A merger had been discussed in the late 1990s, but that hostile approach by BNY to take over Mellon was rebuffed. “What changed since then is that the two organisations began to look more and more like each other,” explains Little. “BNY was the larger player in custody, but was smaller than Mellon in asset management and wanted to get bigger.”
The rationale for the merger in custody, a business Little likens to an arms race, was to gain scale. Following the merger, BNY Mellon is now number one in global custody, servicing over US$23 trillion in assets. There was a similarly clear rationale for combining the two companies in asset management. “One of the really nice things about the deal,” continues Little, speaking from the perspective of his background at Mellon, “was that they [BNY] were effectively building the same model as we had. If you look at firms like Ivy, Alcentra and Urdang, which are three of their alternative strategy firms, they had acquired them and left them entirely separate with their own distinct investment processes.
Little argues that attempting a deal combining a US$300 billion asset management business structured as one giant firm with one organised as a multi-boutique model would have been far more difficult. “You would either have to run with this giant boutique alongside the rest or unpick the big amorphous blob and try to turn it into separate units, which is our style,” he says. “But we didn’t have to do that. We literally bolted on the BNY business to the Mellon business and the integration was largely finished within six months. The end result is a portfolio of specialist investment management firms, each with its own unique philosophy and proprietary investment process. Sixteen of these forms, with US $931 billion under management, are marketed internationally, witrh a smaller offering aimed purely at the US market bringing the total AUM to US$1.1 trillion. Thirteen of those companies offer alternative strategies.
No house view is imposed – BNY Mellon does not have a Chief Investment Officer – and with each manager retaining complete investment autonomy, a focused entrepreneurial approach is encouraged. Little explains that this autonomy is taken very seriously, “Investment research is never ever shared, even to the point of paranoia – we would never bring analysts together for a get-together, for example”
“We have a balanced business,” says Little. “If you look at the ‘cake’ it is nicely balanced between equities, fixed income, property etc and this mix has stood us in good stead over recent months.”
The best performing strategies over the last year have been equity long/short and active currency, which have both benefited from the opportunities created by high volatility. Among its conventional strategies, BNY Mellon highlights global equities, where managers such as Newton and Walter Scott came into 2007 with the opinion that financial stocks were heading for a fall and sold pretty much all their banking exposure. At the other end of the spectrum the worst performing strategies have been the quant-based global macro strategies. “Like most quant managers we took a beating in the fourth quarter of 2007 and the first quarter of this year,” admits Little, although he adds that performance has picked up recently.
Little accepts that there is a need to examine the model and ask what lessons can be learned, but cautions against declaring that the whole idea of quant models is broken. “It has happened before, we have had situations where we have underperformed for three, four or five months and then we have seen a snap back where valuations have gone back to where they should have been. It’s a bit like being at a football match when your team is 2-0 down; you have to get to 90 minutes first before saying things didn’t work.”
But how does BNY Mellon determine the appropriate scale of its business? “People ask what’s the optimum size, and whether we are going to buy another 50 firms or build another 50,” says Little. “The answer is partly determined by the market. As long as we keep spotting things that we need more of, or gaps open up where product didn’t exist before, or wasn’t particularly big but suddenly becomes a key product, then we’re interested in acquiring.”
BNY Mellon, for example, would be interested in adding to its private equity capability, which is currently quite small, and also in adding capacity in commodities. While its presence in US equities is already substantial, it could also accommodate another US equity manager. Equally, there are areas where BNY Mellon is happy with its exposure. “We have three funds of hedge funds managers, but if someone said to us ‘there is a great fund of funds firm available, would you buy it?,’ then the answer would be no, because we have plenty of capacity in that area and don’t need any more.”
In a similar fashion, BNY Mellon has no prescriptive rules on the proportion of hedge fund strategies that its portfolio should contain. Little wants to avoid a ‘barbell’ model with a lot of high-risk strategies at one end, low-risk commoditised products at the other end and nothing in between. “If the business was, say, 50% alternatives, unless that was the way the market goes, with alternatives becoming completely mainstream, we might feel a little unnerved. It’s a question of striking the right balance.”
Growth is delivered in three ways. Firstly, by growing the existing companies organically. “We are always trying to grow the firms themselves and alternative investments are a good example. Firms that five years ago just ran conventional products have turned those products into alternatives by adding leverage or by adding shorting capacity.”
Secondly, BNY Mellon has also grown new operations out of existing companies. Standish, one of the group’s fixed income managers, has developed a unit called Coefficient. It is still part of Standish, but has been separated off to focus on absolute return fixed income products. These were felt to be an underexploited area of operations, but would have been more difficult to manage within the existing, larger, fixed income business.
The third source of growth is through buying and also building new companies. “Take Pareto, we [ultimately] acquired the rest of it, but it was set up and built substantially under Mellon’s ownership. Similarly with Franklin Portfolio, which was one of the first ever quant managers, the first dollars they had to manage were from Mellon. We have built and bought, it’s not just been all buying and I think that is a crucial distinction,” says Little.
With this philosophy in mind BNY Mellon would rather own all of a company, or the majority of it, rather than take minority stakes in fund managers, although there are exceptions. “We have owned 19.9% of Hamon Investment Group, one of our Asian managers, for a long time. It’s a happy relationship, which works very well and we have left it alone.” WestLB Mellon is another example, where ownership is split 5050. WestLB was keen to retain some upside in the asset management business, while BNY Mellon wanted to gain access to a distribution network in Germany.Equally, BNY Mellon has not shied away from disposing or merging units with others in pursuit of the optimum portfolio. “We’ve done a bit of merging over the years, mostly in the area of commodity type products. When we merged, BNY Asset Management didn’t fit into the boutiques – it was passive, short-term fixed income and US core fixed income. It had good people and good products but nothing really differentiated it so we just moved the pieces in amongst the subsidiaries.”
On occasion disposals have been made, more for reasons of compatibility than lack of performance. “We sold Fursa, a single strategy hedge fund manager, two years ago, after buying it in 2001. It was very entrepreneurial, very trader-driven which just didn’t really fit and they never really felt they were part of the group,” says Little. “At the time we thought the only way of getting into alternatives was to buy hedge fund firms. We learned that the way to get into alternatives was to grow the capabilities that we had rather than go out and spend a lot of money buying expertise.”
In addition to growing the number and range of asset management strategies it offers, BNY Mellon is also pursuing a growth strategy aimed at expanding its footprint in developing world markets. “There are places where we want to be and we’re not or where we are currently taking steps to be in. The example we have announced is China. We have a JV with Western Securities, a local securities firm, where we’re building from scratch there,” explains Little. “We’ve done a lot in China. We were the first people to launch a QDII (Qualified Domestic Institutional Investor) fund there, and we were the biggest launch ever.”
The QDII program enables Chinese investors to access foreign fund management capabilities. In September 2007 BNY Mellon announced that the QDII mandate it sub-advises on behalf of China Southern Fund Management Co Ltd had launched at a capped US$4 billion in assets having received US$8 billion in subscriptions from Chinese investors. “We expected strong demand from Chinese investors but this exceeded anything we had anticipated,” says Little. China is not the only area of focus within the rapidly growing BRIC economies; BNY Mellon also recently made an acquisition in Brazil (see box on previous page).
At a time when some of the world’s large investment banks have grown their businesses faster than their ability to manage them, BNY Mellon’s boutique approach offers an alternative solution to dealing with the problems of increasing scale.
“That’s the nice thing about our model. It requires less management than an equivalent organisation of the same size [which is run as one firm],” states Little. “The structure helps manage itself. In our situation there are chief executives of the separate investment companies who, frankly, live and breathe the success of their organisations. Their bonuses, and the bonuses of their staff are dependent on the success, not of the whole company, but of their own organisation.”
Each of the CEOs has a strong vested interest in watching risks and expenses, and in ensuring they come up with new products and manage their teams effectively. Under BNY Mellon’s remuneration structure, all bonuses are based on pre-tax profits, after operating costs have been deducted, not on some measure of revenue generated. The individual businesses are FSA or SEC registered and managers are, therefore, personally accountable and liable. “Our model is a like a ship with lots of different compartments. A problem in one compartment doesn’t sink the ship.”
Keeping individual business units relatively small avoids other pitfalls. “Managers don’t get better as the business gets bigger and there is some evidence that they get a lot worse,” suggests Little.
Little admits that there is a risk from the complexity of running such a wide range of strategies. “Could I or other members of senior management possibly be expected to know, or am I qualified to know every intricacy of every model we have got? Of course not, but we have the right controls in place and the right people in place, who are accountable. The people who work in our asset management business aren’t bankers, almost without exception they are people who have spent their entire careers managing money.”
BNY Mellon is also aware of the risk that its businesses may be vulnerable to the loss of key managers. This type of risk was vividly illustrated with the departure in April of Greg Coffey from GLG Partners, where he had managed US$7 billion of the firm’s US$25 billion AUM. “You can’t completely avoid that risk. We had a problem like that last year, where we lost a team from the Boston Company [an active fundamental equity manager],” admits Little. “We control it in a number of ways. Firstly we are not really a star shop. We have been offered the opportunity to buy star-driven companies and have always walked away.”
Care is also taken to avoid any manager controlling too high a proportion of any particular business. “You can always lose a team or key individuals who the market thinks are important to your process. Any one of our firms could lose a key person and it would hurt, but it wouldn’t kill the firm or ruin our reputation. We would be concerned if one individual was one third of our profits, in fact we would get concerned if they were even one thirteenth or one thirtieth of our profits.”
An approach that avoids single manager risk, however, need not result in a relative lack of expertise. “If you go to any of our companies and talk to the individual managers they are all so different. The quant guys and the stock-pickers, they wouldn’t agree on anything.” The multi-boutique model allows BNY Mellon to offer investors access to highly regarded managers, providing opportunities in virtually every style, strategy and class of investment management.
Summing up the company’s philosophy, Little adds, “If you tried to run it as one firm you would lose the purity of the underlying culture.”
Jonathan Little is Vice Chairman of BNY Mellon Asset Management, Chairman of BNY Mellon Asset Management International, the international distributor of the investment skills of BNY Mellon Asset Management, and is Chairman of The Dreyfus Corporation, one of the leading mutual fund companies in the United States. Little joined Mellon in July 2000 from JP Morgan Investment Management, where he was head of sales and distribution for its international fund & sub-advisory businesses outside the United States. Prior to that, he was director of sales and business development for Fidelity Investments in the United Kingdom.