In late February, Deutsche Bank released a statement announcing that it had entered “exclusive negotiation with Guggenheim Partners on the sale of its Asset Management businesses.” The sale is expected to net Deutsche about $2 billion. However, a recently reported clarification of the deal suggests that Deutsche may be liable for further loses if the businesses underperform. According to Reuters, “the deal structure under discussion includes a provision whereby Deutsche Bank may have to make up for lost profits if certain assets perform below expectations after the sale.”
Will the asset management business meet performance expectations after the sale?
Deutsche Bank asset management includes DWS Investments, a mutual fund business in the United States, and RREEF, a series of real estate investment trusts, that manages money primarily on behalf of pension funds. Both businesses face potential risks.
A change in ownership to the DWS funds could affect their performance for two reasons:
- The sale would end DWS’ relationship with Deutsche Bank’s global research engine. Deutsche Bank does not financially back DWS Investments, but DWS advertises its connection with Deutsche as one of its key strengths. According to its website, “Building on the research expertise and global resources of Deutsche Bank—one of the world’s largest and most trusted financial organizations—and leveraging first-hand, real-time insight from a global research engine that links more than 750 analysts and investment professionals through a proprietary platform—DWS helps clients translate this knowledge into timely strategies.” To the extent this has been an important selling point for the DWS funds, it is unclear what effect the Guggenheim sale might have on the DWS franchise, since Guggenheim lacks a comparable research infrastructure.
- Management turnover, already an issue, could increase. In recent years, DWS has reallocated management of several key funds to its parent company. According to a Morningstar Report in December of 2010, DWS “has shifted the management of some key mutual funds to the asset-management operation of [its] parent company, Deutsche Bank in Frankfurt, Germany.” Furthermore, according to Morningstar, “The investment culture of the Frankfurt office is much stronger and more cohesive than that of DWS Americas, which was cobbled together through a series of acquisitions. The resulting investment culture was uneven and inconsistent, and DWS has struggled to improve it ever since.”
Meanwhile, RREEF’s ability to sustain strong performance following the proposed sale has been questioned by both investors and other potential buyers:
- As a result of the RREEF’s impending sale, investors have reconsidered their positions in RREEF. On February 7, 2012, Pensions and Investments reported that the Massachusetts Pension Reserve Investment Management board had terminated RREEF America as a manager. According to the report, “The decision by RREEF’s parent company, Deutsche Bank, late in 2011 to seek potential buyers for both RREEF and other parts of the bank’s global money management business was the “No. 1” reason to cut the company, John F. LaCara, investment officer at the $48.1 billion board, said at Tuesday’s meeting, ahead of the board’s vote.”
In a February 15 meeting of the Imperial County Employees Retirement Association, Scott Whalen, the fund’s investment consultant, “addressed the recent reorganization at Deutsche Bank and its selling of its real estate investment management firm, RREEF. Mr. Whalen recommended that the board consider terminating the asset manager from its portfolio.”
- Potential buyers of RREEF have also expressed reservations about the funds’ instabilities. According to the Wall Street Journal, “some potential buyers [of RREEF] said they were concerned that RREEF had suffered high staff turnover at the top since 2007, and that the performance of some funds has not recovered much since the financial crisis.”
The asset management business performance is especially uncertain because Guggenheim is a relatively unknown company in the two markets in which DWS and RREEF compete, with idiosyncratic leadership.
- Guggenheim Partners was founded in 2000. It has $125 billion under management and is currently the 164th-largest asset manager in the world. The transaction to purchase the Deutsche Bank asset management business would more than quintuple Guggenheim’s assets under management.
- Guggenheim’s CEO is Alan Schwartz. Schwartz was previously the last CEO of Bear Stearns. Under Schwartz’ leadership, Bear Stearns was sold to JPMorgan Chase for $2 per share. The deal was later revised upward to $10 per share. According to Forbes, in the aftermath of the sale, “shareholders were decimated, more than 7,000 employees lost their jobs, and Schwartz found himself facing tirades from employees who couldn’t understand why their livelihoods were destroyed.” Schwartz has since said that there’s “not much” he would have done differently before Bear Stearns collapsed. But “[t]hose of us who were responsible for the firm were supposed to keep it out of trouble, and we didn’t,” Schwartz said.
- Guggenheim’s Chief Investment Officer and the CEO of Guggenheim’s Asset Management division is Scott Minerd. Minerd is an iconoclastic investor. He has said:
“I would propose that Alaska today could be referred to as America’s crown jewel. Within our lifetime, Alaska has the potential to become the most dynamic growth engine among all the states of the Union.”
“A portfolio designed to build wealth should have something like 10%-20% in art and collectibles. Americans are not as experienced with art and collectibles as Europeans are, but art has some unique attributes to it. Besides the fact that there is a limited supply once as artist is dead, the other great advantage to art is that it is portable.”
In mid-March, Henry Silverman joined Guggenheim Partners as vice chairman of its investment management business. Silverman is well known in corporate governance circles as the former CEO from 1997 to 2006 of scandal-plagued Cendant Corporation and, prior to that, from 1991 to 1997, as CEO of HFS, one of Cendant’s predecessors:
- In 1998, an accounting fraud scandal tarnished Cendant. According to Fortune Magazine, one of Cendant’s predecessor companies, CUC, “had been padding its results since at least 1995, creating more than $500 million of imaginary profits to meet Wall Street’s expectations.” According to Fortune, “Coming on the heels of several smaller book-cooking scandals, Cendant naturally became a potent symbol of the most egregious excesses of the great bull market of the 1990s.” As a result of the scandal, Cendant’s share price dropped 46% in one day, and market cap eventually fell over $20 billion.
- In 1999, CalPERS and two New York pension funds, as lead plaintiffs, managed to recover $2.8 billion for shareowners in a settlement that, at the time, was “the largest securities class action recovery in history.” The settlement also forced a number of corporate governance reforms at Cendant Corporation.
- In the same year as the accounting scandal, Silverman exercised stock options to generate a profit of $61.1 million. According to a New York Times story in 2006, Silverman had “received more than $68 million in compensation in the last three years” and stood to collect $62.7 million in January of 2007.In 2006, Cendant broke up into four separate companies largely because of “its unhappy investors” and sluggish stock performance.
It is unclear how a figure who led a scandal-plagued company while it was being sued by public pension funds, as lead plaintiffs, alleging materially false and misleading statements as well as fraud, can now reassure RREEF’s limited partners, most of whom are public pension funds and many of whom have expressed dissatisfaction or are attempting to redeem their shares (See In Re. Cendant Corp. Litigation, 182 F.R.D. 144 (D.N.J. 1998) and In re Cendant Corp. Litigation, 60 F. Supp. 2d 354 (D.N.J. 1999)).
Will Guggenheim’s new management team be able to successfully swallow a business five times its current size while maintaining challenging client relationships amid high manager turnover? And given Deutsche’s commitment to backstop losses, who will pay the price if these problems accelerate?