Forum Post: Poster child for lopsided reward system at AllianceBernstein

This story appears in the Nov. 21, 2011, issue of Forbes magazine.

If ever there were a poster boy for the kind of lopsided reward system Occupy Wall Street protesters are fuming about, it could be Peter Kraus, current chairman and chief executive of money management firm AllianceBernstein.

You may remember Kraus as the colorful former Goldman Sachs partner who made $29.6 million during a three month stint at Merrill Lynch, after the broker was sold to BofA. Kraus had been a top banker at Goldman who eventually ran its asset management business. He jumped to Merrill in 2008 just as hedge funds he oversaw, including one called Global Alpha, were suffering severe losses. John Thain welcomed him with open arms, but his biggest accomplishment may have been redecorating his office with expensive postmodern artwork before BofA booted him.

10 images Photos: When Is It Time To Fire Your Financial Advisor?

Photos: 10 Ways Investors Sabotage Themselves After Merrill Kraus moved into a five-bedroom Park Avenue apartment that he purchased for $37 million and in December 2008 was hired by AllianceBernstein’s French parent, AXA, to turn around the beleaguered asset manager. Out went AllianceBernstein’s legendary value investor chief executive, Lewis Sanders, and in came Kraus. His pay: $6 million up front and potentially $50 million more in stock over five years.

How has Kraus been doing? Here’s what the 59-year-old told analysts during the firm’s third-quarter earnings call in October: “Put simply, the fundamental rules of prudent long-term investing aren’t working.” For shareholders as well as dozens of pension funds depending on AllianceBernstein’s investment success, those words were like a kick in the stomach.

At its peak in 2007 Alliance had $837 billion under management. By the end of 2008, when Kraus took over, assets were $462 billion. Three years into his reign Alliance is still hemorrhaging. Today assets sit at $402 billion. Among the departed: Vanguard, which was using Alliance as a manager for its U.S. Growth fund, the state of Oregon and Xerox.

Alliance Bernstein say it still manages over $3 billion in assets for Oregon. As for Vanguard, Alliance says it’s still a client but could not provide the amount of assets it oversees for the firm.

The numbers are bad across the board: Third-quarter revenue fell 15% to $642 million, with $15.4 billion in net outflows. For the nine months ending in September requests for redemptions totaled $72 billion and net outflows were $49 billion. Since January 2009 AllianceBernstein’s NYSE-listed stock is down 20% versus a 46% gain for the S&P 500 and a gain of 35% for rival Legg Mason. In 2011 its shares have fallen 39%.

Two problems plague this once admired investment house. As Kraus pointed out in his presentation, Alliance’s investment funds, both institutional and retail, have had lousy performance. Add to this a hasty corporate makeover and the result is a crisis of confidence among clients.

According to analytical firm eVestment Alliance, more than 90% of all money managers outperformed AllianceBernstein’s institutional funds over the most recent three- and five-year periods in such important categories as U.S. large-cap value equity and global large-cap value equity. On the growth front Alliance has not fared much better. In U.S. large-cap growth more than 80% of its competitors outperformed it over the last five years.

Kraus would not speak to FORBES, but his October earnings call with analysts expounded on the firm’s problems. Lamented Kraus: “Rather than rewarding long-term earnings growth this market tends to reward current earnings and dividend yields. And rather than see opportunity in cheap stocks this market sees risk. The cheaper companies get the riskier they get.”

Kraus’ complaints speak to the very core of AllianceBernstein’s once coveted and copied investment approach. Bernstein’s strategy was all about fundamentals: Find stocks with low price/earnings multiples and relatively low price-to-book-value ratios and hold on with the expectation that these widely followed measures would move back to the historical mean. Armies of value investors continue to hold on to the belief that this is the best approach for long-term stock market profits.

This worked nearly flawlessly for several decades but met disaster when Alliance’s low P/E stocks, primarily in the financial sector, got caught in the liquidity meltdown. Think Lehman Brothers, Fannie Mae, Freddie Mac and AIG.