Anatomy Of A Mutual Fund Steal

Bought for a song, RS Investment makes a comeback

Trying to sell a mutual-fund company during a stock-market meltdown is like hawking a beachfront cottage in a hurricane. That's the bind G. Randy Hecht was in a year ago when he sought a buyer for Robertson Stephens Investment Management, the firm he headed. Many fund companies looked, but not one made even a lowball offer. Hecht and other employees ended up buying the unit for a song from its owner, Bank of America Corp. Now it looks like Hecht got the deal, or perhaps the steal, of the year.

It wasn't just the stock market, blindsided by Russia's debt default and the collapse of Long-Term Capital Management, that scared off buyers. The biggest problem was the performance of its flagship, the Robertson Stephens Contrarian Fund. The mutual fund had been heavily marketed in the mid-1990s as a safe harbor in stormy times. But for the second time in two years the fund's value was melting down faster than the market itself. Contrarian had more than $1 billion as recently as 1996, but a river of red ink and the resulting shareholder exodus had whittled it down to $90 million by September of last year.

ROCK BOTTOM. "We were seen as damaged merchandise," says James L. Callinan, portfolio manager of RS Emerging Growth Fund. So last November, the Bank of America, which had acquired this unit through a megamerger, agreed to sell to Hecht and an employee group for $20 million--about 1% of assets, a rock-bottom price as long as the asset erosion didn't worsen.

But as Hecht and the bankers were working out the details, the hurricane headed out to sea. The market bottomed early in the fourth quarter, and fund performance bounced back strongly. Five funds are up in excess of 40% so far this year, and all but two of the 10 funds are beating the Standard & Poor's 500-stock index. Cash started to flow back to the firm, mainly to Callinan's RS Emerging Growth Fund, the firm's leading performer this year.

Some cash is even starting to trickle into Contrarian, which is enjoying a bounceback, up 40.8%. Total assets under management--including separately managed accounts and hedge funds--now stand at $4.5 billion, up from $2.9 billion at the end of February when the deal closed. Hecht estimates that the performance rebound and asset growth give the company a private market value of about $160 million--based on a recent fund industry acquisitions priced in the range of 3% to 5% of assets.

Though Hecht is still chairman and CEO, there have been some significant changes since the buyout. Last month the firm renamed itself RS Investment Management (RSIM). The reason: It sold the right to use the Robertson Stephens name for $10 million to BankBoston Corp., which acquired its onetime parent, investment bank Robertson Stephens from the Bank of America.

Some portfolio managers have changed their status as well. Ronald E. Elijah left to set up his own firm, but continues to manage RS Value+Growth and Information Age funds as a subadvisor. Rick Barry, a hedge-fund specialist and co-manager of Contrarian, also started his own shop but retains a subadvisory arrangement. Still, because the firm is now employee-owned, it will be easier to attract investment talent, says Larry Lieberman of The Orion Group, a fund industry recruiter.

The firm needs to repair its reputation with investors, especially with independent investment advisers such as Michael Hengehold of Hengehold Capital Management in Cincinnati who once flocked to its funds. "I once had a lot of faith in Paul Stephens," says Hengehold, talking about the portfolio manager of Contrarian and a founder of the investment bank. Hengehold put his clients into the fund, whose concentrated positions in undervalued stocks and short-sale positions gave it some traits of a hedge fund. When Contrarian started to slip in 1997, even as the market was rising, he held for about two months and then sold out.

Stephens plays a much-reduced role today. Last September, Hecht assigned Andrew Pilara, who runs other RS funds, and Barry to join Stephens as co-managers of what's now called The Contrarian Fund. Each runs about a third. The trio approach improved performance by diversifying what had become a concentrated fund, damping its volatility. A rebound in natural resource and energy prices and the surge in tech stocks bought on the cheap, such as Qualcomm Inc. and Apple Computer Inc., also helped.

Going forward, RS Emerging Growth Fund may be more problematic. Standing at just over $400 million at the start of the year, the fund is now $1.2 billion, and size can slow performance. But Callinan, who joined the firm in 1996, insists size is not an issue. He says he ran far more money in his previous fund, Putnam OTC Emerging Growth. "When it went from $885 million to $2.6 billion, the fund was in the top 25%" of its peer group, says Callinan. But the performance of RS Value+Growth, a hot fund in the early 1990s, has slowed in recent years as its assets grew and it evolved into a large-cap portfolio.

Even if the funds continue to hum, the firm needs better distribution. Most of its money has come--and gone--through mutual fund supermarkets such as those run by Charles Schwab & Co. and Fidelity Investments. Hecht says the firm is getting inflows from Merrill Lynch & Co.'s mutual-fund wrap accounts program, and he's also courting other companies' wraps and 401(k) plans. One reason Hecht had sought a fund-company buyout was to gain new distribution channels, "but now I think we can do it better on our own."

Whether RSIM has turned around enough to command the premium valuation of $160 million is debatable. But Hecht says the firm has no interest in putting itself on the block yet again. Says Hecht: "Frankly, we're enjoying our independence."

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