AB's Shakeup Is a Reason to Pause, Not Panic

Executive Summary

On May 1, 2017, French insurance conglomerate AXA Financial,

Separately, on May 11, 2017, AXA announced that it would divest a portion of its stake in the firm's U.S. insurance operation in an initial public offering. As part of that transaction, AB would become a wholly owned subsidiary of the newly created public firm, reporting to the leader of that business.

Having evaluated the facts and circumstances surrounding these events and after holding discussions with senior leaders of both AXA and AB, we have opted to leave AB's Parent Pillar rating unchanged at Neutral. In short, while these changes are troubling on the surface, we do not believe they signal a wholesale shift in AB's strategy or the role AXA will play in overseeing the firm. That said, we will be closely monitoring future events for signs of personnel turnover, client upheaval, or leadership and strategic flux, evidence of which would likely trigger a downgrade.

Background On May 1, AXA replaced Kraus as CEO with 30-year JPMorgan veteran Seth Bernstein and added former World Bank president Robert Zoellick as chairman. Simultaneously, AXA ousted six independent directors and replaced them with four AXA-affiliated members. Two holdover members of the board, Mark Pearson and Denis Duverne, serve as executives within AXA. The result of these adjustments is an AB leadership slate that is clearly stacked to AXA's benefit.

AXA has been AB's majority shareholder since 2000 but has been largely hands-off, more or less leaving AB to its own devices. It did step in on a few occasions, most notably in replacing former CEO Lewis Sanders with Kraus in December 2008 following AB's dismal performance through the financial crisis. But by all indications Kraus and his leadership team had a free hand to manage AB's day-to-day operations.

In the eight years that Kraus served as chairman and CEO, he made operational streamlining, team-building, and cross-pollination of ideas a priority, so as to facilitate management of the firm's allocation strategies. In our opinion, he largely succeeded in stabilizing and cohering the firm while instilling it with a more-defining identity (including presiding over the rebranding from AllianceBernstein to AB) and set of values.

That said, assets never recovered to their precrisis levels, and with the exception of the fixed-income investment lineup, the equity and allocation funds didn't establish a performance edge versus competitors. Kraus' relationship with certain board members also reportedly deteriorated over time. Taken together, these factors appear to have informed AXA's decision to replace Kraus and unseat most of the board.

Impact of Changes In our discussions with newly appointed CEO Bernstein, he has been adamant that he believes the firm's strategy is not broken and intends to continue the efforts begun under Kraus. Bernstein indicated there are no plans to reallocate resources, replace investment management personnel, or abandon previously announced initiatives, such as the forthcoming introduction of AB's "performance" series of funds.

We're also encouraged that the core nucleus of investment leaders, particularly on the fixed-income side, remains intact. This should ensure continuity and reassure the firm's client base, a portion of which likely reeled at news of the leadership changes. AB has fostered a successful fixed-income operation that manages more than half of AB's assets under management. Many of the veterans, including global bond manager Douglas Peebles and muni skipper Guy Davidson, have established consistent records of performance and built dedicated teams that have persisted through the noise. It's essential that CEO Bernstein protect this investment strength going forward.

Takeaways Perhaps the clearest takeaway from this episode is that while AXA has mostly been a hands-off owner, when pressed, it will intervene at AB. This raises questions of its own. For instance, will Kraus' dismissal and the board shakeup usher in a new phase in which AXA throws its weight around to a greater extent in influencing AB's strategy and execution? Does this signal that AXA is seeking improvements on a shorter time horizon, and, if so, what implications might that have on AB's investment and stewardship practices? Will AB's future surroundings--as a subsidiary of a publicly traded U.S. holding company--alter the firm's strategy?

To be sure, this additional uncertainty is unwelcome, as AB already faced challenges prior to the abrupt leadership and organizational changes. For instance, the firm continues to deal with heavy fee pressure and incursions by low-cost alternatives to active investing such as index funds and exchange-traded funds. Yet our Neutral Parent rating already considered these challenges and the attendant risk of organizational instability, which unfortunately has come to pass.

We support the broad contours of the strategy Kraus put into place and so were heartened at Bernstein's insistence that he intends to see these initiatives through. But the onus is on him, his leadership team, and AXA to demonstrate that AB is a stable firm that retains its people and inculcates a culture of investing excellence and commitment to investors. If we see signs that the firm is flagging in executing that strategy, that key investment personnel are jumping ship, or that clients are leaving en masse, we'll promptly reconsider our stance.