A Good Fit

This article originally appeared in the October/November 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.

Aster Investment Management and Arrowpoint Partners were two firms on different trajectories.

Heading into 2013, AIM, based outside San Francisco, was still reeling from the sudden death a year earlier of its president, Rick Aster, who was synonymous with the firm he founded in 1977 and the Meridian Funds that AIM had managed since their respective inceptions. Almost $900 million had exited the funds' coffers since Aster's passing, and Meridian's trustees were searching for an outside investor who could help the firm and the funds survive. "It was clear we were missing Rick's hand" on Meridian Growth (MERDX), says Jim Glavin, a board member.

Meanwhile, Arrowpoint, located more than 1,300 miles to the east in Denver, was enjoying a comfortable existence as an up-and-coming money-management firm. Arrowpoint was stocked with blue-chip talent who had left Janus, including co-founder David Corkins, who had skillfully managed $20 billion in accounts and at funds such as Janus Mercury (now Janus Research (JRAAX)) and Janus Growth & Income (JDNAX). Since opening its doors in 2007, the firm's assets had grown to $2 billion as it posted solid performance in its clients' accounts during the 2008 downturn.

The firms, though, are now more closely linked than their predicaments or the distance on a map suggested. In May, Arrowpoint quietly bought AIM for an undisclosed sum. Mergers in the mutual fund world aren't uncommon, but this one was notable for several reasons. In the minds of wary investors, it likely stabilized AIM, which was one of the best small independent fund companies in the United States when Aster was at the helm. The deal also signals that Arrowpoint is a firm worth watching as it enters the retail fund business and possibly adds to its lineup in the future.

While the union makes sense, there will be challenges to pulling off the marriage. First up will be the task of meshing the two firms. Arrowpoint agreed to retain a majority of AIM's current staff. There will be a premium on communication because the two firms will remain in their respective locations: Denver and Larkspur, Calif. Maybe more pressing is the overhaul of Meridian Growth, a job that will fall to new hires Chad Meade and Brian Schaub, who posted a stellar seven-year record at Janus Triton (JGMAX) before leaving earlier this year for Arrowpoint. Then, there is the work of pulling the moving pieces together within the confines of a growing firm. Arrowpoint doubled in size to more than $5 billion after shareholders approved the deal in September. However, Corkins and co-founder Karen Reidy aren't interested in creating another version of Janus. Instead, they have focused on attracting top talent, with asset flows a pleasant side effect.

"We wanted to be big enough so that we didn't have to worry about raising money, but we still wanted to be nimble," says Corkins. "We are always looking for human capital first and then an opportunity."

Coming Together
In many ways, it isn't surprising that AIM merged with Arrowpoint Partners. Corkins had met Aster through the years and respected the track record he had amassed before his death. Corkins was also acquainted with Michael Stolper, a Meridian Funds board member who previously served in a similar capacity at Janus. In addition, the two firms invested with a similar mindset: Buy financially sound companies with competitive advantages that are trading at a discount to their intrinsic value. When Corkins heard AIM was searching for a buyer, he and his team started poring over the holdings of Meridian Growth, Meridian Value (MVALX), and Meridian Equity Income (MEIFX). They found overlap between what the three Meridian funds owned and the companies they had analyzed for Arrowpoint's own accounts. It was clear, says Corkins, "Meridian was a good fit in terms of philosophy."

Other firms thought so, too. By all accounts, the Meridian trustees handled a tough situation well. When Aster died, they canceled AIM's advisory contract and reinstated the firm on a temporary basis until shareholders could vote on a new agreement. They also set about exploring deals with several firms. In late 2012, they were close to signing with one that would have left AIM largely intact. The outside investor, though, let the deal expire. "We had a handshake and then they kept negotiating," says Glavin, who grew frustrated with the suitor. "When they let the time expire, we had had enough."

Corkins and team quickly made an offer. For AIM, a main concern was cashing out Aster's heirs while at the same time preserving his legacy. To Arrowpoint, the transaction made sense because its leaders had talked about getting back into the retail fund business. It had started laying out the infrastructure for such a move, including taking a stake in Destra Capital, which will serve as one of the primary distributors for the Meridian Funds. Both sides also say they were pleasantly surprised after meeting face to face.

"When Corkins showed up, it sounded like a perfect match," says Glavin. "He didn't want to be center stage, which intrigued me. It's not like he came in and said, 'I'm in charge. Let's do this, that and the other.'"

Preservation, But Not Without Change
While Arrowpoint will keep most of AIM's staff, the office in California, and the Meridian name, fundholders should brace for Arrowpoint to make some changes.

Mainly, Meade and Schaub will overhaul Meridian Growth, whose Morningstar Analyst Rating is currently under review during the transition. Aster built this portfolio by searching for companies capable of growing their earnings at least 15% a year. He avoided overpaying for his best ideas, which meant the portfolio's price multiples were often lower than the mid-growth category average. He also kept the portfolio focused on just 45 to 55 holdings and routinely avoided commodities and energy, investments he deemed too volatile. Aster posted a 12.8% annualized return over a 28-year stint, outpacing the typical peer by two percentage points.

Under Meade and Schaub, the fund is likely to diverge from its historical profile in several ways. First, Meridian Growth will become more diversified. At Janus Triton, the pair ran a portfolio of 70 to 90 holdings. They've also stated that they will largely wind down the fund's existing large-cap holdings, restricting it to stocks roughly below the $10 billion market-cap mark. The fund is also likely to sport energy stocks, too, because Janus Triton owned those types of firms. In all, shareholders should expect the fund's historically low turnover to increase in the near term as the new managers reposition the fund.

There's reason to be patient. During their seven-year tenure at Triton, Meade and Schaub beat 95% of their peers and easily beat the Russell 2500 Growth Index. Aster's influence won't completely fade away. Current comanager William Tao, who worked closely with Aster for five years, will remain in that position.

Meridian Value, also under review by Morningstar, won't undergo as many changes. Its name will change to Meridian Contrarian, but longtime managers Jamie England and James O'Connor remain in place and continue searching for firms they believe can rebound from two or three disappointing quarterly earnings reports. England will relinquish his role on Meridian Growth, which he undertook when Aster died. One notable change will be the addition of Larry Cordisco as comanager. Cordisco helped run the fund for eight years before leaving the firm in 2011. He came back when Aster died and is staying.

Making the Pitch
Arrowpoint will have its work cut out for it with reversing asset outflows. Meridian Growth saw more than $750 million leave its coffers the past year. Some of those outflows are probably due to the perception that Meridian Growth won't be able to duplicate its past success without Aster at the helm.

"You have to ask yourself what was the original reason for getting in. Was the team smart? Experienced? Did it have a great track record?" says Rob Brown, the chief investment strategist at Newport Beach, Calif.-based United Capital Financial Advisers. "If those reasons still hold, you should stick around. If they don't, you should get out."

Corkins and team realize that. They are familiar with the problems flows--both positive and negative--can cause from their time at Janus. "We each started managing small pools of assets and grew them. We saw the drawbacks of that," says Corkins. "We want to grow over time, but in a methodical way."

Corkins also thinks Meade and Schaub will be able to build at Meridian Growth the kind of track record they did at Janus Triton. If that happens, it should alleviate a lot of investors' concerns. Corkins and Reidy, though, want to build a firm whose reputation extends beyond performance. While launching additional funds or buying other firms is a possibility, Corkins and Reidy have turned down offers to run strategies that were outside their wheelhouse despite the fees such work would have garnered.

Arrowpoint also isn't gutting the Meridian board. Indeed, all of the current trustees remain in place. Fees should remain stable. In addition, Meade and Schaub are committed to moving a substantial chunk of their personal wealth into Meridian Growth right alongside shareholders. (Each manager had more than $1 million in Janus Triton).

From Corkins' perspective, the deal puts strong managers at the helm of all of the Meridian Funds. The managers "are going to be able to keep doing what they do well."