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Growing Pains

Waddell & Reed reps, dispersed around small towns mostly in the Midwest, have long had a strong opening pitch for clients and prospects: I work for one of the oldest mutual fund companies in the country. Our performance has been strong over long periods of time, and if you want to invest in our funds, you can only do so through me. That combination of quality (three-quarters of Waddell funds are ranked

Waddell & Reed reps, dispersed around small towns mostly in the Midwest, have long had a strong opening pitch for clients and prospects: “I work for one of the oldest mutual fund companies in the country. Our performance has been strong over long periods of time, and if you want to invest in our funds, you can only do so through me.”

That combination of quality (three-quarters of Waddell funds are ranked four or five stars by Morningstar) and exclusivity has served the Waddell rep workforce well over the years, but a strategic shift by management is causing reps concern, and some are even leaving.

Specifically, Waddell & Reed has opened the distribution of its mutual funds to third-party reps. It's a bid to acquire more assets for its fund managers — and one that securities analysts and shareholders applaud. But the third-party distribution strategy has left the company's advisors angry and feeling betrayed, and it's also caused many in the rank and file to wonder how they figure into the firm's future — if at all.

One senior advisor who left Waddell during the first quarter says management's increasingly ambiguous plans for advisors convinced him to go. For instance, the advisor says, when Waddell's national sales manager was asked at a meeting about the firm's long-term plans for the proprietary retail advisors, he responded that he would let them know when he knew himself.

“Why stay with a company when they won't tell you what their long-term plan is?” the advisor asks.

On the face of it, it's hard to imagine that Waddell, a company that depends so heavily on its proprietary retail rep force of 3,000 for assets under management, would give short shrift to its own workforce.

But that's just some of the conspiracy theories kicked about in rep circles. “The reps are not completely crazy” to oppose third-party distribution of Waddell mutual funds, says one sell-side analyst who follows Waddell. “I sympathize with them, that they think they are being marginalized.” As in insurance industry a few years ago, “Channel conflict is inevitable,” the analyst says. “Waddell reps are just going to have to get past it.”

Not surprisingly, there have been some departures, though not all stem from Waddell's new distribution plans. In late May, more than 30 advisors from six different offices in New York and Connecticut left for Washington Square Securities, an ING affiliate that had been recruiting former Waddell division manager Todd Slingerland since January. Slingerland, who had spent the last eight of 15 years at Waddell, was suspended in March after Waddell management learned of his defection plan.

The Urge to Diverge

Waddell's acquisitions over the last few years testify to dual ambitions of adding assets and diversifying its product base. The push began in earnest last year with the acquisition of Mackenzie Investment Management and its Ivy Funds, which had $647.6 million in assets at the time of the deal.

The deals continued in April with an alliance with Securian Financial Group, a broker/dealer owned by Minnesota Life Insurance. In this deal, Waddell became the investment advisor for the $2.1 billion assets of a Securian subsidiary, Advantus Capital Management. All told, Waddell had assets under management of $31.7 billion at the end of June, up 15 percent from $27.5 billion at the end of the first quarter.

At the Lehman Brothers 2003 Financial Services Conference in September, Waddell CEO Keith Tucker spoke of some ways that the new acquisitions will help Waddell grow. Referring to Securian's sales force's selling of variable life insurance products wrapped around Waddell mutual funds, he said, “We look for that to have some meaningful impact as we go forward the next few quarters.” Tucker said the company has been marketing funds through retirement plans, registered investment advisors and broker/dealer wrap channels for several years. “We chose those channels because they presented no channel conflict with existing distribution and required no major infrastructure cost for us,” Tucker said.

He added that the Ivy Funds are a vehicle for expanding the company's wholesaling practices. “Moving into the wholesale channel, there's no question that business has a lower margin, and so as we build that out — and I've said we want to build that out aggressively — you can expect our margins to come down somewhat,” Tucker said.

It's precisely that aggressiveness that has some of the firm's reps concerned about where they figure in the long-term picture. And there's little doubt the company's third-party distribution initiative — now in its third year — is making itself felt among Waddell & Reed Advisors, the retail workforce. After adding more than 500 advisors in 2002, Waddell shed 479 in the first half of this year, according to company documents. Though the departures now have slowed, the first-half runoff represents more than 15 percent of the total advisor workforce.

One 15-year Waddell veteran who quit in the first quarter, says the firm has “an agenda that doesn't involve [proprietary] advisors.” Others fear the firm is focusing on its asset manager business at the expense of its retail financial advisory network. The change of focus, some reps gripe, manifests itself in a lack of communication.

“We haven't seen these kind of acquisitions or alliances, and I think in some regards it benefits us as advisors,” says Gregory Schmautz, a Waddell senior financial advisor and certified financial planner. “But we still feel a little left out of the communication loop.”

Still, he says, “I think we have reaped some benefits and will continue to do so…The biggest winners are going to be the asset management team.”

Another rep says that while the company's acquisitions and alliances have helped increase assets under management and expand the product line, access to non-proprietary products remains difficult. “We see this expansion and it doesn't seem like a two-way street,” he says.

Among those who feel that communication is on the mend, many point to chief investment officer Hank Herrmann's weekly electronic broadcasts as evidence.

Steven Schwartz, an analyst at Raymond James, says Waddell is simply managing “channel conflict” as many other firms have before. “They're not the first to have to manage this, and they will get through it,” he says. “It was a long, somewhat laborious process for the entire insurance industry to go from exclusive career agents to third-party agents and managing general agents, and Waddell is kind of in that insurance company mold.”

Part of the Plan

Even if the changes are likely to act as a stabilizing force for the company long-term, advisors are not all convinced they will be left on solid ground. Some, like Slingerland, have left in search of more certain footing. Around 50 other Waddell advisors have joined him at a new firm, Capital Financial Planning, based in Latham, N.Y., he says. According to other recently departed Waddell advisors, similar departures and defections are happening across the country among experienced top producers, albeit on a smaller scale.

Tucker says the attrition Waddell has experienced recently is part of a plan. The firm expanded its advisor workforce by about 10 percent each year since 1998, but it is now purposely letting it shrink. “We want our division managers to be less focused on recruiting and more focused on helping our existing financial advisors improve their productivity,” Tucker told the audience at the September Lehman conference.

One advisor tells of a colleague who left before Waddell made the Ivy deal because he saw the company changing and was unable to find out whether it was going to focus on fee-based planning or commission-based planning. “When the company straddled the fence, he decided to get off,” the advisor says.

Still, the advisor says, Waddell has put a fair amount of money and resources into building a strong technology and information platform for reps in the field, efforts he says indicate the firm's commitment to its reps.

Schmautz concurs. “The amount of assets they put toward fee advisor work — software technology around our interaction with clients, our management of clients — they've spent a huge amount of time and money on that,” he says. “So I think there's some people who have good vision and they want to expand both sides of the house.”

Analysts say it makes sense to open its asset management to outside platforms. “Distribution is key,” says one analyst. And the aging demographics in America, which should mean extraordinary sums of money rolled out of 401(k)s, 403(b)s, 457 plans, and so on, into IRAs, this puts Waddell in a good position for the long term, says Raymond James analyst Schwartz.

“Waddell's financial advisors are working in smaller towns, cities and rural areas, and they're going to know their clients very well, so they're not only going to know when their clients retire, they're probably going to be at the retirement parties,” Schwartz says.

While it's true that Waddell's transition to third-party distribution might have been handled better, many reps who remain with the firm are convinced that the future is bright.

“I wish there was better communication,” says Schmautz. “But I don't think we'll be hung out to dry.”

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