March 5, 2009
Battle Lines Drawn
By CAREN CHESLER
As Philipp Hensler, CEO of DWS Investments, explains his firm’s strategy for gaining U.S. market share, one can’t help but notice some of the objects around his office: a baseball, a football, an American flag in a coffee cup. The objects don’t quite jibe with Hensler’s thick Swiss accent, but it’s a dissimilarity he hopes will shrink over time, just as he hopes his firm, owned by the German banking giant Deutsche Bank, will one day be viewed as a player in the American market, like Franklin Templeton or Blackrock. Until then, he compares himself and his firm’s fight for U.S. assets to King Henry V and the Battle of Agincourt in 1415, in which the English faced a French army six times its size.
“It was basically hopeless, and it reminded me of my situation when I came here,” Hensler says. “People told me, whatever you do, you will never unseat or dethrone the top layer of U.S. firms.”
As it turns out, Henry V gave a compelling speech that rallied his troops to victory. It also didn’t hurt that rain made the battlefield so muddy, the French had difficulty moving in their heavy armor.
“He shifted the focus from a gloomy today to a glorious future. He painted a picture of victory,” Hensler says. “I told my guys we are not here to compete with the best in the industry. We are here to change how asset management is done.”
Currently the ninth-largest retail asset manager in the world, DWS Investments, the mutual fund arm of Deutsche Asset Management, would like to jump to number five and it knows it can only get there by growing its U.S. market share. Only 30% of its assets under management come from America. Most of its assets, 65%, come from Europe, where it is the second largest retail asset manager. But instead of going head-to-head against American giants like Fidelity Investments and The Vanguard Group, DWS executives decided four years ago to gain market share through an innovative approach to asset management.
“We knew that even if we did things a little better, we had a brand disadvantage that we could never escape. The only way to gain market share was not to compete in the industry but to change the way the game of asset management in the U.S. was played,” Hensler says.
One example of its innovative approach is its structured products—a product category that has been popular in Europe for years but which has just recently gained a foothold in the U.S.
DWS has introduced to the U.S. market something called M-Notes, a principal protected structured product that can potentially benefit investors in both a positive or negative market.
Here’s how it works. An investor buys, say, a $1,000 note that says an underlying index cannot rise or fall more than 20% at the close of any trading day through the life of the security. If the underlying index stays within these limits during the term of the note, the investor will receive his principal back, plus a bonus based on the absolute value of the index’s movement on the day of maturity.
For instance, if the index closed up 17%, the investor would receive a return of $170. If the market was down 17%, the investor would still receive $170. So the investor’s total return at maturity would be $1,170. If an investor buys the same note and the index rises or falls more than 20% before maturity, the investor receives only his principal back.
As a component in a portfolio, the M-Note is designed to lower overall volatility, while guaranteeing a minimum return at maturity. In return for this protection, investors surrender upside potential and any dividend distributions.
The product, with a required minimum investment of only $1,000, can stipulate rise-and-fall limits ranging from 15% to 30%. M-Notes can also be structured to provide a guaranteed minimum return beyond the original investment.
“It’s good for people who want to participate but don’t know which way the market is going,” Hensler said. “It’s our most popular product right now.”
The product has generated increased interest as investors have increasingly sought safe havens for their money. The firm began selling it in 2006, when it generated $300 million in net new assets. It was forecast to bring in $750 million in 2008. Hensler says his advisor clients initially think the product is too good to be true and are reluctant to put client assets into it. But once they see how it works, they come back for more.
Indeed, the product’s popularity has helped DWS gain client assets. Deutsche Asset Management, which comprises DWS, an alternatives unit called RREEF, an insurance unit called Deutsche Insurance Asset Management and an institutional unit called DB Advisors, had $650 billion in managed assets as of September 30. DWS accounts for $337 billion of those assets, of which more than $115 billion is based in the U.S. It brings in those assets by selling products through wirehouses such as Morgan Stanley or banks such as Bank of America.
Hensler says DWS’ novel approach to asset management couldn’t have come at a better time. Investors, faced with lower return expectations and higher volatility, have come to crave consistency and predictability. The average annual return on stocks in the 1990s was 18.2%. That figure dropped to -0.04% from 2000 to the end of 2007. Annual bond returns, which averaged 12.4% in the 1980s, fell to 7.7% in the 1990s and were 6.19% from 2000 to 2007. With the current market meltdown, returns have only eroded further.
Making matters worse, the correlation between investments has increased, defeating the purpose of diversification. The result is that the current paradigms for modern portfolio theory and asset allocation are, at least temporarily, no longer working. That, Hensler says, has created opportunities for managers that can be creative.
Investors, for example, have demonstrated they want more alternative investments. U.S. institutions allocated only 3% of their assets to alternatives in 1997, but that figure jumped to 13.8% last year. They are also looking for more “liability driven investments” that protect against things such as inflation, interest rate risk and a poor market. And they also want to ensure their retirement assets remain safe. Traditional asset allocation targets do not always correlate with life events such as retirement. Liability driven products do.
Hensler believes his firm can capitalize on the need for a new financial paradigm because it has an investment bank, Deutsche Bank, that can manufacture these novel products and has a distribution network, DWS, that can sell them. Hensler says DWS wants to democratize the investment process—giving retail investors access to “smart money” strategies typically only used by institutional investors.
“We were talking about these issues before the market fell apart, and we were hoping there would be a small dislocation to prove us right. We didn’t see, we didn’t expect and we didn’t wish for the tsunami that hit us,” Hensler said. “But as far as DWS is concerned, we don’t need to adjust our vision or strategy. Today’s market conditions have proven us right.”
DWS was on pace to grow in 2008 despite the down market. DWS had $12.5 billion in net new assets in the first 10 1/2 months of 2008, matching its total for all of 2007. Hensler views that as testament to the firm’s ability to resonate with investors in both bull and bear markets.
DWS actually has a long history of innovation, given the pedigree of its components. DWS is an amalgamation of Bankers Trust and innovators Scudder Investments and Kemper Financial. Scudder was the first firm to launch an international mutual fund in 1953 and Kemper Investments launched the first technology fund, called the Television Fund, in 1948. After its inception in 2005, DWS launched a structured notes product for advisors in 2006. A year later, it unveiled a climate change fund that capitalizes on how regulators and companies are adjusting to the threat of global warming. It also launched an alternative asset allocation fund, which is a traditional mutual fund that has eight different alternative investment classes. The alternative investment fund, the firm’s top-selling fund, was launched in July 2006 and, as of July of 2008, had $500 million under management.
The firm continues to battle net outflows, with $106 million in net outflows in the second quarter—though that was an 89.4% reduction over the $1 billion in net outflows the firm suffered in the first quarter.
Hensler says his first challenge in building U.S. business was to convince his own sales staff of DWS’s capabilities. Like Henry V rallying his troops, he told them they were part of Deutsche Bank, with 700 investment professionals, $800 million under management and innovative products that include alternative investments and structured notes. His next job is to convince the rest of the market.
“We got everyone passionate. That was step one,” Hensler says. “The next step is to convince the rest of the market that [we] are a competitive threat.”
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