Morgan Stanley Investment Management looks beyond U.S.

Morgan Stanley Investment Management is counting on overseas growth to help get it back on track as revenue continues to fall. But the hurdles are high, particularly in Europe, where unfavorable market conditions in the retail sector, combined with recent high-profile departures, have weakened the firm, according to analysts and consultants. Still, industry watchers said, several companywide initiatives — including an effort to broaden alternative-product offerings, most notably in hedge funds — are be-ginning to pay off internationally and will place the firm in a more competitive position in the long term. The asset management subsidiaries of global financial services firms generally are playing a more important role in stabilizing their parent companies' earnings, because management fees help to offset the volatility in the trading and investment-banking businesses. Financial institutions are "realizing that the asset management business is beneficial, especially right now, due to the attractive multiples, at least compared to the investment banking side," said Ben Phillips, managing director at investment bank Putnam Lovell NBF Securities Inc. in New York. He has been named a partner at money manager consultant Casey Quirk & Associates LLC of Darien, Conn. The situation is no different at Morgan Stanley Investment Management, where the credit turmoil has brought a renewed sense of purpose to the asset management division in relation to its parent company, New York-based Morgan Stanley. Morgan Stanley has been battered by about $14 billion in write-downs since last summer, but the damages are viewed by analysts as less severe than at other major competitors, such as Citigroup Inc. and Merrill Lynch & Co. Inc., both of New York, and UBS AG of Zurich, Switzerland. Morgan Stanley at this point isn't likely to have to sell its asset management division in order to raise capital, analysts said. Morgan Stanley Investment Management reported $605 billion in assets under management as of May 31, an 8% increase from the previous year. In the fiscal second quarter ended May 31, the manager re-ported net inflows of $15.5 billion, representing the seventh consecutive quarter of net inflows.

INTERNATIONAL GROWTH

"If you take a look at where growth has been coming from during the past three or four years, it's all been in international," said James Dilworth, the London-based chief executive of Morgan Stanley Investment Management in Europe, the Middle East and Africa. "What we're doing now is a continuation and re-emphasis of our desire to grow our international business." At the same time, however, revenue fell to $488 million at the end of the quarter, a 10% drop from the previous quarter and 68% below the fiscal second quarter of 2007, ac-cording to data from the firm. Asset management net revenue as a percentage of Morgan Stanley Investment Management's contribution to the overall company fell to about 7% for the first half of the fiscal year ended May 31, compared with 19% a year earlier, according to data provided by the firm. Inflows have been dominated by lower-margin strategies such as money market funds, while losses in real estate and private-equity strategies have significantly reduced revenue, according to company officials. In addition, performance issues in some of the firm's equity strategies have been compounded by general market volatility, and investors are leaving, analysts said. Morgan Stanley Investment Management declined to provide data by region, but overall, equity assets under management fell to $239 billion as of May 31, from $265 billion at the end of its fiscal year last November. "The problem was that we weren't growing," Mr. Dilworth said. "It's nice to have a good profit-before-tax margin and running a low-cost business and getting a nice return on investor capital, but [the firm] was becoming a smaller and smaller part of a growing Morgan Stanley." Key departures have also hit the company. David Germany, managing director and chief investment officer of global fixed income, and Hywel George, managing director and head of equities for the London-based equity team, left this year. Kevin Klingert, chief operating officer of global fixed income, has assumed Mr. Germany's responsibilities until a new CIO is appointed. The firm doesn't plan to replace Mr. George, but equity portfolio managers Hassan Elmasry, Margaret Naylor and Peter Wright have taken over his responsibilities. "I think there's a lot to do here at MSIM; it remains a challenging environment in a positive way," said Mr. Dilworth, who was recruited from New York-based Goldman Sachs Asset Management to expand the Europe, Middle East and Africa business. "It's all about just executing our strategy — continuing to find good people, investing in these people and making sure they're in the right place." Morgan Stanley Investment Management's non-U.S. assets under management accounted for about 22% of the total for the first half of the fiscal year ended May 31. Data for assets under management ac-cording to regions weren't available, but according to analysts, the Europe, Middle East and Africa region makes up the majority of the firm's assets under management on behalf of international clients. "We effectively built a retail business [in the Europe, Middle East and Africa region], with the exception of the Middle East," Mr. Dilworth said. "I'm looking to balance that, not by de-emphasizing the retail business but effectively going into a whole new channel and a whole new market, which is the institutional business." To attract more overseas institutions, Mr. Dilworth said, the key is strong multiasset capability. Investors are reducing beta exposure to equity markets and shifting assets into commodities, fixed income, and beta-neutral and alpha strategies. Analysts added that Morgan Stanley Investment Management needs to diversify its offerings further in order to capture those flows. "Morgan Stanley [Investment Management] has to do this," said Brad Hintz, a senior analyst at Sanford C. Bernstein & Co. LLC in New York, referring to expanding alternatives. "It has moved a bit into this direction, but it's not quite there yet ... Regrettably, it is difficult to grow asset management quickly, and acquiring [alternative managers] is expensive."

BUILT FROM SCRATCH

Morgan Stanley Investment Management built its hedge fund capability almost from scratch about two years ago. In 2006, the firm acquired three hedge fund managers: Brook-ville Capital Management LLC of New York, FrontPoint Partners LLC of Greenwich, Conn., and Oxhead Capital Management LLC of Boston. The firm also now holds minority stakes in Abax Global Capital of Hong Kong; Avenue Capital Group and Traxis Partners LP, both of New York; and Hawker Capital (Cayman) Ltd. and Lansdowne Partners Ltd., both of London. The manager may purchase additional stakes in hedge funds. "The game there is not only to buy stakes in hedge funds but also to broaden our capabilities in such a way that we don't cannibalize our existing franchise," Mr. Dilworth said. "Going out and taking a major stake in an institution that walks and talks like FrontPoint, for example, would not be to our advantage." Internal capabilities were boosted in its quantitative- and structured-solutions team, which is in charge of such strategies as currency, commodities, 130/30 and portable alpha. Other alternatives units, such as infrastructure, have also been strengthened. Morgan Stanley Investment Management raised $4 billion this year for an infrastructure fund that had an initial target of $1.5 billion. The fund manager is also looking to shore up traditional capabilities and is looking to acquire a style-neutral global equity manager, "but that remains tough," Mr. Dilworth said. Although alternatives allowed Morgan Stanley Investment Management to grow, "it's not the endgame," he said. The firm still depends largely on core and core-plus equities, and fixed-income strategies, for about three-quarters of its total assets under management, according to data from the firm. Thao Hua is a reporter at sister publication Pensions and Investments.