Friday, June 21, 2013

The conflict between managing funds and selling funds

BT Australia - before it was purchased by Principal Financial Group for AUD2.1 billion - was the dominant independent fund manager in Australia. Its position seemingly secured by a very good (albeit aging) record of funds management and an unbeatable sales force. That $2.1 billion was paid in the third quarter of 1999.

And then it all went wrong.

The bellwether for a spectacular decline was the launch of the TIME fund. TIME stood for Technology, Internet, Media and Entertainment. The launch date I believe was 14 March 2000, the exact date the NASDAQ peaked. Here is an article from May 2000 expecting 15-20 percent annual returns.

It did not work out quite that well.

As the 2003 Form 10K for Principal says:

On October 31, 2002, we sold substantially all of BT Financial Group to Westpac Banking Corporation ("Westpac") for proceeds of A$900.0 million Australian dollars ("A$") (U.S. $499.4 million), and future contingent proceeds in 2004 of up to A$150.0 million (approximately U.S. $80.0 million). The contingent proceeds will be based on Westpac's future success in growing retail funds under management. 
The decision to sell BT Financial Group was made with a view toward focusing our resources, executing on core strategic priorities and meeting shareholder expectations. Changing market dynamics since our acquisition of BT Financial Group, including industry consolidation, led us to conclude that the interests of The Principal shareholders, BT Financial Group clients and staff would be best served under Westpac's ownership.

Westpac later largely closed the funds management part of the business.

In three years the business was largely destroyed along with the career and reputation of the then Principal CEO.

The "retrospectoscope"* is a fine instrument - but it is still obvious what happened. BT launched a tech fund at the height of the dot-com boom because it was easy to sell. They put "sexy" dot-com stocks in their portfolio because they made the product easier to sell. And they burnt their clients beyond a cinder of recognition.

Pretty it was not.

They did it because they got led by their sales force. If you do what the sales force wants and you have a competent sales force you will sell lots of funds. As a funds management business you will be big and profitable.

But the target for BT Funds Management's sales force was a financial planner in Doncaster (10 miles from Melbourne) with gold-rim spectacles (or the same in Parramatta or any other middle suburban Australian center). These guys are the modern bell-boys. Whey they are putting their clients into tech stocks there is nobody left to sell to.

And so it is - the most extreme example I have ever seen of the conflict between managing money and selling funds management products.

Imagine the patter

I wish I had a recording of a BT "sales call" from say April 2000. The market was off pretty hard - but all was OK in the financial planner in Doncaster. Economic growth looked great. The record for the NASDAQ measured in Australian dollars was astounding - not only because the NASDAQ was astounding but the AUD had collapsed to below 50c in the dollar.

The image projected would have been competence, technical sophistication and certainty.

About this time I ran into David Drury, then CEO of Principal at a CSFB insurance conference in New York. He found out I was Australian and regaled a circled crowd with his version of the BT mid-2000 spin. BT Funds Management was a very fine asset. Later I told two of the people in the circle that I thought the acquisition would cost him his career - but I did not have the courage to tell Mr Drury himself. In my memory I like to kid myself I did have that courage - but whilst I had that view I was racked with doubt about it. Mr Drury was an important man with an illustrious career, BT had a great reputation and I was just a junior analyst.

Mr Drury was a better salesman than I will ever be. He projected the illusion of certainty. [See here and here for a discussion about that illusion...]

Good spin versus good funds management

What makes for good funds management is -

(a) contentious, but well thought through opinions,

and in direct contrast,

(b) doubt sufficient to make sure the downside is always well covered

This is a schizoid requirement. People who have both these features are strange - flat out weird.  People with only (a) are engaging but dangerous.

At Bronte we have both - but only because there are two of us. I am the contentious one. My business partner - his job is to extinguish any passions that I might have. [He is a real spoilsport - ed.]

How to manage financial product salesmen

A good financial product salesman knows things that a fund manager can't know. He knows for instance what is going through the mind of that financial planner with gold-rimmed spectacles in Doncaster. He knows what will sell.

At best he knows how to craft the message so that it will sell, so that it will not trigger any red-flags, so that it will make the recipient comfortable.

And that is good, you can say things in a glass half-empty way or glass half full way without bending the truth. Trivial example: risks are a bad thing, so focusing on the the risks does not sell your product whereas risk management is a good thing so focusing on that might help you sell. You can't actually do good risk management unless you focus on risks - but the angst that gives a good fund manager need not be seen by clients. A good salesman will hide that angst because - well - what sells is the illusion of certainty.

But a salesman who drives changes in the product because, so changed, the product will sell better is on the path that eventually destroyed both BT and Mr Drury's career. And good sales people are empathetic to the needs and desires of their targets so that is the path they tread...

But it is a dangerous path. Really dangerous.

I know (and respect) a fund manager with a very harsh solution to this. When the salesman tells him how to design his product he gives him a warning. The second time he fires him.

He has gone through a few sales people. And eventually he sold lots of product because the performance was too good to ignore.

But it is harsh, unpleasant and not very effective as a sales strategy.

Anyone got a better idea?


*Retrospectoscope is - to my knowledge - a Trade Mark of Platinum Asset Management - a very fine firm who took over BT's dominant Australian position.


Anonymous said...

Q3 1999 not 2009

filthylucre said...

I think that you mean that the transaction closed in 1999 not 2009

John Hempton said...

Two comments fixed. Thanks.

John said...

How funny that this morning I read a more or less similar comment about Kyle Bass on a forum.

(I don't know Kyle Bass enough to have an opinion myself.)

Anonymous said...

The BT story is even more poignant than you make out.

In the late 1990s, BT Australia was a merchant banking power-house in Sydney. Aside from that, it had the leading corporate superannuation business and one of the more prominent funds management operation. (Your former master, Kerr Neilson, learned the ropes there.)

Unfortunately, the Australian operations were controlled by BT out of NY, which was, at the time, struggling in the bulge-bracket.

Then some clown in NY got the bright idea to sell 'butterfly swaps' and some other nifty derivates. That business was profitable for a while, that is until clients got burned. Litigation followed, the BT stock price tanked in response, and Deutsche Bank bought BT for a song.

The inevitable rationalisations followed, in the desperate search for 'synergies'.

Among other things, the Australian operations, which were very strong performers, were dismembered.

A large part of merchant banking business in Sydney was sold to MBL, which was a good acquisition for them as it laid the foundations for what later became known as the 'millionaires factory'.

The superannuation and funds management business were, as you say, sold to the Iowa boys, who quite frankly, struggled to come up with any direction for those businesses, and they soon sold it to Westpac. By then, Kerr had taken the client list and set out on his own, forming the basis for Platinum Funds Management, which is was worth billions when it listed a few years ago. (Incidently, wasn't that float the source of your fortune too?)

The remaining stub of the BT merchant banking operations in Sydney (and the much smaller Melberg office) were retained by Deustche Bank, but they were starved of capital and slowly run down over the years, due to issues which have plagued DBAG in Germany.

This is this sorry history of how a very successful financial player can fall, all because some fool on swaps desk on the other side of the world does something stupid.

How to I know all this? Well, I was a lawyer with a front-row seat to this circus. (NB. what I've sketched out here is publicly available information).

Unknown said...

Interesting post John. I think it was T.Rowe Price who once said "The quality of a financial service is inversely proportional to the willingness to offer it..." Best, Drew.

homeandhosed said...

A very good analysis of the inherent difficulties of combining investment maangement and business development.

I would go a step further and suggest that institutional funds management businesses generally are problematic - general management meetings, IT shutdowns, HR policy updates, etc., none of which I've ever seen create much in the way of investment returns.

Ultimately investment managers are selling trust in their judgement in an unknowable future. If clients are sold on some other reason then sooner or later it unravels.

Like minded clients who buy into what you do is the obvious answer, but admittedly as helpful an answer as telling the runner to win the race by going faster!

John Hempton said...

Oh, I think TRowe Price is wrong. I like to think we offer good financial services - and I am plenty willing to offer them.


Not in my league - but Warren Buffett in the days of Buffett partnerships - had trouble getting clients.

The clients he did get did rather well though.


Colin P said...

John, You're like Larry David when he was an up-and-coming comedian. I once was told his shows weren't well attended, but the few people in the audience were other comedians, many famous. He was the comedians' comedian.

What's more important, the respect of your peers or getting clients? What's harder to attain?

David said...

"Anyone got a better idea?"

Don't use salesmen?

Find a few old fashioned stock brokers or financial planners with small numbers of longstanding clients. The type of clients that are now friends due to the excellent advice they have received over decades.

These people are around, and I know several in Melbourne.

You only need a few people like this, as you do not want to be manageing billions I imagine, and the rate you are compounding, unless you limit your distribution network, you do not have many years left.

I think Buffett only lasted 15 years or so before he wound up, and I think you are compounding faster.

Tim said...

John what you mention is also something I have given a lot of thought and is really the chicken and egg problem in asset management.

You can have the best fund in the world (performance and low and fair fees) but if someone doesn't sell it it's all no use.

In most cases they need commissions to do that which means higher fees.

This leads to most companies either becoming an asset gatherer or fund manager.

The asset gatherer usually flames out as your said.

The fund manager builds a reputation and AUM over a long time.

The next question is a open ended or closed end structure so your AUM doesn't leave when the best buying opportunities are there.

All difficult questions with no easy answers only compromises...

Anonymous said...


Have you thought about opening a fund for retail investors? I'm sure some people who read your site would like to invest but do not have the high amount to invest in a wholesale fund?

David said...

a retrospectoscope is a very old medical term, probably used for 100 years.

Someone who uses a retrospectoscope talks down other doctors who have seen a patient in the past before the diagnosis had declared itself.

Anonymous said...

As a former alumnus, I think you're too hard on the sales staff: the money managers drank the Nasdaq cool-aid (and one or two other noxious brews) without any outside prompting...

Unknown said...

Hiring the right people doesn't hurt. But the only thing I've seen work is to create an alignment of interest based around the long term value of the funds management business:

1. Ensure most compensation is variable, and mostly paid in firm equity.

2. Lock up the equity awards for a reasonable time.

3. Firm equity has value. (No profit participation without capital participation).

4. Provide liquidity for the equity, so it can be sold for fair value.

5. Restrict managers to selling only a small amount of their equity at any time, to minimise the opportunity for timing.

6. Until they retire, the majority of senior manager's net wealth remains firmly tied to the long term success of the firm.

The above applies to both your PMs and your senior sales team. Similar issues:- short term opportunities also distract PM's, to the detriment of their real job of acting in clients long term interests. But you're right, the problem is more acute for sales; they can blame the PM for a blow up and move onto their next job with their reputation intact.

And finally, avoid over-diversification of the business. Ideally, 1 team, 1 investment process, sometimes multiple products (build on that single investment process) and 1 bonus pool. No-where to hide, and nowhere to shift blame.

Anonymous said...

Great discussion. In my overstated opinion and limited experience, rules and regulations in a company, country, or elsewhere rarely drive the culture. And, the culture is both a result and a cause of thoughts, actions, and character. If your company culture is what it looks like it is from the outside then you'll be fine until your culture changes. The simple answer...keep your culture. The harder Want to grow...bring someone in that fits your culture and structure it to address the how in a way that makes sense to you.

Your thoughts?

General disclaimer

The content contained in this blog represents the opinions of Mr. Hempton. You should assume Mr. Hempton and his affiliates have positions in the securities discussed in this blog, and such beneficial ownership can create a conflict of interest regarding the objectivity of this blog. Statements in the blog are not guarantees of future performance and are subject to certain risks, uncertainties and other factors. Certain information in this blog concerning economic trends and performance is based on or derived from information provided by third-party sources. Mr. Hempton does not guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. Such information may change after it is posted and Mr. Hempton is not obligated to, and may not, update it. The commentary in this blog in no way constitutes a solicitation of business, an offer of a security or a solicitation to purchase a security, or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author. In particular this blog is not directed for investment purposes at US Persons.