Step-change for SGAM
“The road of cross-border mergers is strewn with failures,” notes Patrick Pagni who, as a senior Société Générale Asset Management (SGAM) executive, was one of the principle negotiators of its 2001 takeover of Los Angeles-based Trust Company of the West (TCW). The deal marked a step change for Société Générale, taking it from being a leading European player with an Asian and middle eastern presence to being a global contender.
But the acquisition did not have the most propitious of starts. “It corresponded with two adverse developments,” recalls Pagni. “First, there was the market collapse and second there was a widespread upsurge of Iraq war-linked anti-French sentiment in the US just as TCW was preparing to go to its clients to announce the new ownership arrangement.” That exercise was put on the back burner, where it remains.
“The relationship has been stress tested,” says TCW president Marc Stern. But despite such odds he characterises it as “an extraordinary success”. Among the reasons Stern highlights is the way the deal was negotiated. “We were not for sale and we met SGAM initially to discuss a marketing relationship. But the more we talked the more it seemed to make sense and after nine months of discussion at every level - executive and management on both sides - everybody realised what was expected of everyone else. So unlike a number of other deals, people went into it with their eyes open.”
Because TCW was not for sale it was able to drive a hard bargain. “We had a difficult time in the negotiations,” SGAM chairman Philippe Collas notes. “As well as our due diligence on them, their executives came to Paris to do due diligence on us. It’s not very common for the subject of a takeover to due do due diligence on the buyer.”
SGAM bought 51% of TCW for $881m (e694m) gross of escrow and has since raised the holding to more than 66%. “We didn’t pay on 2000 results, at the top of the market, but on 2001-2002 results, so it was a risk for us and for TCW,” says Collas. “We had an escrow call of $132m and a claw-back of $90m, and when we settled the deal in March 2003 after the 2001 and 2002 results, escrow account and the clawback were returned to SGAM. At the same time the value of the euro increased by 40% against the dollar and SocGen stock rose 20%. So TCW shareholders get their money in terms of dollars, and we paid a fair price for what we bought.”
Stern adds: “We worried whether the arrangement would impede our entrepreneurial spirit, and the answer was absolutely not. Paris does not have the ego in terms of being the ultimate financial centre as you might have with Tokyo, Frankfurt, New York or London. There’s an awareness that if you want to be truly global - and SocGen wants to be truly global - you have to be more open and more respectful of ideas. So basically, the core of what we do is business as usual. And if you benchmark with other acquisitions you’ll see that the ability to innovate, to bring new products after an acquisition, is quite limited and for those that are a relative success it is generally with the same products. But we have a new product, our credit mortgage-backed securities, that we did not have when this transaction was closed, and now have just under $8bn in assets under management in that product. So we have demonstrated the ability to do what a good asset management company should be able to do, which is create new products as market conditions change. They’ve let us be entrepreneurial and if SGAM’s distribution channels in China, India and Japan want US product, that’s us.”
Indeed the TCW acquisition marked a rare break with SGAM’s preferred strategy, which was to pursue distribution networks and has agreements with 700 institutions internationally. SGAM established itself in Japan by buying Yamaichi AM when its parent bank failed in 1997, merging it with Resona AM, the mutual fund business of Resona Bank, Japan’s fourth-largest bank, giving it access to Resona's distribution network. “Last year we sold $4bn of mutual funds net through the network,” says Collas. SGAM also has a new joint venture with the Industrial Bank of Korea, South Korea’s third-largest bank, with China’s Bao Steel which gives access to all its banks, and most recently with the State Bank of India Fund Manager (SBIFM). “We have a presence in every major Asian market and we don't have to have anything more,” he says. “What’s of interest is to have access to a distribution channel in each of them.”
“Since we did the deal we have had a $20bn, or 22%, increase in our assets under management during a period when all three of the major US indices - the Dow, the S&P and the NASDAQ - have been negative,” says Stern. “And since the arrangement was put into place there’s been $14bn of cross-selling activity, $10bn of which was for TCW products. So effectively half of the increase in our assets have come from cross selling,” says Stern.
Pagni, now TCW Group executive vice-president, notes that there was very little overlap between SGAM and TCW and there were huge synergies. “TCW specialised in long-only products and, for example, had no hedge funds,” he says.
“Cross selling accounts for around 30% of SGAM’s flows,” says Jerome de Dax, global head of business development at SGAM. “We know TCW’s ability to push the appropriate strategies on the US market is very strong and there is no question of not raising significant amounts of money from US clients through hedge funds. But the US market is particular and apart from US assets it views an ability to diversify the portfolio as being less important than do other markets. The main areas that we have been presenting to US clients are Japanese equity strategies, our global equities expertise and the alternative investment capabilities that are articulated between Paris and TCW.”
However, more than 70% of the cross selling business is dedicated to opening new distribution channels for TCW strategies to clients in Europe, Asia and the Middle East, he adds. “We offer some as a replication of the original model portfolio while we have chosen to repackage or to make a more customised approach with others, a couple of which can also come with currency hedging if needed. This is something that we have been offering through Sogelux, our Luxembourg umbrella fund where all US strategies are offered with or without hedging into euros as part of our global offer.”
On equities, de Dax notes that “TCW has more than 10 different ways of running US equity portfolios and they are very specific - there are growth, core and value oriented, large-, medium- or small-cap, and so on - and targeted at very defined investors. But, and it is the second issue, in some non-US markets, especially across continental Europe, this is a bit too specialised so we have been able to combine TCW’s expertise in running US equities and asset allocation with TCW expertise in combining strategies, mixing styles and level of capitalisation. We are putting this into a single portfolio, the US equity multi-strategy approach, which brings together three or four strategies, for example large cap or style oriented. By combining both elements we have produced a product that is very successful among European clients, not only external distributors but also with some key institutions across Europe.”
The other key TCW product has been US mortgage-backed securities (MBS). “These are very attractive for European investors who are able to look at the defensive position that is afforded through the MBS exposure but without having to take the dollar verses euro risk. Thus they can have the added value coming from the MBS portfolio management on the US yield curve while being hedged back to euro.”
Jeffrey Gundlach, president TCW Asset Management Company and head of high grade fixed income, says: “The highest Sharpe ratio of all US asset classes, stock or bond, are US mortgage-backed securities. This is interesting as people conceptually think that MBS are tricky, potentially riskier than other securities, but the fact is that they have the highest risk-adjusted returns over the last 10 years. TCW’s mortgage-backed securities have a Sharpe ratio that is more than triple that of stocks, so investors would have had triple the returns if they’d invested in mortgage-backed securities leveraged a couple times, with the same bumpiness of the ride that they received in the S&P 500.”
De Dax notes: “Pension funds are increasingly interested in high alpha products, and it is the case that TCW has some very specific strategies dedicated to delivering significant alpha. On both the equities and the MBS sides of those alpha-oriented strategies are very successful among pension funds. In northern Europe, for example, we are very successful in pushing TCW strategies on the equity and fixed income sides, mainly MBS. There is always a debate between the core/satellite approach to portfolio management. Pension funds and other institutions are very anxious to add satellite strategies that are alpha driven to the core side of the portfolio. This alpha generation is one of the key points in the TCW offer.”