aside the U.S. to mount a regional challenge to World Bank–style development financing.

France’s newest big bank is already a European powerhouse in asset management. Now CEO Pierre Servant has set his sights on the world stage.

SPECIAL REPORT

COPING WITH CRISIS

PAGE 42

PAGE 56

WALL STREET AND REFORM REGULATORS RETHINK BASEL II TOP INVESTORS PONDER MARKET MADNESS

Reinventing Retail

Raising the

Stakes

The Gulf’s Buyout King


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Arif Naqvi wants to build Abraaj Capital into the next great private equity shop.With strong backing from the region’s biggest investors, he might just get there.

PAGE 32

Standing

These are tough times for European equity research, but top analysts are up to the challenge. Presenting the 2008 All-Europe Research Team.

PAGE 34

PAGE 37

PAGE 52

The Wallenberg family holding company enjoys new prosperity by investing like a private-equity player

Moscow rules: Ignoring the credit crunch, investment banks vie for talent as they bid for Russian supremacy

Central banks open the money spigots in an effort to prevent the credit crisis from spinning out of control

Barclays Capital makes a run at Wall Street, adding staff and new products in a bid to win business from reeling rivals

Société Générale’s Oudea stresses continuity in the wake of the trading scandal: Investors remain skeptical

Investor favorites: Europe’s most shareholder-friendly companies pursue clear strategies and plain talk

Griffin, Kovner, Simons head list of inductees as Alpha inaugurates the Hedge Fund Hall of Fame

Switzerland’s private banks look for opportunity in the turmoil afflicting the country’s two banking behemoths

The Gulf’s Buyout King: Arif Naqvit plans to build Abraaj Capital into the world’s next Blackstone


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Private bankers scramble to recruit and train financial advisers as the number of wealthy investors explodes

Allianz’s Diekmann returns the insurer to profitability, but he must fix troubled Dresdner to regain favor with investors

Latin America’s resilient markets spark investor interest and demand for sell-side equity research

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Last

Resort

Amid the wreckage on Wall Street, the Federal Reserve makes a historic rescue to prevent the credit crisis from escalating. Will relief lead to meaningful reform? PAGE 91

Dead Plans Waking: Why so many money managers are suddenly rushing into the defined benefit business

The Power 75: Our inaugural ranking of the most influential figures in global finance

Columbia Management aims to overcome the loss of Marsico and the costly overhang of SIV holdings

SPECIAL REPORT: MONEY MANAGEMENT

WORLD ECONOMIC FORUM

AIG BOOSTS ITS INVESTMENT ARM

SPECIAL REPORT

PYRAMIS GETS SERIOUS

An exclusive interview with France’s Lagarde

PBGC TAKES ON MORE RISK THE II300: AMERICA’S TOP ASSET MANAGERS

The Power 75: The movers and shapers of global finance Dubai bids for banking dominance in the Gulf

La Belle

Alternatives

Finance Minister Christine Lagarde is driving ambitious reforms as part of President Nicolas Sarkozy’s goal to restore French confidence — and influence in the world.

Mr. Fix-It

New President Ma Ying-jeou reaches out to Beijing in a bid to thaw relations and inject Chinese dynamism into his sluggish economy.

PAGE 51

AMERICAS’S BEST CEOs

Shelter from the Storm

In our annual ranking, investors celebrate those chief executives, like Exelon’s John Rowe, who can steer their companies through the tough times ahead.

PAGE 64

Martin Flanagan has turned around a battered asset management firm by fashioning a collection of boutiques into a single, focused company.

PAGE 42

China Card

Amid the gloom, America’s money managers explore new strategies for growth.


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Europe’s top CFOs combine financial acumen and a firm grip on operations to steer through market turbulence

Leadingfrom the Top

All’s Wells

Searching for

France

PAGE 50

PAGE 32

PAGE 58

Rebuilding Invesco: How Russia’s business leaders Martin Flanagan brought defy global economic woes a chaotic fund group back and keep their feet on the to order, and profitability gas in a drive to expand

Munich Re’s von Bomhard has turned the giant reinsurer around, but activist investors are resisting his growth plan

Carbon credits lead solar energy and biofuels in climate-change market potential, traders say

University of Michigan CIO Lundberg lifts the school’s endowment into the top tier and looks abroad for alpha

Moscow rules: Ignoring the credit crunch, investment banks vie for talent as they bid for Russian supremacy

Christine Lagarde’s push for economic reforms aids President Sarkozy’s drive to restore French confidence

Dubai stakes a claim to banking dominance in the Gulf with a merger to create Emirates NBD

Can a hedge fund thrive in OMV’s bid to create an Tokyo? Asuka Asset Manage- Austro-Hungarian energy ment bets on diversification to giant meets a nationalist overcome a harsh climate backlash from MOL Group

The 2008 All-Europe Research Team: The best analysts rise to the challenge of tough times

Strauss-Kahn seeks a new role for the IMF: helping to fight the credit squeeze and warning of future crises

Georgia’s Gurgenidze insists Central banker Meirelles that the conflict with Russia maneuvers to keep Brazil’s won’t stall the pace of reform inflation in check and its or hold back the economy impressive growth on track

Can Banco del Sur and Chávez challenge the United States — and Venezuela’s neighbors?

Argentina’s banks benefit from an economic boom, but President Fernández keeps on calling for cheaper credit

Natixis, the fledgling French asset manager, aims to boost alternatives and expand globally

IMF-WORLD BANK SPECIAL REPORT SOVEREIGN WEALTH FUNDS CHINA’S LOU SPELLS OUT HIS PLANS TO BUILD CIC BANKERS FLOCK TO THE GULF AND ITS RICHES THE TWO MASTERS AT KOREA’S KIC DMITRY PANKIN ON RUSSIA’S NEW WEALTH

The Power 75 Our exclusive new

ranking of the most influential leaders in global finance shows the rise of Asian executives like No. 4–ranked Jiang Jianqing, chairman of the Industrial and Commercial Bank of China.

Righting the

ShipBuffeted of State by subprime losses, staff turnover and client lawsuits, State Street Global Advisors puts Old Mutual’s Scott Powers at the helm.

Banking on Insurance Michael Diekmann has restored profits

PAGE 50

PAGE 90

Banking on India

Upping theAnte

New Delhi’s economic emergence has attracted a stampede of global investment bankers — and the recent market turbulence isn’t slowing them down.

Russia’s Medvedev promises to ramp up spending, but can Putin’s successor maintain economic stability?

PAGE 34

at Germany’s Allianz. Can he unload troubled Dresdner Bank unit and win investors’ favor?

PAGE 66

PAGE 62

PAGE 34

Arun Sarin on leadership: Have a vision, stick to it and ignore the naysayers, advises Vodafone’s CEO

Force for

Change

Embracing activism, CIO Yngve Slyngstad shakes up Norway’s giant oil fund. Will the returns justify the political risks?

The Best of the Buy Side: Demand is up for investment analysts, and our exclusive survey names the finest

Chile’s Codelco is riding high, thanks to surging copper prices, but politics makes management tricky

THE BEST

INVEST MENT

BANKS ’07

Central banker Meirelles maneuvers to keep Brazil’s inflation in check and its impressive growth on track

Top analysts overcome cost pressures to meet their clients’ demands: the All-America Fixed-Income Research Team

Georgia’s Gurgenidze insists that the conflict with Russia won’t delay reforms or hold back the economy

NYSE Euronext’s Niederauer says volatility and demand for trading expertise breathe new life into the exchange

Emilio Botín’s relentless retail focus has Spain’s Banco Santander thriving and expanding amid crisis

Reports of the demise of quantitative investing are premature, writes hedge fund manager Cliff Asness

How the mighty have fallen: Jean-Claude Trichet tries Britt Harris charts a course Our Power 50 list shows how to sustain consensus at the in alternatives for the stodgy the credit crisis has shaken up ECB, and growth in Europe, but politically charged Teacher Retirement System of Texas the global financial elite amid pressure for action

Japan weighs the creation of a sovereign wealth fund to lift returns on its pension fund and vast currency reserves

Emilio Botín’s old-style approach to banking lets Banco Santander thrive, and expand, amid crisis

Fashion victim: How high leverage has humbled France’s Wendel and set off a bitter family struggle

Japan’s best CEOs look to new business models and products to drive growth even as the economy slows

Oligarchs on the run! The rout in Russia’s stock market slashes the wealth of many of the country’s top industrialists

Emilio Botín’s old-style approach to banking lets Banco Santander thrive, and expand, amid crisis

IMF-WORLD BANK SPECIAL REPORT SOVEREIGN WEALTH FUNDS NORWAY’S SLYNGSTAD TAKES AN ACTIVIST TURN BANKERS FLOCK TO THE GULF AND ITS RICHES

The

Inside China

Innovators

Investment Corp. In an exclusive interview, Chairman Lou Jiwei explains how he aims to “maximize returns” and “be a good public citizen” while turning China’s sovereign fund into one of the world’s leading investors. PAGE 60

Introducing our first ranking of America’s leading investment banks, as chosen by the folks who know them best — their clients.

ADVERTISE US: Christine Cavolina ~ [email protected] Europe: Spencer Wicks ~ [email protected] Asia: Wendy Gallagher ~ [email protected]

As Japan’s economy turns down, the country’s top executives are looking to new products and business models to drive growth. Introducing II’s exclusive ranking of Japan’s Best CEOs.

Back to

Basics

PAGE 56

Scandale!

Wendel v.Wendel The credit crisis threatens a storied French dynasty that has survived three centuries of war, revolution and nationalization. Can chairman Ernest-Antoine Seillière overcome risky leverage and an unprecedented family squabble?

A strong balance sheet built in good times helped U.S. Bancorp weather the worst of the credit crisis. Now CEO Richard Davis and his team are pushing old-fashioned loan and deposit growth.

PAGE 48

PAGE 48

Our last best hope PAGE 7

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