Two years ago, Merrill Lynch & Co.'s asset management group was hurting. Jeffrey M. Peek took charge just as its mutual funds started to melt down. Group founder Arthur Zeikel had built a reputation with his trademark value funds. But when investors started to clamor for growth funds instead, Merrill had little to offer. Worse, one of the few growth offerings it did have, the Merrill Lynch Growth Fund, self-destructed, finishing 1998 down 24%, when large-cap growth funds in general gained 34% on average. "I lost a good deal of my stomach lining a year ago," Peek recalls.
To raise the group from its ashes, Peek, an outsider recruited from Merrill Lynch's investment banking division, raced to outflank competitors by paying $5.3 billion for British pension fund manager Mercury Asset Management. He broadened the group's business, then made up primarily of retail mutual funds, by selling fixed income and equity funds to institutional clients. There are signs of progress: In the first quarter of this year, his group boosted assets under management by $10 billion, to $568 billion, making the division the world's sixth-largest asset manager. It raked in $76 million in earnings that contributed 8% to Merrill's $1 billion first quarter bottom line.
But the problems in the group's highest-profile product line still need to be fixed: Investors pulled out $1.6 billion more than they invested in Merrill funds in North America in the first quarter. Merrill lost ground as mutual funds run by rivals Goldman, Sachs & Co. and Morgan Stanley Dean Witter had positive inflows. Funds superstar Janus Funds netted as much as $28.2 billion, according to Boston mutual-fund consultant Financial Research Corp.
CRUSADE. Now, Peek, who has never managed a mutual fund, is on a crusade to resurrect Merrill's proprietary mutual-fund business. He is shaking up the chain of command, recruiting new talent, streamlining old funds, launching new ones, and pressuring portfolio managers to perform better. "None of the other good things that follow in asset management can happen if you don't have good performance," says Peek. "In terms of our global image, it's a prerequisite."
He is even dumping the division's name. From June 30 on, employees of Merrill Lynch Asset Management and its far-flung constellation of fund-management operations--from London's Mercury Asset Management to Hotchkis & Wiley in Los Angeles--will all carry business cards bearing a new name: Merrill Lynch Investment Managers.
With parent Merrill Lynch's main retail brokerage business under attack by discount brokers, it's crucial that Peek succeed in remaking his group into a mutual-fund powerhouse. Merrill urgently needs new fee business to replace dwindling commissions.
It's going to be a hard slog. America's mutual-fund industry is brutally competitive and dominated by a handful of supersellers. In 1999, Fidelity Investments, Vanguard Group, and Janus together took in $102 billion of $151 billion of net inflows into equity and bond mutual funds. Merrill's problems are compounded because its funds have comparatively high management fees. And to top it off, its fund mix is weighted towards money funds. So Merrill has a relatively modest initial goal for its mutual funds: By the end of this year, it just wants to attract enough new money to cover redemptions.
Even attaining that will be a struggle. Some analysts question whether traditional brokers such as Merrill should even bother to run their own funds anymore. "Most financial intermediaries have difficulty building large top-rated fund-management complexes," says Henry McVey, financial analyst with Morgan Stanley Dean Witter. "It's no longer obvious that retail brokerage firms need to manufacture all products and services."
Moreover, Merrill is not the only broker trying to overhaul its operations radically. Citigroup is putting pressure on the asset management divisions of Salomon Smith Barney and Citibank by merging them into a single unit that answers directly to CEO Sanford I. Weil. Morgan Stanley Dean Witter has folded together several acquisitions and is implementing a "Best of the Best" program, reassigning its best fund managers to its new funds.
Peek is undaunted. He's recruited almost an entirely new senior team, including Robert C. Doll, who he snagged last June from OppenheimerFunds Inc. to pull his asset-management group out of its retail rut. Doll wants 80% of the group's retail assets under management to earn top four- or five-star ratings from Chicago fund tracker Morningstar Inc. for their three-year performance, up from 39% today.
So Merrill has rushed to build up an arsenal of new offerings. In March, it rolled out two new growth funds--the Focus Twenty Fund and the Premier Growth Fund run by Jim McCall, a new recruit from PBHG Funds Inc.--that raised a combined $1.2 billion. "They have a whole bunch of new launches," observes Kunal Kapoor, analyst with Chicago fund-tracker Morningstar Inc. "Now they have to make them work."
Peek is adjusting portfolio managers' pay scales to increase their incentive to raise fund performance. Before, their salary was based on track records reaching back as far as 15 years. Now, it's based on their funds' first-, third-, and fifth-year returns. He has tied 10% of their pay to Merrill's mutual funds' performance as a whole, to encourage them to work as a team.
TOUGH RIVAL. Some new initiatives are having a rough start. Merrill raced out its growth funds just before the Nasdaq tumbled. McCall's two funds, heavily weighted toward technology and telecom stocks, have fallen 20% and 24%, respectively, since their launch. And some of Merrill's highest-performing funds still trail their categories' average.
But there are some successes. "They're definitely a tougher competitor," says Thomas W. Jones, chairman and CEO of global investment management and private banking at Citigroup. Merrill has climbed up to the middle of Barron's ranking of retail mutual-fund families based on their five-year performances, from dead last in 1998. Meanwhile, veteran portfolio manager Steve Silverman has remade Merrill Lynch's Growth Fund by dumping oil stocks and REITs while emphasizing the likes of biotechs. Says Silverman: "I made the fund into what it was supposed to be."
Doll still faces a major challenge in persuading Merrill's own brokers to sell his funds. Last year only 19% of the funds they sold were from the Merrill stable. Doll wants that figure to double to 40%. That's still below the 50% share that the group enjoyed in the mid-1990's, before Merrill brokers started to sell 130 mutual fund families, instead of just Merrill product. Even Peek is getting into the act, taking weeklong road trips to win over thousands of Merrill's brokers everywhere from Salt Lake City to Fort Myers, Fla. "This is a political campaign," says Peek.
Merrill is also hunting for new investors. For the first time, it's chasing after banks, independent financial planners, and regional brokerages, not only overseas, but also in the U.S., to sell its products. In April, for example, it signed a distribution agreement with St. Louis regional brokerage A.G. Edwards Inc. It is negotiating a series of similar agreements with others.
Abroad, Merrill is making inroads in markets stretching from Tokyo to London. Merrill has become the largest foreign-owned asset manager in Japan, with $42 billion under management, mostly in institutional products. It expects to see these assets surge 30% this year. And London's Mercury has become the largest cross-border fund manager in Europe. There, it manages $170 billion in assets, even though an industry source believes it lost as much as $12 billion in British institutional assets to competitors since Merrill bought it at the end of 1997.
Peek has ordered his division to pull in more than $2 billion in new assets worldwide every week this year. He wants the total under management to almost double, to $1 trillion, by 2004. By the same year, he wants the division's annual net income to triple from $335 million.
He is making some noise about the possibility of yet more acquisitions. "We have been acquisitive in asset management, so I wouldn't rule out over the next several years that we wouldn't gain more assets through acquisition," he says. But first, Merrill needs to regain its strength in retail mutual funds at home.