Q&A: AllianceBernstein’s Peter Kraus

It’s been just over a year since Peter Kraus took over as CEO of AllianceBernstein LP. While he came to the troubled firm with stellar credentials — he had been a former co-head of Goldman Sachs Asset Management — he was known more for the size of his last paycheck. That’s because at a time when most Americans were still reeling from the sheer size of the financial bailout, Mr. Kraus walked away from Merrill Lynch with a $24.9 million haul for just three months’ worth of work. That he was contractually entitled to the money after Merrill was bought out by Bank of America Corp. was beside the point. To most Americans, he was just another symbol of Wall Street excess.

That image was burnished when Mr. Kraus was awarded a $52 million pay package from AllianceBernstein. In December 2008, he replaced Lewis Sanders, who had been at the helm, through legacy value investing and research shop Sanford C. Bernstein & Co. Inc., for 40 years. Mr. Sanders was ousted after AllianceBernstein lost almost half its assets in 2008.

Since coming on board, Mr. Kraus has made some changes, namely creating a partnership structure within the firm to attract talent and boost compensation. He’s also tackling the “silos” that he said have limited AllianceBernstein’s ability to bring products to market. Outflows in the institutional business continue to plague the firm but are stabilizing in its retail and private-client businesses.

AllianceBernstein, which has $484 billion under management and is part of Axa Group, is virtually unique in the private-client business in that it has a “closed-architecture” format, offering customers only its own investment products. Mr. Kraus said in this interview that the firm will soon break away from that, however, and adopt a fund-of-funds approach for hedge funds.

“They’re definitely in a tough spot,” Greggory Warren, senior stock analyst at Morningstar Inc., said. “Institutional clients are not the ones you want to lose, because they’re tougher to get back. There’s definitely some convincing they have to do. There’s a lot of respect for the brand, but it hasn’t translated into the investment outperformance that you would like. If you’re not generating outperformance, then it’s a harder sell.”

In fact, according to the firm’s earnings call last quarter, many of AllianceBernstein’s investment portfolios improved last year, outperforming benchmarks. Several fixed-income strategies, for example, outperformed by at least 5%.

Q. Do you deal with any lingering criticism following your $25 million windfall from Merrill Lynch?

A. The short answer is no, I really don’t. People have moved on. I have never been the butt of the anger. That has been directed at the people who are still operating in the large banks.

Q. How do you feel about federal pay czar Kenneth Feinberg’s work on executive compensation?
A. Tough job; I hope it works out. I’m happy for him to call me. If you look at my compensation structure, I think you’ll find it pretty Feinberg-friendly.

Q. What do you think about financial regulation?
A. There’s definitely parts of an additional regulatory infrastructure that we need, for sure. Treasury, or the government, should have a way to resolve large institution insolvencies in a manner that doesn’t spook that market every time it happens. If a large organization gets into trouble, or multiple large organizations get into trouble, investors need to understand what the rules of the road are.

Q. Tell me about changing the organization of AllianceBernstein since you came on board?
A. When I came to the firm, I thought there was very definitely a culture of partnership. It had historical antecedence, but I also didn’t think it had been embellished much, and I didn’t think it had been reinforced. I felt that if we were able to be a real partnership, we would create an aspirational group that younger people in the firm could look up to and want to be part of. It gives you a feeling that you’ve got a voice at the table. And from a compensation point of view, partners should receive a premium if the firm does well, and should make less if the firm does poorly.

Q. It’s been 10 years since Alliance Capital bought Sanford C. Bernstein, and management still talks about value strategic business units and growth strategic business units. Are there lingering integration issues?
A. I’m trying to wean them off the value strategic-business-unit concept. But just to be clear, we’re still very much attached to value and growth. The investment processes around value and growth are distinct, and we don’t intend to change that. But if you go below the investment process to the infrastructure of the firm, too much is “siloized,” and it became inefficient.

We’re trying to create a single platform across all the services. We put together a product development group. Before, when you wanted new products, it was kind of like: Who’s in charge? How did you know whether the product made commercial sense or investment sense? Was the infrastructure available? Could you trade it or settle it? There was none of that. No one was in charge of anything. We’ve tried to organize it in a way that was efficient, so you can actually bring out new products and have confidence that they make sense.

Q. Why is AllianceBerstein still a closed-architecture firm where, especially in the private-client area, the trend is toward open architecture?
A. I’m all for freedom of choice, but if you really are going to exercise your freedom, then you’re going to have to proactively choose managers. It’s hard enough to pick managers, but if you have to pick the ones who are outperforming at a discrete period of time, that’s almost impossible.

For long-only managers, we have a closed shop. We don’t have much of an alternative space, but if we had a hedge fund space, that’s a place where I could see picking outside managers. In that instance, you’re not choosing the time frame, you’re choosing the kind of risk that you want your money to be exposed to. That’s a capital allocation process. In the hedge fund space, I do think open architecture makes sense. In the hedge fund space, open architecture will work. And we will be doing it as soon as practicable.

Q. But doesn’t closed architecture make you more money?
A. Yes, it does, but that’s not connected to whether you’re getting a good investment experience or not.

Q. Where does AllianceBernstein fit into the competition for wealthy clients?
A. The funny thing about the private-wealth business is, it’s very, very fragmented. Nobody has a big market share. It’s really not a market share game. It’s much more about convincing people that what you can do for them has long-term credibility, and will help them preserve and grow their wealth, and live the lifestyle that they want.

Q. The private-client business is about 20% of the firm. Will that increase?
A. I think it will be hard to move it much. Institutional will stay the largest part, though private client may take up a bigger part of the margins.

Q. You were on the scene for many of the events of September 2008. How is AllianceBernstein fitting in with the new competitive landscape, and who are your strongest competitors?
A. We’re well-positioned, along with others [T. Rowe Price Group Inc., Franklin Templeton Investments, BlackRock Inc., Wellington Management Co. LP], to grow as the asset management business grows. More challenged models would be the models inside of large companies, and the smaller asset mangers. The Bank of America [Corp.]/Merrill Lynch [& Co. Inc.] model, the Wells [Fargo & Co.] model — they’re here to stay. There are enough people in the world that they each see the risks differently. We can all coexist.

E-mail Hilary Johnson at [email protected].