Analysis: Teamwork, controls yield rare comeback for MFS

BOSTON (Reuters) - For the rare comeback story among money managers, look to MFS Investment Management, one of the oldest names in the mutual fund business but also one of the most battered after the Internet bubble popped in 2000. Getting caught up in the industry's trading scandals just as stocks recovered only made matters worse.

Yet unlike other firms that crashed and remain on the outs a decade later -- a list that includes Janus Capital Group and AllianceBernstein Holding -- MFS is decidedly back.

The firm posted three years of inflows from 2009 to 2011, according to Lipper, a unit of Thomson Reuters. With $7 billion taken in through the end of May, its 2012 flows are on track to break its 1998 record haul of $13 billion. In May alone Morningstar ranked MFS inflows of $2.6 billion third in the entire industry.

The quiet shop in Boston's Back Bay neighborhood avoided the fate of so many others by improving and sustaining its investment performance while avoiding the worst of the financial crisis.

MFS Chief Executive Robert Manning, a onetime junk bond fund specialist who took over in 2004 after the market timing scandal, points to his emphasis on cooperation across stock and bond teams, plus an aggressive expansion of overseas offices that helped bring in institutional customers. His background also led him to install one of the industry's strongest risk management systems.

"If you grow up as a junk bond analyst and manager, there are nothing but bad things that can happen to you," Manning said in an interview.

TOUGHER TURNAROUNDS

Financial advisers said the firm's recent performance has gotten their attention.

Kristin Fafard, head of research for Federal Street Advisors in Boston, said her firm began recommending an MFS stock fund for the first time two years ago. She said Federal Street kept track of the MFS fund manager for a decade before it switched. MFS deserves credit for letting the manager, whom she declined to name, stick with his stocks even through bad runs.

The MFS story shows a bigger lesson: Engineering a fund company turnaround is much harder than in other industries.

An automaker's customers might defect, for instance, but they will be shopping for a new model in several years after the car wears out. But as long as returns are good, investors or wealth managers do not need to shop around for a replacement mutual fund. That can mean a longer lag before performance improvements draw back customers.

Take Clifford Caplan, president of wealth adviser Neponset Valley Financial Partners. Caplan once had about $3 million of client assets in MFS funds until he began pulling out in 2002.

Since 2009, MFS has gotten about $1 million worth of his clients' money again, mostly through indirect channels like variable annuities.

In lieu of MFS funds, Caplan now uses international bond funds from Pimco and Fidelity Advisor New Insights as a large-cap growth fund. "When you move money to another fund family, you're unlikely to go back. It's not because of the past egregious acts, but because you have new relationships," Caplan said.

Comparing the collective performance of a fund family to its competitors is a challenging task. Simply reviewing average fund performance fails to account for firms' running more funds in strong or weak underlying markets.

According to Lipper, at least half of the assets invested in MFS funds have performed better than the average in their categories over the past five years. In the tough year of 2008, MFS funds beat 59 percent of peers on an asset-weighted basis, Lipper found. Competitors like Janus and Putnam Investments have been below average three of the past five years, and Legg Mason Inc funds for two years. AllianceBernstein funds have been below average each year.

MFS is the only one of the group to post positive inflows each year since 2009, and for 2012 through May.

LESS PRESSURE, FEWER EGOS

In a recent interview at the company's office tower, CEO Manning described his approach as the opposite of the star system used by some rivals. Employees are expected to work closely together and sacrifice their egos as necessary; even fund managers with terrific performance records will face bonus cuts if they do not treat other employees respectfully, he said.

MFS also benefited from not being publicly traded directly like some of its competitors, who can be under more pressure to show short-term, quarterly improvements. MFS's owner, Canadian insurer Sun Life Financial Inc, stuck with the firm through hard times.

A low came in 2004 when the U.S. Securities and Exchange Commission ordered MFS to pay $225 million to settle fraud charges involving market timing, and required then-CEO John Ballen to step down. Ballen and MFS did not admit or deny wrongdoing.

Manning, at the time the company's chief fixed-income officer, took over as CEO. A local boy from the blue-collar Massachusetts town of Methuen, Manning had joined MFS's high-yield group in 1984.

He often got offers to buy bonds from the king of the industry, Michael Milken. Manning says he also attended the infamous "Predators' Ball" conferences Milken hosted in Los Angeles.

In the end, Manning drew more cautious lessons from the high-finance era. He said Milken's firm, Drexel Burnham Lambert, sold MFS on some winners like McCaw Cellular. It also wound up with losers like hospital chain Republic Health Corp, which eventually went bankrupt.

Markets were less liquid at the time, making it hard to find a buyer for assets tied up in court proceedings. Defaults could force investors into legal cases that could take years to resolve. Risk controls were key.

In that spirit, Manning set about putting more controls in place and naming a chief investment risk officer for the entire firm. He brought along a bond colleague, Michael Roberge, to oversee all investments. Roberge became president of MFS in 2010.

COHESION YIELDS WARNINGS

The changes paid off in 2007, when MFS bond specialists started to detect worrisome signs about credit exposure and mortgages. Because of the tight team meetings, they passed on warnings to equities analysts and managers who then avoided some of the worst blowups, like AIG and Fannie Mae.

The message was, "It's time to get in the bunkers and stay there," recalled Kevin Conn, leader of MFS's global financial services sector team.

Morningstar analyst Bridget Hughes credits MFS with avoiding financials at the time. More recently controls have kept its funds from being too volatile. There is some risk from worrying too much about risk, she said. "The risk is that they move into mediocrity," she said, if too many controls force managers to move away from contrarian bets.

Overall the company has done a good job restoring and sustaining performance, she said. That is important as investors increasingly look to a fund's results over three and five years, rather than chasing the hottest managers of the moment.

"Performance sticks with you," she said. "It takes some time for bad years to roll off" a fund's record.

(Editing by Prudence Crowther)

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