Waddell & Reed, Inc.

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Waddell & Reed, Inc.

6300 Lamar Avenue
Shawnee Mission, Kansas 66202-4247
U.S.A.
(913) 236-2000
Fax: (913) 236-1543
Web site: http://www.waddell.com

Wholly Owned Subsidiary of Torchmark Corporation
Incorporated: 1937
Employees: 2,130
Total Assets: $5.93 billion (1996)
Stock Exchanges: New York (pending)
SICs: 6311 Lite Insurance; 6331 Fire, Marine & Casualty insurance; 6719 Holding Companies, Not Elsewhere Classified

Waddell & Reed, Inc. is one of the nation’s leading financial services organizations, managing mutual fund portfolios and institutional investment funds, including the investment assets of parent company Torchmark Corporation, primarily a marketer of insurance products, and its subsidiaries. The company manages more than one million mutual fund accounts, valued at more than $20 billion. Through Waddell & Reed’s affiliate, United Investors Life, a variety of life insurance and variable annuity products are offered. According to Bob Hechler, president of Waddell & Reed, “There are now over 2,700 equity mutual funds, but only one in four have been around long enough to have a five-year track record.” The year 1997 marked the 60th anniversary of the company.

Getting in on the Investment Company Act of 1940

Waddell & Reed was founded on September 3, 1937 by two World War I Air Force pilots, Chauncey Waddell and Cameron Reed, who decided to take the plunge into the financial business after their return from military service. Chauncey Waddell joined a New York securities firm that became Herrick, Waddell & Co., while Cameron Reed began his financial career through the establishment of Consolidated Trust Inc., a forerunner of United Funds. Before long their merger formed Herrick, Waddell & Reed and was based in Kansas City. Soon after the United States Congress approved the Investment Company Act of 1940, the company became one of the first to register under the new law. The partners recognized that mutual funds could offer an enormous investment opportunity for people and, consequently, began two of the country’s first mutual funds, United Income Fund and United Accumulative Fund. By 1943, Waddell & Reed became the principal underwriter of United Funds, Inc. Herrick was dropped from the company name in 1949. By 1950 Waddell & Reed managed assets reaching $700 million, making it one of the top five mutual fund sales organizations in the country.

As the first company to open a mutual fund sales outlet in a department store, Waddell & Reed made news with its 1958 opening in Buffalo, New York. It was a novelty for department store shoppers to have the option of buying fund shares along with the everyday tangible items they purchased. Other early company innovations included the policy of hiring a substantial force of part-time sales agents, as opposed to the customary hiring of all full-time personnel, a policy that engendered considerable and far-reaching criticism from the industry. In 1961 Waddell & Reed had a staff of 4,500 managers and representatives, of whom nearly half were part-time employees, including accountants and school teachers who concentrated selling efforts in smaller cities and towns. Critics, including those on the board of the New York Stock Exchange, argued that the part-time employees were underqualified salesmen [persons] selling a prepackaged product and not adequately trained. Leery of the relatively new mutual fund sales industry, critics feared that sales of general securities might be jeopardized, which would antagonize brokerage houses, and voiced concerns that unscrupulous or undertrained salesmen could do harm to public confidence. In response, company officials explained that their employees were carefully selected, trained, and supervised. The part-time sales personnel were not responsible for selecting individual securities, but could do a respectable job of explaining the preselected program, how mutual funds worked, what services they provided, and so on. More than 90 percent of Waddell sales were made through its own representatives. The company continued its rapid expansion, with United Funds assets reaching $1 billion by 1961.

1970s Plan for the Pacific Stock Exchange

“Differences over matters of sales policy,” was the explanation given by Dudley F. Cates, as he resigned from his position of president of Waddell & Reed in 1963. He had served as president of the Continental Research Corporation and as investment manager of the United Funds before taking the executive post with Waddell & Reed. He was succeeded by Cameron Reed, former president and company co-founder. The company applied for membership to the Pacific Coast Stock Exchange, which would enable the new brokerage subsidiary of Waddell & Reed (called the Kansas City Securities Corporation) to provide investment management of the four United Funds. At that time, a seat on the exchange cost approximately $10,000. The move was touted as a plan to pass along savings to the 330,000 shareholders of United Funds by cutting management fees—a move that aroused wide interest in the entire securities world, according to Vartan, writing for the New York Times. Waddell told Vartan that if the subsidiary gained admission to the Pacific Exchange, “Waddell & Reed will propose to its client, United Funds, that its investment advisory and management fee be reduced in each year by an amount equal to some agreed percentage of the brokerage commissions or the profits earned by its subsidiary.” He added that transactions of United Funds, which included the United Accumulative Fund, the United Income Fund, the United Science Fund, and the United Bond Fund, had generated about $4.2 million in brokerage commissions in each of the two prior years. Company executives predicted that the Pacific Exchange’s approval of the subsidiary would eventually mean greater competition among the nation’s stock exchanges. Those who favored Waddell’s seat argued that membership was the potential source of much new business and that when orders could not be filled regionally, brokers were forced to go to the New York Stock Exchange, where commissions had to be shared. Waddell’s application was approved in 1965, still arousing fears that a membership parade would ensue, whereby some of the biggest institutional customers in the business would become brokers themselves.

During this period, Cameron Reed resigned as president and director, selling his stockholdings to members of the du Pont family and their associates. The sale involved almost 49,000 shares, giving the du Pont group about 24 percent of the voting stock. The company began having problems with internal relations, resulting in the resignations of several key research executives. William Armstrong, vice-president of Waddell & Reed’s investment management division, was the first to go. He was also serving as director and as vice-president of United Funds, Inc. Several others followed suit, mainly among the research analysts. New York Times reporter Terry Robards communicated that the bear market of 1966, which followed a period of record highs, led several key men at Waddell & Reed to believe that the decline in share prices was temporary. The company went ahead with a decision to move heavily into cash and out of equities, within two months of the time when the market hit bottom. “The decision to re-invest was not made until the market had rebounded substantially from its low,” he reported, which resulted in a relatively poor increase in net assets.

In 1969 the Continental Investment Corporation of Boston bought Waddell & Reed for $82.5 million. Adverse operating results were disclosed in 1975. The company lost $16.2 million that year, following earnings of $4.3 million the year before and $8 million in 1972.

An Old School Management Style for the 1980s

In 1979 Russell Thompson, a University of Missouri M.B.A., began serving as Waddell & Reed’s United Income Fund portfolio manager. The small town Kansas native wore the reputation of conservative manager and soon established one of the best ten-year equity records in the business. Oliver wrote in Forbes, “In the 1980s Thompson clung steadfastly to the school of investing that emphasizes what a company would be worth if its business operations and other assets were auctioned off.” During the 1980s, when many of his portfolio holdings were taken over in leveraged buyouts, his type of management worked very well.

Liberty National Insurance Holding Company, later renamed Torchmark Corporation, a Birmington, Alabama-based health and life insurer, bought Waddell & Reed for $160 million in 1981. In the 1980-1981 period, the company’s managers decided that two things were important. First, that interest rates were going to fall. They responded by purchasing a lot of interest-sensitive investments, mostly in the financial services sector. Second, they trusted that assets were undervalued, so they bought companies that were asset-rich. They bought a million shares of RCA, for example, at $22 per share. RCA was later bought out by General Electric for $68 per share. By 1991, Thompson outpaced the Standard and Poor’s 500 index by almost 300 basis points and ranked number one in Lipper Analytical Service’s ranking of equity income funds of more than $1 billion.

Company Perspectives:

In 1964, Cameron Reed said what was to become the guiding principal for the firm: “Long experience has dictated that, as a general approach to financial planning, everyone needs three things: 1) cash for emergencies and current living; 2) insurance for protection; and 3) a plan for investing surplus funds accumulated over a long period for possible profit and growth.” Waddell & Reed still follows that philosophy. Since the time of the company’s founding, the company mission has been: Helping people make the most of their financial future. The company offers its financial planning services and products through financial advisors and believes that personal, face-to-face service is the best way to serve its clients.

Thompson held the view that the critical variable in forecasting the markets was inflation, which characteristically controls interest rates. He and other senior managers developed a process for investing that they termed “top-down rotational.” Their method first involved a clear determination of where they stood in the economic cycle, from the early stages through the inflationary stages. Then as the economic cycle progressed, they would structure the portfolio to do well in that particular part of the cycle and then choose stocks that should do well in the segments they had stressed. In addition, they would search for companies in the process of change—companies that had not necessarily done well, but that they expected to do well, within the industries they had selected. They also sought out companies that grew dividends.

In the summer of 1991 when company analysts believed the economy was weakening and that the Federal Reserve Board would soon ease interest rates, the company continued to keep a significant number of financial stocks, which included Wells Fargo, Bank of America, and Household Financial. Then Saddam Hussein attacked Kuwait and the fund suffered dramatically. Bank examiners became much more restrictive, because of political and economic uncertainties, and the real estate market plummeted—the financial stocks halved. Thompson and others decided that despite the war the U.S. economy was not going to go away and that the financial assets would soon improve once the Federal Reserve began to ease. They added to the company’s financial portfolio, and those stocks soon doubled. When interest rates were low the company invested in a large number of cyclicals. It also focused on the infrastructure stocks, such as Foster Wheeler and Morrison-Knudsen. The company bought Deere, Caterpiller, Ingersoll-Rand and, in electronics, Motorola, AMP, and Intel. The company is seldom fully invested and normally reserves 15-20 percent in cash, which facilitates getting in and out of industries.

Waddell & Reed and its affiliates always relied heavily on internal research. The company’s analysts/portfolio managers cover their industries and provide needed information. They also make buy and sell recommendations based on information from company sources, Wall Street, and various literature sources. Thompson told Sharon Harvey of Institutional Investor, “In some cases, we think we have better analysts than the Street does.” For larger holdings, Thompson would talk to the companies himself. He added that the company “would like to be characterized as a fund that anticipates change.”

Catering to middle-class America (people with incomes from $40,000 to $100,000 a year in 1996) the company continued in its “homey” marketing tradition. It refused to market on the Internet, through brokerage firms like Merrill Lynch & Co., or through PaineWebber Group, Inc., in the belief that an exclusive product gave Waddell & Reed sales representatives an advantage with customers. Typically, the sales representatives become acquainted with future customers in a coffee shop; those customers have been attracted by the idea of a conservative stance in fund management. Representatives meet face to face with clients at least once or twice a year. The approach tends to attract loyal customers. As a sales philosophy, the company emphasizes multiple sales over time, rather than a one-time sale of a particular product.

Catching Up with the 1990s

Groundwork for new changes had been laid in the early 1990s. Poor producers were culled from the sales personnel; 40 percent of the sales force was cut. Company analysts had determined that baby boomers were amassing assets and were willing to pay for professional financial advice. In an attempt to adjust to changes such as the growing market, Waddell officials decided to rebuild their sales force, with the goal of hiring 3,500 representatives by the year 2001. The company also needed to rethink its policy concerning sales load, since personal finance magazines and books about investing consistently discouraged investors from paying a sales commission. Even so, load funds continued to constitute bigger business than their no-load rivals. The United Funds carry a sales load of 4.25-5.75 percent commissions to invest. Waddell & Reed Funds do not charge a sales load when customers invest, but they may pay one when they sell. Studies indicated that investors were increasingly willing to pay for help to pick among the thousands of mutual funds available in the market.

Responding to the need for a larger, better trained sales force, additional changes implemented by the company included the replacement of its 1970s financial planning software, making graphics, estate planning, and other planning features available as a sales tool to help representatives. New levels of support were set up for the newly hired sales personnel. The pay increased to $2,000 a month, contingent upon a determined amount of commissions, for up to six months after the representative’s first 90 days (replacing an old program that paid only $750 a month for three months, at which time commissions were expected to provide a comfortable living). Managers were given incentives for spending more time with new representatives. Titles were upgraded, and after meeting state licensing requirements sales representatives became financial advisors, as a further inducement to baby boomers looking for expert advice. The sales force decreased by 280 during 1996, according to company reports, which may reflect a 1993 cut in sales commissions on its funds to 5.75 percent from eight percent; the company is considering further cuts.

Although financial advisors can sell other funds to customers, incentives are geared toward selling United and Waddell & Reed Funds. Critics argue that investors do not merely want help in choosing a fund, but that they want to choose between many fund choices. They charge that the exclusive-product appeal is not in touch with the contemporary supermarket trend. The performance of Waddell and Reed’s Funds showed great profits, but lagged, nevertheless, behind the industry boom.

In November 1997, Torchmark Corporation announced that its asset management subsidiary, Waddell & Reed, planned to make an initial public offering of common stock early in 1998. Torchmark had plans for a tax-free spinoff of its remaining shares, subject to regulatory approval. The parent company claimed that the action provided an opportunity to enhance shareholder value and that the spinoff would split the asset management business from the insurance businesses, which would allow a more accurate determination of the value of each company. R. K. Richey, chairman and CEO of Torchmark would become chairman of the executive committee of the board of directors of both companies. Keith A. Tucker, Torch-mark vice-chairman and board member, would become chairman and CEO of Waddell & Reed.