How Putnam Landed in This Pickle
By Faith Arner
In 1994, Putnam Investments figured it was time to take on its crosstown rival and giant of the mutual-fund industry, Fidelity Investments. After all, Putnam had yet to attract the billions in assets accumulating in 401(k) plans. So it cobbled together a cheeky ad campaign that promised truth in labeling, indirectly poking at Fidelity, which had taken flak when one of its growth funds invested a chunk of client money in no-risk Treasury bills.
The Putnam ads -- one featuring a fierce Doberman Pinscher wearing a dogtag that read "Kitty" -- worked beautifully: Cash started pouring into Putnam. Even longtime CEO Larry Lasser seemed surprised. At a meeting with executives, some who were there recall him musing aloud that he worried about the day Putnam's ability to sell funds would outpace its ability to manage the money.
Turns out he had reason to worry. The $50 billion that Putnam pulled in over the next three years was just the beginning of a gusher that would eventually spray out of control. Much of the cash went into Putnam growth funds that invested heavily in tech companies. As those stocks and Putnam's funds soared during the roaring '90s, more investors started sending money Putnam's way. From 1997 to 1999, the Boston-based group raked in an additional $35 billion, fueling even more investment in tech companies. At its peak in August, 2000, Putnam had $425 billion under management, up from $25 billion in 1990.
But when tech began its long, steep slide in early 2000, many of Putnam's funds went with it, falling harder and faster than their peers. Cash flowed out as nearly quickly as it streamed in: Putnam lost $10 billion to redemptions last year and $8 billion more in the first eight months of 2003. At least two dozen senior executives and fund managers have left since 2000.
Putnam now has even bigger trouble on its hands: On Oct. 28, the Securities & Exchange Commission and the Massachusetts securities regulator charged it with civil securities fraud for allowing six fund managers as well as individual investors to trade frequently in and out of Putnam funds in a practice called market timing. Putnam generally bans such trading because it pushes up fund costs, hurting overall returns.
Two fund managers -- Omid Kamshad and Justin Scott -- were also charged with fraud for allegedly trading in and out of funds they managed. The two were among the highest-paid money managers at Putnam, each earning more than $10 million annually in the go-go years. Putnam has denied any wrongdoing. Kamshad's lawyer, John Gilmore, said "the trades do not violate any rule, regulation, or statute." Scott did not respond to a call seeking comment.
Although Putnam brought in a new co-chief investment officer in late 2002 in an effort to halt the slide in its funds' performance, keep investors from further cashing out, and heal internal rifts, this new damage to Putnam's reputation could take years to repair. And the stock of Putnam's parent, Marsh & McLennan (MMC ), dropped 2% since the charges first came to light on Oct. 21. Both Lasser and Marsh & McLennan have declined requests for comment. But in a letter to investors, Lasser wrote "we are embarrassed and feel terrible" about the trading by employees. But he added: "We strongly believe that our actions were not fraudulent."
What tripped up Putnam, the country's fifth-largest fund family with $272 billion now under management? In addition to a turbocharged sales culture, analysts, observers, and many former Putnam employees lay the blame right at management's door for allowing the "quants," or quantitative analysts, to call the investing shots.
These number-crunchers took the wheel at Putnam around 1998 and centralized key functions such as trading, risk management, and research that had long resided in teams that managed funds. The reorganization was led by Tim Ferguson, who had left HSBC to become Putnam's chief investment officer, though he had never managed money.
BEHIND THE CURVE.
Ferguson's quants urged fund managers to trust the central mathematical models more than their own fundamental analysis -- and gut -- when it came to picking stocks. The models coughed up a benchmark for the funds to meet, one laden with tech stocks since they were driving the market. Even value funds were urged to buy tech shares, say former execs. "There was investment management by committee," says Matt Scholz, an analyst with Morningstar. "That's why a lot of portfolios tended to look more alike than they should have."
Quant models also have a major problem: They don't pick up a downturn until after it occurs. Indeed, Putnam kept launching tech funds after the market started to slide in April, 2000. Ferguson, who recently left Putnam after being moved to head human resources a year ago, didn't respond to repeated requests for comment.
The fund managers were under the proverbial gun. If they didn't meet their benchmark every quarter, they'd get a visit from the performance police inside Putnam. This central group of monitors would rake over a portfolio to determine why it didn't meet goals and how to correct it for the next quarter. "But performance over any one period can be random, and having people swarm in to look for something wrong misses that point," says Steve Oristaglio, one of Putnam's current co-chief investment officers. By Faith Arner
This "gotcha" culture and emphasis on short-term results fed a sense of paranoia, which encouraged fund managers to make big, risky bets so they could meet quarterly goals -- and also earn a big bonus.
The results were disastrous. After skyrocketing during 1999, many of Putnam's most popular funds gave back their gains and more from 2000 to 2003. The Putnam OTC Emerging Growth fund, for instance, was the darling of the tech boom, gaining 127% in 1999. But when the market turned, it lost 54% in 2000, 46% in 2001, and 33% in 2002.
"It bought into tech hook, line, and sinker," says Dan McNeela, who follows Putnam funds for Morningstar. "The losses were really devastating for anybody that got into the fund late." This year, it's up 26%, placing it in the top third of mutual-fund performance.
Nearly half of Putnam's 55 funds, including one of its largest -- the $18 billion Voyager fund -- still lag behind their peers. Voyager trails 56% of funds in its peer group. Only 14 of Putnam's 55 funds rank among the top 25% of their peers. And more than half of those are low-risk, municipal-bond funds, according to Morningstar.
Putnam is desperately trying to turn around performance -- and reverse the outflow of cash. Lasser brought in Charles "Ed" Haldeman, the former CEO of Delaware Investments late last year as the change agent. Haldeman, a longtime money manager, is co-chief investment officer with Oristaglio, a quant who joined Putnam in 1998 from the former Swiss Bank Corp. Together they're working to bring about a lasting truce between the quants and the fundamentalist money managers.
They're making some progress. In just a year, they've changed the way Putnam runs its funds. One key move has been to give more power back to portfolio managers. Rather than having all funds rely on a central team of researchers, risk managers, and traders, they've pushed research and risk functions down into the organization to help individual fund managers. "When you give people more autonomy and control, you get huge productivity enhancements out of it," says Haldeman, who has also called off the quarterly performance police.
The duo is also trying to change Putnam's investment mission. Instead of having fund managers swing for the fences every quarter to pull in big bonuses if they succeed, they're emphasizing consistent, dependable results. That means staying in the top half of the class every year and definitely out of the bottom quarter over one, three, and five-year periods. The bonus structure has been changed so fund managers max out when they reach that level. Gone is the bonus of 100% of annual pay for managers who perform among the top 10% of their peers.
Though many within and outside Putnam applaud the moves, it will take steady, superior performance for the fund family before outside brokers aggressively push Putnam funds to investors. (Unlike Fidelity, Putnam doesn't sell directly.) "You burn enough people enough times, and your reputation is shot," says one former Putnam executive. "You can give away a lot of baseball tickets and not turn that around."
The fraud charges won't undo Haldeman's work, but they're likely to delay any positive impact. Already, a Massachusetts state pension fund is considering pulling its $1 billion out of Putnam. Others may follow. For Putnam to win back the money, it's going to have to earn the trust of investors all over again.
Arner is a BusinessWeek correspondent in Boston