I sat down recently with Peter Kraus. In December, at the height of the market turmoil, he became Chair and CEO of Alliance/Bernstein of New York, one of the world's largest asset management firms. His predecessor had bet heavily on financial stocks and Kraus was brought in because of his 30-year track record on both sides of the street, buy and sell, mostly recently with Goldman Sachs and Merrill Lynch. As of July 30, Alliance/Bernstein managed for institutions and individuals $467 billion, or nearly twice as much as the combined total assets invested by Canada's five biggest pension funds.
About 65% owned by France's AXA, Alliance/Bernstein has seen its assets shrink dramatically in the past year as a result of the market meltdown and investor redemptions that have swept the industry. Assets are growing now. He spoke with SmartShift about the future, architects of change and business models:
Q: You were brought in to effect change at Alliance/Bernstein in the midst of a crisis, how did it feel?
A: The world was definitely in a difficult spot in December of 2008, but I didn't face any greater problems than other people faced. In fact, I did not have a balance sheet at risk, I did not face funding problems, we were not at risk of failure like some large financial institutions were. Alliance/Bernstein's portfolios had, through 2008, a significant weighting in financial stocks and that caused some under-performance but was not 100% of the under-performance.
Q: How is the situation now nine months later?
A: Happily, I can report that the majority of the investment services are outperforming, in the value space and fixed income space; more strongly outperforming in growth but not as strong as in the other two areas. We have experienced a significant turnaround.
Q: You have gone from the buy to the sell to the buy side, why and what are the differences?
A: Since the start of 2001, I've been on the buy side and there is definitely a difference. The sell side is more transactionally-based, revenues are generated that way. The buy side is an investing process. The basic business models are quite different, transactional versus investing longer term. The sell side has a buy side often or merchant banking.
Q: Are these business models changing?
A: One thing we might see over the next five-plus years is a de-acceleration of the conglomeration of business models under the financial supermarket world. From the mid-90s to the 2000s we saw transactionally-based sell side with buy and lending and deposit capabilities. A conglomeration of skills. We're likely to see a de-acceleration of that. Some organizations will simplify themselves. There will be a reversal of the trend. Within the business models themselves, the sell side will also bifurcate into those selling organizations willing to be risk takers and liquidity providers and those seeing themselves as more advisory focused and less risk-taking focused. There will be more specialization.
Q: Will we see a return to Glass Steagall, of 1934, or the separation of investment and commercial banking?
A: Unlikely that the world goes back to Glass Steagall. I would say there are some basic principles I expect to take place: One is that U.S. banking regulators will be more thoughtful about how they control overall leverage inside banking organizations.
I think the originators of assets (mortgage lenders) should be required to have material ongoing amounts of their capital at risk for the assets they originate." Mortgage banking organizations sold to Wall Street and got paid a fee to do that and have no risk. They suffered no consequences if those assets went bad and that's not healthy. The guy who knows the asset best is the originator.
Q: How do investors have to change?
A: Investors need to find ways to identify and understand valuation anomalies that exist in different markets. It's one thing to understand an equity or bond but it's another thing to know why the credit market is behaving in one way and the equity in another. I think that risk and the pricing of risk is actually more global and transparent between markets and investors haven't grasped this.
Savvy investors need to look beyond the investment silos to identify inflection points and to produce better returns. Derivatives allow investors and traders to express their points of view in more of a continuous fashion than if you just had cash bonds and cash equities. You can today take bets on what the price and/or volatility will be of interest rates, equities or credit spreads out over time. Those vehicles didn't exist 10 years ago and they affect values.
Q: Have you stayed the course as the storm broke around you?
A: If you looked at the company from 100,000 feet in December, and today, you would say it is still in value, growth and fixed income. So to that extent we haven't adjusted our basic business model. But we are a little bit like the duck paddling: it looks placid on top but we're paddingly fiercely underneath.
We have streamlined the company, given the investment process more robust eyes and ears around trading, risk and liquidity. We are giving younger talented people bigger roles and bigger opportunities. We are launching some new services.
One big strategic change is that the mortgage finance business in the U.S. is broken. We think that's a big opportunity so we've built a core capacity to build a new investment process that will be able to adapt and take advantage of the mortgage finance market in the U.S.
Q: Have markets bottomed?
A: There are different currents going on. I have a fair amount of confidence that the lows of March are unlikely to be tested. I would point out, however, that the volatility is still quite elevated but it's more than its long term averages, close to double that.
Debt markets are unlikely to see the complete cessation of financing that occurred in the September 2008 time frame, where almost no bank in the G7 world would issue debt which was not guaranteed by its own government. Having said that, if you compare the issuance of unsecured bank debt today, compared to normal time periods, it is quite anemic. Same with corporate debt. We don't have a normal credit market although we're not at death's door.
Q: Are you a change agent?
A: I would say about myself that I'm a builder, an out of the box thinker and willing to challenge conventional thinking and that out of those three elements you might make changes and might not.
Q: Is the U.S. banking sector stronger than the European one as some Canadian bankers believe?
A: It's a hard thing to see. If you look in the UK, there has been a fair amount of tough medicine. If you look at the continent, less tough medicine. It is hard to tell what the underlying balance sheet strength really looks like. I would say the history of U.S. regulatory reform and action has been to move quickly and I think the quicker we move to resolve, the faster health will return to the system. But we still have significant wood to chop through in both consumer loans and commercial real estate and significant risk in regional banks.
Q: On a scale of zero to 10 how has Washington fared in fixing the financial mess?
A: I would restrict my answer to the regulatory financial infrastructure. Politics are the politics and I don't know how to respond to that. But I think there are two acts to it: Act One was avoiding catastrophe and apocalypse and Act Two was managing out of the problem.
I think Act One gets very high marks because regulators were fluid, decisive, pragmatic and allowed the system to move forward. That's a clear winner. That's a 10. You can argue policies, i.e. should we have let Lehman go, shouldn't have; Fannie Mae, Freddie Mac, TARP.
Act Two. I would have liked them to have acted faster but don't think they could have. They have been doing the best possible with the politics they have to deal with. I have to marvel at the ability of these leaders in a tumultuous economic set of conditions and difficult set of political conditions. I have to give them a 10. How can you not?
Q: To what extent was Wall Street greed to blame for the crisis and what must change?
A: I believe that individual executives should have a significant amount of their compensation paid to them in the underlying equity of the entity they are a part of. I believe that equity should vest over a time period. I believe that if you do that, and it's significant, that people will behave in a manner that is commensurate with protecting that asset.
Q: Does the meltdown represent an inflection point in economic history that will transform business models. Which will prosper?
A: I cannot tell you which capital goods manufacturers will do well, which energy company, which biotech, which retailer, I don't know enough about the various sectors and companies in them.
I would like to be more conceptual, I think that what is happening - you can see this in the numbers - is that companies are likely to be more successful going forward if they are capable of adjusting their two forms of capital - human and financial capital -- more quickly than others.
Companies that can take inventories down, cut employees and still run their businesses have actually seen their profit expand even with revenues down. Those companies will be more capable of adapting to changing market conditions. Companies that cannot do that will be slower in recapitalizing - both in human and financial capital terms -- be slower in the growth phase and will lose.
Q: What are the winning skill sets of business leaders?
A: Again leaders have to be capable of adaptability, to lead an organization in an adaptable way. That's always difficult for people who have been in a company for a period of time. Biases are there and they don't work today.
Q: Should leaders understand China and global markets?
A: China is a huge market but it must make sense to be there. It's complicated. But what investors have to learn is that markets move more quickly, information travels more quickly, local competitive advantages dissolve faster, pricing advantages dissolve faster, capital is more flexible, labor more flexible and therefore your competitive position in any place is unlikely to be maintained. Success is about changing and executing in an adaptive way. CEOs of corporations in high tech have these characteristics.
Q: Must the traditional board of directors model change too?
A: A strong board is a good board. It should be as strong as you can get. You want independent thinking, outside people because when you need a board the most is when things are tough. That's when you need people that are talented and capable in those time periods. 2008 was a perfect example.
Q: What is tomorrow's smart investor profile?
A: It will be the investor that can do two things: be very good at the securities selection, or the bottom up construction of a portfolio; but also capable of thinking about the information in adjacent markets, their impacts, economic scenarios and how to deal with those risks.
Q: What about alternative asset classes or regions?
A: I love art, and I continue to collect, but I wouldn't have any investors go into the art market.
Mortgage finance and real estate are huge opportunities and we want to take advantage of that for our investors.We're already in emerging markets and global securities and alternatives, hedged; one thing we don't do is real estate.
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