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"Capital Group's story could
John Grisham page-turner.
..
.Welcome
the world's best fund
A
to
off the
pages of a
what many believe
to
be
management organization."
— Financial
C
come
P
I
Times
ItA
The Story of Long-Term Investment Excellence
CHARLES
D.
ELLIS
Foreword by Burton G. Malkiel, author of A Random Walk Down Wall Street
L
More
Praise for
CAPITAL
# "The
exciting evolution of Capital
vestment management firms, special
is
Group, one of Americas great
in-
an inspirational story of creating a
environment of discipline and freedom, accountability and
support, and stimulation and study. Understanding
made
traordinary people in this organization have
how
this
the ex-
work
will
help managers everywhere do a better job."
—Byron Wien Morgan Group
"Capital that
we have
Charley
Ellis
is
all
Stanley
an extremely successful investment organization
admired from
afar.
In this intriguing history,
recounts the birth and evolution of Capital
analyzes the origins of their success
and a must-read
for
all
—
Group and
a thoroughly engaging story
those seriously interested in investments."
—
^Jay
O. Light
Harvard Business School
''Capital
is
a wonderful
book about one of
the best firms in our
business and provides fabulous insights into the two most important assets that
and
its
any investment management firm has
—
its
people
culture."
—
^Jack
Brennan
Chairman and
CEO
The Vanguard Group
CAPITAL
CAPITAL # The Story ofLong-Term Investment Excellence
CHARLES
ELLIS
D.
WILEY John Wiley
& Sons,
Inc.
Copyright
© 2004 by Charles
Published by John Wiley
&
D.
Hllis.
Sons, Inc.,
All rights reserved.
Hoboken,
New Jersey.
Published simultaneously in Canada.
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Charles D.
Capital
:
excellence p.
the story of long-term investment /
Charles D.
Ellis.
cm.
Includes bibliographical references and index.
ISBN- 10 0-471-56704-3 (CLOTH) ISBN- 13 978-0-471-56704-2 (CLOTH)
ISBN-10 0-471-73587-6 (PAPER) ISBN-13 978-0-471-73587-8 (PAPER) 1.
Capital
—
Group
History.
2.
Investment advisors
—
History.
I.
Title.
HG4621.E45
2004
332.(>—dc22
20030207 Printed in the United States of America.
10
9876543
visit
our web
f
With admiration and
affection, this story
professional excellence
is
of global
dedicated to
Richard C. Levin, Yale University's great
and twenty-second
President,
exemplary servant-leader, pragmatist-scholar, native Californian,
and baseball
fan.
Digitized by tine Internet Arcliive in
2011
littp://www.arcliive.org/details/capitalstoryofloOOelli
—
ACKNOWLEDGMENTS
LINDA Koch me
couraged tions
—some on
some
in
New
Lorimer,
my
beloved wife and best friend, en-
with penetrating questions and helpful sugges-
trips to
China, some on vacation in Europe, and
Haven. Heidi
Fiske,
my
friend over 35 years, uncov-
ered historical sources of information and gave generously her keen editorial skills
and her
knowledge of Capital. Randy
journalist's
Whitestone combined good humor and discipline to help
and tighten the Rintels gave
text
—
numerous
significantly.
Jack
usefiil suggestions.
clarify
MacDonald and David
Kimberly Breed cheerfully
converted the complexities of various pieces of text collected into
complex paste-ups with extensive handwritten annotations, arrows,
and codes into toward
clarity.
draft after draft in the ungainly process of struggling
Dozens of Capital Associates gave
me great help and
a
first-hand experience with the Capital process of making decisions
generosity in support and assistance all final
decisions were entirely
and the
mine
to
clear
understanding that
make.
C. D. E.
Vll
.
CONTENTS
Foreword
XI
Introduction
CHAPTER
1.
I
The Founding
9
CHAPTER 2.
Staying Alive
25
CHAPTER 3.
The Multiple-Counselor System
35
CHAPTER 4.
Organizing the Core
49
CHAPTER
Mutual Fund Distribution
6i
CHAPTER 6.
Crossing the Rubicon: Capital Group
91
CHAPTER 7.
Shareholder Services
lOI
CHAPTER 8.
Acquisitions and Start-Ups
123
CHAPTER 9.
Capital Guardian Trust
CHAPTER
10.
Global Investing
165
CHAPTER
1 1
Emerging Markets
185
CHAPTER
12.
Managing People
201
CHAPTER
1
Management
223
5.
3.
IX
Company
139
X
CONTENTS
CHAPTER
14.
Compensation
249
CHAPTER
15.
Investing
265
Afterword
291
APPENDIX
I
Summary Statement of Corporate Objectives and Goals
301
APPENDIX II
Outline of Basic Managerial Beliefs
307
APPENDIX III
Growth of The Capital Group Companies, Index
Inc.
309 311
FOREWORD
IT I
ALWAYS
IS
am honored
new book by Charley Ellis, and an introduction. The practice of invest-
welcome
a treat to
to provide
a
ment management owes Charley an enormous is
one of the
titans
has
made
who combines
keen observer of
horse sense, and an influential consultant, Charley
Ellis
a
profound and
The
lasting impression
on the landscape of the
firm he founded, Greenwich Associates,
many articles and books have improved
his
a
and
a wTiter
investment business.
and
A seminal thinker,
intellectual rigor
financial markets,
common
of finance.
investment decision
making
for literally
vestors.
Charleys wTitings have become investment
Game"
Loser's
ment
He
intellectual debt.
is
business.
and individual
thousands of institutional and individual in-
mandatory reading
How
to
Win
for
anyone entering the
Game
the Loser's
classics.
"The
invest-
provides institutional
investors with an indispensable guide for effective
asset allocation. Classics:
An
Investor's
Anthology (Volumes
I
and
II)
brings together the major pieces in the literature that have helped
change the practice of investment management from an ence. Wall Street People naries
from Warren
Capital, the story of
ment
(Volumes
Bufifett
organizations in the world
For
many
largest
profiles
and most
Wall Street lumi-
And now comes successfiil invest-
—The Capital Group Companies.
reasons, Charley Ellis
siOTY of this remarkable firm.
II)
George Soros.
to
one of the
and
I
art to a sci-
The
is
the perfect person to
tell
the
building of Capital and the values
XI
V
xii
O
W
R E
the firm are not dissimilar to the development of
that sustain
Charleys
R D
C)
own
Greenwich
firm,
Greenwich the premier global
as
"among
most important
factors that
made
financial strategy consultancy firm
bear a close relationship to those that
by Charley
The
Associates.
made
Capital a firm described
the best at everything
factors are absolute integrity
does." Perhaps the
it
and "what's good
for
the client" as the essential driving principles of both firms. In these
days of tainted research, insider trading, obscene compensation
arrangements, and mutual fund complexes that put the profits of the firm above the interests of the shareholders,
reminded that successful firms do
flourish
reassuring to be
it is
by holding
fast to
funda-
mental values: sticking to the right path; taking the long-term view;
and
insisting always
and
quality
and
excellence.
and Greenwich have been
that both Capital tenacity,
on
inspiration,
who know what
it
And led
finally, it is clear
by
men
of vision,
takes to bring a start-up
to grandeur.
Indeed, this
book
represents a perfect pairing of one of the
astute observers of the investment scene with
standing investment firms ever created.
he
is
most
one of the most out-
Not only
is
Charley smart;
a professional listener. In preparing this volume, he inter-
viewed the people involved in the building of Capital, and he has an ability to
say
is
make everyone he
talks
with believe that what they have to
of the utmost significance.
molding a
set
He
recognizes the importance of
of enormously capable colleagues into a community
and of continually
raising the bar to define excellence.
not be a better person than Charley
with such finesse and
critical
Ellis to tell
the story of Capital
understanding.
In another sense, however, Charley
am
There could
is
a very unlikely person to
write this book, and
I
word. Charley and
are soul mates in believing that stock picking
a losing
game and
vestment advice
is
I
a very unlikely person to provide
that the
most
in selecting
its
Foreis
useful function of professional in-
an appropriate
tent with the needs, circumstances,
asset allocation consis-
and preferences of
different
Foreword
investors
— not
in trading
from one stock
to another
on the
perceived differences in valuation. Indeed, w^inning the is
xiii
of
basis
loser's
game
accomplished by using investment funds that simply buy and
hold the stocks
well as
(as
bonds and
investment committee where Charley and
me
my
for
mended
—
man who
a
once chas-
by indexing only half of the
start
Charley wanted to go Ellis
served, he
I
much
farther.)
then,
recom-
(I
portfolio.
would Charley
our stock markets are so dominated
believes that
by talented and dedicated
Why,
trusts)
a foundation
only lukewarm espousal of indexing.
we
that
On
market index.
that comprise a very broad-based
tised
investment
real estate
institutional investors that
virtually
it is
impossible for anyone "to do significantly better than the others, particularly in the long run"
raison d'etre
There of Capital
The from
is
—even
a basic
write a
active portfolio
are at least
first
—
two
praising a firm
whose
book about the
virtues
management?
justifications for a
for such
confirmed indexers
reason to extol at least
paradox in the theory of
were always perfectly
book
efficient, there
some
as
Charley and me.
active
managers stems
efficient markets. If
would be no
markets
incentive for any
professionals to uncover the information that so quickly gets reflected in
market
that information
prices. is
Markets need some professionals to ensure
quickly incorporated into market prices, and
those professionals have to earn above-market returns to
them
sate
search.
I
for the time
and
effort involved in
firmly believe that too
much
compen-
doing fundamental
effort
is
put into finding
mispriced securities and that few investors actually gain from the fort.
But the market could not be
efficient if
vested in index funds. Paradoxical as
it
may
ef-
everyone simply in-
sound, markets need
firms such as Capital to ensure that low-cost indexing
winning
re-
is,
in fact, a
strategy.
The second
justification
is
that Capital
is
one of those very
rare
investment managers to have achieved superior long-run investment returns.
The
records of the mutual funds
managed by Capital
are
xiv
F
O R
WO
E
R
L)
and we can examine the long-run
publicly available,
results
of these
funds compared with broad-based index funds. In the table below,
compare the
of the general domestic equity mutual funds
results
managed by Capital with Wilshire 5000 indexes. the
the returns from the
The S&P and Wilshire
S&P
table
shows that investors would,
by investing
in those
500 and the
returns are
same 30-year period over which the fund returns
The
I
in fact,
shown
for
are measured.
have been better off
mutual funds managed by Capital. Capital has
indeed produced above-average and even well-above-average market returns for investors.
What
Capital's secret?
is
Why
has this organization excelled in
the investment race while most others have played the
game
—
at least
where investment
pages, Charley Ellis
tells
results are
the Capital story
loser's
concerned? In these
and shows how the orga-
nization of the firm has been designed for sustained success.
Of out.
the
The
many
first is
factors explaining Capital's success, three stand
Capital's unusual
way of organizing
its
"knowledge
workers" in an industry that typically celebrates individual "stars"
and where hubris is
is
common. An unusual amount of effort and
care
taken in recruiting, coaching, and developing Capital's exception-
ally talented
investment analysts. There
Average Annual Returns, June
30,
is
1973-June
no room
30,
for egotistical
2003
Indexes (before expenses)
S&P
11.46%
500
Wilshire 5000
11.58
Domestic Equity Mutual Funds Managed by Capital
(after expenses)
AMCAPFund
14.71%
Growth Fund of America
15.33
American Mutual
13.36
Investment
Company
of America
13.25
Washington Mutual
14.02
Income Fund of America
12.28
Sources: Lipper
and CRSP.
xv
Foreword
removed that would
hierarchical symbols are
and
stars,
with individuals working effectively together in groups.
interfere
The
organi-
zation has been successful in creating a pervasive tone of trust,
mu-
and interpersonal enjoyment.
tual respect,
A second— and related— unique feature of the Capital organization
is its
innovative "multiple counselor system" of portfolio
agement. Each portfolio
man-
assigned not to an individual manager
is
but instead to several individual managers (which might include
some of the
firm's research analysts),
one part of the sions.
overall
The system
effectively copes tions:
As the
size
is
responsible for
fund and each make direct investment deci-
ensures that there will be no star managers, and
of the
assets to
Finally, Capital has
be managed increases, the
managed
the face of changing fads
is
flexibility
often severely constrained.
to maintain a long-term focus in
and the changing popularity of
invest-
In inevitable periods of underperformance, Capital's
styles.
answer to the question, "what are you going to change?" ing."
it
with a problem endemic to investment organiza-
of an individual portfolio manager
ment
each of whom
When
popular faddish products (such
as
new
is
"noth-
Internet or
high-technology funds) have been brought to market by competitors,
Capital has refrained from bringing out similar products.
Capital eschews publicity. Capital's leaders are not interested in
promoting
stories
about their funds
"hot"
—because they know
their
money
—
especially those that are
that investors invariably tend to put
in such funds at just the worst time,
results are likely to revert to the
when investment
mean. Capital does not even use
the term "performance" to describe investment results view, performance should be used only to describe in
Hollywood or
who made
organization that the
in
its
actors
do
New York.
In these pages, you will find
people
what
—
more frequent
some wonderful
stories
about the
Capital the outstandingly successful investment it is.
Occasional failures are recounted
successes.
and eloquence. Charley
Ellis
And
Capital
is
as well as
written with grace, wit,
has an anti-Midas touch. If he touched
XVI
F
O
gold, he
R E
w
c:)
R n
would bring
it
to
life.
I
can't
imagine another writer
who
could make a discussion of custodial services and the transfer agency function interesting.
And
all this
sion of the investment business
from
unexcelled.
is
bark on some delicious reading
whose comprehen-
You
are
about to em-
bon appetit!
Burton Author,
a writer
G. Malkiel
A Random
Walk
Down
Wall Street
INTRODUCTION
NOTES FOR READERS While dozens
hove mode themselves
of Capitol Associates
avail-
able for candid interviews and several hove helped on factual accuracy, this
certainly not
is
an authorized biography. Out of
all
the
information provided to me, only four small, factual deletions v/ere
requested and made. at Capital that
I
v/ould
along,
All tell
it
as
I
it's
see
been understood by everyone
and
it,
I
have done
just that.
NO
INVESTMENT ORGANIZATION in the vv^orld has ever done so w^ell for so long for so many cUents as The Capital Group Companies. It is one of the v^orld's largest investment management organizations, consistently earns the admiration of clients petitors,
ment
and decade
results.
know^ very
This
is
financially
decade achieves superior long-term invest-
Yet most people, even
little
no
after
and com-
its
ov^n customers and clients,
about Capital.
accident. Capital
and philosophically
is
a very private organization
—and
^^^^
no benefit
from organizational recognition or individual fame.
to
its
—both clients
2
CAPITAL As an organization, Capital
other investment organization
is
is
designed for sustained success.
and mo-
so well organized, staffed,
tivated to continue striving to be
among
No
the best at everything
it
does while achieving superior long-term results for clients around the world.
Capital does not advertise and avoids the media. sion,
one of the world's
a completely different
most people do not
One
largest
Its largest divi-
mutual fund organizations, even uses
name: "The American Funds." That's why
realize that Capital
of America's three
largest
is:
managers of mutual funds
serving over 20 million shareholder accounts and
four of the nation's 10 largest mutual funds.
long-term record of investment
results, it is
managing
With
the best
gaining market
share.
A
leading institutional investment manager, serving 35 per-
cent of America's large institutions and 65 percent of those
very large funds with assets over $ 1
One of the
largest
tions in the
world
billion.
independent investment research organiza-
—
repetitively identified as
having the most
capable research analysts.
One
of the most respected investment managers in each of the
world's large national markets: America, Japan, the United
Kingdom,
Australia,
Canada, and continental Europe
—and
gaining market share.
The
world's leading international investment manager.
The
largest investor
Much more
—by — far
in the
emerging markets.
important to the company and to
its
investors,
Capital achieves superior long-term investment results.
Over the
past 5 years tal's
and 10
years,
20
years,
50
years,
and longer
investment results rank in the Top Quartile.
ment manager
has done so well for so long.
No
Not
—Capi-
other invest-
nearly.
And no
Introduction
Other organization
and so well organized
so well resourced
is
3
to suc-
ceed in the future. Unsurprisingly, Capital
would most
like to
recommend
as
mon
work and is
is
also the
would most frequently
one investment organization senior corpo-
would most
have owning their company's com-
like to
stock.
Finally, Capital
is
both the one organization most
favorable expectations over likely to say or
who
the firm they
long-term investment managers for their family and
friends. Capital rate executives
where most investment professionals
is
many years
likely to fulfill
into the future
and the
least
even acknowledge such prospects. As Jon Lovelace,
has been central to Capital's development, says, "Nothing wilts
faster
than laurels rested upon." Modesty
where people
are far
more
interested in
is
what
pervasive at Capital,
lies
ahead than in past
achievements. Investors
—both
and
individuals
institutions
—
seeking to un-
why Capital is such an admired organization will find in book many important lessons in organization design, manage-
derstand this
ment of professional
people,
and
strategic
development. These
les-
sons will not only inform other investment firms, they also have application for other types of professional organizations. Capital
may
well be the world's best-designed organization of
Drucker so wisely that
make
calls
what Peter
"knowledge workers." The major
factors
Capital the world's most admired investment organiza-
tion include:
Long-term focus. Capital fortable saying
"No"
is
creatively conservative
to currently popular
profitable ideas that, in the long run,
until the
market
is
and apparently
might harm
Capital comfortably defers action on
and com-
investors.
new mutual funds
truly attractive for long-term investment
commitments, even though
this will often
be the very same
time the market for that particular type of investment seems least attractive.
Capital
is
comfortable absorbing significant
4
CAPITAL operating losses
—
for
many
years
—
to support strategic
com-
mitments that can prove rewarding over the long run.
—and many
While most investment organizations too hard
—
keep up with changing fashions
to
shown
Capital has
try
in investing,
that over the long term, faithfully serving
long-term interests will build a remarkably
investors' true
strong, growing,
and
profitable franchise.
Consistent objectivity. Rational thought
mount
try
Investment
at Capital.
quently and compensation
is
and behavior
are para-
results are reported quite fre-
carefully linked to long-term
results to assure consistent objectivity.
People-centered operations.
With
all
its
systems and consis-
tently rigorous rationality, Capital's operations
and long term
—
are
remarkably
each individual. Capital
is
—both
humane and
sensitive to
unusual in the time and care
vests in recruiting exceptionally talented people
work
well together
and produce superior
daily
services
it
who
and
in-
will
results
for investors.
Capital
ment
it
is
even more remarkable in the continuing invest-
makes
capabilities
in helping each individual develop her or his
and in designing
the organization in ways that en-
able each person to contribute most. Jobs are designed,
and
continuously redesigned, around specific individuals to match
and
capitalize
on
Capital
not so
is
in the business
and
will
make
their particular strengths.
much
in the investment business as
it is
who
can
of developing individuals and groups
superior investment decisions and deliver su-
perior service to clients.
At
this, it excels.
Seminal organizational innovation. Capital's seminal organizational innovation fully utilize
—
is
—which perhaps only
Capital
itself
can
the multiple-counselor system of portfolio
management. This system
deals effectively with the formi-
dable "asset-size barrier" that eventually confounds most
Introduction
growing investment organizations. The problem of cannot be eliminated, but
it
can be
viding large portfolios into several
5
size
made manageable by disegments. The manager
of each segment invests in her or his "highest conviction" ideas
—with
accountability for
full
rigorously
measured
results. Flexibility in the organization. Capital's overall organization flexible
phous.)
and
fluid.
The
(To outsiders,
it
is
often appears vague or amor-
firm disperses decision-making power widely and
keeps strategic options for future development open as long as possible. Since stable structure
enemy of dynamic
strategy,
is
too often the dangerous
all
Capital avoids such tangible indica-
tors
of organizational status
and
hierarchical reporting. Corporate titles
and have
as vested titles, different size offices,
significance.
little real
Flexibility in compensation. Capital's
both very
flexible
ment over
change frequently
and based
several years
directly
compensation policy
on the
is
objective measure-
of each individual's long-term contri-
butions to Capital's long-term goal to serve three equally
important and ultimately complementary groups: investors. Associates,
and owners.
Private ownership. private ownership
The broad and is
equitable distribution of
considered essential.
Recognition of the need for ego strength. Although egotistical
manners and negative remarks
are verboten, each individual
needs quiet ego strength to flourish professionally and person-
when surrounded by skilled and dedicated professional colleagues who work closely together and continuously comally
pete to achieve superior long-term investment results.
As an organization. Capital has made back in the 1970s, but
it
has
made
serious mistakes, particularly
fewer major mistakes and has cor-
rected those mistakes sooner than
its
competitors.
And
individual
CAPITAL
6
people
make
Capital
at
mistakes: Feelings get hurt, tempers
of course, mistakes are made takes
how to
avoid repeating them
—
is
Capital
Group Companies would be
not and never has been perfect
is
—and
the best measure of a learn-
ing organization that will continue to get better and better. ple inside Capital
and
in investments every day. If making mis-
the inevitable cost of striving, correcting mistakes
is
learning
flare,
first
The
peo-
to say that
and hopefully never
will
be because the drive to do better and better creates the dynamic tension in the pursuit of excellence that keeps Associates focused
and on continuous improvement.
future
Hard stay a
on the
as
it is
champion, the hardest task
to become a
champion. The longer an organization has been
harder
it is
to sustain the creativity
for longer than
always to
successful, the
and competitive commitment
—and
quired to continue improving
is
Capital has been
any other investment organization
more
re-
successful
Each
in the world.
year of success adds to the cumulative challenge to prevent the con-
ventional and insidious diseases of "success": complacency, insularity,
and overconfidence.
If the Lovelaces, father
and son, represent two
generations of leadership, then the third generation of leaders
Shanahan,
Rothenberg, and others
Fisher,
—
is
already devolving
major responsibility to the fourth. To succeed with
many
leaders within Capital
stand,
is
success, as the
Group Companies know and under-
a forever challenge.
A view toward
the future raises
more generalized
questions:
Has
Capital overinvested in talent for the incremental rate of return actually
earned? Will success lead to inbreeding or cult culture? Should
Capital have been
much more
bond management
successful in developing
business in
or in serving wealthy families? Will Capital's
complex and subtle corporate culture nations around the world? all
its
Can
flourish in each of the
many
Capital maintain consistency across
those very different nations and business cultures? Will successive
generations of leadership continue to develop a stronger and stronger
organization that
is
great constituencies?
able to
As
do more and
better for Capital's three
institutional investors increasingly
dominate
I
f
Introduction
7
the world's capital markets, can even as strong a research-based in-
vestment organization
as Capital achieve results that are consistently
superior to passive investing?
To what
sionals use their understanding
extent will Capital's profes-
of investing to work with clients
as
investment counselors, helping each client develop the appropriate investment program to meet
Although Capital
is
tions, the questions
likely to
its
long-term and interim objectives?
develop superior answers to these ques-
remain challenging
—even
for Capital.
I
CHAPTER
1
THE FOUNDING
NOTES FOR READERS An
management organization — like any
investment
professional or-
ganization—is profoundly dependent on the capabilities, character, motivations,
and values
of
its
people.
And
the attributes of the early
joiners primarily determine the kind of professionals the firm will attract in future years. is
Once
the die
Is
upgrading an organization
cast,
very hard. For an organization to upgrade
itself
at
a
later
date
is al-
most impossible. So, the founders and early joiners matter greatly.
Hundreds of investment management during the past
50
firms
have been launched
years. Collectively, their behavior
in
recruiting
professionals confirms the grim validity of David Ogllvy's caution: ''Only giants will hire giants. Ordinary less
than they
are— and
stature until the
ing
then those will
whole organization
and building and then
is
men
go on
will hire
to hire
men who are
men
of even less
replete with pygmiesV'^ Creat-
sustaining a superior professional firm
always deliberate, continuous, and "unnaturar' — unnatural ^
Confessions
1994).
of an Advertising
Man
by David Ogilvy,
NTC
Publishing
in
is
the
Group (March,
C A
lO
P
1
I
A L
sense that something
new and
different
being brought
is
to
and
life
built to last.
Jonathan
Lovelace^ and his son Jon Lovelace repeatedly
Bell
demonstrated leadership
By
to Capital.
in
reaching out
their persistent
to bring
exceptional people
searching for strong people
tively taking the initiative to exploit "lucky" opportunities
sembled a collection of talented professionals
became
together. Capital
usually
— repeti-
— they
who worked
as-
well
increasingly recognizable as a firm of un-
capable and congenial professional people: a good group
to join.
The core group of individuals
illustrates
one not so obvious. The obvious lesson
and
highly motivated
is
talented individuals
one obvious lesson and
that attracting is
essential in building a su-
perior professional firm. The familiar keys to success are
and imaginative
(3)
uncompromising search
the distribution of rewards
and
many
persistent
responsibilities
for
accep-
meritocracy
according
in
to real con-
start-up firms
and
collegiality. In
sad contrast, when hiring
make expedient compromises
recruit too
few
real leaders to ever
that they
become a
superior firm.
The deeply
prove
obvious lesson — but no
less
new
to identify to
be
and then bring aboard those their
and
in
the
thin
success— is how
threads of possibility
individuals
who
will
later
exceptional and indispensable people. Although the
view of
steps along the
have led
less critical to
depend on pursuing very
firms
retrospective
tain
and
genuine
(5)
later learn to regret truly
)
devotion to professional excellence and superior service
tribution; (4)
people,
(1
recruiting; (2) consistently high standards for
tance into the group;
to clients;
and keeping
history, with the
way seem
outcome known, may make
natural or even preordained, those
the
who
development of great organizations know how uncer-
fragile the early stages
always are. As key people appear
in
the Capital story, readers might enjoy imagining the consequences for
^Founder of Capital
in
1931.
Capital ther
among many
if,
had not expanded
met Jonathan
Bell
other coincidences,
cement business
his
Lovelace or
The Founding
ii
Coleman Morton's
fa-
Alabama where he
into
Coleman Morton had
not been sold
in-
surance by Jim Fullerton or Bob Egelston had not agreed to see Jim Fullerton or in
Bob Cody had
an aborted merger or
brary on Okinawa,
how
not gotten to
know Jonathan
Newton hadn't
Bill
well investment
in
through a
window
at
In his
the Post
in
Harvard or
Howard Schow had
Ned
li-
luncheon group or
if
Bill
if
not
had not de-
Bailey
cided to go to Virginia to follow Charlie Abbot or included Jon Lovelace
Lovelace
managers were paid or Bob
Kirby had not cracked his ribs racing cars or
looked
noticed,
Bell
Hurt had not
Bob Kirby and Dick
Barker had not been flying across the United States on the
same
plane or Nilly Sikorsky had not needed a part-time job while
grad-
In
uate school or Jim Rothenberg's classmate had not mentioned his
name, and so on, and on. Ancf what mined
who were
individuals
people had not pursued
to find strong
Madam
if
deter-
slight possibilities?
As
Curie so shrewdly and famously observed, "Chance favors
the prepared mind!" In
addition to organizing a core group of mutual fund Investment
managers, a
set of significant decisions
Jon Lovelace overcomes
are
made
In this
chapter:
and accepts
his thoughtful reluctance
the
leadership of Capital, where he then promulgates a three-way organizational mission of serving Investment clients, Capital Associates,
and
Capital's
leader that
owners— and begins a career as
will
Capital's servant
continue for four decades. Capital establishes
itself
as an important mutual fund manager, and the American Express
and Anchor Group funds are taken over on what prove vorable terms. The separately sales organization
Is
brought
owned and managed Into Capital.
So
Is
to
be very
mutual fund
a faltering East
Coast investment operation. Venture capital and international ing are initiated
— the
first
outside the organization,
deeply within It— even though international investing
had no
many
at Capital
real place In
fa-
and
invest-
the second
would hove thought
a West Coast mutual
12
CAPITAL
fund organization struggling financially
a depressed investment
in
market.
fw"
EVEN THE MOST thoughtful observer would not have imagined the future in store for the modest 34-year-old in the brov^n business suit, gazing out at the uninterrupted prairie of the Great Plains
from the w^indow of
his
room on
the Santa Fe Super Chief
It
W2is
1929, and he w^as on his w^ay to Los Angeles with his wife and 2-yearold son, where he the century,
would soon
would become the
ment management
firm that, by the end of
start a small
world's leading professional invest-
organization: the Capital
Group Companies.
Jonathan Bell Lovelace^ had a rendezvous with the emerging pro-
management. Raised
fession of investment
where
his family
architect in
Auburn
two
was
active in timber, Lovelace trained to
study
years'
University.
One
Alabama
at
year
football
team
and mathematics, and
as
manager
—and developed an enduring
Enlisting in the U.S.
Army
new
Lovelace encountered
for
for a
interest in
European duty
concepts and
he knew trigonometry, he went into the
new
renamed
special aptitude for
mathematics, he earned a master's degree while serving in architecture
become an
Polytechnic, later
showing a
later,
Alabama,
in southern
in
as instructor
championship
t^am
sports.
World War
I,
technologies. Because
artillery.
A whiz at
mental
arithmetic, Lovelace joined a group that pioneered antiaircraft artillery,
^
Known
by solving the problem of hitting fast-moving
as
JBL
to identify
Jonathan Bell Lovelace ciates as JL. (Initials
more people were
Jr.
him
and
separately
later
from
changed
were originally used on
targets.^
who was baptized name and is known by his assomemoranda to save space as more and
his
son Jon Lovelace,
to the shorter office
to receive copies.) Today, Capital Associates are routinely identified
by
their respective assigned initials.
'^Lovelace contributed to the writing of the Army's
coached Edward MacCrone,
who had
use of tangents, sines, and cosines.
Manual of Anti-Aircraft Artillery and
never gone to college, but was very bright, on the
— ^
The Founding
Lovelace provided the necessary calculations, and his was the
American
He
artillery unit in
mustered out
During
new
down
Edward MacCrone. With
including
plane.
to Europe.
interesting
their last
names
and MacCrone had ad-
camp^ and then on the troopship
joining bunks in officer training
them
German
met new people with
in alphabetical sequence, Lovelace
that took
a
Their friendship, which began with
this
same
alphabetical accident, flourished during their service in the
combat
first
as a captain.
his service, Lovelace
ideas,
coming
France to shoot
13
unit.
MacCrone had
Earlier,
split
of Merrill Lynch to form E.E. brokerage in Detroit
—then
today's Silicon Valley.
from a firm that was a predecessor
MacCrone
&
Co., a small stock-
the equivalent in industrial creativity to
He had
the support of important clients like
Walter Chrysler, W.C. Durant, and Stuart Mott of General Motors.
Eddie MacCrone urged
and exciting
field
of investments
MacCrone's proposition:
men
his thoughtful friend to get into the
to sell!" Lovelace
as his firm's research statistician.
"You'll pick the stocks for
had other
plans, so
MacCrone assured him that such a when Lovelace were ever interested.
our customers'
he demurred.
position'^
Jauntily,
would be open
Noting that only one major building was constructed state
and make
Jim and
Jay,
—
temporarily
bought
He and his
broth-
a date ranch near the
to the higher
many years, he
erly Hills
Fortress
basement
Monroe
demand and
town of
a salary of $
1
Indio.
But
had contributed
favorable price level of
kept a large chunk of wood from the fuselage of that plane in his Bevas a souvenir.
in Virginia
housed two training units before they shipped out
one from Chattanooga, Tennessee, and one from Battle Creek, Michigan.
At
in the
Great
the war's end also ended the sugar shortage that
^
and
his future elsewhere. After the
War, Lovelace ventured a brief stint in California:
^For
if
of Alabama during the year he graduated, Lovelace resolved to
leave architecture
ers,
new
50 per month.
to
Europe:
^
14
CAPITAL
dates.
With
peacetime and normal pricing, the Lovelace
a return to
brothers' venture in date grov^ing
soon faded.
In 1919, Lovelace decided to join Eddie MacCrone"^
and moved
East to Detroit. Lovelace quickly established himself as an "idea
man," organized
the early pioneers in securities research.
public companies disclosed very ience;
and was one of
a small but effective research unit,
Moody's and Standard
&
No GNP
data was available;
data and only at their conven-
little
Poor's did not yet publish;
Dow Jones Average included only 20
industrials until
and the
October 1928.
Finding the available data inadequate or out of date, Lovelace cham-
pioned independent
field research.
MacCrone had
Lovelace and
amount of time Lovelace devoted wanted
concentrate on
to
a series of disagreements over the to investment research.
underwriting
new
issues
MacCrone
—where
the
underwriting spread was a rich 15 to 20 percent and there were no bureaucratic delays
—
tion^^ if Lovelace
would concentrate on the firm's underwri tings.
They agreed on
compromise: Research would be done Lovelace's
a
way, and the firm's coverage.
so he offered to pay for a
new
issue underwritings
agreed to help
solicit
MacCrone
worked
well fpr the companies involved,
many years and
ran
The Desert Date Shop. 13, 1919. The firm was suspended
& Company was formed on February
New York Stock Exchange for one year on October 27,
1
926
of the exchange's constitution by paying two branch managers salaries
get full research
corporate finance business.
^Jay maintained the ranch for
from the
would
organiza-
As part of the arrangement, Lovelace, who enjoyed design-
ing financial structures that
'^E.E.
new research
—one
for violating a section
—
in addition
to
their
half of their offices' net profits without having obtained prior written ap-
proval from the
Committee on Quotations and Commissions.
Later,
on February 24, 1930,
the brokerage business and assets (including six offices around Michigan) were sold to Pierce
&
Company, which
later
known today as Merrill Lynch. 1934, when it was succeeded by
became E.E. B.E.
part of Merrill Lynch, Pierce, Fenner
EA
and Beane,
MacCrone & Company continued in business until Hopper & Company, with Edward E. MacCrone and
Bernard E. Hopper partners. '^Lovelace recruited Albert Hettinger and Donald Smith, from Harvard Business School;
Alexander Standish, from
Ragnar Naess, of the
AT&T; Ray Chambers, chief of statistics at the U.S. Treasury; and Federal Reserve. He also set up a group of economic consul-
New York
tants that included Professor Lionel
ing Fisher, from Yale;
Edmund
D. Edie, from the University of Chicago; Professor
Irv-
Ezra Day, from Michigan; and Joseph Davis, from Stanford.
The Founding
His
real
enthusiasm during
this
15
period was in developing the in-
vestment trust business for individual investors of moderate means. This almost became the very
first
mutual fund
United
in the
States.
Lovelace had studied the Scottish investment trusts, whose sole pur-
pose was to invest in other companies based on the concept that individual investors
spreading the
ment
would
risk,
fare far better
by combining
and retaining professional investment manage-
on margin through
retail
to organize a similar investment
com-
instead of buying individual stocks
stockbrokers. Lovelace
pany
for
American
their investments,
wanted
and MacCrone eventually agreed. But
investors,
believing that his firm deserved half the profits above a 6 percent re-
turn on investors' capital,
MacCrone designed
company with heavy leverage from debt and
preferred stock. For each
share of common stock bought by the public, E.E.
would
get a perpetual warrant to
new investment
the
MacCrone
& Co.
buy an equal number of shares. The
new investment company was named
the Investment
Company
of
America. underwriting the company,
Before
agreed to obtain at least
from
some kind of approval
a regulatory authority.
The
MacCrone their new idea
Lovelace and
logical choice
for
was
to get the blessing
of Michigan's Commissioner of Banking. But the commissioner was a
who
felt
competition for their
own
conservative regulator
much
ment company idea,
but
if this
money out of the so
I
will
is
as
good
savings banks
not authorize
it."
trust
as
you
Investors' Trust
—had won
it
hoped, to a
series
the invest-
a very interesting
and we're not going
it is, it
to have that here,
approval and
official
more months, to
will take
market
as a
so
re-
by the
Michigan
—Massachusetts
Boston group's entry
the race to
five trustees.
Company
a
is
fellows think
Company of America came
^^JBL was one of ICA's the Investment
this
Trying to get any
on March 27, 1926,^^
down
good, so he turned
solving various design issues took several
time Investment
banks already faced too
state's
"Gentlemen,
idea, saying:
thing
the
become
the United States'
first
Investment Research Corporation was organized by
of America trustees to provide investment research to
of regional investment companies.
ICA
and,
CAPITAL
l6
mutual fund. Following MIT's approval
in Massachusetts, the
bank-
ing commissioner in Michigan gave his approval to ICA.
The
momentum
stock market was gathering
in the
major
boom
of the 1920s, and Eddie MacCrone wanted to get extra gains from financial leverage
by adding debt
to the
new
fund's capitalization.
Lovelace didn't want to incur the risks of financial leverage, but he lost that battle, leaving the
when
crash
it
finally
new fund
extra vulnerable to the market
came.
MacCrone's firm did quite well
at
underwriting local industrial
companies and organizing and sponsoring a
series
of closed-end
in-
vestment companies— often concentrating investments in a specific
MacCrone
industry or one region of the country. In 1928, E.E.
Co. was prospering ipated a bright
as a stockbroker.
new
Most
&C
business executives antic-
era for the United States
—and
particularly for
the stock market.
He
In a strong stock market environment, Lovelace prospered.
enjoyed considerable success E.E.
MacCrone
&
as
an investor and became a partner in
Co. in 1924.^^
Still
in his early 30s,
he was
fi-
nancially independent.
While others might have been
carried
the great bull market, Lovelace thought
away by the euphoria of
differently.
Based on
his re-
search into market price versus true investment value, Lovelace was
becoming
enthusiasm
among
knew
—
as if
New York bank^^ was nearly equal to its
they didn't have any deposits or
that this high stock market valuation
In the
summer of
excess
one calculation, he found that the
investors. In
stock market value of a major total assets
what he considered
increasingly concerned about
liabilities!
Lovelace
was unsustainable.
1929, Lovelace became bearish on the stock
market and sold most of
his
own
'^Lovelace was listed as a partner in E.E.
stocks
MacCrone
and bonds
&
in August.
Company, along with
E.E.
He Mac-
Crone, C. Collins, and C. Timewell from 1924 to 1930. '^
First
National City Bank,
now
Citibank, a part of Citigroup. Asked,
Lovelace that Charlie Mitchell would
but that never happened.
make
MacCrone assured Motor Company,
millions underwriting Ford
The Founding
tried, unsuccessfully, to
Unable
conservative.^"^
persuade
MacCrone
become much more
to convince his friend, Lovelace
He withdrew from
pendent action.
to
took inde-
the stockbrokerage business and
MacCrone
negotiated the sale of his 10 percent interest in E.E.
Co. (Modestly, Lovelace would
vj
later confess
&
he had not liquidated
everything: Responding to his partner's request that he not visibly
withdraw completely, he
left
some of
his capital in the firm until
year-end.) Fortunately, while the market broke sharply in September,
had recovered somewhat by year-end when Lovelace with-
it
drew
his capital.
Then, over the next three
90 percent of their peak market
Having to
man
"retired" as a
move back
Lovelace
activities,
Angeles
—
Lovelace decided traveling to
Chief
established
Lovelace, Dennis
Jim Fullerton
recalls a
a reputation for
1929
at 34,
As usual when
^^
a
investment firm in Los
small
& Renfrew—the nucleus of what would
become Capital Group Companies. ^^ Lionel D. Edie and Albert
later
''*As
of wealth
1931, to develop the information needed for his various
In
had
value.
to distant Los Angeles.
California, he took the Super
years, stocks lost nearly
conversation in the early 1960s, he asked, "Jon, you've always
being a great market timer.
just before the crash,
what were the
When you
signals that
— not then and not now. What
not a market timer
got
me
simply kindergarten financial research. At that time, the favor in the market. Everyone
looking times
at
its
me
to
more than
so
much
its
that
I
share.
I
deposits.
didn't
own
1
I
was
929 was
center banks were in great
number of shares those deposits:
it
had outstanding
selling in the
mar-
They owed them. That
did the same simple arithmetic with a lot of other companies.
found that people were climbing
all
me
I
over each other to buy 100 shares or 10,000 shares of
those 'hot' stocks. But no one in his right
high price. That's what got
more per
money
found that each of those banks was
They
replied, "Jim,
out of the market in
My kindergarten research consisted of
own them.
each of those banks and multiplying the
market price per
ketplace for
scared
wanted
got out of the stock market in
you saw?" JBL
mind would buy
out of the market.
It
the whole
company
was a very simple
share for a company's stock than you'd be willing to pay
if
lesson.
at
such a
Don't pay
you were buying the
whole company." ^^Characteristically, Lovelace
demonstrated
his
long-term value orientation to investing in
when he built a handsome home in Beverly Hills, employing highly skilled craftspeople who badly needed work and produced superb workmanship. He also showed his sense of humor by referring to the vacant lot he owned next door as "the tennis court." *^ Capital Research and Management Company. 1930
to 1931,
i8
C A
P
Hettinger
TA
I
L
—both had been with him
ports for Lovelace's
new
in Detroit
—
^wrote research re-
firm.^^ Lovelace's business included acting as
financial advisor ^^ to California companies; serving as an expert wit-
on the
ness in utility rate cases; advising
issues that
companies faced
coming out of Depression-induced bankruptcy; and evaluating
pri-
vate holding companies as well as large blocks of stock in family-
controlled businesses going through probate.
new
In 1931, Lovelace's as the
firm succeeded E.E.
MacCrone
& Co.
investment advisor to two closed-end funds originally spon-
sored by MacCrone: American Capital Corporation and Pacific-
Southern Investing Corporation.^^ Lovelace was elected president of
Company
Investment
With
trouble. ^^
^''
&
the leverage Eddie
formed one of the
Later, Edie
Co.
all
of America in 1932, when
—which
ultimately also
Freres after retiring in his 60s
—
was
MacCrone had
nation's largest investment counsel firms
became part of
from
—
in serious
insisted
on
Lionel D. Edie
Merrill Lynch. Hettinger joined Lazard
a distinguished
made
School. Then, over 30 years, he million
it
academic career
a personal fortune
—estimated
at
Harvard Business
more than $100
at
investing in "adventurous novelties" such as Japanese insurance stocks at three
and
four times earnings long before other investors would even consider Japan. '^Clients included the Gross brothers, for
control of Lockheed Aircraft; Pacific
whom
Mutual
Life;
Lovelace helped raise the capital to buy
Capitol Records, where he was a found-
ing director; Muzak, where he was one of the original investors; and Walt Disney, where he served as the
first
outside director.
He worked
particularly closely with
was struggling with the financing of movies and banker, A.
P.
Roy
Disney,
who
Lovelace introduced to a rising
Gianinni of Bank of America. Lovelace also helped finance the noted cartoon
movie Fantasia.
on financial
whom
If
he couldn't work on architectural structures, joked Lovelace, he'd work
structures.
Out of
the Disney connection
came
the Lovelace family's long-
term involvement with Cal Arts (the California Institute of the Arts), the avant-garde school that aimed to do for the arts what
MIT and CalTech were doing for engineering.
such public service organizations
Huntington Library
in
—
on investment committees Southwest Museum, and the Today, more Capital Associates serve on pro
'^Lovelace also set an enduring example of serving
often
as Children's Hospital, the
Southern California.
bono boards in California than any other company. ^^
Lovelace had been one of the five trustees of Investment
was organized
in Detroit as a closed-end
investment
Company
company
of America when
it
or mutual fiand in 1926.
Lovelace was also president of American Capital Corporation, which purchased from E.E.
MacCrone
its
controlling interest in Southern
was the location for Investment shareholders.
Company
Bond
& Share. Into the early 1960s, Detroit
of America's lawyers and annual meetings of
adding to
capital structure, the trust lost over
its
value during the stock market collapse.
term debt and $4 million of equity,
The Founding
19
70 percent of
its
With $3
ICA had
million in long-
a coverage ratio of only
133 percent: At 125 percent, the bondholders would automatically take over. So to prevent falling below the trigger point, the assets of
ICA were
all
invested in government bonds. In 1933, a deputation
of the distinguished executives on ICA's Advisory Board^^
had
lost all
—who
confidence in MacCrone, but trusted Lovelaces invest-
—
ment judgment
him to take ment trust.
traveled
from Michigan
to California to persuade
management of what remained of this
over the
invest-
com-
Recapitalized as a publicly owned, closed-end investment
Company of America had assets of less than $5 ICA retired its debt, and in 1939, it converted to
pany, the Investment million. ^^
In 1936,
open-end
status to get
away from the problems of selling
ket at a 25 to 30 percent discount
Over the next 10
from net
Investment
years.
asset value.
Company
in the
mar-
^^
of Americas in-
vestment record was exceptionally favorable for three reasons: the
^^
Members included
the President of Burroughs
Adding Machine;
the president of Parke-
Davis pharmaceuticals; Roy Chapin, the chairman of Hudson Motors; Stuart Mott; Edgar A. Pierce of EA Pierce
but no power ^^
—
until
& Company;
ICA
and
several others.
The Advisory Board had
prestige,
got into trouble.
& Share and Pacific Investing Corporation were merged to form Pacific
Southern Bond
Southern Investors, which, in turn, acquired a 40 percent interest in Investment
Company
of America, a Delaware corporation. Reorganizing the highly leveraged complex that Mac-
Crone had structured involved complex negotiations and exchanges. One
result
was a per-
petual warrant that, Lovelace stated, "caused perpetual problems." Assets fluctuated in a
modest range
for
many
years.
million in 1948. Lovelace in 1969. ica
is
As one of Americas
the only fund
in that
group ever
would have grown
on the
since.
ICA grew
would
best performing
list
With
all
Index, or just $135,000 in a is
in
but then
mutual funds, Investment
fell
under $18
nation's 10 largest
Company of Amer-
by the end of the century
bank savings account). With
assets over
ICA
in
1934
million for the
(vs. $6.()
$50
billion, the
the third largest of all equity mutual funds in the United States.
Pacific Investing, another closed-end
ICA and
in 1945;
fund become one of the
dividends reinvested, $10,000 invested in
to be $15.2 million
fund ^^
$22 million
of the largest funds in 1969 that has remained continuously
S&P
now
to
live to see the
investment company, had an $800,000 investment
the market discount threatened to trigger
Investing and
its
large percentage
ownership in ICA.
its
bondholders taking over Pacific
C A
20
P
I
T A
fund's leverage
I.
working favorably; the advantages of maneuverability
given the fund's small
and
size;
Lovelace's skill at capitalizing
on the
investment opportunities he found in the stock market. As the
Dow
Jones Average gained 7 percent annually over the decade, Investment
Company Over
of America did twice
20 years
its first
distant perspective
—
—
14 percent annual gains.
as well:
a very long period, even from today's
Capital was, on average, only a break-even op-
eration.^^ Today, senior executives look at the daily
back and shake
minutes cost an
initial
in carefully
$3
—
which the
communication
relied
on mail
ted out with used furniture.
the
main
Poor s loose-leaf
office in
three
planned sequence, with each person waiting
service: After
easily beat long-distance toll charges. ^^
&
first
or about $25 in current dollars) were
Most
turn to conduct his part of the pending business.
Standard
their heads
economies that were considered necessary. To control
expenses, office-to-office telephone calls (for
made
^"^
all,
tear sheets
Los Angeles
set
was 3 hours ahead of Los Angeles,
three-cent stamps fit-
received the leftover
on public companies from
—but only
been replaced each year by a new
interoffice
The New York office was
And New York
in
of tear
after those reports
sheets. If
staffers joked,
it
had
New York City was
also a full
year behind. In addition to his cost-conscious
manner and commitment
to
fundamental research, Lovelace believed in working with people he really liked,
investing
who
and
shared a disciplined
commitment
to rationality in
to integrity in serving investors. Reserved in
demeanor,
^"^The perpetual warrants continued to be a marketing nuisance, because competitors
would ask
darkly,
"Do you
really
want
your customers a mutual fund with
to sell
overhanging dilution?" (In the year 2000, clever brokers were their advertisements suggesting investors look ^^
Investment
still
through their old papers for
results suffered in the late 1930s,
perhaps because
all
that
gathering responses to
JBL was
ICA
warrants.)
so deeply involved
Company Act of 1940 that would govern the mutual Company of America was converted into an "openend" investment company or mutual fund and Investment Company Distributors began offering the shares of both Investment Company of America and Pacific Southern Investors. in the
development of the Investment
fund industry. In 1939, Investment
^^
When
came
in
Capital
on
moved from Spring
a Saturday to
Street to the Statler office building, the research analysts
unpack boxes
—and
to
keep reference books
in the right order.
The Founding
Lovelace was an unusually good and attentive listener
—and
effective
group thought-leader. Analysts found the insights from
as a
industries.
Quiet during the investment meetings he
chaired, Lovelace took extensive notes
summarize what had been agreed.
his in-
own judgments on
vestment meetings helpful in developing their
companies and
21
said
on
pad and would then
a legal
and what he understood had been
^^
Never outwardly warm or gregarious, Lovelace was certainly not effusive
with
praise,
but he was also slow to
organization during his tenure
and ample time ments of
to
felt
criticize.
had a
that they
their capabilities. "I don't
well aware of what
lot
of elbowroom
perform before he would make any
judg-
final
know how he accomplished
Coleman Morton, "but you always had
says
Everyone in the
it,"
the feeling that he was
you were doing and how you were doing without
any feeling that he was peeking over your shoulder." Lovelace understood that mistakes, even big ones, are an inherent part of invest-
ment management and
company
is
that the
in a long-term
way
to judge
an individual or a
framework.
Lovelace established an attitude toward individuals and organizations (see Chapter
1
3) that
still
pervades Capital and provides the
essential basis for the organization's success in
and engaging outstanding people of many love
was to serve
says
Howard Schow
an accouche'
them
—
different ages. "His
an investment banker to
Chapter
(see
a midwife to ideas
2).
real
first
met,"
had accomplished
entrepreneurs,"
"He was what
the French call
and the ventures that could bring
he listened to
recalls Nilly
a great deal;
me
Sikorsky (see Chapter
knew many
8), "I
substantial people;
was only 19 years
tleman. If it weren't for
luncheon
with great care and respect, clearly listening to
my deep
respect for JBL,
at the old California
have the
JBL
learn.
He had
JBL was
an ex-
a real gen-
could never have accepted his invitation didn't
admit
women
or Jews
—and
I
was
—
him to invite Chuck Schimpfif and his wife too so fun of being with another woman. But, of course, Mrs. Schimpff and I were
both. JBL's consideration of others led I'd
I
Club when they
old.
and was widely admired.
traordinary ability always to respect others and never to seem superior.
to
main
to life."
^"^"When we
Still,
as
managing succession
nearly 50 years apart in age!"
CAPITAL
22
Lovelace enjoyed serving on corporate boards with people
had Midwestern
social
and moral
He
values.
who
cared greatly about
thoughtful business strategies and conservative financial strategies
and distrusted investment bankers with ners. (After hearing a
they
made
few
and man-
New York investment bankers describe how
deals, Lovelace
what /ever
breezy, big-city talk
murmured with
quiet disdain: "That's not
did!")
To determine
the long-term worth of a company,
JBL
relied
on
thorough, original research into investment values that others might
have overlooked
Combining
—followed by purchases
careful research with a long-term
Capital's portfolio turnover
"Looking
Bob
Kirby.
"The only
at reasonable
at a
was and
still is
below industry norms.
far
recalls
invest in guys he really believed in."
difference between Chrysler Corporation
JBL
prices.
view on valuation,
company's numbers was never enough,"
"JBL would only
predecessor,"^^
market
and
its
failed
often said, "was Walter Chrysler."
Lovelace had a
strict
sense of morality
and was
all
probity.
Clearly unusual in Los Angeles, he wore dark three-piece business suits
with a gold watch chain across his vest and a hat that he tipped
to the ladies. Lovelace
seldom took off his
the Spring Street office, which had
suit jacket or vest,
even in
no air-conditioning. He spoke
almost quietly, with a Southern tone of voice. Only 5
softly,
inches
tall,
his
slim build
matched
feet
7
calm, gentle demeanor.
his
Lovelace was exceptionally modest about his considerable contributions ful
and achievements, but he
attracted
many
capable and power-
people because he had remarkable insight and was comfortable
around smart people with ambitious
ideas. ^^
profile and unassuming, and a genuine
Lovelace was both low
risk taker
who
allowed and
encouraged young people with ideas to run with them.
^^
Maxwell Motor Company
^''In
1955, he supported
failed
and was absorbed by Chrysler.
Coleman Morton's
initiative to
ternational investing: International Resources Fund.
launch an early venture into
in-
The Fou?iding
Believing in independent thinking, Lovelace
combined
his
contrarian view with genuine politeness, often explaining,
portant to be accommodating. ^Tien everyone wants to
commodate them and
WTien everyone wants
buy.
accommodate them and
sell.
Dont
own
"It's
you
sell,
buy,
to
23
imac-
you
Don't
try to get the last 5 percent.
be greedy."
A
made
conversation with Lovelace nearly a generation ago
lasting impression
on one of Capital's current
leaders
—
a
partly in the
thoughtful rigor on the substance of the discussion; partly in the collegial sr\4e or
tone of the discussion. Lovelace, in his early 70s,
made an appointment As
usual, Lovelace
wore
Deferentially, he called
"What
for
luncheon wdth David
a three-piece,
David "Mr.
attracted you,
Mr.
Fisher,
dark brown
who was
suit
and
28.
a hat.
Fisher."
Fisher, to this r\^pe
of work?" inquired
Lovelace after they were seated at their table. Fisher ventured to explain his appreciation for the mar\'elous operating leverage
accelerating profitabilir\^ that could
ment organization with market rose and new
come
to a
well-managed
relatively fixed costs if
assets
came pouring
and the invest-
and when the stock
in.
Explaining that he doubted there was any age over the long term in the investment
real
operating lever-
management
business,
Lovelace expressed concern that any apparent leverage was more likely
an indicator that not enough was being reinvested
in skilled
people, systems, and customer service to enable the organization to
do
its
work well
ter 9, "If the
in the ftiture. (As
investment
Jim Rothenberg explains
assets supervised
by Capital
in
Chap-
are adjusted or
deflated to eliminate the impact of market appreciation, the underlying growth is
also
is
about 7 percent. The increase in investment people
about 7 percent. So, just
age in the business.'
as
JBL
said, 'There's
no major
lever-
")
"Jonathan Bell Lovelace's concern about investing enough in the ftiture
continues to be a hallmark of the organization today," ex-
plains Fisher.
"JBL always took
a ver}"
long-term view and wanted to
CAPITAL
24
be sure Capital would do better and better better
and
continue doing
better long after him."
With design innovations making seminal
contributions, the
lit-
company that Lovelace started in an unlikely part of country would grow in assets managed from $5 million in 1933,
investment
tle
the to
—and
$300 million
well over
$500
in
1958
billion
to over $1.1 billion
by 1967
by the turn of the century.
organization grew comparably in
staff:
—and then
And
to
the Capital
fewer than 20 in 1933; 30 in
1953; and 120 in 1967. Capital Group Companies
now employs
over 6,000 people.
Not only the world,
Capital one of the largest investment managers in
is
it is
also recognized as
sustained success for
its
three
one of the very best
main constituencies
—
at
achieving
consistently su-
perior investment results for investors; attractive long-term returns for owners;
and
fulfilling career
important to those
who
opportunities for Associates. Also,
devote their careers to Capital
dimension. As Bob Kirby
says, "Capital
is
a
is
a spiritual
company with
a soul."
CHAPTER
2
STAYING ALIVE
NOTES FOR READERS Although seldom recognized at the time, the long-term destinies of
most investment management organizations are disproportionately
determined by compromising decisions years of the organization's history. sions are
made
made
Many
during the very early
of these determining deci-
almost casually.
Examples abound of investment organizations around the past performance record — and ing investment
managers who have
often feels
in
the organization's
about "my
ation will
name and
firm." But in a
in
firm.
organized
— of
the lead-
and entrepre-
The founder's name
is
way the founder talks and who was present at the cre-
the
few years,
seem almost accidental.
Capital's early years
were
different.
As founder, Jonathan
Lovelace
was remarkably sanguine about
the losses
— for
20
long years
developing a superior
any
self-interests
the self-confidence
new
neurial determination to launch a
that are
of the
— because
firm. This
ownership decisions
personally absorbing
his
long-term focus
enabled Capital that so often
to
all
was on
avoid making
boomerang
Equally important and equally unusual, Lovelace
25
Bell
was
later on.
interested
in
26
A IM T A L
c:
sharing ownership as soon as
it
was worth having — and
arrange financing so Associates could invest Capital
was a very
small firm
in
Capitol.
in
a small business
28 employees and managed only $36
only
company
Time
is
Of
1950.
for
It
hod
any eco-
such a margin-
as Capitol then was.
often the most precious resource in organizational devel-
opment, especially at the supply.
in
million. Virtually
nomic or market setback could hove been too much ally profitable
willing to
start-up stage
made
the contributions
all
when
to
it
is
in
Capitol by
such very short its
founder, the
most precious and productive over the long term must have been the
freedom of time
develop as an organization.
to
# LiNDLEY Morton ran assistant
and
in sales for a
a Naval aviator during his 20s,
learned
it
at 13,
worked
as a lab
cement company, and then served
World War
I.
After the war, Morton,
found an abandoned cement plant
He
vania.
away from home
was owned
still
as
in
in Phoenixville, Pennsyl-
in foreclosure
by the
local bank,
arranged to meet the bank's president, and boldly offered to buy the
cement
plant.
"What do you offer?" "What are you looking
"My bank lent lowest
I'll
the prior owners one million dollars, so that's the
go."
"Okay! But
come
for?"
I
can only pay one dollar
down
—with
the rest to
over the next ten years."
"Sold!"
In time,
Morton expanded
abama, where he met Jonathan
him
to join the Investment
tors.
In 1928,
Morton
spectacular prices at
the business, particularly in Al-
Bell Lovelace. Later, Lovelace asked
Company
sold his
of Americas board of direc-
cement company.
He had
which other company owners were
seen the
selling out.
Staying Alive
27
He
got
and he knew competition was getting tougher and tougher. a
good
price,
but soon had a problem.
Morton put one
third of the proceeds into
what looked
like
an
—
new way to invest one of Wall Street's newly organized investment trusts. With apparently great early success, these trusts exciting
would pyramid control of operating companies through layer
of holding companies and holding companies ^/holding com-
panies, fueling expectations of financial leverage
was
on
layer
From
profits.
But
works both ways and Morton's main investment
in the ill-fated
very badly.
making highly leveraged
Goldman
its
Sachs Trading Company, which failed
Goldman
high, the price of shares for
Sachs
Trading plunged a ghastly 98 percent.
But even
Morton was
of one third of his fortune, Lindley
after the total loss still
a rich
When his son, Coleman Morton,
man.
was
a senior at Yale,^ he chose as the topic for his senior thesis in
economics, a study of bank service charges.^ While visiting Cali-
Morton was invited friend from Alabama
fornia to complete his research,
of
in the office
his father's
hang
to
his hat
—^Jonathan
Bell
Lovelace. After graduating from Yale and serving in
joined Capital as a junior analyst in 1945. his father
and brothers
World War
II,
Morton
A year later, he left to join
in the oil fields, prospecting hopefully for the
Big Find. After searching for a few years without making any great discoveries, the senior
you boys how
trying to teach
you
^
I
likes to tell the story
great grandfather
will devote
to
how
haven't even learned
Coleman Morton
"My
Morton
my life
was
to the
pretty
win
work of the
at the
$100
bets.
So you're
of how he chose to go to Hotchkiss and then to
by Indians.
Lord.'
He
Over
He
prayed to God,
'If
I
brothers and
I
went
Yale:
did escape, of course, and took up his
reli-
Hotchkiss School, Mrs. Hotchkiss
at the
to Hotchkiss
all
ever escape,
local to represent scholarship boys; she chose great grandfather.
much why my
been
window, but
bettor's
win $2 show
to
partially scalped
gious duties in Salisbury, Connecticut.
wanted someone
called his sons together: "I've
—and then on
^For data, he turned to Joe Rosenberg, a family friend
at
to Yale."
Bank of America.
And
that's
CAPITAL
28
Coleman Morton returned
firedr^
and did
The ownership
well.
today be appreciated percent
A
as
tall,
who was
He
to increase that to
stylish,
to Phi Beta
Kappa
would
once owned 10
25 percent.
handsome, and engaging man, Morton
conservative dress and
worked hard,
position he developed at Capital
remarkably favorable:
—with an option
and was elected
gifted
to Capital in 1949,
intellectually
is
at Yale. In contrast to the
demeanor of most Capital people, Morton
—wore
confident, and outgoing
Savile
Row
suits
with colorfully different mouchoirs tucked into his breast pocket each day.
He
traveled widely
and
in style,
belonged to the right clubs
home and abroad, and radiated an air of great self-confidence. He lookedX'ks: a CEO.^ With a charismatic personality and a clear, strong
at
Morton was an
voice,
portfolio
manager
among
and
original ideas,
on Wall
Morton was
finding, motivating,
ital
—
^just as
dominant
mutual funds
firm's
rec-
—and by
management depended
and backing exceptional people, Jonathan
and again
Bell Lovelace again
the
at
Morton, however, was not alone.
Street.
Believing strongly that the success of any
on
group
managers and was widely
Capital's portfolio
ognized by the broker-dealers selling the the leaders
a highly visible
in the otherwise low-key, conservative
Capital. Full of bold
personality
and
effective public speaker
attracted unusually able people to
he had attracted unusual
talents to E.E.
Cap-
MacCrone
&
Co. in Detroit. Harleston
As both
J.
"Hardy" Hall joined Capital
a portfolio
manager and an
tributor, particularly in the years in
New
York
companies
all
Street.
In future years, Lindley
Morton
to ask them: "Well, fellows,
that's
important^
fact,
over the years,
serve as their head.
ran a solo research outpost
conducting
his
own
research
primary
on
liai-
As an engineer from Georgia Tech, Hall was
week ^\n
was a major con-
over the East Coast, he served as Capital's
son with Wall
^
an analyst in 1936.
analyst. Hall
when he
City. In addition to
as
many of
liked to have breakfast with his
two sons once each
what have you accomplished during the
his "outside activities"
past
week
sought out Coleman Morton to
Staying Alive
certain that the stock
lar
know
market must have an underlying mechanism
somehow be
understood.
The
the underlying
momentum
of earnings, so he paid particu-
that could to
29
attention to any
company
that
had
a
key,
he thought, would be
down
quarter in earnings,
seeking always to understand exactly why.
Chuck Schimpff came Bradstreet in Chicago
and did most of the work required
American Mutual Fund
—
Dun
to Capital after several years at
Capital's^
second mutual fund
Famously honest, Schimpff meticulously
tallied
up the
to
—
&
launch
in 1950.
sales tax
he
paid each day. Proud of the corporate perquisites he had earned, he
men
expected younger
the status of having his
to address
own
him
reserved parking space.
tioning into retirement, he did not
manager began parking manager continued action:
come
Jules
in every day, so the building
to take
Schimpff 's space, so Schimpff took direct of heavy-gauge it
steel chain, tied
the of-
leaving a note stating that he
in his office.
Hoffman,^ based
in Detroit,""
was an expert on
corporations, particularly the auto companies, sales
transi-
Schimpff s space. Despite a warning, the
fending car to a post, and padlocked
—
As he was
in
He bought a long piece
had the key
"Mr. Schimpff" and enjoyed
as
volume drove demand
parts suppliers. Hoffman's
for rubber, steel,
custom was
and
industrial
whose increasing all
the
many
to visit three or four
panies each day and write six-page reports
auto
com-
on each of those com-
panies that same night. Using a time-saving standardized format, he
could complete and mail several reports back to the office the next day.
Always comfortable with blue-collar workers, Hoffman advised,
^The
full
name
in this era
After working at the
came
CFO
He was
was Capital Research and Management Company.
MacCrone
so successful in
company decided
working out the company's financial problems that the head of the
his son-in-law
what was expected
to be a
could take over. So in 1953, Hoffman rejoined Capital on
temporary
^In 1942, with a war on and assets troit office
Hoffman had a successful business career and becompany in Detroit that had worldwide operations.
firm,
of a major construction
basis.
down from $23
was closed and then reopened
million in 1936 to
after the war.
$12
million, the
De-
C A
30
P
I
TA
"You can learn
L
a very great deal
of information
if
you're always nice
little
business: only 16
to people."^
was a small firm with
In 1948, Capital
employees and one mutual fund with $17.5 million Pacific
American, a closed-end fund
Jonathan
Bell Lovelace nicely
Mutual
ing any leaks that
fiind.
momentum.
little
demonstrated
financial structures with the early
offering of American
—and
in assets plus
his skill in designing
1950 creation of an Then, with
would have ruined the
deal,
initial
public
tight security prevent-
American Mutual was
merged with Security Company."^ This closed-end investment company was
selling at a substantial discount to net asset value, so
its
come into American Mutual at full The combination advanced American Mutual's $10 million and the management fees on this new fijnd
shareholders were delighted to
net asset value.
—
assets to
put Capital,
for the first time, safely in the black.
It
also gave Capital
a second
mutual fund that brokers (who worried about ICAs potential
dilution
when warrants were
have
third
its
Chapter
mutual fund
exercised) could
in
sell.
Washington Mutual Investors Fund
business in mutual fund first
What Jonathan
He
later
boom
became recognized
Company was
which
is
Market averages
why
25
years.
would
last,
associates.
must have appeared
to be the easi-
also
all easy.
used frequently
as
Jon
con-
investing.
the securities
common
affiliate,
organized by Security Bank during the
practice then,
affiliate's
portfolio.
any unsold shares
Not
left
over from under-
surprisingly, investment results
were
the shares sold at a major discount from net asset value.
rose nearly 50 percent
September 1954, the averages full
good new
the most important recruiting
and Albert "Doc" Hettinger were
writings were placed in the
^^
as
key
recruited his son. This task, however, wasn't at
of the 1920s. As was
miserable,
that Capital's profitability
Bell Lovelace ever did
on the economy and
^Security
last,
Capital was strongly in the black for
selling shares in Capital to other
^Professors Lionel D. Edie sultants
sales.
Now, confident
time.
JBL began
est:
(see
5).
In 1954, with a strong stock market^^ and, at
the
would soon
Capital
from September 1953
finally regained their prior
peak
to
in
September 1954, and
September 1929
—
in
after a
Staying Alive
31
Lovelace was very reluctant to join his fathers firm after graduating
from Princeton^
in 1950.
where he
institutions,
ogy.
^
first
He had majored became
in considerable affluence as the son of a
prominent man, Jon Lovelace wanted
to
concerned about being subordinated to
made
ply because his father
Pacific
summer later,
succeeding sim-
young Lovelace
jobs in Personnel Administration at Lockheed
he realized he wasn't interested in a long-term ca-
recognized an opportunity and called to suggest com-
ing to Capital, "This business
good
You're
alternatives,
at dealing
why
not try
it? I
to
think you'll like
me,
know something about
to
about people and numbers.
all
is
with both. While you're thinking about your
something ever happens
it
would be
it.
And
if you don't, if
useful to our family for
the company." In October 1951, Jon
Lovelace joined Capital as a statistician in Los Angeles.
He
doubts.
first six
After taking a course in
months went
summer
Still,
he had
two checkpoints: 6 months and
resolved to reconsider at
24 months. The
' ^
started his
with Pacific Finance and should look for alternatives. Hearing
this, his father
you
own way and was
his
his father or
easy. So,
it
make
^^ Finance and on graduation, joined Pacific Finance.
But, one year reer
for each other, they
an easy personal relationship.
Having grown up
career with
social
interested in industrial psychol-
Although father and son had great respect
didn't always have
and
economics and
in
well,
but even
at
1
8 months.
school so he could graduate early from Beverly Hills
High School, Lovelace took a year at the Hotchkiss School. In 1944, wanting to get into service, he took and passed the qualifying test to get into the V-12 OCS program, but illness prevented his going in, so after graduation, he enlisted as a radar technician. Identified as a
man who had
scarlet fever
passed V-12, he took the
and missed
his
V-12 unit
test again,
again. V-J
passed
Day came
—but came down with
in the
middle of his training
and, after 18 months of service, he was home. During training, Lovelace lived for a
few weeks
in the
Honeymoon
Suite at the Del
Monte Hotel
—
in
bunks with seven other
seamen.
^^The Gross brothers of Lockheed developed
Pacific
Finance in response to JBL's admoni-
tion that they couldn't expect to continue selling lots of airplanes after
and would need
became
a
to be in businesses that
would prosper
World War
in peacetime. Pacific
II
ended
Finance
major West Coast consumer finance company and was subsequently acquired by
TransAmerica.
CAPITAL
32
much
he did not expect to stay
longer.
Then
a
change
in his father's
health changed everything (see Chapter 4).
The in 1953.
and
mother of invention came suddenly
traditional
Jonathan
nately, Lovelace
died at age 84.) diate; the
He was
Bell Lovelace suffered a heart attack.
his doctors insisted
would
he not work for live
58
at least a full year.^^ (Fortu-
another 26 years
The impact on
to Capital
—
when he was imme-
until 1979,
organizational leadership
impact on the investment process came a few years
later.
Leadership at Capital had been concentrated in JBL, so his
withdrawal from the firm was a sudden and dramatic change. Now, everyone would have to pitch in and share management responsibili-
Hardy
ties.
Hall,
Coleman Morton, and Chuck Schimpff would
serve as a triumvirate in leadership, with Hall serving as president.
(Jon Lovelace was not yet part of the inner attack," recalls
on
just one
Bob Cody, "we
manager
in
any
tually fortunate because
it
realized
circle.) "After JBL's
we should
never be dependent
area. In this sense, the heart attack
taught us
JBL's serious heart attack
all
heart
was
ac-
a very important lesson."
was not the only confrontation with
death in the Lovelace family. JL and his wife
second child
Lillian's
died as an infant in 1954. Their grief was profound. Agreeing that a
change in scenery might help them deal with their
^^
loss,
they
moved
While outwardly formal, JBL was widely recognized as having an engaging and original "Work was one of JBL's greatest pleasures," recalls Jim FuUerton. "So
sense of good humor. after his heart attack
and retirement,
I
kidded him that
his definition
of retirement was
simply no longer working every Saturday and Sunday!" Fullerton was visiting with JBL his office
one afternoon and was
Lord, Jon,
is it
keep the clock say,
'Oh!
It's
startled
when he happened
already twenty past four?" "No," set that
way
so if I'm feeling a
four o'clock already.
Time
to be
came
in
"Good
the laconic reply with a chuckle, "I
little tired, I
going
to look at the clock.
home
can just glance
at the clock
and
soon!'
humor is further illustrated by another Fullerton recollection: "He came we were in New York Civy one day with good news: ']\vn, I have two tickets for tonight's World Series game. Would you like to go?' I explained, 'I have a longstanding business commitment with a major distributor, and I just can't join you.' JBL drew himself up Lovelace's dry
to
me
and
while
replied:
'That answer, Jim, causes
me
to question
your business judgment!'
Staying Alive
to
New York City in
their daughter. Lovelace
The New York
with Hardy Hall. center,
1955 with
office
would work
would become
with young analysts rotated in so they could
33
call
a training
on Eastern
companies and learn firsthand the strengths and weaknesses of Wall Street's firms
—and develop
the requisite skepticism before rotating
back to Los Angeles. (Having serious responsibilities in
away from headquarters would become
well
experience for
young people
When Jon
field offices
a characteristic learning
in the Capital organization.)
New
Lovelace returned to Los Angeles after a year in
Howard Schow succeeded him in New York. Schow grew up on Long Island, became an Eagle Scout, and served in the U.S. Navy during World War 11. Mustering out in 1946, he attended
York,
Williams College and the Harvard Business School, determined to learn
all
he could for his intended career in investments. During his
second year of business school, Schow was in a serious automobile accident and received a settlement of $6,000
$4,000 on a $10,000 award
—
—which gave him
after lawyers' fees
the stake with
of
which
to begin investing.
At Harvard, Schow took
a course in finance
where he heard Dr. Albert Hettinger pressed by the lecture,
and investment, ^^
deliver a guest lecture.
Schow later saw Hettinger
at the dean's
reading annual reports, and asked his view of Capital.
came the
laconic reply
been employed
as
—without any mention
"Good
years before in Detroit
After writing to
and was currently consulting
numerous investment firms
house firm"
that Hettinger
Jonathan Bell Lovelace's director of research
Im-
had
many
to Capital.
across the country
Schow got an invitation to interview with Capital Research and Management Company, a firm he'd just heard of. Learning that Capital was located in Los Angeles, which Schow disdainfully thought of as "only Hollywood and movies, not
with
^"^
little result,
With
Professor Charles Abbott
34
CAPITAL
investing"
—but having no
get into investments,
Lovelace in
New
other offers, yet being determined to
Schow
He
York.
interviewed w^ith
received
Hardy Hall and Jon
and accepted an
offer to join
Capital in early 1956.^^
managing four investment com-
In the mid-1950s. Capital was panies^^ Pacific
—
three
open-end mutual funds, and one closed-end fund:
American. ^^ At Schow's
main speaker was
group meeting
first
surprisingly familiar:
at Capital, the
"Doc" Hettinger.
^^
Capital's regular recruiting at business schools
^'^
Hardy Hall managed Investment Company of America; JBL managed American Mutual
began a year
later, in
1957.
Chuck SchimpfF, who was not really an investor, but enjoyed being "inColeman Morton managed Pacific American; and JL managed Washington
(together with volved");
Mutual, which was quite small in
assets
merged
1956.
into
American Mutual
'^Open-end mutual funds
in
offer to
buy or
fund twice each day and so are "open" regular basis. Closed-end funds regular companies,
is
and had
to
sell
funds inflow. Pacific American was
shares at the net asset value per share of the
new
do not buy or
little
investors or to
sell
their
own
determined by supply and demand.
redeem current shares on
shares.
Their
price, like that
a
of
CHAPTER
3
THE MULTIPLE
COUNSELOR SYSTEM
NOTES FOR READERS Transformational innovations— even those that appear obvious several years later— seldom arrive like lightning bolts
spring like Athena,
fully
and even
less often
developed, from a person's head. Instead,
they are the product of a vague, uncomfortable awareness of the
a better way;
need
for
sired
concept or solution; a sense of the general direction
intuition
about the general outline of the de-
move; and great personal persistence ment. There
is
also that
No wonder
system
to
and develop-
luck,
which
is
so
transformational innova-
organizational design, are so rare.
Capital's great transformational
counselor
exploration
magic ingredient of good
often crucial to great successes. tions, particularly in
in
which
in
of
portfolio
innovation
management.
was
the multiple-
Like
many
innovations— particularly transformational organizational
great innova-
tions—Capital's multiple-counselor system of investment manage-
ment did not arrive
fully
developed.
35
It
began as a
tentative.
CAPITAL
36
way
pragmatic
specific prior experiences strongly influenced
persisted
and
of dealing with a specific set of circumstances,
— tfirough
and
several years of cost
evidence of progress — to work out the
it.
effort
many
Capital's leaders
and without much
details of the multiple-
counselor system.
As an organizational concept,
the multiple-counselor system en-
ables Capital to deal constructively with the major problem that
and
confronts,
often confounds, most investment
management
or-
ganizations: Investment success leads to asset growth that eventu-
overloads the organization's capacity
ally
produce superior
to
investment results J
Great success assets that
when
it
investments can cause such rapid growth
in
quickly overwhelms a manager's capacity. Ironically,
professional success produces a business success, professional
disappointment or even
management,
it
happens
the
all
the leaders for
and over
30
business results,
is
growing well because
may
manager has
when an
investment
investors are achieving
to peel off to
"lost
— or
it"
is
or
more key
form a
new
good
portfolio firm.
man-
Or a
star
forever? The organization must decide be-
replace him or restructure his
If a red ant
in
sales versus the apparent
role — changes
that the hero
were 8 inches high, the geometrically proportional weight of
external skeletal structure.
body weight would
his
perhaps, an early indication that the
it,
tween the hero's marquee value
it
an exception —
is
manager, with a compelling public following, can lose
touch for a year or so
make
its
difficulty,
away one
bid
agers—or they may decide
its
decade were no longer
very few firms have been
more years. Capital
or
five
the very long term, the unique exception.
competitors
portfolio
sadly, in investment
each of the past
In
start of the
another version of the same
In
'
time.
decade. And
leaders by the end of the
among
And
failure often follows.
decades, half of the leaders at the
crush
in
require such
And
if
an Indian elephant were
bone and muscle strength
simply too heavy for the muscles to
lift
and the
in
beast,
its
1
its
need
may
body would
5 percent larger,
legs that its
to
find
its
weight would
unable to move, would starve.
The Multiple-Counselor System
Or a
unacceptable.
rapidly developing
sonally ready for major portfolio
may
seem
not yet
vs^ise to
turn
young
investor
management
may
37
feel per-
responsibilities, but
it
over an entire fund to her manage-
ment. Sometimes, several of these disruptive difficulties develop simultaneously. All of tic:
these frequent growth problems have a central characteris-
They each expose the investment organization
individual
to the
major
egos and business opportunities (both often dominated by
short-term factors) being
conflict with the organization's long-term
in
professional responsibilities. Capital has been almost unique ity
to
risk of
keep
its
been the key
and
priorities right,
in its abil-
the multiple-counselor system has
factor.
Astonishingly, almost no other investment organization^ has cho-
sen to replicate Capital's transformational innovation. This lack of replication
particularly surprising since a
is
world's foremost investment
large majority of the
managers continue
to
produce
inferior
investment results because they are not designed for organizational effectiveness
on a large
difficult to replicate, the
and does work very
While
scale.
the multiple-counselor system
evidence continues
and
well
that
to
accumulate that
it
is
can
no other organizational design
deals effectively with the daunting challenges of actively
managing
large assets successfully.
management
Investment
is
hardly a
or adopting a transformational innovation partly
because the business
bother?
— but
is
fertile in
their
own
vesting that they can give
for
producing
organizational structure-
usually highly profitable as
primarily because talented
dominant within
field
investors
it
is,
so
(who are usually
organizations) are so deeply absorbed little
time or talent to
why
managing
in in-
their organi-
zations as organizations. Therefore they are unlikely to initiate major innovative
change
profitable
is
that
in their firms.
(The reason the business
is
usually so
most managers— unlike Capital — underinvest
ducing service value and also tend
to
overcharge
^PRIMECAP, which was formed by Howard Schow and
in
pro-
their clients.)
included a group of Capital alumni.
38
CAPITAL The multiple-counselor system may only be possible
zation
like
in
on organi-
Capital that has a culture (see Chapter 9) that has largely
displaced the chronic constraints of individual egotism. At most other
manager
investment organizations, each portfolio
confronts the world
daily as a hero. Capital has displaced individual heroism with a sys-
tematic commitment to personal modesty, continuous rationality, rigor-
ous measurement of
results,
and organizational
Capital's cultural values, recruiting, sation system reinforce to the
its
explicit
effectiveness.
management, and compen-
commitments
to
meritocracy— and
primacy of successful investing.
AFTER Capital ll\d a few years of success having one portfolio manager 1958 that
it
of the four funds, the firm recognized in
for each
had
a significant
management
challenge where
tered most: investments. "Investment results were not as
wanted
in the late 1950s," says
derstatement.
"We
Jon Lovelace with
it
good
matas
we
characteristic un-
studied ourselves and concluded that committee
decision-making was
at fault, particularly
when members of
the
committee genuinely disagreed." Capital's leading portfolio ties
and noticeably
different
managers had very different personali-
ways of thinking about investments, so
they were virtually sure to have genuine, strong disagreements. decisions about investments were
all
too often compromises, the
worst kind of decision-making in investing
commodation muddles cisive action;
when
interpersonal ac-
creative thinking, rational decisions,
and trying
Group
to forge a consensus
and de-
from competing, even
conflicting, differences of opinion resulted in social
and mental
ex-
haustion. Cross-sterilization was
more
of insights and ideas. This
particularly harmful in investing
where the liest,
is
best ideas are often tentative
and potentially most
likely
and
than cross-fertilization
"soft-shelled" at their ear-
profitable, stage. If investing
is all
about
9
The Multiple- Counselor System
creativin'
3
and making unusual, unconventional, and even unpopular
made by individuals of their own acts.
decisions, great investment decisions are best
taking direct responsibilit}' tor the results
Capital tried having each portfolio manager
manage
own
his
three or four years of experience,
fund independently, but
after
actual investment results
seemed strangely skewed: The growth-
oriented portfolio of Investment
more
conser\'ative than
—
portfolio
Company
of America was actually
American Mutuafs presumably
conservative
even though their respective mandates were the other
w^ay aroundl For example, in 1957, Sputnik raised concerns about
America's prospects; and the stock market, anticipating recession, started to decline. ings,
was actively
Company
Hardy
Hall, seeing a
so he
in corporate earn-
selling stocks to raise cash reser\'es in
Investment
of .America. In contrast, JBL 'liked Ike"' and saw
opportunities for growth in the overall tries,
slowdown
was taking
a
much more
stocks in ^\merican Mutual.
The
economy and
in
many
major indus-
positive approach, boldly
buying
between the managers'
differences
portfolios were not complementary^; they were contradictory.
Coincidentally,
meant
JBL and Hall planned
Company
that both Investment
to
soon, which
retire
of .\merica and ^Ajnerican
A
Mutual would need new portfolio managers.
choice
be made benveen Coleman Morton and Jon
Lovelace
ferent people. Capital's quickly approaching
need
to
would have
—
two
to
ver)' dif-
make important
decisions helped give birth to a major organizational innovation. Capital's leaders agreed that neither of the
zational structures used in the
mutual fund
independent management of each fund by 07-
collective
compromise
its
traditional organi-
—
industr}^
own
separate
portfolio
and
manager
management by committee based on consensus and
—would
give Capital an effective solution to a serious
and pressing problem. Something very Instead of compromising
or,
different
President Chvieht D. Eisenhower.
was needed.
even worse, combining the two
ditional, inherently contradictor}' structures,
-^
two
tra-
Jon Lovelace suggested
^
CAPITAL
40
to his father that they
might deal with the problem by taking the best
components of both
structures.
new
He
tentatively
time,
became an
ment
organization. After a slow start, this
entirely
counselor system of portfolio
structure for an investment
—
new design management proved
—
in
manage-
the multiple-
to be superior
of the two traditional structures.
to either
The
proposed what,
multiple-counselor system of portfolio
management began
with a decision to divide the problem into parts and then rearrange those parts.
The
was
step
first
to divide each
funds into four separately managed parts ton,"^
JBL
(assisted
of Capital's two large
—one each
funds would be a blend of each manager's best
Jon Lovelace explained
into several separately
results
of both
efforts.
his idea for dividing the funds
managed components, Jonathan
gave the proposition his strong sponsorship as well as "multiple-counselor system." (This terminology tual
Mor-
by Schimpff), and JL. Each of the four portfolio
managers would manage part of each fund, so the
When
for Hall,
is
Bell Lovelace its
name: the
used in the
mu-
fund business, but the conventional term "portfolio manager"
used with institutional for the idea; but JL,
clients.)
who
JBL wanted
to give his son full credit
might not be helpful
realized that this
is
in
gaining acceptance for what others might view as a radical idea,
JBL
asked
to
recommend
the change alone.
"Everyone knew that keeping perfect track of all the transactions
would be
'^
Since
difficult," explains
Coleman Morton was
Jim Rothenberg.'' "But
several people in
the only investor with experience in natural resources or in
international investing, he continued "solo" with International Resources Fund.
^Jon Lovelace, however, was fully prepared to take complete responsibility «of
work out
^Jim Rothenberg went directly from Harvard College he took
—along with
three quarters of his
tional investing taught
dent in that
if his
idea did
well.
class
Harvard Business School, where
to
650 classmates
—
the popular course
on
institu-
by Professor Colyer Crum. Jim FuUerton was interviewing
who was
"Gee, Mr. FuUerton, you
set
on venture
really
ought
capital, so there
to interview
was no
fit.
Then
a stu-
the student said:
Jim Rothenberg. He's the smartest, best
thinker in our class!" Professor
Crum had
asked Rothenberg to consider staying on for a year as his Research
Associate and case writer but,
when
asked about investment firms, suggested that one of the
The Multiple-Counselor System
management recognized Capital was going to
that
it
Capital was going to expand, a7id
move each of
to be changed."
the necessan* records kept by hand,
all
counselor system began operation on April
some
Dav.) Nine to
months
later,
the multiple-
1958. (Naturally,
1,
reminded the proponents that
skeptics
if
mutual funds away from de-
its
pendence on one individual, something had
With
41
this
was April
Fool's
the multiple-counselor system was applied
Washington Mutual. .\lthough
was
it
developed
a de yiovo innovation,
as a
pragmatic
solution for a specific problem, the multiple-counselor system of
management
portfolio
in structuring
has proven to be Capital's central innovation
an investment management organization. \s Rothen-
berg explains some
years
-tO
later.
'"In
developiyig the concept,
Jon
played the central role in a father-son arrangement,, while iinplement-
made
ing'w was
possible by
pon was needed ver}'
JBLs strong sponsorship. This strong sup-
because, at the time, Jon
had not been with Capital
long and several people opposed the idea, some because
it
considered heres)' and others because they simply thought
was just
it
wouldnt work.'
The
operational aspects underlying the multiple-counselor sys-
tem have subsequently been worked out at considerable cost
—
the software used to operate the multiple-
counselor system has cost over SI 00 million
"On one
modified.
in the beginning,
elaborate, as
He
was
says
just as
is
Rothenberg.
simple
"On
^7
?2/^
profound
another
as
level, it
to be it
was
quite
is
learned from painful experience."
inte^^^e^ved %^ith Jan Greer
—and
been west of Detroit -\ngeles.
level, it
— and continues
was Capital. At home that night. Rothenberg happened to receive a lener from
best oucfics
Capital.
we Ve
considerable detail
in
took Dr. Sanford
his h^st-e^e^
and then Mike Shanahan. Ha\-ing
—Rothenberg
that far only to play football
s
personaht)'
Japanese meal.
tests,
and went
.After dinner, the
to Shanahan's
rwo men talked
ne\'er before
gladly
home
went
to Los
for dinner.
until 3:00 a.m.
—
It
\^'hich
was 6:00 A.M. Eastern Standard time. By then. Rothenberg had given up any thoughts of being a case
Adding
\'.Titer at
Har%ard.
to the managerial challenges
of keeping complex records up-to-date when
—one with
kept by hand, two separate groups in accounting
—werent
r^vo
able to
work
three
all
were
members, one with
effectivelv %\ith each other in the earlv vears.
42
C A
P
A L
1
1
"The multiple-counselor system was introduced periment during a
who was
initially as
difficult transition period," explains
Bob
an ex-
Egelston,
deeply involved in working out the operational and compu-
tational complexities of the system
—
before
was computerized.^
it
took several years of patient nurturing and development.
Its role
"It
grew
out of Jon's concern over the geometrically increasing burdens of
growth in the
scale
and complexity of Capital's work and
his desire to
stay ahead of that curve."
"For several years,
something of
was unique.
felt
the multiple-counselor system was
Coleman Morton.^ "We knew
We knew it was not easily implemented. And we knew
Some wanted
worked."
JBL
a trade secret," says
to keep the multiple-counselor system a
plete secret so others wouldn't catch on.
saying,
so complex, if
"It's
derstanding
it,
seconds
—
it
com-
But Bob Cody was sanguine,
any competitor
tried
it
without
un-
really
they would sink!" Associates agree that the multiple-
management can be explained
counselor system of portfolio
30
it
or in
fiill
briefly in
operational detail over 30 days.
Monitoring the multiple portfolios requires a lot of time
complex task that
a
is
and attention by investment people
still
to pre-
vent frustrating errors and misunderstandings.^^ To work well, the
^Capital
felt it
could not use off-the-shelf systems that are usually considered cost-effective,
because the available systems w^ere portfolio
designed with a
all
common
—
manager would be the ultimate decision maker
Capital was striving to avoid with
its
assumption that one
same
the
multiple-counselor portfolio
central
star
problem that
management
process.
^Morton introduced parts of the system at Trust Company of the West, where he later worked. The "fund of funds" structure used to combine several separately managed hedge funds into one aggregate portfolio has some similarities and
is
being increasingly used.
'^An important cushion was invented to manage the process when one of the counselors
working on
a
fund wants to
sell all
or a part of a fund's holding.
the other portfolio counselors working
an internal exchange
though an actual
do not want
is
sale
to take
made and
in a
sell.
Committee
This
seller's
If they
it
over, the stock
to sell
calls for special
Reserve.)
is
First,
the stock
is
offered to
wish to take the position over,
investment performance will be measured
had been made into the stock market.
one portfolio counselor wants decision to
the
on the fund.
(If
sold into the market.)
and others do not want
The
to
as
other portfolio counselors difficulty
comes when
buy and disagree with
the
record keeping. (Occasionally, small amounts are held
The Multiple-Counselor System
43
multiple-counselor system also needs at least one senior sponsor^
who
^
can smooth over the interpersonal rough spots that are virtu-
ally inevitable in
and
closely
any
effort to
have creative people work together
interactively.
As though
to prove that the multiple-counselor system
is
hard to
adopt and implement effectively without strong sponsorship, even Capital was not always successful with
its
introduction. Far from
it,
as
explained in Chapters 9 and 10, in the early years of subsidiaries
where portfolio managers
all
too often reverted to the "hero fund
is
the principal reason other investment
manager" syndrome which
organizations have not adopted the concept.
The
difficulties
tem were
of managing effective implementation of the
particularly evident as the portfolio
Guardian Trust
tried
it
their
portfolio managers, but there
ment agers
styles
—
results,
so
and too
when two
little
clients
own
way. At
managers
first,
was too much
at Capital
they simply paired
differentiation in invest-
communication among
portfolio
man-
with the same mandate compared their
they could be very different. Naturally, such unexpected and
And in consultants who
inexplicable differences were disconcerting to clients.
competition for vise
sys-
new
business, the investment
the ad-
new investment managers
pension funds on the selection of
found such differences simply unacceptable. "Personally "I like
and
everything about the multiple-counselor system except trying
to explain
it,
particularly to a client
sophisticated about investing. ftiU
time,
stocks.
one portfolio counselor,^^
professionally," says
it is
This
Even
who
is
not very experienced or
for those
of us
who work
here
hard to be completely on top of 90 to 100 different
is
particularly true of the
clients will needle
you about during the
needle' stock
—
the stock
portfolio review meeting if
performance has been disappointing."
^^
Provided for
^^Dick Barker
many years by Jon (see
Chapter
8).
Lovelace, but
now provided by several
designated seniors.
CAPITAL
44
But
and
as clients
their consultants got used to the system anddiS
Capital Guardian's results became
more
needed and significant increase
in organizational discipline (see
Chapter
10),
both
clients
consistent through a
and consultants came
multiple-counselor system's benefits more
fiilly.
much-
to appreciate the
Today, Capital
about internal systems that can readily accommodate growth
is all
in size
and complexity.
The
and powerfiil process
phisticated
and complexity
challenges of size tual fiind or easily
become an
multiple-counselor system has
extraordinarily so-
that enables Capital to lessen the
that
accompany growth. As
an institutional account grows larger and
among one
be divided
or
more
mu-
a
larger,
it
can
additional portfolio counselors.
Meanwhile, portfolio counselors concentrate on the kind of investing they do best, each managing a portfolio of assets that size.
The system
is
a comfortable
enables each portfolio counselor to focus on achiev-
ing Capital's primary objective: producing consistently superior long-
term investment
results.
Competition folio counselors.
since everyone selors
know
is
always with par, never with other individual port-
(Of course, compared
is
internal comparisons can't be eliminated
same external measures.) Coun-
to the
they will significantly increase their pay by achieving su-
perior investment results for clients because investment results are
linked directly and explicitly to each counselor's compensation over a
weighted four-year moving average
(see
Chapter 14
for details).
For large mutual funds. Capital will have a half dozen or more separate parts with each counselor in full authority over,
accountable
for,
fiilly
the investment results of his or her portion of the
total portfolio. Portfolio counselors eral different funds.
vidual's
and
These
each manage portfolios for sev-
several portfolios are
measured investment
all
part of the indi-
results.
In the early years at Capital, investment information was not
broadly shared. But now, sharing frequently
on investment
counselor system. all
The
full
all
results are
information and reporting
both integral to the multiple-
and prompt disclosure of all buying and
selling decisions dissipates
any tendency
for investors to "go
it
— The Multiple-Counselor System
alone" and
buy or
sell a
45
particular stock in the portfolio they are re-
sponsible for before sharing the idea with other portfolio counselors.
Each portfolio counselor
is
expected, after hearing and consider-
on
ing the information from peers, to act
his or her
own
strongest
convictions with that part of the total fund for which he or she has re-
Newton proved how much freedom each concentrate: In his part of the New Perspective Fund
sponsibility. Bill
has to total
of $3 billion
—he once held
"You only own what you
ing:
There
really
cussion interest,
among and
relative conviction,
—
Not only
a
to
clarifies
own."
and
simplifies
communi-
particularly in a dis-
senior portfolio counselors of relative value, relative
clarative statement: "I
of this stock
want
no way that additional words,
is
—worth
just nine stocks, laconically observ-
The multiple-counselor system cation.
counselor
at the
am
can compete with
this simple, de-
authorizing the purchase of 200,000 shares
market
"
now.
are portfolios diversified across
are also diversified across different styles
many
investments, they
and concepts of investing and
across the several counselors' differing perspectives
on the market.
Portfolio counselors are not individually responsible for achieving
optimal overall portfolio diversification. oversees the
of the
Investment Committee
whole portfolio and coordinates the component subport-
folios to ensure that all tives
An
investments remain within the overall objec-
ftind.
The major
benefits of the multiple-counselor system are:
Individual accountability for action, linked directly to financial
and nonfinancial compensation.
Objective measurement of results. Professional satisfaction
and
ftilfillment.
Increased portfolio diversification.
Each portfolio counselors investment reported frequently and regularly to
The
Portfolio
all
results are
measured and
the other portfolio counselors.
Review System reports each portfolio counselor's
46
C A
P
r
I
investment
A L
results
on
and monthly
a daily, weekly,
The open
basis.
flow of information and complementary compensation policies en-
courage portfolio counselors to help each other by sharing ideas and information, but they have no need to compromise or persuade and are expected to act independently
and boldly
in
making
their
own
in-
vestment decisions.
Developing consistency and continuity of results through diver-
making
sity in decision
on an added dimension with
takes
Capital's
globaUzation. "Major clients," explains Rothenberg, "want and ex-
pect consistency of process and results as a key indicator of quality,
and
that
means our
large, global clients
tency in investment objective, portfolio overall
approach across
our country
all
local units in different countries
own
their
different experiences.
management
practices
do
But the
effectively,
is
Over
specifics
and investment
The
creativity,
histories
and
we celebrate we'll move with
to
work on
individual respon-
appropriate care."
multiple-counselor system encourages personal growth, par-
ticularly
among
research analysts,
Capital very early in their careers.
ing in his or her
own
and more. Some money,
that our various
we intend
time,
and
of their investment
reducing these differences. But since sibility
process,
reality we're liv-
own
each have their
So the
differ.
management
units.
manage
ing with, and are working to
look to Capital for consis-
all
who manage real investments at An analyst typically begins invest-
—one
or two stocks at
industry
manage very
analysts eventually
in the industries they
know
best.
And
first,
there
then more
amounts of
large
is
no
clearer
or stronger professional and personal affirmation for an investment analyst, than to
know
analyst has just
recommended.
Visibility sions.
of results
is
facilitating
addressed," explains
Bob
it
will
professionals are never
made
peers.
show up
Egelston.
what the
tough people deci-
Capital uses in investing leads
open personal reviews by
anyone has a problem,
ment
key to
also
The open information system
naturally to
so if
portfolio managers are buying in size
Still,
"It's
early
quite systematic,
on
—
so
it
decisions about
can be invest-
quickly, because Capital's kind
The Multiple-Counselor System
of investing takes time to mature (see Chapter 15). at least three vears to
management
It
47
usually takes
mo\"e someone over and out of the investment
process, but
it is
always done
when warranted
—with-
out emotion ^?2^ graciously. Capital illustrates the multiple-counselor s}'stem for mutual
fund investors with Table
3.1.
some of the younger people
In early 1962,
sion asked at a corporate retreat, ''Wliy not
in the Research Divi-
us
let
manage some of
the money?'' But after the sharp stock market break that spring, interest in the idea
Jon Lovelace tails
Then in 1965. after succeeding Bob Egelston worked out the de-
faded for a while.
as research director.
of the Research Division Account. Research analysts act directly
on the
portfolio,
menting
Table
their
3.1
buying and
own
best ideas
and imple-
selling specific securities
and information
in real-time decisions
Benefits of Decision Structlres \lu:::p^e-
Portfolio
Manager Highest conviction ideas
Invesrment
Comminee
J /
Method of diversification
-
-
Counselor
Approach
J
y
Diversin- of ideas
Portfolio
-H
J J
manager
accountabilit)-
J
J
J
J
Portfoho manager satisfaction
Research analyst
y
accountabihn.-
Research analyst
y
satisfaction
Continuity'
manager
if
portfoUo
/
leaves
Consistency of results Benefits to client's
ponfolio
Value added
by
y
y y
Diversification
Best of
creative
and
ideas
control
risk
both v.orlds
CAPITAL
48
instead of having to convince portfolio counselors to take action.
The
analysts' portfolio has frequently achieved superior results,
the Research Division
mutual funds and
now manages
significant
and
segments of both
institutional accounts as part of the multiple-
counselor system.
When assets
Capital began using the multiple-counselor system, total
under management
w^ere only
$400
million. Today, assets are
over 1,500 times larger and over 150 investment decision makers are
simultaneously running parts of various funds and portfolios, making decisions to
Rothenberg,
buy and
"It's really
sell
specific securities every day. Explains
a case of diversity
promoting continuity."
CHAPTER
4
ORGANIZING THE CORE
NOTES FOR READERS Far from being a charismatic personality, Jonathan Bell Lovelace nnodest, reserved,
and unassuming. These personal
was
continue to
traits
characterize Capital's organizational culture. Even more important,
Lovelace
was
bright,
rational,
and
self-disciplined.
He sought
ented people and backed individuals with ideas. His calm
was
ideally suited to both long-term investing
sional organization through In
its
and
tal-
demeanor
nurturing a profes-
formative years.
addition to being nondirective as a
manoger— encouraging
oth-
ers to take responsibility for investment decisions and for entrepreneurial
initiatives to build
He backed
large
up Capital — Lovelace was often a bold leader.
and decisive
actions: innovating the mutual fund con-
cept; taking over a troubled Investment
nizing
American
Mutual;
agreeing
to
Company a
novel
Washington Mutual; empowering Ward Bishop
of America; orga-
arrangement
to build
for
an indepen-
dent mutual fund sales organization; launching venture capital; and
backing the multiple-counselor system of investment management.
49
CAPITAL
50
had a continuing leadership
His son, Jon Lovelace, has
40
Capital for more than
role at
years, during which he has taken a series
of strategic initiatives, beginning v^ith designing
and proposing
the
Group
multiple-counselor system: orchestrating the transition to Capital
as a holding company; supporting several important acquisitions; strongly supporting a sustained
and leading As
vital
magnificent
is
to international investing;
comprehensive compensation and ov^n-
the creation of a
ership strategy that
commitment
in its
lack of self-interest.
ascent to professional and business
to Capital's future
leadership as the early "survivor' years clearly were
embedding
in
on
late fifties
organization
strengthen
and grow
may be
always the
would
were
crucial years
the thin threads of possibility
While
to
were made
this is
the highest form of en-
the accessibility of individual possibili-
"fortunate," the creation of a great firm
realization of
build-
be capable of continuing
investment management,
result of
in
an enduring and dynamic professional service
trepreneurial leadership. ties
the sixties
after JBL's era.
into the strong fabric of In
and
that
Over and over again,
organization.
in
the fledgling firm the values that Jonathan Bell Lovelace
epitomized— the ing
— particularly
is
never lucky:
determined, imaginative persistence
an inspired
It
is
the iterative
in
vision.
ANOTHER IMPORTANT MANAGERIAL thread became part of the fabric of Capital during this period: recruiting. After graduat-
ing from Stanford and Harvard Business School, Jim Fullerton went to
Mexico
hand
— "where polo was
as a writer. After
up the
writer's career
fast
and
living
was cheap"
publishing several short
and went into
to try his
stories, Fullerton
selling insurance.
He
comprehensive personal insurance review and analysis
man Morton. And Morton
—
gave
soon did a
for
.
.
.
Cole-
quickly recognized that Fullerton was
Organizing the Core
man
just the
to
fill
the challenge Jonathan Bell Lovelace had given
man
him: "Find us a
Fullerton was
51
who's got a good head for numbers."
good with numbers and very good with words
and, most particularly, with people.^ Tall, slim, and good-looking,
and
Fullerton has an engaging personality
a
warm, baritone voice
with which he cheerfiilly demonstrated his soon-to-be-legendary ability to tell original
tended
series
and entertaining
stories
— including an
ex-
of exploits by two apocryphal Japanese adventurers
good
that he modestly acknowledges are "simply too
to tell."
Recruited to Capital in 1957,^ Fullerton soon launched an ex-
At the Wharton School of
tensive nationwide search for talent.^
Business, the placement officer gave Fullerton a set of carefully selected candidates' resumes. All
had good grades and
business studies, with both a bachelor's degree
of
six solid years
and an M.B.A. from
Wharton.^ Fullerton read the resumes with increasing dismay and then pleaded:
^
"I can't
use any of these fellows!
John R Kennedy while he was
Fullerton's wife, Harriet, a striking beauty, dated
student at Stanford visit
—
in her lack
young couple soon went
who was
briefly a
Rose Kennedy decided to
until their relationship got so serious that
California to check her out. For both Harriet,
was remarkable
They may sound good
not Catholic, and for Rose,
who
of warmth, the interview was decisively not favorable and the
separate ways.
Still,
Harriet kept on a side shelf a framed photo of
herself seeing Jack off at the Pasadena railroad station.
Even many years
later,
both figures
were quite recognizable, and guests of the Fullertons instantly identified JFK. House painters, after several days'
work
for the Fullertons, couldn't resist asking
the picture they'd recognized: "Mrs. Fullerton, that
.
story ^
.
.
all
When
the
.
.
.
uh
.
.
.
I
the better in future telling: "Yes.
You have
made
is
the
a very sharp eye."
Fullerton joined Capital, there were only 32 employees
first
about the part of
ask you, ma'am, in that picture,
Glendale railroad station?" Harriet Fullerton's laconic reply
mittee consisted of JBL,
^The
may
Coleman Morton, Hardy
Hall,
recruiting at business schools began with
and the Investment Com-
and Chuck Schimpff
Jon Lovelace going to Stanford, where
he found only two candidates signed up for interviews. Fortunately, one of these was Ted
Hinshaw,
who
served in a series of very different positions
—
a "nonpattern pattern" that
Capital celebrates. Beginning as JBL's assistant, the prized position he was initially recruited
for,
he became the transportation industry analyst
a truck driver) and, in the early 1960s,
was an
(in part
because he'd once been
all-star airline analyst.
During the formation
of Capital Group, he was director of planning and then managed the transfer agency. In 1976, his love of sailing took
^Wharton
him
offered both bachelor's
to the
Olympics and into retirement from Capital.
and master's degree programs.
CAPITAL
52
to
some
to
do every routine thing
looking
for.
We
know
but they're not for me! They'll
recruiters,
need
correctly,
men
but
that's
not
who'll be great investors.
at all
how
exactly
what
we're
That means they
Do
simply must be imaginative, creative, and independent thinkers.
you have any men who might be the
The placement
"We do
we need?" was perplexed. Then he brightened
officer
sort
have a fellow you might speak
to. First in his class,
not sure what he wants to do. He'll be over in the
and met Bob Egelston,
went
to the library
They
talked for half an hour
different eras
—
in the
when
along well,
stop talking. "All
same
don't
library." Fullerton
and learned they had both served field artillery unit.^
They were
we can
learn in an
hour of talking
now know I
I
you come
our
to
administered psychological
sort of individuals
and
New
York
test,
is
whether we
interested in investing,
office
and meet some of
and the
sort
dence when
.
.
.
,"
and odd-shaped holes
—
the
of firms found in investing.
others, Fullerton looked over test.
self-
explaining that Capital had found
day, as Egelston interviewed in
psychological
in
don't not like you. If you feel
helpful in matching odd-shaped pegs
Next
—
getting
our people?" Egelston agreed, and Fullerton handed him a
it
he's
a graduate of West Point.
same about me and think you might be
the
but
Fullerton surprised Egelston by suggesting they
don't or won't get along.
why
up:
To complete
New York with Hardy Hall
what Egelston had written on
his
the sentence, "I feel a lack of confi-
Egelston had written, "jumping out of planes."
"Have you ever jumped out of an
airplane?" Fullerton asked
Egelston. "Yes."
"How often?" "Fourteen times." Egelston was hired
as
an analyst. In 1964, he became research
director with a staff of eight
^The 76th still
Field Artillery Battalion.
had horse-drawn French 75s,
a
— including
his earlier
mentor, Jules
When
Fullerton joined on April 7, 1942, the battalion
model
first
produced
in
1897.
Organizing the Core
53
Hoffman.^ Other promising young professionals were being hired by Capital.
Fund management was what Howard Schow really wanted to do: "It was explained to me that fund management at Capital was done in Los Angeles not New York. Since I'd been in the Navy and
knew how
to say 'Aye, aye,
sir!,' I
moved from New York
to L.A. in
1962." Increasingly recognized during the 1960s as an unusually
Schow was one of Capital's leadinvestment managers through the 1960s and 1970s. He made a
imaginative and effective investor, ing
major impact on Capital's mutual fund product
line
by successfully
advocating establishing a growth stock fund to extend the firm's offerings
beyond the middle-of-the-road "growth and income"
tioning of Investment
posi-
Company of America.
In 1967, Capital's fourth fund,
AM CAP Fund,^ was launched at
Schow's initiative to represent Capital in the growth sector of the
mutual fund market. At the time, stockbrokers were agog over the apparent "performance" of such hot funds as Gerry tan Fund, Fred Carr's Enterprise Fund,^
and Howard
Fund. Americans were reading The Money
Tsai's
Manhat-
Stein's
Dreyfus
Game by Adam
Smith,'
and everyone was talking about performance investing and go-go funds. But Capital's
much growth
at
new
growi:h fund did not, at
experience
all.
^In 1969, Egelston became the president of Capital either president or
first,
Group
and, for the next 23 years, was
chairman of this holding company.
''The name was chosen after the Securities and Exchange Commission resisted using the name proposed originally American Capital Growth Fund. ^ Under Fred Carr, Enterprise Fund mushroomed in assets as new sales poured in because of apparent "hot" performance, but much of the performance was self-generated because the fund bought more and more of the shares in small companies it already owned. The fund suffered large redemptions when letter stock holdings collapsed in market value, and performance seriously disappointed investors. Shareholder's Management Company is now out
—
of business, but
at its peak,
it
was managing more
assets
than Capital. Over
apparently top-performing fund's real time-weighted results average,
and most
investors lost
money
performance appeared to be proven. As
fell
because they invested is
its
career, this
noticeably below the market
when
the record of superior
so often true, appearances were deceiving.
C A
P
The
best part of the strong
54
due
A L
1
I
to delays
due
demand
for
growth funds was missed
to internal uncertainties over the exact type of
"growth" fund to launch. Also, Capitals mutual fund
Chapter
tion (see
and so did not
5)
was not enthusiastic about
really try.
As the
AMCAP
selling a
tried to reach for current performance, so
growth fund
fund manager, Schow
had missed the market and would
feared that he
sales organiza-
get
whipsawed
he held back.
Finally,
if
he
with
pressure from the directors, he got the fund fully invested. But by then,
it
was too
catch the wave of the mid-1960s market, and
late to
sales
came very slowly
sults
accumulated (particularly
AMCAP lidify
s
for several years. Later, as
re-
1973-1974 bear market),
after the
assets increased substantially.
good investment
And
this success
helped so-
Schow's leadership position within Capital.
Believing he should devote most of his time to investing,
was reluctant
do and
as
to devote extensive time
Jon Lovelace
—
as others
clearly preferred to
do
—
Schow
were prepared to
to careful discussion
of each and every aspect of each business question to be sure they explored and understood every alternative. While in investing at Capital,
way worked
each portfolio counselor could operate in whatever
best for
him
—and such independence worked
managing Capital together.
And
as
Schow
well for
—
in
an organization, everyone would have to work
increasingly, the
way they would work
together was
being determined by Jon Lovelace. Greatly admired as an investor,
Schow was not
always an easy per-
son for others to work with and could be very confrontational intellectually,
folio
then personally, and finally
politically.
As
—
first
a leading port-
counselor with direct responsibility for substantial
assets,
and
with both long tenure and sizable ownership, Schow expected to be a clear leader
on both
the professional
and business
sides
of Capital.
This was particularly true with major organizational decisions.
Another great investor came
originally
from Canada.
Bill
Newton
graduated from the University of Southern California, and worked briefly at Transamerica, the insurance erate, prior to entering the
U.S.
and
Army
financial services
conglom-
in 1951. After basic training.
Organizing the Core
55
he was sent to Okinawa where, to reheve boredom, he read books in the Post Library. After completing almost
all
the books in the Post's
motley collection, Newton began browsing through Report on Investment Companies? This
compendium was
nor entertaining reading, but to Newton ternatives because
Newton
bergen
it
was about
Wiesenberger
its
it
seemed
neither light
better than the al-
his real interest: investing. In Wiesen-
noticed that senior investment executives at IDS, a
big mutual fund outfit, were paid the princely annual salary of
$300,000. That was Occidental Life
(a
than anybody working in mortgages
far better
at
subsidiary of Transamerica), where he had been
employed. So when he got out of the service and returned to Occidental Life,
ment
Newton
applied for a position in the investment manage-
unit. (Just in case,
he had also scouted out job
offers
from three
other investment organizations.)
The head of investments
at
OccidentaP^ decided he would
inter-
view Newton; liked him; and virtually concocted a new position for
him on
the spot.
began with the
ment
securities.
panies with
new
Newton would
(Two other
Newton expected But
to
A
phone
Wiesenberger s editor was Lucille
all
call
article
^ ^
They worked
changed
called: "I
the leading mutual funds.
Buell at
strong mentor, Newton's analysts
a deter-
well together
and
his plans.
think you ought to meet Jon
young investment
Thompson, who was working
George Bjurman.
Henry
A
about the recapitalization of
basis for Wiesenberger Reports. ^^
M.)
them with Newton, who was
Lovelace. He's one of the best
records of
would divide coverage of com-
to stay for a full career of investing at Transamer-
in 1958, a
Al Drasdo wrote an
to
companies whose names
—which included U.S. Govern-
staffers
a fast learner.
A friendly stockbroker^^
^
Z
all
on telephone conversations with broker
carefully critiqued
mined student and
ica.
N
names beginning
boss listened in
and then
from
letters
cover
McDonnel
& Co.
Thompson
ICA
professionals in
at Barron's,
that
where
Capital's
compared performance
liked Drasdo's idea
and used
it
as the
CAPITAL
56
Los Angeles." Less than
Newton,
day
a
later,
one of the best young investment
saying, "I'm told you're
professionals in this area
Lovelace was on the phone to
and that we ought
about lunch?" They got together for lunch after, Bill
—and
Hurt of Dean Witter invited Newton
hit
to
it
Members of the group
also included
become
Bob
Not long
off
of the Every-Other-Thursday group that met twice each luncheon.
How
to get together.
member month for a
Kirby^^ and Jon
Lovelace.
Lovelace approached
He was
demurred.
Newton about joining
loyal to his mentor. Besides, in
Capital was small:
Capital, but
learning a lot where he was and
It
managed
felt
comparison to Transamericas less
Newton
personally billions,
than $300 million. Monthly
calls
from Lovelace asking Newton what questions he might want answered culminated a year
later in
one decisive
we've been talking about here at Capital needs to be
want you
to join us.
But
hire another person."
money market As key
if you're
Newton
reserves
and
"The position
call:
filled.
not ready to come now,
We
we'll
really
have to
joined CapitaP^ in 1959 to manage
serve as JBL's assistant.
individuals joined
and Capital grew
as
an organization,
the firm's business was expanding. "Assets under
management
crossed $1 billion in early 1966, "^"^ recalls Morton.
"Our
in the Statler Building,
which could get room
joining Statler Hotel, so
service
we ordered champagne
major milestone. With only 40 people to
serve,
it
offices
first
were
from the ad-
to celebrate this
didn't require very
'^Additional members included Harold Tanner (later cohead of investment banking at Salomon Brothers and then head of his own firm), Doug Fletcher of Shareholders Management, and Bob Thuerkoff, who developed the Korea Fund at Scudder, Stevens & Clark,
where he was chief investment to be to
it
with
second
in
back then, but
Doug
'"^
firm:
Noting
how
difficult
it
must have been very uncomfortable
it
for
must have been Hurt
Bill
says: "I
Jon to be
at
was
for Capital
insensitive
those luncheons
Fletcher."
'^A few years
own
officer.
Los Angeles to Shareholders Management,
later, his
mentor, George Bjurman, would leave Transamerica and
George Bjurman Associates.
1960 was the
first
year Capital earned over $1 million.
start his
Organizing the Core
many bottles.
Later,
mark
the market
fell
went
off and Capital's assets
Chuck Schimpff suggested we should have another
below $ 1 billion, party to
when
57
the event with comparable emphasis
—
as
an affirma-
tion of our professional integrity."
Coleman Morton was
and Jon
the heir apparent at Capital,
Lovelace was neither expected nor expecting to succeed his father.
While JBL and JL had mutual respect and regard for each other, theirs was more of a professional connection than a personal, fatherson bond. Moreover, ther,
JBL had
personal loyalties toward Morton's
an early investor in Capital. Most important, Jonathan Bell
Lovelace was conscientiously rational in larly
fa-
about people and organizations
all
his decisions
—
particu-
—and would have been
quite
cautious about the well-known dangers of soft thinking so often glossed over in nepotism.
"Through the 1950s, we had
all
assumed Coleman would suc-
I ceed JBL,"
recalls
Jon Lovelace, "but an unfortunate
article in a busi-
ness magazine appears to have been the turning point."
photograph of Coleman Morton and Jim FuUerton, the cated that a
young team might soon take the lead
"liven things
up compared
understandably miffed
to the old fogies."
Chuck
article indi-
at Capital
The tone of the
and
article
of the mutual ftind directors
who
it.
Then,
in the late 1950s,
Schimpff became opposed
hand man science
a
Schimpff, Hardy Hall, and Jonathan
Bell Lovelace as well as several also read
With
two more things happened.
—Schimpff was
least as significantly,
As JBLs
to Morton's succession.
for administration
—and
First,
the firm's dour,
Chuck right-
Germanic con-
very protective of JBL and his company. At
Morton
virtually
took himself out of considera-
tion in the following way: Apparently doubting a small investment
firm located in remote Los Angeles could ever
amount
to
much,
Morton proposed, more than
once, selling out. This clearly dismayed
may
have been objective in his appraisal of
JBL. Although Morton
Capital's business prospects,
Simultaneously,
it
was
irrational for
some mutual fund
directors
him
to be so rational.
were encouraging the
58
C A
P
I
idea of JLs
TA
L
becoming
JBL's successor, even
not personally interested in being
though Jon Lovelace was
CEO and did
not consider himself
particularly well qualified for the role.
significant
own health made a thinking.''' At home in Whit-
an unexpected problem with
Ironically,
impact on Jon Lovelace's
his
tier in
February 1961, acute pain struck him in the abdomen.
Rushed
to the local hospital, he
he very nearly died. For
doctors' care at
six
do
to
having
weeks, Lovelace remained under
home. The consulting physicians
"The only thing
as
of appendicitis. Running a fever of 104 de-
diverticulitis instead
grees,
was incorrectly diagnosed
is
cut
him open and
finally decided:
find out what's the
problem here" and found that he had a ruptured appendix of an unusual kind: retrocecal or "tucked in back," where hard to find. After a fine,
but
knew
he'd
month of proper
had a
it
had been
treatment, he was feeling
close call with death.
Later that year, Lovelace took his
first
business trip to Europe, in
1961 accompanied by Ken Mathysen-Gerst. They visited Denmark, the Netherlands, France,
and Germany.
went up and a week
wall
met were impressed two weeks from
JFK's
Americans in
bout with appendicitis
During
visit,
corporate officials they
their city.)
Returning
home
he was put back in the hospital with an abscess
later,
his first
death.
to see
after
(In Berlin, shortly after the
convalescence,
his
—and
a second close call with
several
ICA
Lovelace, at least in part to say that his future role
were on their minds. After
directors
and
visited
responsibili-
JBL was 66 and still had not stated any plans to step down. Some directors felt pressure from Morton, who must have wondered about his own future, to get JBL to make plans for leadership succession. Then, in November 1963, ties
Jon Lovelace was ing European
'''This
hit
trip.
all,
with severe pneumonia
after
another exhaust-
Lying in bed while recuperating from his third
was one of several times that serious health problems precipitated significant deci-
sions at Capital.
Organizing the Core
59
brush with death, he came to a personal realization: "I'm surely
liv-
on borrowed
ing
time, so
what the
hell, let's
do
it"^^
—and accepted
the inevitability of becoming president of Capital.
JBL announced the selecsuccessor and named him executive exactly when he would become pres-
Shortly after Jon Lovelace's decision, tion of his son as his expected vice president
—but did not
say
ident. Significantly, particularly for the small firm that Capital then
made without losing Morton. ^^ time, Jon Lovelace made a seminal contribution
was, the succession decision was
At about
this
to
and development of Capital by preempting
the long-term growth
a
potentially divisive internal debate about Capital's primary strategic
Two
objective.
separate
camps had been developing within Capital
Some emphasized
concerning the organization's primary purpose: service to investors; others
fore
emphasized return to Capital's owners. Be-
he would take on the presidency, Lovelace met with Morton,
Hall, Schimpfif,
and JBL
corporate objective.
Then
1963
in
to gain
in a short
agreement on the overall
memorandum
the conclusions from the group's discussions
that crystallized
(see
Appendix
I),
Lovelace put forward the agreed central proposition: Capital would
not be managed to achieve either one or another of those three
""Near encounters with death
may well
have contributed to Jon Lovelace's existentialist ap-
proach to management and organizational development.
He
believes in carpe
day) but has almost infinite patience with continuous development, as
is
diem
shown
(seize the
in the fol-
lowing chapters. ^^
more
After eight
the
West and
would be
years,
Morton would
to invest in venture capital.
leave Capital in 1971 for the Trust
Company
Demonstrating affection and respect
a characteristically persistent priority for seniors at Capital.
For
for
of
Morton
many years,
until
age-determined retirement, Morton would continue on the Advisory Board of Investment
Company
of America.
In 1972, Jon Lovelace initiated a self
(During
same time, Lovelace and put these two riod,
program of sabbaticals
his sabbatical, the idea for his wife
"facts" together
Coleman Morton made
ever taken sabbaticals.)
moved
—and promptly took one him-
New Perspective Fund was
and assumed he might be planning
a desultory attempt to gain control.
developed.) At about the
months. At Capital, some
to Santa Barbara for four
to retire.
During
this pe-
(Only two Associates have
6o
CAPITAL
competing
goals. Instead,
achievement
—
it
would be managed
as fully as possible
and on
a
for the balanced
continuous basis
—of
reasonable objectives for three groups:
1.
Clients
2.
Associates
3.
Owners
As the to treating
largest share-owner,^^
Jon Lovelace's
three constituencies equally
all
many Capital Associates
as
explicit
was and
is
commitment
recognized by
very significant and unusual. ^^ During the
several decades since his original declaration
of the three-way, bal-
anced objective, Lovelace has demonstrated the strength of
mitment on
several occasions
by making major decisions
his
com-
to assure the
three-way balance. Capital's
newly
of objectives was matched in
clarified troika
importance by simultaneous changes in the nature of Capital's
in-
vestment organization. Although individual responsibility for investment decisions and long-term given, a strong
results
would always remain
complementary commitment was
also
made
markably open sharing of investment information and
a
to a re-
ideas.
Some
of Capital's independent-minded investment professionals did not easily accept the deliberate
mixing of individual responsibility for
action with collective development and sharing of information.
would, however, become accepted
It
as essential to Lovelace's trans-
formational organizational innovation: the multiple-counselor sys-
tem of managing investments.
'^In 1967,
JBL was
still
a large share
back then only B shares had a vote.
25 percent.) Today, both
shares,
peaked
''^Since
Capital Group's owners are
of their
at
own money
its
invested in the
retirement plan for Associates
Venn diagram.
owner and JL owned 39 percent of the B shares, and economic ownership, combining both A and B
(JL's
—
A and
Associates,
B
shares vote (see
and the
American Funds
—
v^ssociates
Chapter
13).
have well over $1 billion
primarily through the organization's
the three interest groups overlap like a three-dimensional
CHAPTER
5
MUTUAL FUND DISTRIBUTION
NOTES FOR READERS Mutual fund organizations are ainnost always either sales-centered or investment-centered
— and
most are sa/es-centered
(as
are most
insti-
tutional investment organizations).
Buyer beware or caveat emptor
is
byword
the
where headquarters decision makers have no ultimate consumer;
where
investors'
few years; where investors flock short-run difficulties;
average ownership
to short-term
and where competition
is
others will/'
does
it"
and
"Let's
take
it
while
we
an industry
direct contact with the lasts
only a
performance and
flee
and
are
intense
so driven by current sales that such cynical phrases as it,
in
"If
profits
we
don't
do
can/' and "Everyone else
proliferate.
Capitol
is
different
— very
investment-centered. While
has great strength
in
its
its
different.
It
is
clear priority
neither sales-centered nor is
investing, Capitol also
mutual fund soles organization: American
Funds Distributors.
6i
CAPITAL
62
more than 50 years
After
of
development from a
tiny
start-
up and semi-independent mutual fund distributor— followed by a rescue buy-in^ at
tfie
grim nadir of the mutual fund industry nearly
30 years ago — integration
of
American Funds
Distributors has pro-
vided Capital with a strong, balanced combination of both
ment and sales centering
may be
that
unique
in
invest-
the mutual fund
industry.
Openly trast to
make its
paternalistic in
its
relationship to investors,
it
deems are
and prospective
present
the long-term best interests of
never be popular because
will
hard
it
dominant
the
to
recognize
why
have been doing very well
and emphasizes
that
against the crowd look for
long run. But to
think
in
the market
have been beaten down. Going
what experienced
is
often
is
it
tide of general opinion, Capital fre-
quently avoids sectors that sectors
should
it
investors. Since Capital believes that the
investors understandably find
go against
in
a particular time
really right fund at
ways
sharp con-
most other mutual fund managers, Capital believes
those decisions
right to
in
in
investments because
it
is
understandably
investors like Capital's al-
can be so rewarding
it
difficult for individual
and act independently when
"the
in
the
investors
crowd" seems most
convinced — and convincing. Capital conscientiously does what other organizations might find
noVve or unrealistic: is
It
concentrates on long-term value judgments and
persistently skeptical
example: deciding not
to join the
ducing money market funds vestors might their equity
^
The
in
parade
the early
1
of fund organizations
970s
intro-
out of concern that
be tempted by the convenience of switching
capacity to acquire the money-losing distribution business and rebuild its fiscal
in-
to get out of
funds and into "cash" at those low stock market levels
example of Capital Group's corporate strategy of assuring gic decisions
One
about short-term prices and popularity.
it
was
independence
— an
a signal
for strate-
by reserving substantial sums during good times and investing those funds
boldly during bad times (see Chapter 11).
Mutual Fund Distribution
action that
would have done grievous harm although the clear leader
sults. Similarly,
ing, Capital
would not introduce a
emerging markets ers
at the height of broker
believed— as was
would not
fully
retail
shown
later
to
understand the price
63
in
to investors' long-term re-
emerging markets
invest-
mutual fund specializing
and
investor interest.
Its
in
lead-
be the case— that individuals emerging
volatility inherent in
markets investments and would be all-too-tempted to
sell
low— afrer a
market decline— what they had bought high at the peak of public
in-
terest or excitement.
Most mutual fund organizations concentrate on
selling to individ-
ual investors, touting recent performance; developing public recogni-
and spending heavily on
for their star investors;
tion
They openly describe themselves as
what
"selling
sells."
felt,
innovation sions
new
investment funds
constructive conservatism.
methods of
in
and 401
(k)
gatherers"
and focus on
Capital goes the other way. Being very deliber-
ate about introducing
deeply
''asset
advertising.
It
is
only part of Capital's
is
equally conservative about
distribution, such as 12(b)-l trailer
commis-
Defined Contribution employee benefit plans.
Conservative and often reserved but consistent, sustained,
and
in
making
steadily assertive
strategic in
decisions—
execution— Capital
enjoys the several advantages of having developed unusually strong
mutual fund distribution. Broker-dealers and investors /enow Capital puts
sound investing well ahead of sales or marketing
in
every busi-
ness decision.
While most mutual fund organizations concentrate on ing
and
selling to individual
consumers, American Funds Distributors
concentrates on the broker-dealers to influence their thoughts
for individual investors
will
who
sell
mutual funds, striving
and actions toward what
will
work
best
over the long term. Capitol believes that
broker-dealers are well served
and
advertis-
and
correctly motivated, they
if
con
provide the steady guidance that individual investors need
in difficult
markets to stay focused on the long term and so be
successful
in
investing.
truly
CAPITAL
64
who represent American Funds Distributors are brokers who are, of course, "economic animals." So
The wholesalers working with
the wholesalers' challenge
how
they can
high road"
devoted
is
to find the right
make good money over
and helping
show them
brokers and
the long run
by "taking the
investors to invest well. Particular attention
to assuring dealers get first-rate service
is
and providing an
array of investment alternatives that are unusually reliable
in fulfilling
expectations. takes long years of patient, persistent
It
and
work with both dealers
investors to gain their confidence, but Capital has already de-
voted those business
many
and
years to developing that
professional franchise:
vital
component
of a great
trust.
Most mutual fund organizations concentrate on building public recognition
and consumer brand awareness through
even though
cally,
it
now
serves over
consumer brand or franchise. Quite
and does not
by an
advertise.
entirely different
Like
million individual shareholder
Group Companies has never developed a
accounts. Capital
licity
20
a modern
family of mutual funds
Its
even known
is
name: The American Funds.
illustration of
ing bull markets, but
strong
the opposite: Capital avoids pub-
Aesop's fable, The Tortoise and the
Hare, Capital expects to lose market share
tention
advertising. Ironi-
more than make up
and higher market share
of
in
mutual fund sales dur-
for this with both higher re-
new
business during
bear
markets.-^
Among ested
in
those particular broker-dealers that Capital
working with,
best— usually
the
AFD
is
well recognized as
best— at every aspect
fund distribution. After distribution system
and
many its
most
is
one
of the very
and mutual
of investor service
long years of building
and
inter-
nurturing
investor service capabilities, the
its
American
Funds are clearly gaining market share— from a high base.
^In 2002 and 2003, two fund groups
—American Funds and Vanguard—joindy gained
more than 100 percent of the mutual fund sets
industry's total net sales because they gained as-
while other funds collectively lost assets through redemptions.
Mutual Fund Distribution
AMERICAN Bishop of
—
Funds Distributors
search clearly
fit
at Capital as
and put
it
to
JBL
be a 'money manager'
can't
Bishop
first
an analyst. Although
re-
much more
with his academic background, he was
interested in sales
"You
Ward
the youngest person to earn a Ph.D. at the University
Bishop started
lUinois."^
began^ in earnest with
65
in his characteristic blunt way:
if you
have no
money
to
manage!"
got acquainted with the mutual fund concept in
the 1920s, while working as a securities analyst in Detroit under
Jonathan Bell Lovelace omist and teacher
at
at E.E.
MacCrone
& Co. Then, as an econ-
Lehigh University in the 1930s, Bishop be-
came more and more
fascinated with the
whole idea of mutual
He spoke and wrote about mutual funds with increasing enthusiasm. As World War II began, two former students persuaded
funds.
Bishop to join with them in buying a screw-machine company they
hoped would earn
large profits in the
war-induced buildup of de-
mand. Bishop hated every minute of it. He was looking ternative
when
Lovelace,
who remembered Bishop
Lehigh's academic dean as a
recruiting
him
for distant
Los Angeles and Lovelace's
didn't even
to join Capital. Leaving
know what
dor: "I didn't give a
In 1947,
less
his
mentioned
al-
name
to
hard worker and was soon
Garden
Long
Island,
outfit.
Bishop
City,
unknown little
pay would
his
an
for
be, saying
with typical can-
damn."
than 10 years after
ICA had been
converted from
closed-end to open-end status,^ Bishop was working in accounting,
^Before Bishop took over tributors (w^hich
AFD, ICA shares were
distributed by Investment
was originally formed by Hayward Thomas).
He worked
Company
Dis-
with two local
dealers until 1943. Then an assistant, named Yarnsey ran the company from 1943 to 1945. Then Roy Georgeson & Company, the proxy solicitors, took over distribution for six months. Georgeson's interest was bought out for $20,000 when AFD was formed.
His career
in
academe was aborted because he would not take the time
^Closed-end mutual funds (or investment companies fixed
number of shares outstanding and
as
to write a book.
they are formally known) have a
are often listed for trading
on the
New York Stock
CAPITAL
66
but complaining about Capital's anemic getting anywhere
and
Company
saying
"Joi^^ you're
not
can help!" Lovelace invited him to see what
I
he could do to develop mutual fund
vestment
sales,
sales
and distribution
of America, suggesting Bishop
own
for In-
the whole-
saling organization. (A wholesaling organization will typically have
25
to
who
75 missionary salespeople
visit
stockbrokers, seeking to
convince them by services and persuasion to give preference to the particular "family" or
jumped I'll
at the
group of mutual funds they represent.) Bishop
opportunity: "That's for me!
pay my own
expenses;
and
I'll
quit being an analyst;
my daughter will
keep the books!"
Dramatically different in personality and manner, Bishop and Lovelace
somehow worked
well together. Bishop was bold
and out-
spoken, while Lovelace was modest and soft-spoken. Lovelace was
calm and consistent, while Bishop could
"shatter
you with words and
then melt your heart with his winning smile and another flow of
warm words," and tal
says
Graham Holloway. Bishop
decisive role in the long-term
by making a
an unusual
also played
growth and development of Capi-
special appeal to
JBL:
"All
have to
I
sell
the
is
—
name so please bring your son Jon over here!" His timing was good: The younger Lovelace happened to be considering a job Lovelace
change
(see
Chapter
2).
Stocky and only 5 salesman with a personality. saler
feet 8 inches
commanding
But he had
mutual fund
Bishop was a compelling
presence and a hardworking, forceful
little else
promoting Capital
tall.
when he began
to stockbrokers
as the single
whole-
and representing only one
—Investment Company of America.
Bishop also had to overcome an interesting marketing handicap:
Over JBL's objections
(as
explained in Chapter
1),
Eddie MacCrone's
firm had granted perpetual warrants to Investment America's
initial
shareholders.
Exchange, where they typically
Open-end mutual funds
sell at
Those warrants were
Company a
major
of
sales
a discount of 10 to 15 percent to net asset value.
for investment
companies
offer to sell
new
shares or
standing shares at the net asset value of the fund's portfolio of investments.
redeem out-
Mutual Fu nd Distribution
problem
Bishop because competitors would darkly ask stock-
for
you
brokers: *'Do
want
really
to
sell
your customers a mutual hind
that overhanging risk of dilution ot the net asset value per
with
all
share
when
JBL would
those warrants are exercised?'' (To get rid ot this nuisance, personally
buy
— and
retire
— any warrants
expanded,
offered
Company
market.) Over the years, as the size of Investment ica
67
on the
of .Amer-
simply outgrew the steadily diminishing problem of
it
potential dilution.
Bishop expansively named Distributors^
—
— and
bravado
in part
be
set off to
lar2;e
firm .\merican Funds
out of patriotism and in part out of sheer build a sales or2;anization, saving, ^'TU
enough mutual fund business fees will
new
his tiny
enough
to
so Capitafs investment
me what
pav
I
know
Bishop's stated ambition was to bring Investment
up
icas total assets
times larger
S600
over
—
to
S50 million. (Today, ICA's
nearly S50 billion
— and
I
m
sell
management
reallv worthl"^
Company of .-Amerassets are now 1,000
Capital's total assets are well
billion.)
Traveling three and four weeks at a time. Bishop recruited and trained an outstanding group of mutual fund wholesalers to do the
all-important missionan' selling sell
more
shares of the .\merican
(The 80-plus wholesalers are r\^pically after
work of persuading stockbrokers
who now
on the road from
early
represent the .-Vmerican
Monday
to late
Funds
Friday— week
week. They are proud of what they are doing, are recognized
the best in the business,
and
are
to
Funds Group of mutual funds.
as
one of Capital's outstanding busi-
ness strengths.)
Graham FioUoway, and, for many years, the
the
"'
Billy
Graham"
of
mutual fund
leading wholesaler for the .-Vmerican Funds,
Company Distributors, Company of .\merica Distributors, Inc.
^'Organized in 1939 as Investment
Inc., its
1944
In 194"^,
to
Investment
president and sole owner.
A compelling speaker.
The name .\merican Funds
Bishop once signed on
always. Bishop quit
as a
name was changed in Ward Bishop became
Distributors was adopted in 1951.
speechwriter for Wendell Willkies 1940
Going aboard Willkie's campaign train at a whistle-stop, he was haWng breakfast with Franklin D. Roosevelt's son, Jimmy. Decisive as
presidential campaign.
aghast to see Willkie
sales
on the
spot.
CAPITAL
68
explains the serendipitous
was
his career developed:
me
become an American
to
already in mutual funds, but
to
wholesaler, too.
was very reluctant
I
who Ward
"A friend
American Funds^ recommended me
a wholesaler for
Bishop and urged
way
to
I
was
change from the
small firm two of us were then running in Atlanta: North American Investors. (We'd inherited that small firm with
the unpaid sales commissions
the whole firm
—
ment.) While
I
owed
was saying 'No'
my
as a
to the idea of leaving Atlanta
Ward
poor boy
theaters,
work
the day-in, day-out hard
ment
skills
combined
HoUoway became
says
a dy-
he learned dramatics while
HoUoway was
particularly effective in
wholesalers do with stockbrokers. His
with his obviously sincere commit-
effectively
HoUoway up
a lot of business
and
could drink gin
like a
to
visited often.
Washington, D.C., where he did
They had lunch and
could soon
feel
the effects. But
the afternoon because ftinds.
Every so often,
want
don't
you're
to
we both
I'd say,
move and
gonna take
Bishop,
who
horse drinks water, ordered up a second round
of martinis. "Serious drinking was not I
any
to help individual stockbrokers achieve better sales results.
Bishop invited
"so
to
a fine sense of theater. (His father
and HoUoway
watching movies in the 1940s.)
jump
and
Bishop. At least talk to Ward.'
in the South,
namic and imaginative speaker with
seUing
to us got larger than the value of
friend urged me, 'Don't
conclusions before you talk to
had run movie
name when
big
so the prior owners just gave us the keys as a settle-
joining American Funds,
Growing up
its
we
recalls
even loved, mutual
'Ward, I'm happy where
I
And Ward would
—and continue
Late that afternoon, as he had
HoUoway,
kept on talking right through
appreciated,
travel a lot.'
this job!'
my custom,"
am.
I
say,
really
'Now,
right on."
said he would,
HoUoway
turned
Bishop down.
A
week
later.
Bishop had
HoUoway on
the telephone and was
charging straight ahead: "Get off the dime! I'm tired of talking to you.
You
are going to take this job!"
^Claude Thomas.
HoUoway
turned him
down
I
Mutual Fund Distribution
was
again, but Bishop
and
persistent,
American Funds wholesaler
prett}^
soon,
69
HoUoway was
the
from the
for the territory that stretched
Mississippi River to the Rockies.
While Capital focused on serving the long-term investors,
Bishop defined
who would
dealers
was creating
sell
a public
his target
market
AFD
at
broker-
as the
Capitafs funds to investors. So while Dreyfiis^
image through consumer advertisements
ing their growling Dreyfus lion
coming up out of the
featur-
New York
City
He
subway. Bishop accepted public anonymity for American Funds. focused directly on showing brokers
how
everyday needs was and
is
sell
me
visiting a brokerage firm,
the
priorit);
and
in particular.
he would
tell
Over and over the
small group of stockbrokers and then he
names and phone numbers of
like to prospect,"
and cheerfully
a live demonstration of
how
He was
to stockbrokers.
salesman of mutual funds in general
and of Capital's American Funds
stor}^ to a
broker's
the overall idea of mutual funds,
particularly their benefits to investors as a great
and
effective
Meeting the
AFD's most important
Bishop's objective was to
when
more
to be
successful in selling, particularly repeat selling.
widely recognized
of
interests
dial
American Funds
would
say,
"Give
a few people you'd really
away on the telephone
to use the
again,
to give
American Funds story
in
real-life selling.
A
compelling personality and speaker, Bishop never had any
interest in addressing large
groups of stockbrokers and no patience
with the "desk-hopping" approach taken by most mutual fund wholesalers short
visits.
—
selling to individual stockbrokers,
"Busy stockbrokers stop what
the office
all
manager wants
'Jack Dre\-fQS, founder
Lehigh Universin*.
of-
at a
The
challenge
the stockbrokers w^ant to go to his
people to go
the Dre\-tus Fund,
to.
time in
doing
they're usually
only one reason: because they are enthralled. develop a meeting that
one
Time
is
and
for to
is
that
money
for
had been one of "^'ard Bishop's students
at
^
CAPITAL
70
everybody, so the key
being very well organized, interesting, and
useful''
Bishop was an entrepreneur and wanted each of to
do very well
his wholesalers
within their marketing
as entrepreneurs
"The more they make,
work by
to help brokers succeed at their
is
the better!" ^^
Still,
territories:
Bishop never got over the
cost-consciousness he had learned during the Depression. (In the early years,
it
helped
when Bishop
got elected to the board of direc-
tors
of the Chicago and North Shore Railroad: The railroad paid
way
to
Chicago
mutual funds paid
their
all
to host
for directors' meetings
—
after
which he would
his sell
in that region of the country.) Bishop's wholesalers
own
expenses: If the wholesaler thought
1 50 stockbrokers for a dinner,
fine.
it
But he paid
ner himself Bishop had a clear-cut policy:
productive
for that din-
"No overhead
—and no
other business!"^
Bishop
knew the importance of his wholesalers
also
—
other personally
would want
so they
enjoying each
each other ideas and encouragement in the good times tional support in the
seeking always to
tough times. "Capital
\\2iyQ families feel
is
—and emo-
very family oriented,
happy," observes Holloway. "They
encouraged us wholesalers and our wives to get together
and
and feed
to help each other
to support each other, sharing
couples
as
ways to handle the problems of
our being on the road so much. That original group of wholesalers
grew very
'^Following
close to
J BL's lead,
best wholesalers.
Bishop paid out ' '
at
of
1
sell
the
—and we
still
are!"^^
Bishop shared ownership in American Funds Distributors with
Graham Holloway
still
remembers with pleasure receiving
Christmas in Holloway s
Bishop believed in giving the
would /4
one another
maximum
American Funds. So out of an
first
year with
a $
1
his
,000 bonus
AFD.
possible allowance to the stockbrokers
who
8/4 percent "load" or sales charge, he kept just
percent for American Funds Distributors and paid out the other 8 percent to the
stockbrokers.
And most
of AFD's
/4
percent went to the wholesalers
who
paid
all
their
own
expenses.
'^Claude Thomas,
who
introduced Holloway to American Funds,
to join Massachusetts Financial Services (at least in part out
Holloway promoted Holloway 's regularly.
to National Sales
great "fishing buddy,"
left
many
years ago
of disappointment in seeing
Manager ahead of him). Thomas continues to be visit and stay in each other's homes
and the two men
—
— Mutual Fund Distribution
Bishop always looked for ways to gain the vantage of having enough time to
and
detail.
A man who
sell
vital
71
competitive ad-
the American Funds in depth
loved to drink and
talk,
Bishop believed in
—and — he
taking small groups of interested stockbrokers out for drinks
then on to dinner and then back to his hotel for more drinks
would
really get to
know them
so
while continually
as individuals
sell-
ing the concept of mutual funds and the American Funds.
Bishop looked for connections that mattered personally to stockbrokers and particularly
bonded wanted
his wholesalers
with individual stockbrokers.
to find those special interests that gave his whole-
opportunity every salesperson
salers the
He
prizes:
extended time in a
fa-
vorable setting where he can engage the customers attention and
develop lived in
real interest in his particular
Washington, D.C., and liked to
the stockbroker, "If you like to fish the
man
gion
is
get to
product or
service.
Bernie Nees
So Bishop would say
fish.
and you ever get
to see to find the best fishing in the
to
to
Washington,
whole Mid-Atlantic
re-
your friend Bernie Nees." Or, on a different tack, "If you ever
Washington, Bernie Nees would
just love to take
kids to see places in our nations Capitol that
any of those standardized bus
tours. So, if
you
you and your
just won't find
you want
on
to get off the
beaten track and see something really special, just get in touch with Bernie Nees, and
With two-day learn
all
he'll
take
good
Bishop's support, "total
care of you."
Graham Holloway
organized a
series
of
immersion" programs, where stockbrokers would
the advantages of mutual funds
and
fund concept better
learn
why
and how
to sell the
their best choice
mutual
would be the
American Funds managed by Capital. Holloway believed that any stockbrokers
who had
spent two
full
days in Los Angeles meeting
with Capital's investment professionals, in a format the investment professionals
found
effective
with the managers and
would
naturally
want
and convenient
staff
—followed by meetings
of American Funds Distributors
to sell to his individual clients the funds
man-
aged by Capital. Even brokers not yet committed to selling Capital's funds were welcome to
come
to Los Angeles
and learn about
selling
72
C:
A
P
I
TA
L
mutual funds and about holder services, and
would
inevitably
its
Capital's investment capabilities,
He
services to brokers.
share-
its
believed these brokers
become convinced they should be
selling the
Amer-
ican Funds.
much more
Bishop was
interested in building his business with
small stockbrokerage firms than with the major
—
understood that a small mutual hand firm the 1940s
—could not hope
as Capital certainly
to be considered
He
wire houses.
retail
was
in
important by a major
wire house that would always be served intensively by
the biggest
all
fiind groups.
Bishop wanted to develop relationships where American
Funds would
clearly
be important to particular brokerage firms and to
each stockbroker at those chosen firms. For example, building business with a stockbrokerage firm like tractive to
Bishop because
it
by /^//wholesalers. "Tough
Edward
would be recognized
for
Jones's strategy
fices
having only one broker.
ters:
As
as
very challenging
our competitors makes
is
communities
offices in small
& Co.'^ was at-
Edward D. Jones
to have a large all
it
better for us!"
number of very
many
across the country, with
And
this
is
where the
small of-
difficulty cen-
Edward Jones insists that any mutual do business with the firm must do busi-
a matter of policy,
fund group that wants ness with each
to
and every branch
alized that this for every other
"Cover 'em alir Bishop
office.
daunting requirement,
difficult as
it
clearly
re-
was
mutual fund organization, meant American Funds
could create a strongly advantaged position by playing by the
Edward Jones house rules. As long as other mutual fund organizations shied away from making the necessary commitment, American Funds Distributors could be each Jones
mutual fund
Bishop and
distributor.
AFD
office's
made
mitment while other mutual fund groups did strated the sincerity
and persistence of
years, Bishop's strategy
worked
well both ways: Capital's
'^Now Edward
Jones
& Co.
better
his
and
American Funds
most important
the requisite
not.
As he demon-
commitment better.
are
com-
And
Edward
it
over the
worked
Jones's
most
"
Mutual Fund Distribution
important mutual funds, and Edward Jones
American Funds'
largest selling dealer firms.
Edward D.
In the early days,
But
mutual
fiinds, so his
Teddy
his son,
among
^"^
Jones, the founder of the firm, was
only interested in trading individual stocks. care about
consistently
is
73
He
really didn't
much
firm only offered the Fidelity fiinds.
Jones, believed he could build an important
business in mutual funds with "investor savers," a separate market
from
So he concentrated on mutual funds.
"traders."
"In the late 1960s,
"He knew and will take
I
called
visit
recalls
—and
will listen.
So Teddy waved
*Don't want you selling any big city ideas to our small
To
my
this,
small
town
tomers?'
simple reply was,
'How about
ideas that are right for
Now,
t/7^r
Teddy Jones
Holloway.
and he loved small towns, where
liked farmers,
time to
on Teddy Jones,"
if
I
town
folks
me
brokers!'
could help them
them and
off,
sell
right for their cus-
caught his interest."
told
Holloway he should come
for lunch.
arrived at Jones's office, fully expecting to take
him
When he
to the best
restaurant in town, Jones announced, "I've already paid for lunch,"
and pointed
to the
bag in
his
hand. Walking over to a bench looking
out over the Mississippi River, they
dogs and Cokes. "Teddy
said, 'Tell
Then he probed, 'Can you
did.
sat
me
together and enjoyed hot
the Capital Story'
tell this
—which
I
story without pushing our
brokers to trade?'
That was easy ing for brokers
for
Holloway, because American Funds was look-
who would
stay with
them and would encourage
their
customers to stay with the American Funds for the long term.
"All
wanted
sell
I
to do, as
mutual funds
I
told Teddy, was just to
show brokers how
effectively."
"Will you travel?" asked Jones. "Yes!" said
Holloway with obvious conviction.
"Okay, you try Kansas
^'^In
some
vears, Merrill
Lvnch
— and
sells
we'll see."
even more shares of the American Funds.
to
74
CAPITAL "And
that
was the
of
start
it.
I
must have eaten more than one
hundred hot dogs with Teddy Jones!"
Holloway remembers stopping Kansas prairie and making they were
all
his wife
his car in the
and
friends get out
flat
is
my
territory!"
a sweep of
They
all
piled back in the car. For Holloway, that territory,
would
would go
An
As
di-
all
his arms,
laughed
—and
which looked so
actually prove very fruitful because
nobody
else
there!
important advantage of doing business with Edward Jones
their customers' very
erages over are never
low
rate
20 percent annual redemptions, Edward Jones' customers
above 6 percent. Since mortality runs over 4 percent
50s and 60s
—Edward
Jones'
And many Edward
ably low.
is
of redemptions. In an industry that av-
cause the prime age group for buying mutual funds late
look.
land stretching forever in
Holloway proudly announced, with
"Stop! Look! Listen! This
barren,
and
standing beside the car thinking there truly was noth-
ing to see except the unending rections,
middle of the
low redemptions
is
—
be-
people in their
are indeed remark-
Jones investors never redeem:
They
simply pass their mutual fund shares directly to their children. With
such strong shareholder persistence, Edward Jones has been something of a bonanza for American Funds.
On Lynch.
the other end of the spectrum from
^^
Edward Jones
is
on
sell-
actively.
The
In 1966, Merrill Lynch, having previously focused
ing only individual stocks, decided to
head of mutual fund
sell
sales at Merrill
mutual funds
Merrill
Lynch was on the phone
to
American Funds Distributors every month, asking the same question: "Are
we your Number One
that other firms
had
lots
seller yet?" Patiently
of experience and
sales
explaining
momentum,
the an-
swer for several months was: "No. Not yet!" But after just seven
'^Over the long term, an important change has forced
its
way through
the mutual fund
market. Most of the big "wire house" stockbrokerage firms are gone. All the firms that were
major mutual fund distributors
in the
1960s
Hutton, E.R Hutton, Blythe, and so on tionalization of the stock market.
—
— Bache,
are gone.
Harris Upham, Hayden Stone, W.E. They could not adapt to the institu-
Mutual Fu nd Distribution
months, the answer was
"Yes!
This month, Merrill Lynch
is
75
Number
One." Since then, Merrill Lynch has been a consistently important dealer for
American Funds.
Ward Bishop met
Bill
Bagnard, his successor
as
head of AFD,
USC and courting my future wife, who was at UCLA. As a student, my special project was financing a new fraternity house for Lambda Nu Alpha, of which I was President. We developed the idea of selling construction bonds while Bagnard was
I
called
occasions
on
when
at
several different kinds
my girlfriend one evening,
her father.
opportunity! Pretty soon,
Ward
—
offer.
was one of those
rare
Ward some of our fraBagnard on a new career: sell-
was trying
I
it
of bonds to
Bishop, was at home. This was an
ternity bonds." Instead, Bishop sold
ing mutual funds
was
in college: "I
alumni and had
to the
When
still
at least part-time.
to sell
^'^
when Bagnard was heading Harris, Upham's Los Angeles office. Bishop recruited him to join AFD. In making his case. Bishop got help from JBL, who took Bagnard to lunch. With a series of probLater,
ing questions, he soon had Bagnard selling himself
switch from the pressure cooker
work of managing
on making
a
a retail stock-
brokerage office over to the calmer world of Capital and the Ameri-
can Funds. Says Bagnard with a smile,
"I
thought
a lot longer.
I'd live
Ward Bishop was a truly great salesman, but he was no businessman. So we made a good pair." Bagnard helped develop the home office operation and congenial relationships with senior people at the major
stockbrokerage firms that sold American Funds.
Bishop wanted each of
own personal Graham HoUoway.
his wholesalers to
develop his
style. "I
nisces
"It
'^
But not
mandy
right away: First
invasion,
and
serve
public Supply, selling
Bagnard had
oil field tools,
drove a white Cadillac," remi-
helped
to join the
under General George
and began
have the freedom to
me
get the attention of the
Army, land on
S.
Omaha Beach
Patton. "After the war,
selling
mutual
I
in the
worked
Nor-
for Re-
ftinds part-time at night.
I
made more money selling mutual fijnds for an hour each evening than I made in a ftill day's work selling tools, so after ten years with Republic, I went to Harris Upham and got into the securities business."
76
c:
A P
stockbrokers.
my Caddy then
fly
much
A L
r
I
^^
They
noticed.
and
in a garage
back to
my
At the end of a week of seUing,
territory
territory to cover,
stick to that schedule
had
I
—
to
home
fly
to Dallas for the
and
extra favors.
weekend
to town.
to have a schedule
worked out
make
all
park
—and
With
and drive from town
so
—and
the most productive use of my time."
Brokers can be demanding, making services
I'd
it
clear that they expect extra
But Holloway was always so well organized,
with his every hour committed to a carefully structured day's schedule, that
when
a broker
would ask him
to
Holloway could show the broker how graciously explain that kers' respect for
it
tightly organized
was impossible
Holloway and
change that preset schedule,
to change
his self-discipline
he was and
his plan.
The
bro-
grew and grew over
the years as he always stayed "on plan."
Stockbrokers wanted to go to HoUoway's meetings. tablish rapport at the start jokes.
Then, with
into the
fund
his
by
first telling
He would
some of his warm, engaging
audience in a receptive mood, he would launch
American Funds
Story. ^^ In the early 1970s,
when mutual
were very low and stockbrokers were badly discouraged
sales
about mutual funds, HoUoway's favorite speech had a surprising for a
mutual fund missionary:
Good!" Catchy enough course, a strongly
to stimulate attention, the speech was, of
dtvdopcd positive
now and with
title
"Why Mutual Funds Are No Damned case for
mutual funds.
appeal to stockbrokers to take the bull by the horns and
funds
es-
extra vigor
—even
It
sell
was an
mutual
though the times looked
dangerous, they would surely prove to be a major opportunity.
"Everybody needs a
story," says
Holloway, "a story that makes
sense to them; one they can relate to and remember. Stories are
the best
—maybe
way
ways told
stories.
the only
Everybody
when
they remember more
'^Holloway covered so much white Cadillacs
—each parked
—people
way
likes to laugh.
it
was natural
remember. So
They
listen better
they're enjoying themselves.
territory that
many
I
al-
and
Brokers
people assumed he must have several
in a garage in a different city.
'^Holloway was always sharing interesting and useful wholesalers, so
will
to
make him National
sales stories
Sales
Manager.
with the other
AFD
Mutual Fund Distribution
want so
to learn useful things that will help
made
I
certain they
would
all
learn
them
sell
funds even
new ways were so
miles, because his meetings
better,
to sell funds that
they could use." Brokers went to HoUoway's meetings,
40 or even 60
77
some driving
They
useful.
also
knew that after the meeting, which always ran from 6:00 to 7:30, HoUoway would have a case of whiskey in the trunk of his white Then,
Cadillac.
after a
40 or 60 miles back
drink together, the brokers would drive the
to their
homes, while Holloway drove
to his
next town.
Some
stockbrokers don't want to give up their hopes of success as
stock pickers managing other people's money. So, Holloway explains, "I'd just pass
ferent movies.
I
them
wanted
Nothing personal; we were
by.
to find those brokers
mutual funds and then convince them can Funds.
I'd tell
with them, year
them
And
then
AFD
want stockbrokers who
tions, particularly in those difficult
on the Ameri-
work
I'd
its
closely
American Funds. So
will discourage
usually the worst time to
sell.
redemp-
market environments when indi-
vidual investors are under the most emotional pressure to is
really sell
after year."
Capital wants long-term investors for Capital and
who would
to concentrate
the Capital Story.
just in dif-
So
AFD
sell
—which
wholesalers seek out and
build long-term relationships with conservative stockbrokers will find
term
and work with conservative, long-term
traders.
That's
why
investors^
who
not short-
redemptions for the American funds are
less
than half the industry average.
Even with
its
low
needs $40 billion in
rate
sales
of annual redemptions. Capital
now
each year just to replace redemptions. Less
than one third of this huge
sum
will
come from
the reinvestment of
The other two must come from new sales or
dividends by current and continuing investors: thirds
new new
—
over $25 billion every year
investors, creating a large
and recurring need
for substantial
business.
Using
how
—
history. Capital gives a
large a role can be played
compelling illustration of just
by an unusually
patient, stabilizing
C A
78
P
r
I
A L
who
Stockbroker
convinces mutual fund investors to stay invested
during difficult market periods. In the 1968 to 1974 market slump, the unw^eighted index of New^ York Stock Exchange shares dropped
78 percent
before the further hurt
for the negative
impact of serious
the average stock
And, many
investing forever.
who
investors 1
970s
left
During the same period, fell
83 percent.
got burned by "hot" fund prod-
the stock market
They never came
market of the next 25
bull
results
investors got hurt even worse than those market averages
back in the early
ucts
inflation.
on the American Stock Exchange
Many of the
indicate.
of adjusting those nominal
and mutual fund
back. So they missed the great
years.
Capital understands the secret to having a stable group of shareholders
is
work
to offer investors only those funds that will
well for
them through many different market environments over many years.
The
right
way
to build
business
its
is
to develop products
and
their
channels of distribution so the appropriate customer can and will find the appropriate product to that leads to
consumer
Capital's intention nitely,
loyalty
to have
is
buy and own with the
and
satisfaction^^
to repeat purchases. Specifically,
mutual funds bought and held
indefi-
with additional purchases made through the reinvestment of
dividends and future savings.
American Funds' wholesalers focus on long-term investor
and always
try to
results for the
work with those stockbrokers who
sell
what people need, not what people currently think they want. The right
fund to buy
rently will
''^
at
any particular time
market
is
usually cur-
unpopular and appears unattractive to most people.
appear most unattractive exactly
Under
in the
Fullerton, Pete Langer, with suggestions
when
it is
the best value
Investors'
Guide
to
put several
parate pieces of sales literature into a single brochure. Langer also undertook the sponsibility for writing the annual reports for Capital's several
typically "worried" over the wording.
working
his
returning to
way through each page it
10 years
later.
mutual funds.
mutual fund annual reports held up However, Langer came
to assure himself that
it
as
it
and
from both Graham Holloway and
Bagnard, organized the Investment Company ofAmerica
frustrating to have the printing of his
And
Bill
dis-
main
re-
He found
it
Jon Lovelace
to
understand that JL was
would
also read well to a reader
Mutual Fund Distribution
set to deliver
the best results over the long term. So, to be helpful to
investors, Capital believes the broker
who
is
the individual investor at the time of decision
currently popular thing. This
is
So the individual investor
when
feelings
and
difficult
will
with
in direct contact
must be well compen-
sated for doing the right thing: convincing investors not to
markets
79
do the
work.
do the
right thing in turbulent
anxieties are particularly strong, the
broker-dealer needs to have and hold the investor's trust and confi-
dence when discussing investments that go against the tide and against the crowd.
The most
helpful broker-dealer understands
and
always takes the long-term view. But that means he will often say
way most people
things that are contrary to the will convincingly say
such things
buy more" or "Stocks
are up, so
is
as
let's
sound and based on a long-term
crowd that ous
way
is
it's
perspective,
it is
not easy work to
—and go
and broker-dealers have learned they can
to protect their long-term interests
prospects appear
for long-term investment.
This
and
zations are sales driven
against the
like the obvi-
is
all
rely
on Capi-
by only offering new funds
wrong, but are
unusual.
really attractive
Most mutual fund
so will launch
Capital has carefully avoided "hot" investment ideas, ^^ the benefit of the long-term investors
it
a recent five-year period, Capital introduced
new
funds,
new funds. "Some of the more bizarre
sell.
only one
That's
new
sales.
much
and the
seeks to serve
tion of brokers looking for something "hot" to
Price introduced 14
organi-
new mutual funds when
comparable funds are "performing" well and are getting good
During
time to
be cautious." While such advice
heading for trouble by doing what looks
when investment
^^
He
to go.
Investors tal
"Stocks are down, so
and use such advice
get investors to understand
usually think.
to
frustra-
why Capital
fund, while T.
American Century introduced 45, and
^^
Rowe
Fidelity unveiled an
incredible 138 '^
ideas
of the past few
years:
given investors the Stock Car Stocks fund and the Pauze in mortuaries
March 1999.
The mutual fund
industry has
Tombstone fund, which
invests
and cemeteries." "Capital Appreciation," Christopher Oster, SmartMoney,
C A
8o
P
r
1
A
I.
has been slow and careful about introducing
new mutual
funds, rec-
new mutual funds almost
ognizing that good timing on introducing
always looks like quite poor timing at the actual time of introduction,
"We
acknowledging, sult,
Capital expects to lose market share
investors
and stockbrokers have
speculative,
a lot
launch new funds into a sea of doubt." As a
a
and Capital expects
—when
the outlook
is
—and does
lose
market outlook that
to gain
market share
some
—when
euphoric or
is
—and does
in
1994
—
at the
very bottom of the municipal
Riding the recovery in fixed income, top 3 percent of its fund category.
duced
in
1999
stantially
fund
this
later
intro-
bond market. ranked in the
The New World Fund was
intro-
of generally disappointing emerging
after five years
market returns and
gain
uncomfortable or even negative.
The American High-Income Municipal Bond Fund was duced
re-
after the Southeast Asia capital crisis^^
had sub-
reduced investors' expectations for the emerging markets
and most competitors' emerging market mutual funds were
experi-
encing net redemptions due to investors' disappointment.
At Capital, any idea
—with
abruptly
don't say,
for a
new fund
has to start
—and can
stop
the judgment of the investment professionals. If they
"Over the long terrriy investing
be a good idea for shareholders,"
it
in this
simply
fund now
can't
will
prove to
and won't happen.
Recalling one of his early contributions to Capital's successful
concentration on long-term marketing ing,
Jim FuUerton
more than
says:
"Since
interesting to
had beaten both the years.
Soon enough,
make
a startling
me
I
from
liked to play with numbers,
that Investment
Dow Jones I'd
as differentiated
and
S&P
Company
sell-
it
was
of America
averages over the prior 10
played around with the results enough to
and marvelous discovery: Investment Company of
America had beaten those market averages FuUerton became the
first
in every 10-year period."
person to show investment
results
with
rolling 10-year periods that enable investors to see for themselves
^^Also contributing to investors' caution were the severe crises in Russia and the collapse of
Long-Term Capital Management
in
1998.
i
1
Mutual Fund Distribution
the importance of cumulative long-term results. '^One year
is
8
much
too short a measurement period to provide meaningful information.
Even ten
may
years
and long enough
right direction
had enough
be too short, but
show
calculations to
outpaced the market indices for
it
certainly
most people.
for
a
is
move
Prett}-
in the
all 10-year periods."
bull
1980s and for the next few
in the late
market roared into the 1990s, Capital's
orientation kept the funds
with the
S&P
"correction,"
averages.
it
With
manages too
but
years,
"safet}^ first"
as the
defensive
conserA^ative to keep
up
the turn of the centur)^ stock market
its
two
largest stock funds.
pany of America and Washington Mutual two equity mutual funds
to have
Knowing
Com-
Investment
Investors, are the only
outperformed the
S&P
500
90 percent of the many different 10-year periods over the
porarily better
was
it
of Capital's funds are again well ahead. ^^
all
Capital cares that
years.
had
that all our funds at that time
True enough for the 33 years covered by the study when
completed
we
soon,
in over last
40
there are always going to be fund groups with tem-
1-, 2-,
and even 5-year numbers, Capital emphasizes
the consistency of those 10-year records over the ver}^ long term.^'^
"Our
job
to create wealth for shareholders," says
is
"with the least risk and the most opportunit);
HoUoway,
Most mutual fund
vestors are over 50 years old, so 10 years matters a lot to them. just don't
in-
They
have 30 or 40 more years to accumulate savings for their
retirement. "There's always a reason to save.
much, the worst your kids or in
life?
'^^In ""^
that can
charity.
So
happen
start
What do you want
is
And
if
you somehow save too
that you'll have
more
to give to
What do you want to do In particular, how do you
with your goal.
to accomplish?
the bull market of the 1950s, Capital's funds also lagged the market.
Later on, consistently superior long-term investment records
icant for investment organizations such as Capital institutional business
the keys that opened
would be
managing pensions and endowments. Ten-year
many
doors.
particularly signif-
Guardian Trust that wanted
to develop
rolling records
were
CAPITAL
82
kind of
visualize the
how
you get
will
With
its
life
you
11
want
to lead
when you
there?"
knowledge of investing and investments, Capital
deep responsibility to investors to
do and wont do.
And
retire?
tell
them
has often presented
It
what
a lot about
feels a
cannot
it
consciously as "the firm
itself
that can't do," explaining that to have the very best performing tual fund, the
manager must be very smart, do
take big investment risks in the portfolio,
Ifzn investor could pick a
—from $10
50 percent
with $10,000
He would the whole
to
at age 30,
series
$15
—
and have
York Stock Exchange by age 56
$10
to
$15
if an
than he really
at
started
age 36.
age 48; the equal of the
at
—and
way back
and
is
will
all
of
New
the wealth in the whole
to that first
It
cant happen and
it
six-month move from
be tempted to try again
real danger.
and negatives
bilities is characteristic
plified
months and
investor does get lucky, he'll think he's a lot bet-
This can put him in the risks
of luck!
lots
in a single stock.
Of course, ter
the
.
at age 44; the value equivalent
world by age 60. The obvious implication: all
.
right,
of stocks that would each go up
in every six
American Stock Exchange
—
.
he would have over $1 miUion
have nearly $ 1 billion
won't happen
of things
lots
mu-
Understanding the
—even —and
harder.
limits
before looking for opportunities
of decision making
by Mike Shanahan,^^ who
at Capital
and
and
is
all
possi-
exem-
has been a leading investor and
a leading executive in Capital nearly four decades. "I've never
known anyone who could ^^
so quickly
and consistently understand
After graduating ftom Stanford, where he played "scratch"
on the golf team, and then
from the Stanford Business School, Shanahan joined Capital, where he quickly acknowledged to friends that he intended to become
CEO. He had
already demonstrated two
long characteristics: brilliance and an acute case of stubborn persistence
through
his stellar
academic record; the
latter in the various
put himself through college with a Naval
—
life-
the former
ways he saved money. Shanahan
ROTC scholarship and money he'd earned during
summer vacations until his free-spending ways left him flat broke. Determined to make his own way, he cut costs sharply by sleeping for several months in the backseat of his car. A stubborn chain-smoker, he has almost given up flying rather than abstain from smoking, even for a few hours.
An
intense
and competitive
frustration, practices almost every day,
personality,
and continues
he has thrown golf clubs in
to play to a 3
handicap in
his 60s.
Mutual Fund Distribution
and
the essential realities of virtually any business situation
common
83
see the
sense answer to a problem so clearly," says Holloway. "If
something was ever could straighten
it
to
go wrong, Mike could figure
And
he
out, too!"
While American Funds Distributors funds managed by Capital, the funds
out.
it
managed by
distributes only
mutual
does not handle every aspect of
it
Capital. ^^
all
In a unique and long-standing
arrangement, one of the nation's largest mutual funds, Washington
Mutual, has
its
portfolio
managed by Capital and
its
shares distrib-
uted by American Funds Distributors, but the business manager for
Washington Mutual
a subsidiary of the Washington, D.C., bro-
is
kerage firm^^ that organized Washington Mutual back in 1952.
Washington Mutual's story ^^ began with the 1929 Crash. Personal trust investments suffered badly, so laws and regulations were
Many were
promulgated to prevent a recurrence. ularly in the District of trust investments to List.
No
issues,
^^
mostly issued by public
S&P's
a lawyer,^^ Bernie
Capital Research and
^''Johnston ^^
And
stocks were allowed.
and was determined
&
Poor's Blue
only about 200 individual bond
with a few from small
utilities
select
rail-
list.
Nees became fascinated with Rule 23
to learn
all
about
it.
Believing there are always
Management Company.
& Lemon.
Washington Mutual was
originally distributed separately, but since
Funds Distributors has distributed
it.
1953, American
In addition to an equity stake in Capital Research
and Management Company, Bishop owned ^^
strict, partic-
Columbia, where Rule 23 limited personal
bonds that were on Standard
roads, were admitted to
As
quite
all
After graduation from high school, Nees's
of American Funds Distributors.
first
—
job
as a
NW
Bank of Washington at 14th and E Streets vanced to Head Runner. The bank was prepared to pay mercial
—
runner
—was with
the
Com-
After six months, he was ad-
the tuition if employees
went
to
banking school, so Nees signed up. As a runner, he had plenty of time for schoolwork during
lulls in
took
a day's routine.
at least
Taking
an hour on the
a draft
trolley,
and
from downtown Washington over a runner could easily read
In 1928, an officer of the bank told Nees about a local savings director) that
had an opening,
whose son had decided
to
at far better pay, for a
go to law school
at night,
bookkeeper.
asked Nees
doing the same course of study, with the bank paying the
bills.
all
& loan
The
if
to
Georgetown
the way.
(where he was a
president of the
S&L,
he would be interested in
"Why not
go together?"
CAPITAL
84
exceptions to any rule, Nees found 10 bonds
were
selling for just 502^
everything
behind the words
is
In 1968, .American
Funds
Ser\'ice
we
far
important. \(e Ve tried to apply this thinking consistently to pects of our business.
own
its
establishing comparabilit}^ in pay
of course, important, but the
are,
105
\s do'
more all as-
Company
was organized so Capital could control product qualirv and transform .\FS from just a transfer agenc}' into a
Cody made try-
it
clear to
all
full-sen.'ice
organization.
that Capital was going to be the indus-
leader in shareholder ser\-ices, saving: 'This cut the fuel line to the
fires
of paranoia within .\FS.
To
assure accomplishing a qualit}' job,
Cody knew
that Capital
first-qualit}'
people and recognize the qualit\' job they would do. Cap-
ital
would need
would need
to inculcate this
to attract, recognize,
new and
and reward
different kind of thinking
about the shareholder sen-ices unit throughout the whole Capital organization, so one of
Cody s
priorities
was
to
make
the importance of
superior administration recognizable to ever\-one at Capital.^
This
would
increase
expenses
— and
significantly
the operating losses Capital was then experiencing
increase
— but both JBL
and JL took the long-term view and endorsed Codvs
costly
recommendations. Cody's timing was perfect. indisputably signaled.
-Ks
the shoebox stuffed with records
Bank of .-Americas
transfer agenc}' operations
Coleman Morion had been an earlv proponeni:. Bob Cody established and managed an effective Management by Objectives fMBO) program. Ks a colleague obs€r\ed, "Only after Bob retired did we realize what was required to do what Bob alwa\3 did: carefully re\'iew each indi\'idual's actual results relative to his or her objectives. ^Then we realized how much work was involved, we had to suspend the commitment for a few years and give evert'one the same percentage bonus until we had "
—
the managerial capacity- to get back to where
persons
real
—
Bob had
alwa\-s been: carefully re\ie\^ing
accomplishments and matching compensation
to results.""
each
— lo6
CAPITAL
were
in real trouble. Part
of the problem was the Enterprise Fund,"^
managed by one of Bank of Americas other customers. (The Enterprise Fund had rapidly grown very large with numerous small investors investing through long-term contracts that called for regular
monthly additions
as
additions generated
$10 or $15. These small monthly
small as
of unprofitable transaction
lots
dition, each shareholders account
had
activity.
In ad-
to be accurately priced twice
each day. All this activity flooded the Bank of America's dataprocessing systems at a time
and
so-called
dustry's
when Wall
Street
was
still
paper-based
to deliver^ ^ were severely clogging the
fails
whole
in-
plumbing.)
Making
Bank of America's
matters worse,
centralized data-
processing department was headed by classic computer technicians
who were
unable to anticipate
—
and again by capacity.
—and
therefore were surprised again
the exploding bankwide
demand
for data-processing
This exploding demand caused data-processing
and schedules
to
priorities
change often and without warning. The bank's
California retail banking system, with over a thousand branch offices,
was the Bank of America's
moneymaker, so
real
its
data-
processing needs always received top priority and were allow^ed to
jump
the queue.
And many
other profitable units easily took prior-
over such low-margin units as the one serving mutual funds
ity
including the American Funds.
^^
^Sponsored by Shareholders Management. '°In the paper-based system used in the 1960s, the broker representing the buyer
broker representing the
seller
had four business days
complete the previously agreed-on transaction. the securities, that broker had a
payment fails
—but would have —
to
were a small matter
Several brokers could not
rupted. For others,
it
was
"fail"
or a
"fail
to deliver
If the seller's
to deliver"
broker was unable to deliver
pay the cash proceeds expected by
until
volume mushroomed and
make up
fails
the difference with their
a painful, costly
for
and the
or the securities to
and would not be given the cash his customer.
Occasional
increased geometrically.
own
funds and were bank-
mess that took many months to clean up.
''Mutual fund shareholder processing was not the only casualty ter trust
money
area.
The
bank's large mas-
and custody business of serving corporate and public pension funds was starved
computer power and,
in a
few
years,
was obliged
to
drop out of the business.
SharthoUer Services
in-house shareholder senices had not been
If Capital's switch to
made when
it
mushrooming senice shortcomings
was, the
107
at
Bank
of .\merica would have severely damaged Capital s franchise with
and with stockbrokers. Cody's timely
investors
initiative
what soon would have become
Capital to dodge
a fusillade of seri-
ous senice problems.
made
Cody's persistent effons
prising the majority' of Capital for excellence
—
now^ com-
equal in accountability
with those in marketing and investing. So the opera-
dons people would be physically on with "Capital standards," .\neeles to
—
the operations group
employees
s
enabled
moved
the\'
own and
their
in equal faciliues
1983 from downtown Los
in
suburban Brea" in Orange Countv.
In the past 26 ye^js. -\FS has increased from 160 to over 2,000
and now sen es over 20 million shareholder accoimts from
.Associates
four interconnected call centers in different locadons around the
The
countn*.
coming
four
—
calls
answering
statt at
peak load
^with
e\'en' call
financial ad\isors
handle a daily average of 25,000 in-
call centers
capacity'
of 35.000
within three rings. Calls
—
and shareholders
spect. In a field
where 60
nimover
is
at
.\FS
and
from 180,000
60:40 mix. The
to
"The move
to Brea
cnndnues to
—
-^
scr.e
San Antonio, Texas; Norfolk, Virg
"^The lowest employee tuniover
which
at 13 percent,
is
is
in
'.:
7
r
highest
chums would not be accepted at AFS.^ 1 effort: Before the move to suburban Brei
—
in
AFS
;
li-'
^:
—
_
.
T.i't: T.u z-tzT. '
for investors
Hampton
Roads,
Wi-
pays good bonuses for
.dr pexsooal pals because
.
:
strives to
of Navy families ftom the
_W
-
.
thev know that Capital has verv high hir-
of .Associates to
new offices
is
:" *?r5
driven b
:t
the
'rniianapolis, India na.
C^
maior U^. htnry base at Nodblk. ""Itoil good introducnons. Associates are often
common,
re-
:A. In the 1990s, branch c^Bces were set 1
r
if transfers
eel for opening :
is
only 9 percent."' .AFS
it is
:
^arounc
with equal personal
percent turnover
only 12 percent, and
or sfaaieholder services or both
of other fund com-
le\ el
are treated
"^0
other Capital units are excluded,
ginia,
in
a standard of
.APS senice centers differ from the investment organization in
panies' senice ztr.ztz stafrs
in
come
usually in a
education and pay, but are well above the
up
—and
: ^
:
1
:
:"Z"-ize
that
many c^ their
^:.-r;d through ddibeiaK
ckkse to 'industrr
nomiaL*
io8
c:
A
p
r
I
A L
increase service capabilities years,
and lower
costs every yearJ"^ In recent
powerful information technology capabilities enabled
its
to serve five million additional shareholder accounts
additions to staff Put another way, the
with only 100
number of accounts
American Funds
served
And
per Associate has increased from 5,000 to over 9,000. greater productivity enables the
AFS
this
to keep expenses
charged to the American Funds well below industry norms. People feeling good about
what they do
And
tion.
is
who
central to people
their direct supervisor
they
where they
are,
are,
and
wanting to stay with an organiza-
how
key to
is
people
on the
feel
all-important "soft" dimensions, so Capital devotes extra time to
helping supervisors understand and appreciate the great importance
of their
Being truly respectful of people
roles.
middle management or
effective
line
—always —
supervision
takes
person-to-person involvement over years and years and
One
Capital's flat organizational structure.
employee benefits
is
of
like a big
it's
work
still
Funds' low shareholder redemptions or
gaining market share
is
very
visible: the
determination to convert
Tim
Weiss came out of Cal State
heard of Capital or AFS, but tion
—
Capital Data Systems
nications
—
all
Jim FuUerton
at
American Funds reports from
Northridge
I
was assigned
as
an
an English major.
ombudsman
first sight:
company
This was family
after
company
Kevin Clifford.
do not
just
—and an opportunity
became President of American Funds Service Company '5
as
needed a job and was lucky enough
to join AFS's
to
get along. I
It
never
IT opera-
commu-
— two groups
show what
in 1987.
"I'd
to help facilitate
and cooperation between the end-users and the producers
understandable reasons in love at
I
written
"The American Funds' written
materials are tops," says Cody. This traces right back to
1976,
unit. "If
usually to celebrate something pretty lighthearted
materials produced for shareholders.
'''In
popular
win by the Lakers." ^^
turnover while
his
helped by
6 to 8 days each year we declare
clearly the
One reason for American
and
direct,
an indicator of the personal warmth and infor-
you ask our Associates,
—
is
AFS s most
mality underlying the strongly productivity-conscious
Denim Days
the key to
that for
was, for me,
could do." Weiss
Shareholder Services
simply meeting the
109
requirements into being truly interesting
legal
reading that informs shareholders and gives
them
useful understand-
ing about their investments. After joining Capital and reading the pedantic, legalistic text of the annual
and quarterly reports that
fund managers were then
all
sending shareholders, Fullerton decided to make American Funds' written materials the very best.^^ Searching for Best Practices, he
gathered in every example he could find of what competitors were doing, and then committed to provide attractive graphics and to write the
most informative and
accessible text in the industry.
we
"Capital has never advertised and Fullerton, "but
we decided and
readable, interesting sitting
on the
to read
them and
learn
—we work hard
useful.
We
what they
is
don't
want
them.
to have our reports
We want our investors
ought to know about
really
make them
to
that way," says
it
reports to shareholders truly
—but
their,
is
so very impor-
reader-friendly
and rewarding
not an easy subject
for the time readers invest in
readers
make our
coffee table, just looking pretty.
funds. Since investing tant
to
like
We
really
want
to educate
our
readers with the
first
and have our reports understood."
As a
writer, Fullerton
knew he had
to
hook
sentence and then develop a story throughout the report. alized that layout devices like sidebars
would make the
He also
reports
re-
more
readable; that highlights in large type enable hurried readers to get
the
main messages; and
readers.
One
report took
that pictures of people are important to its
main idea from
given, using his experience as a leading
a talk
Bob Kirby had
amateur race-car
driver. "In
investing, as in auto racing," explained Kirby, "you don't have to
win
every lap to win the race, but you absolutely do have to finish the
While
race.
a driver
""Fullerton also served as
Company News
Institute, in
must be prepared
to take
Chairman of the mutual fund
1973
to 1974, the last
some
risks, if
trade association,
he takes
The Investment
two years of the severe bear market. U.S.
& World Report ^^oit that Fullerton was well suited to the job because he had— and
would
surely need
—
a
good sense of humor. Chuck Schimpfif and Bob Cody had both
served at earlier times and Paul
Haaga would
in the early twenty-first century.
no
C A
too
many
risks
P
r
I
A L
risks, he'll
—and
wind up
there are risks that
against the fence.
make no
sense at
There
are sensible
all."
In 1974, after a long, severe bear market, another report to investors spoke about the possibility of there being a great buying op-
portunity, asking the embattled investor's natural question,
should
I
do with
my money nowV
For most investors,
one of the harshest market experiences
compared
had been
so FuUerton
that market's difficulties with those of the prior worst
market: 1937 to 1942. "Back then,
were
memory,
in
it
"What
we were
in a
major war
—and we
Excess profits taxes were being imposed; price controls
losing.
and rationing were on; and our former international business markets were largely closed to really
American companies. That comparison
put things in perspective. Luckily,
Within days of going up
—
coming
that report
eventually, of course,
way
my
timing was right too!"
out, the stock market started
up.
Governance, a very different kind of service to investors in mutual funds, involves selecting mutual ftind directors and providing
them
with the information they need to carry out their responsibilities fectively.
but
at
Mutual funds
many
are required to have
pendent
directors, the
not
all
that
investment manager that sponsors the fund
(Fund management companies
who
receives consideration.
easily recognize the
ing "cooperative" directors, and at
some fund
gate annual compensation for a director realities,
is
notionally chosen by the other inde-
is
often has considerable influence over
Given these
independent directors,
organizations, the degree of independence
obvious. Although a director
ef-
is
advantages of hav-
organizations, the aggre-
over a half-million dollars.
the risks of cronyism are obvious.)
In clear contrast. Capital's approach to fund directors has long set the highest
standard in the industry, a tradition that dates back
to JBL's early days in the
mutual fund business. Lovelace knew
prominent people, so following
his lead, directors
of funds managed
by Capital have always included the Los Angeles business
JBL
believed in having strong
and
truly
and in keeping them very well informed on
independent all
elite.
directors
matters of potential
Shareholder Services
importance so they the right questions
know
will
and
ill
they are fully informed and will ask
on getting good answers on matters of
insist
governance. Capital looks for experienced people the difference between governance and
who
understand
management and does not
want
directors discussing individual stocks or decisions'^ because
that's
management. Later on,
rectors at
it
was
idea to have the funds' di-
JL's
chosen not by the management company,
as
most mutual funds, but by the independent
serving
now
on each
fund's board. (A
directors already
to Capital, the
commitment
to
watch out
long-term investors shows in
new product on
many
for the long-term interests
of
ways: creative conservatism on
introductions; consistent "steady as she goes" perspec-
investing; informative reporting, always with a long-term
perspective; consistently superior service to investors;
and the
mination to keep costs down, minimize capital gains charge low ital
SEC
requires this procedure.)'^
Capital's
tive
compliment
was the practice
management
fees.
Long
deter-
taxes,
before others got interested,
was conscientiously concerned
for
and Cap-
shareholders about taxes,
its
particularly in seeking to avoid taking short-term capital gains.
Capital will wait to launch a
down good
so that investors results.
Some
call Capital's
until the
market goes
invest at the launch date will achieve
brokers, wanting product to
for a particular type
they
who
new fund
of investment
is
strong,
sell
when demand
complain about what
"holier-than-thou" attitude. For example, Capital
McDonald remembers, "When I joined the Company of America, as the youngest Director, in the mid-1970s, Director, always took the time to talk with me about director con-
^"Stanford Business School professor Jack
board of the Investment
JBL, then an emeritus duct
—how
directors could best contribute to the
vividly a board meeting in
fund and
its
investment in a semi-conductor company, which he regarded
JBL,
sitting at
my
shareholders.
1976 when one independent director was
right side,
whispered to me, 'That speech
helpful to the portfolio counselor
who
has to
pression on me, and I wish that every new wisdom and experience of JBL."
'^Bob Cody, Jon Lovelace, and Jim
make
may
the decisions.'
director of a
RatzlafiF, for
at the
many
critical
time
I
remember
of
a specific
as too cyclical.
be heartfelt, but It
it is
not
made an enduring im-
mutual fund had a tutor with the
years,
were the key people
sured the strength of and worked with the directors of the mutual funds.
who
as-
CAPITAL
112
has run an emerging markets portfolio for institutional investors
with strong
returns''^ since
1986, but brokers buttonholed Capital
and asked v^hen such
executives
a
fund would be available to indi-
vidual investors, they always got the response that the public couldn't
be expected to understand fully the serious downside ing in
by
less
of invest-
developed countries. So, although Capital International
is,
the largest manager of emerging market investments for insti-
far,
tutions. Capital decided not to launch an
fund
risk
emerging markets mutual
for individual investors in early 1997.
would
The
fear
was that
it
too well and later on result in investor disappointment,
sell
because investing in emerging markets involves exposure to the risk
of major changes in valuation. ^^
Then had
lost
in 1999, after the average emerging-markets
mutual fund
—and
well over 50
10 percent a year since the end of 1993
percent in aggregate that
would
market,
it
—CapitaF^ was ready
invest in
launched
to roll out a retail
fund
emerging markets. At the very bottom of the
New World
Fund,^^ carefully composed of
emerging market debt and the stocks of international companies headquartered in developed countries and doing substantial business in the
emerging markets.
Not doing what works is
for other
fund management organizations
a familiar policy at Capital. Back in 1974,
JL decided not
or compete with Fidelity and Dreyfus in offering funds, partly because he didn't to switch out of stocks at
want
^"^
time in the
money market
to encourage Capital's investors
what could and did prove
low, but primarily because he felt Capital at that
to follow
had no
money fund management
to be a
special
market
competence
business. ^^
(Nor did
SmartMoney, March 1999.
^^Even in the institutional Emerging Markets Growth Fund offered by Capital Interna-
new
made available to investors each year are carefully limited. Management Company. ^^ With implementation leadership by Rob Lovelace and Mark Denning. tional, the
^^
shares
Capital Research and
^'Abner Goldstein,
California's
Deputy Savings
Pat Brown, joined Capital in 1966
and helped
set
& Loan
Commissioner under Governor
up Capital Data Systems and then advo-
cated and took the lead on developing fixed income investment management.
"
Shareholder Services
superiority, but others
any other manager have demonstrable
113
went
ahead with their offerings anyway.) After the stock market began covering, Capital developed the specific skills
and did
offer a
re-
money
market fund. Capital's caution tal's
clearly constructive.
is
"A
real strength
of Capi-
franchise with stockbrokers," says Wally Stern (see Chapter 10),
"comes from our never having to apologize to brokers and, even more important, from their never having to apologize to their investors." Capital, like
investment managers,
all
is
a
combination of two
very different disciplines: a business discipline and a professional dis-
"We
cipline.
always to put the professional investment disci-
strive
pline ahead of the business discipline," explains Bill Hurt. "Speaking broadly, there are four widely recognized professions: law, to keep
you
out of trouble or get you out of trouble; the ministry, to help you find
and
stay with your religion; teaching, to
show you how
to learn
and
understand; and medicine, to keep you alive and protect your health.
We think there is a fifth profession: age their
money and
In 1995,
two young
Dave
helping individual investors man-
their relationship to
Short"^
men who
and Kevin
money."
Clifford^^
were identified
as
could provide the leadership that would build
the business and develop the necessary alternatives to
AFD's longtime
stubborn commitment to having only one share
class
As Ward Bishop often
hands.
^^
Dave Short grew up
where he
said: "We'll explore
communications
in Pittsburgh, studied
sen-^es as a trustee,
and joined
AFD
as a
at
of mutual
any alternative to
John Caroil University
wholesaler in 1985 after a few years at
Federated Securities. ^^"In 1981,
1
was working
for a contractor in Chicago," says
from Wabash College (where he now hire
younger people
wanted
my
to give
up part of his
AFD
—
9-state territor)'
wanted
(The formal training program
was see
poning our
so
for wholesalers I
a salesman
trip for a
I
really
few weeks
now
to
takes four months.)
I
knew
I
program.
was
really
was getting married and the training program
am,' and called
—and going
graduated
Gary Reamey of Edward Jones gave them
to start. So, I said to Graham: 'Let me my fiance and proposed: 'How about post-
on the very same day our honeymoon was
how good
who
to hire five people for a three-week training
but there was one big problem.
to start
Kevin Qifford,
"Graham Holloway was looking
of the wholesaling group, and Jim Skinner
to offset the steady aging
name. At the time,
interested,
ser\'es as a trustee).
to
Hawaii instead of Cancun?'
— CAPITAL
114
anything
one
—with one
exception: There will never, ever be
many
of shares!" For
class
American Funds and
From
the 1940s through the 1970s, both brokers and investors
with one
class
of shares
—
the "A" shares
had
sales charge, or load, schedule. All investors
better off with
A shares
decade to
offset the sales charge.
Capital's decision not to
pricing.
it
the
they were being
would
a series of
enough
save
in a
in the
unwise innovations in
market significantly
al-
important for Capital to change.
Rothenberg took Short and Clifford out
them
to be
go "no-load" and has been the solid founda-
But major changes
and made
tered reality
do
This understanding was central to
from which Capital fought off
mutual fund
to
than with any alternative was simply to hold
the shares long term because Capital's low fees
to give
right for
right for the long-term investor.
were generally better served with one
tion
more than
had been
years, that policy
for dinner in
good news: Even though they were
made chairman and
president and
Los Angeles
just
38 and 42,
co-CEOs of AFD.
Clifford was delighted. Short was aghast.
Clifford liked Los Angeles, but Short's family was deeply rooted
Being forced to move to southern California would
in Pittsburgh:
be a bone-breaker. Rothenberg for a
let
the tension build in Short's
few long moments before dropping in the clincher: Given
modern technology and communications. Short could manager from any location
sales
move
not need to
As the new
work
to do.
—including
Pittsburgh.
AFD,
—and AFD needed
Capital
an increasing
Short and Clifford had important
Funds.
know
(When
that's
firms
Bill
try, at
Hurt was
what we
felt
—
in senior
also
been
were mov-
business model. ^^ Instead of
that the sales charge, or load,
the senior
incorrectly
had
to change, too. Stockbrokers
rate, to a different
knows from experience
some brokerage
He would
Communications technology was not the only way
changing ing, at
operate as
to L.A.
leaders of
things were changing. Distribution of mutual funds
^^
mind
is
seen as substantial, so
management level, to deemphasize the American management at Dean Witter, he acknowledges, "I and tried to do at Dean Witter.") In the 1970s,
—
Capital considered switching from load funds (with a sales charge that gets paid largely to
Shareholder Services
115
being paid for transactions with advice provided free of charge, the
new model had
brokers being paid for advice, with transactions pro-
vided free of charge. As the industry was transforming, AFD's consis-
commitment
tent
to "wasteful."
to
AFD
victor}^ (a victor)^
one
single class of shares
had gone from "wise"
appeared to be working hard to achieve a Pyrrhic
not worth winning) because
AFD
had the domi-
nant share of the most rapidly shrinking channel of distribution in the mutual fund business.
"A too-standardized marketing strategy free
is
simply not okay in a
and competitive market," acknowledges Rothenberg, pointing
out that brokers were shunting
sales
over to other fund groups that
offered several different share classes with different sales charges. All three
men knew
that major change
was needed, and Rothenberg,
w^ho had switched back from the institutional business to help
man-
new lieutenants: "What success?" and set down a key de-
age the mutual fand business, asked his two will
you
fellows
cision rule:
need to achieve
The new
real
pricing arrangement
would have
to be fair to
the funds' current shareholders. Privately,
there were
Rothenberg advised Short and Clifford that since
no simple answers that would
for existing shareholders
and
the brokers
also
be really right
and new
investors, they'd
be smart to get Shanahan engaged in working out the solution early in the process.
Rothenberg knew Shanahan's
proach of asking question
the stockbroker
who makes
made by Jim FuUerton, who and
is
after
question would take time.^^
the sale) over to no-load status. feels a
The
deep obligation to do the
highly regarded within Capital
indirect, Socratic ap-
Group
case for not changing
really right
thing
all
was
the time
for asking just the right questions
during
business discussions or organization retreats. His case for keeping the sales charge was
based partly on the investor's need for a steadying advisor during turbulent markets. This
meant having someone paid cost to the investor in the
well to
do that
American Funds
work; over 10 years, however, the
difficult
—when
the initial sales charge
combined with
the organizations low annual
the annual fees
and expenses of most no-load funds.
-
Rothenberg
management
also advised his colleagues to schedule
early in the process
—and
well before any questions
fees
is
total
amortized and
and expenses
—
is less
than
time with Jim Ratzlaff and Paul Haaga
would be
raised
by the fund
directors.
CAPITAL
Il6
many months of analysis and running computer
After
tion after simulation to look at
simula-
the options ftom every angle,
all
they agreed on a series of alternatives.
It
took American Funds from
one pricing structure to fourteen to cover each significant segment
of the complex mutual fund market
—
four plans for college tuition
savings plans, five for retirement funds, four for retail sales, for the financial
planners. ^^ "I
never realized that being
and one
fair w^as so
very difficult," Clifford confessed to JL, w^ho replied laconically: "Yes,
it
usually
is."
The combination of variations is
on pricing
working very
w^ell.
match
to
different investor groups' preferences
"During the past decade,
been one of the
v^e've
strong investment results and the several
fastest growling
mutual
it's
reported to us,
fiind
management
organizations in the industry," says Rothenberg v^ith understated pride. "In 1987, w^e
ranked fourteenth and today
And we
have done
yond
expectation because
all
vestment
among
results
deliver
good value
the brokers
attract
who
sell
and keep the
as
—
—
in-
doing the right work
When
when
momentum
overall
mutual fund
the stock market declines,
sales
slow
AFD's
reg-
gains increasing market share. to
AFD's mutual fund
because the American Funds really delivered on their promise,"
^^B shares convert to shares
and
year after year and particularly dur-
"The 1987 market break was important sales,
in service
Capital believes the broker simply must earn ap-
they always do
steady sales
ular,
funds grew be-
sales.
right stockbrokers
propriately high rewards. ^^
down,
third.^^
mutual funds." Capital currently has
with investors in the right way ing bear markets
rank
and because we've developed very strong support
the leading market share in mutual ftind
To
Our
this the plain vanilla way.
we
v^e
is
A
shares after 7 years,
limited to $100,000. There
is
no
sales
and the amount charge for 401
(k)
that can be invested in
B
purchases or for sales over
$1 million. ^"^In
1974, gross
made ^°
Selling
and
a
sales
by
AFD
were only $75 million. In 2002, $75 million
in sales
were
every 2 to 3 days, and total sales exceeded $70 billion for the year.
$400
few (nine
to in
$500 million of fund 2001)
will sell as
shares a year
much
as
is
$1 billion
considered very good for a dealer,
of mutual ftind shares
in a year.
I
Shareholder Services
"Competitors had hurt themselves by pushing a
ClifFord.
says
lij
bunch of short-term products, hke closed-end bond funds and short-term multimarket trusts that
maybe looked
but in the long run, really didn t work
"We
just will
at
great for awhile,
all.
not even begin to offer to get 12 ounces of juice
The investment guys at Capital had said just couldn't figure out a way to deliver superior long-term rewith those products. Here's the acid test: Can we really do for
out of an 8-ounce orange. they sults
the investor something he cannot do for himselfi^"
An
important aspect of Capital's contract with investors and
stockbrokers fidence.
is
that
it
works consistently
As Graham HoUoway
And
bagged 'emi
that
means
says,
to earn their trust
"We're the only guys
a lot, even
centives of being well paid for today's
more than
work
—
and con-
who
never
the financial in-
particularly for our
kind of investor and our kind of stockbroker, the ones who're in for long-term results. In the long, long run, the
American Funds' redemption ers, is typically less
ages 25 percent;
good guys do win."^^
or loss of mutual hand sharehold-
than half the industry average.
The
American averages about 12 percent.
industry aver-
^^
mutual funds have grown by producing
Capital's
term investment
"When
rate,
results;
it
by developing a powerfiil
steady, long-
and
sales
service
Management went public, JL must have been concerned," recalls management company (despite Jon Lovelace's cautions about getting into the mutual fund business, when Fletcher asked his opinion after services at the church they both attended) for $50,000 when the fund it managed had only S2 million in assets. Some years later, Fletcher briefly enjoyed seeing a market valuation of
^^
Bill
Hurt.
Shareholders
"Doug
Fletcher bought the
over S40 million for his part of the business. "It
must have been hard
Fund did
for
He was
JL because the
not do well as investors. In
fact,
in the
newspapers
all
the time.
vast bulk of investors in the Enterprise
the fund's investors did quite badly.
To
JL, that
just wasn't right."
Enterprise
ment. Although
Fund was it
in the Enterprise
the principal mutual fund sponsored by Shareholders
was advertised
Fund
Funds with
American Funds has over S20,000
a total of
amount with other mutual fund over 575,000.
Manage-
"high performance" fund, the average dollar invested
received far lower returns than the market averages.
^"^The average investor in the the .\merican
as a
in a
S40,000 invested. Since they
families, their total
fund and owns
t}^pically
tw^o
of
have an equal
mutual fund investments
are usually
CAPITAL
Il8
Table
Differences from Inihjsiry
7.1
Norms
American
Industry
Funds*
Average
(%)
(%)
American Mutual
0.58
1.43
Income Fund of America
0.61
1.34
.73
0.56
1.43
.87
Washington Mutual
0.64
1.43
.79
Growth Fund of America
0.72
1.51
.79
New
0.79
1.83
1.04
0.69
1.51
.82
0.90
1.92
1.02
0.63
1.43
.80
Investment
Company
of America
Perspective
AMCAP Fund EuroPacific
Growth
Fundamental Investors *Includes 25 basis points for 12(b)-l
Difference .85
fees.
organization aimed at servicing brokers^^ and financial planners;
and by keeping annual mutual fund operating expenses tal s
mutual fund annual expense
dustry average.
^"^
is
and we keep them
low
very
—
less
than
\
of
1
fees
were
internally consistent
whole family of funds. So the marginal
across our
only half the in-
Rothenberg explains, "Our mutual fund
set originally in the 1930s,
assets
ratios are typically
low. Capi-
on marginal
fee
percent for the Investment
Com-
pany of America." Capital quietly emphasizes differences as
shown
its
low expense
from industry norms on
in Table 7.1.
A shares
ratios,^^ citing the
for several
Such differences can and
will
of its funds,
add up
—
for
the long-term buy-and-hold investor.
A
difficult
question of appropriate practice came to a head for
Capital and the independent directors of the American Funds in
^^Not
far
from the old 80 20 Rule, 71 percent of AFD's
the brokers ^^
:
who
For example,
sell
Fidelity's
Magellan Fund, which
ment Company of America, ^^
is,
of course,
total
is
come through 17
percent of
much
American Funds
expenses divided by total
than 25 percent larger than Invest-
less
generates three times as
Part of the low expense ratios of the
ratio
sales
American Funds.
is
assets.
in
due
management
fees.
to their large size, because the
Shareholder Services
119
1988 with the introduction of 12(b)- 1 programs. ^^ (The 12(b)-l programs pay
a
are
named
for
SEC
an
regulation that allows mutual funds to
who
continuing annual service fee to broker dealers
provide on-
going services that encourage investors to maintain their mutual fund investments.)^'^ Before 12(b)-l, the brokers received
sation in
one lump payment through the up-front
—and had no
"load"
him
to encourage
their
all
sales
compen-
charge or
incentive to continue servicing the investor nor
to staying the course
with his fund. In
fact,
a bro-
ker was rewarded for persuading the investor to switch from one fund to another. For cynical brokers, the goal
they could pick up another sales charge on
as frequently as possible so
the purchase of the next hurts investors,
who
usually because
its
new fund, and then
leave a
the next.
fund that appears
Most switching
to be underperforming,
particular type of stock has been lagging relative to
the overall market; and then well because
was to encourage switching
buy
into a fund that appears to be doing
type of stock has been leading the market. Unfortu-
its
nately, this often results in a
whammy with the investor selling
double
low and buying high. Industry data indicates such switching in investors losing
more than one
they would have earned
if
third of
all
results
the investment returns
they had simply remained with the mutual
funds they already owned.
The movement
to 12(b)-l fees
—where
the stockbroker gets a
Va
percent annual service fee commission^^ for as long as the investor
same fund
stays in the
^^
Graham HoUoway
^^While studying
Haaga worked
is
—
has changed the whole concept of the
recognized as the father of 12(b)-l programs.
for a joint
M.B.A.-J.D. degree
at the Universit}^
part time at Wellington for Jack Bogle
tuses
and shareholder
1974
to 1977,
1985,
when Jim
reports. After graduation,
and then joined Dechert, Ratzlaff heard that
to leave private practice,
come
talk
Price
with us
for
of Pennsylvania, Paul
$6.00 an hour
he went to the
&
Haaga might
—
SEC
—
in
writing prospec-
Washington from
Rhoades, where he became a partner. In
leave,
at Capital.'
he called and
With two
said, 'If you ever
decide
brothers already living in
Los Angeles, the idea of living on the West Coast was "not out of the question," and Haaga joined Capital in 1985. ^
When
and
1
introducing 12(b)-l
5 basis points
on
fees.
Capital charged 25 basis points
existing shareholders.
on new shareholders
CAPITAL
I20
mutual fund industry. With 12(b)-l, the stockbroker
receives a ser-
The
vice fee each year as long as the investor remains invested.
stockbroker
now
has a major incentive to
the fund that
sell
is
right
term and then to provide service so
for the particular investor long
that the investor stays invested.
In the beginning, the largest stockbrokerage firms campaigned
hard to bring 12(b)-l plans into being. They started with the smaller
fund groups with the weakest investment records and said something
"You know,
like this:
we'll
completely. But there to you. If you
would
one
is
set
probably have to stop selling your funds
up
last
hope we
might be able
just
a 12(b)-l program,
your fund shares." Given
to continue selling
to offer
we just might be
able
this proposition, the
weaker mutual fund organizations had no choice but to go along.
Then, 12(b)-l programs spread
Now, they
izations.
The annual fund
—which
and stronger fund organ-
are the industry standard.
12(b)-l
payment
to the broker^^
increases the expense ratio,
the fund's shareholders.
encourages a
to stronger
closer,
and
paid by the
is
this cost
is
borne by
Over the long term, the 12(b)-l
longer-term relationship between the investor
and the stockbroker. This should bring
greater stability to investors'
and
behavior, particularly at major stock market stress points, stability
is
all
trailer fee
this
expected to be good for everyone invested in the funds.
Capital studied 12(b)-l programs thoroughly and concluded
could and should provide industry leadership on issue.
Capital decided that the upper limit
held to 0.25 percent^^ and that above this expenses would be borne by the
^^
Depending on the firm and
its
on
level,
this
it
major pricing
service fees
would be
any 12(b)-l program
management company,
not by the
type of business, the broker will keep somewhere between
35 percent and 90 percent of the 25
basis points as
long
as
he or she
is
the listed "broker of
record" for a particular investors account. '^^As a "transitional bridge," the
holders, whereas
has held and sales
charge
new
now
rules.
assets
the
funds paid only 0.15 percent or
less
on
established share-
paid 0.25 percent. American Funds put forward the pattern.
same pattern has been confirmed by the
NASD
in the
It
maximum
1
Sha reholder
mutual fund
by
^
5%
1
2
offset
on new purchases (and add-on investments by
current shareholders). Capital reduced the percent^ to
would be
investors. Second, the 12(b)-l service fee
a lower sales charge
Services
initial sales
charge from
Sh
percent and completely eliminated the sales charge for
investments over $1 million
"The 12(b)-l
fee the
—and
for
most 401(k) retirement
fund pays out
for investor service
tention can be greater than our incremental
management
plans.
and
re-
fee for
continuously managing these same assets," observes Rothenberg.
"These service
man
—
right
as
much
as
on coming,
tent business. size
fees
can really add up for a strong mutual fund
$200,000
to
$250,000
a year
—and
they'll
sales-
keep
year- after-year, if the broker has sold good, persis-
And that's what we and our wholesalers
always empha-
with the stockbroker."
"^^The SVi percent load was an artifact of the 1950s,
when
brokers were diverting small
accounts into mutual funds and the individual broker pocketed $400 on a $10,000 investment.
CHAPTER
ACQUISITIONS
AND START-UPS
NOTES FOR READERS The record of corporate mergers and acquisitions often, the price
sumed
paid
is,
in
because so many acquisi-
They are driven by the knowing
out— not purchases by an
not good. Too
retrospect, too high. All too often, the pre-
strategic synergies are never found
tions are really sales.
is
astute,
seller
who wants
informed buyer. Acquisitions that
fail,
as a majority do, are driven more by emotion than rational judgment.
The record of acquisitions
been
the investment
management
field
has
particularly poor.
Capital, however, tions
in
has
by being rigorously
long-term value
when
made
rational; being
others
In
it
prepared
to look for
were concentrating on
of short-term cyclical adversity;
able so
several highly successful acquisi-
and see
the acute distress
and by having ample resources
avail-
could buy on favorable terms.
addition.
Capital has
made
itself
the
being the kind of organization that inspires
123
preferred buyer by trust
and confidence
124
C A IM
that
combining
A L
1"
Being trusted
into the Capitol
to serve
organization
mutual fund shareholders
will
work out
faithfully,
even
well. in
the
worst of times, has proven decisive. Even acquisitions not consum-
mated have brought key people
to Capital.
Capitol's successes with acquisitions have several attributes: favor-
able financial terms and modest use of capital; clear strategic business complementarity; and thorough organizational integration.
Not everything Capital
Some moves
but
failed,
tried
in
corporate development worked.
some moves succeeded beyond
all
ex-
pectation.
# Group's largest
CAPITAL while
and
acquisition began with a failure,
largest start-up failure
its
began with dazzling success;
a highly successful venture capital investment
nearly failed to get started at
In 1963,
when
it
was
program very
all.
likely that
San Francisco's
Common-
wealth group of mutual funds would be sold,^ Commonwealth's
Bob Cody
invited Capital's
Chuck
Schimpfif up to San Francisco
for a luncheon.
As they talked together over the next few weeks,
both saw a
combination of strengths: Capital's
real
vesting could
combine with Commonwealth's
and shareholder good one, but
it.
As a senior
abilities in
custody
services.
Cody and Schimpff were a
abilities in in-
classic pillar
sure the combination
would have been
northern California parochialism precluded
of the San Francisco Establishment, Waldo
Coleman, the controlling stockholder
in
Commonwealth,
couldn't
bear to merge his fine San Francisco firm into an organization based in
'
— ugh—Los
Angeles.
And
that ruled out Capital.
Ultimately, 34 potential acquirers got involved.
Acquisitions
This came
as a grear surprise to
and Stait- Ups
final negotiations
25
Cody,- rhe president oi the
Commonwealth Funds, who thought he had been complete
1
authorized to
with JBL.
member of the San Francisco business establishment, swooped in. The president of Fireman's Fund was determined to acquire Commonwealth and get into the investment management business.' The goal was to replicate with Stanford's endowment the kind ot investment firm others Fund
Fireman's
had
set
up with
Insurance, an accepted
Yale. Har\'ard.
ments and then build
a
and
MIT
to
manage
endow-
their
profit-making business managing corporate
pensions and mutual hands." Fireman's
Fund
bid a zero fee to win
the Stanford account.
"WTien Commonwealth was sold Codv. to
"'I
immediately resigned
and without even
a
CEO — without
as
mention
Fireman's Fund,'' says
to
o\
my
a
new
job to go
plans to Capital.
I
called
Jonathan Bell Lovelace on the phone, and he asked right away, AXTien can you come to Los
.-Vngelesr' "
Cody would
play a key
"Cody had joined North .Ajnerican Securities, the investment manager and custodian for the Commonwealth Fund, as an analyst afcer graduating from Stanford and Stanford Business School in the late 1930s. Later, he got deeply involved in ever\- aspect of to the rules
conforming
and regulations under die Investment Company Act of 1940. The 1940
act
modern mutual funds industr}-. so he knew all the ins and outs of the mutual fund business. Years before, when ottered a starting job at Commonwealth, Cody had jumped at the chance to get into what was considered to be the higher class work
was the foundation
for the
of administration. .After all. in the 1930s, investment people were looked down on as guys who all wore green eyeshades. At Capital, Cody would find indicators of status reversed. The administrative staff ere the ones wearing green e\^eshades and laboriously calculating n*.
by hand the net mione\- or
asset value
redeem shares
of mutual funds twice a day so shareholders could invest ne\v
at accurate prices.
Administrative workers
sat in the center
of the
small office area, while the analysts sat on the outside perimeter, where they could look out the \%indows.
'Explains \lc Parachini: "Fireman's fee,
hoping
me. and
1
it
would
managed
^Yale linked with search
Fund bid
to take
on the
sen.e as a prestigious flagship account.
all
of it. and then
at Capital,
Endowment Management
& Management;
and
MIT with
pan of it,
Stajiford endowment at zero The account was assigned to ""
for the next
&: Research: Har\-ard
Colonial Management.
30
years.
with State Street Re-
— CAPITAL
126
role at Capital, developing
its
leading shareholder services organiza-
tion (as explained in Chapter 7).
And
he would have another turn
combining Commonwealth and Capital Group
at
11 years later^
during another round in the convoluted restructuring of the mutual
fund industry.
Two
years after Fireman's
ican Express acquired
all
Fund acquired Commonwealth, Amer-
of Fireman's Fund, and renamed
funds the American Express Funds. Then,
as part
its
mutual
of a product line
extension strategy, American Express launched the American Express Special Fund, an "aggressive growth" fund that invested heavily in illiquid private
placements and special situations.
Responding naively
many
to the trusted
conservative investors,
who
American Express name,
didn't realize the risky sort of in-
vesting they were getting into, bought into the go-go
AmEx Special
Fund just as a severe bear market was settling in. Investment performance of the AmEx Special Fund was not just bad: It was awful. By 1974, after several years of poor investment performance in a cult market, the
American Express funds were
as investors angrily
in
diffi-
heavy redemption
cashed out.
Even more serious
for image-conscious
American Express, the
bad publicity caused by the funds' poor investment performance threatened to hurt the vaunted reputation of the American Express
Green Card. (To protest poor investment performance, some shareholders cut up their
AmEx
American Express with worry was the
flurry
their
credit cards
and sent the pieces back
to
mutual fund proxy statements.) Another
of aggressive
against mutual fund managers. If
class action lawsuits^
AmEx
or the
AmEx
being
filed
Funds were
sued, the bad publicity could really hurt.
American Express decided
it
had
all-important image and credibility.
to act decisively to protect
The
fastest
the fund unit to another mutual ftmd manager.
way out was
AmEx was
M975. *"
Often
filed
by Abe Pomerantz,
a high-profile,
self-promotional
litigator.
its
to sell
the classic
^
Acquisitions
"highly motivated"
seller,
was an obvious potential
AmEx
and Capital, with Cody
and Start- Ups
127
in a key position,
acquirer.
needed to get the word to Capital very quietly and in
the right way. Luckily, cause, as part of
had
Luflcin
& Jenrette.
had
and
a convenient
discreet channel be-
overall financial services diversification strategy,
its
AmEx
it
just
also taken a
major ownership position
in
Donaldson,
This securities firm did stockbrokerage business
with Capital, so the president of American Express asked the president of DLJ,^ to ask
if
call
Bob
would be
Capital
Egelston, the president of Capital Group, to
American Express
interested in acquiring the
mutual funds. It
when
was not an easy question to answer. At Capital
financially.
—and every other mutual fund
New
sales
least
not in
outfit
—was
of mutual funds were virtually
stock market in a harsh bear market, fund assets
management
fees
—
^were
down
substantially.
Capital operated at just breakeven a loss. Moreover, the serious
—and
slump
to
some of
1974
struggling
nil.
With
the
—and investment
With mostly
fixed costs.
then, for several months, at
in business caused the formulaic
valuation of Capital stock to drop, precipitating margin
Bank of America
late
the new,
calls
from the
young owners who had been
borrowing^ from the bank to finance purchases of Capital stock and
had
little
or no reserves to answer the
^Howard Clark was ^
Legally,
call.
A decision
to pass
on the
CEO of AmEx and William Donaldson was CEO of DLJ.
of course, Capital was being asked about acquiring the management company,
not the mutual funds. Only the independent directors of a mutual fund can approve the
governing advisory agreement. John G. McDonald, a professor
at
Stanford Business
School, was then serving as one of the "outside" or independent directors of the several
American Express mutual funds and
recalls:
"As an independent director,
Capital had great people and planned to hire press Investment
would be
Management Company. The
that of an
"^
I
best people
resulting capability to
enhanced investment organization, a 'Capital
tively for hiring Capital as
which
some of the
our new investment advisor of
all
I
determined that
from American Ex-
manage our funds
Plus.' So,
I
voted posi-
the American Express funds
served as director."
Borrowing from banks to buy equity
was the established industry norm.
in privately-owned
investment firms
at
book value
128
CAPITAL
American Express
offer
would have been easy
to justify, even for an
organization with a long-term focus such as Capital.
Fortunately for American Express,
and from
tive position,
knew
a great deal about the
Within Capital, he was well
Cody was
long experience
his
at
in a senior execu-
Commonwealth,
renamed American Express Funds.
liked
and respected, and Capital had
accumulated ample reserves and was ready to weather a storm
—and
recognized an extraordinary opportunity to add assets quickly and at
low
cost.
For just $1, Capital acquired the American Express mutual fund
management company and took million
—including
responsibility for
the Stanford University
managing $700
endowment. Equally
important, Capital gained a core group of strong investment professionals^^
and an investment operation
in retrospect, nearly perfect.
in
San Francisco. Timing was,
The purchase agreement was
the end of what had been a long bear market and so illustration
finalized at
became
a classic
of the advantages of Capital's history of investing: buying
into price weakness with a long-term focus
on unrecognized
value.
The Anchor Group of mutual funds was acquired in 1978 on even better terms: The assets were absorbed without assuming any responsibilities for the costs of their people or the organization. The CEO^^ of the Anchor Group called Jim Fullerton at home one Thursday night (the two men had known each other through their work at the Investment Company Institute, the mutual fund industry trade association) and explained: "Our parent company. National Life Insurance,
Saying he
felt
wants to get out of the mutual fund business."
a great responsibility for assuring the welfare of their
mutual fund shareholders, the a
good job
for our shareholders. Will
"We would
''^Including
George
I'JohnHaire.
caller
—and we
concluded: "Capital would do
you take over?"
did!" recalls Fullerton.
Miller, Victor Parachini,
Bob O'Donnell, and Claudia Huntington.
— and Start- Ups
Acquisitions
Capital bought
when
the
in cash
Anchor Group
for $1 plus 1.2 times
1
book value
Anchor management company's book value was almost
—minus
29
all
an adjustment depending on future redemptions,
which eventually proved original
premium
vestors,
continued
over
enough
large
book
value.
to eliminate almost
all
of the
Only one fund, Fundamental
In-
were merged into
as a separate fund; the others
Capital's existing funds.
Two
other possible acquisitions never happened.
One
could have
been a major winner. Alliance Capital was nearly acquired from Donaldson, Lufkin
& Jenrette for $5.5
million, but Alliance's then chief
investment officer^^ managed to block public and have a market value
it.
(Later, Alliance
more than 100 times
would go
greater.)
Investor Overseer Services (lOS) was also considered, but only
very
Ken Mathysen-Gerst was
briefly.
a neighbor of lOS's Bernie
Cornfeld in Geneva, Switzerland, so Cornfeld
made the initial aborted when serious
easily
contact. However, takeover talks were quickly
study of the
lOS books
payments
mutual fund salespeople.^^ (Of course, Confeld's
to
owed
revealed that the firm
unsavory personal reputation meant there was
little
large contingent flashy,
chance of making
a corporate arrangement with a conservative outfit like Capital.)
Another acquisition by Capital was "within the 1969, Greenwich ^^
family."
^^
Back
Management Company had been launched
in in
Peter Vermilye.
^^The adverse publicity of lOS and
its
would hurt
contractual sales programs
sales across
the whole mutual fund industry for several years. ^"^
Ironically
lOS management
failed to recognize the real strength
low redemptions would characterize the lOS funds ated
on
their cash-basis business
that investors
would terminate
economics and
for
many
of the lOS business: Very
years.
lOS management,
fix-
their large front-end sales charges, worried
their investments early. If so, the sales
compensation already
lOS salesmen would never be recovered through investment management fees. They were wrong. lOS redemptions proved to be unusually low by industry standards for a simple reason: The lOS funds were among the few safe-haven alternatives then availpaid out to the
able
anywhere
to "flight capital" investors
some communist
countries.
These
safe-deposit boxes in safe countries therefore, very low, so
tinuing business.
from the Arab world or Latin America
flight capital
and
left
buyers put their
them
lOS fund
there indefinitely.
managing lOS funds had surprisingly
large
as well as
certificates in
Redemptions were,
economic value
as a
con-
CAPITAL
I30
Connecticut by two Associates, ^^ business unit within Capital.
who wanted
They intended
to
manage more
differ-
entiated mutual funds, believing that Capital's other portfolio agers were too conservative to
backing their
own
to develop their
man-
and were missing the market. In addition
new venture, ^^
Capital agreed that the unit
would be
operated under a separate name; would be independently managed;
and would be located on the East Coast from Los Angeles. The
initiative
ness. It also gave the advocates a
make
would help
America. (The
Management took over an
seller
operating expenses
size,
—
mance
name: Growth Fund of
were only $300,000.) With
assets
its
the fund was in a hopeless situation because
—were
a daunting annual 8 percent of assets!
huge handicap, the fund could never achieve good perfor-
at its small size. But,
with substantial growth in
same operating expenses would, steadily
growth
always deducted from investment returns in cal-
culating performance this
its
aggressive
was paid with a 5-year non-interest-bearing note
mere $30,000. The fund
way-too-small asset
toward insignificance.
as a
Eighteen months
ond mutual fund,
the
later,
percentage of net
those
Distributors
assets.
Greenwich Management offered
Income Fund of America.
aimed away from
assets,
assets, decline
And American Funds
could produce the needed growth in
ately
diversify Capital busi-
chance to earn significant equity and
fund, whose principal attraction was
With
geographically far away
a distinctive contribution to the organization.
In 1969, Greenwich
for a
—
Capital's traditional
It,
too,
"down
was
its
sec-
deliber-
the middle"
approach. In addition to a great
name and
Fund of America had another
a
low purchase
price.
Growth
attraction: a supercharged incentive
'^Ed Hajim and Steve Reynolds: Ed Hajim joined Capital
after
graduating ftom Harvard
Business School in 1964. Steve Reynolds joined Capital ftom the University of Virginia's in 1967 and switched to Greenwich Management in 1969. From management of Greenwich Management owned 30 percent and Capital
Darden Business School 1969
to 1973, the
Group owned 70
percent.
'^Jim Fullerton and
Bob Egelston
served, respectively, as
Chairman and
President.
and Start- Ups
Acquisitions
fee
131
arrangement with 20 percent of all investment gains paid to the
manager!^''
Greenwich Managements deliberately aggressive
encouraged by the incentive management
investing,
in the
produced
country in 1970 and again in 1971.
But 1973 was different
—very
different. If
Greenwich Manage-
ment was an attempt to encourage entrepreneurial initiative by ing committed young people room to pursue their dreams, eventual result was no dream:
slumped, and investment
It
in,
we knew
"particularly in a
it
the
were suddenly very disappointing
results
was merged back into the parent company in
"Going
giv-
was a nightmare. The stock market
Management
cap" growth stocks plummeted. Greenwich
as "small
of
Growth Fund of America was one of the top 10
spectacular results:
growth funds
fee,
style
would be
risky,"
late
1974.
remembers Shanahan,
market that was already high, but Capital did not
have an aggressive growth fund then and the key people were very
keen to
try."
Capital has a history of allowing capable and committed
individuals with an idea ideas.
Shanahan continues,
great success, but he
decision
made by
as a separate unit
others because
with
really
owned
it,
we
"I really don't
run with their
think JL expected a
may have been more willing to go its
to contaminate or
"Afterwards,
was
to
This goes back to JBL and his approach to enterprise and en-
trepreneurs.
away
and conviction the chance
felt
Greenwich Management was
own name
harm
along with the
—on
we
Capital in Los Angeles."
that the
problem
at
Greenwich Management
gave the people the chance they
"We
we wanted. The felt
Southern gentleman's protective and paternalistic views of JBL live
on
here. Later,
we
up
the opposite coast, too far
our problem," explains Jim Rothenberg. because
set
still
recognized that timing and environment had
conspired against the more aggressive approach Greenwich Manage-
ment adopted. feelings:
^''
Besides,
it
must seem inappropriate
to hold onto hard
The Growth Fund of America was only $15
million in assets
Until Congress outlawed such pricing arrangements for mutual funds.
charge 20 percent of profits.
Hedge funds
still
CAPITAL
132
when
it
was absorbed into Capital; ^^
end of the century and
it
was over $30
one of Americas 10
is
billion at the
largest equity
mutual
funds."^^
Buying-in Greenwich Management was one of a cluster of ac-
American Funds Distributors
that included buying-in
tions
Chapter
6)
and buying-out the minority
of those Associates
interests
involved in starting Capital Guardian Trust (see Chapter
Greenwich Management was not the only unit ploding. In Europe, the Capital International
$5 million^^
—
Geneva
for
Fund
9).
that risked im-
got
down
but, thanks to Jon Lovelace's persistence,
While absorbing
going.
many
losses
years, Capital
(see
it
to just
was kept
the international operation in
in
decided to
sell
50 percent of Capital
Manhattan
International S.A. (see Chapter 8) to a unit of Chase
Bank^^ in 1972.
Another major investment
vehicle, while not actually within the
Capital organization, produced remarkable returns on the invest-
ments made by Capital Associates: venture
Mike Shanahan, stocks, recruited
as the analyst
Jim Martin
capital.
covering Steel and Technology
to be a technology analyst at Capital.
Shanahan and Martin came up with the idea of investing capital as a
way
in technology.
to
^^
in venture
new developments
keep up-to-date on important
Acquiring "knowledge capital" by working inside
small high-tech companies might help analysts to evaluate large
public companies from the outside.
Venture capital investing began when JBL's Capital
Management
^^In
in stockbrokerage
EF Hutton, Lehman Brothers, and ING. the mid-1970s, when Bill Newton and Jim Rothenberg
fund,
Valentine^^ joined
Services unit in 1971. Bill
'^Ed Hajim has since had a rewarding career
ment
Don
Newton
got
and investment manage-
at
its
accumulated capital
were tax sheltered
losses
Capital had other international assets under
^'
Chase Manhattan Overseas Banking Corporation.
^^
Martin had been
recruited
its
management
a salesperson at Fairchild, the
same time,
Bill
—
so capital gains
Russell.
at this time.
semiconductor pioneer, with
Don
Griswold, an industry expert with great experience, was
from Kern County Land
^^And Gordon
assets
for several years.
^^
Valentine. At the
each took over half of the
exceeded the remaining net
as a geologist
and
oil analyst.
and Start- Ups
Acquisitions
133
acquainted with Valentine's expertise, his thought process, and his sion for venture investing during a long dinner in Palo Alto. recalls
going to engage in venture investing,
he's
our guy." Then, smiling, he confesses he
any
details
slugged her just
really can't
remember
from that whole evening's discussion, because when
ing the restaurant, they saw a
else
Newton
being very impressed and before the evening was over, reaching
a clear conclusion: "If we're ever
on
vi-
—
hard.
As she
fell
man who was
"He
beating his wife.
we immediately focused and helping that woman. All
to the ground,
one thing: stopping the
assault
simply disappeared from memory!
Through an extended
leav-
—almost
"^"^
endless
—
of meetings,
series
Shanahan, Valentine, and Martin^^ worked out what they hoped
would be an acceptable business proposition, which Newton took
"Of course,"
the board of directors. carefully
and put together what
well-documented case
The nounced
I
recalls
Newton,
prepared very
"I
was confident was
to
a very strong,
for venture capital investing at Capital."
Chuck
presentation was going well, until
Schimpfif an-
his absolute opposition to venture capital investing
within
Capital with a terse pronouncement, clearly intended to be decisive:
"Over
my dead
With
body!"^*^
Schimpfif's boycott, the
poses, over
—even
meeting was, for
all
practical pur-
own
before Jon Lovelace had expressed his
con-
cern about the risk of Capital's portfolio counselors and analysts getting diverted from their primary responsibility:
managing mu-
many of moderate means. Venture investing new technologies and new markets via new and untested
tual funds for investors, in exciting
companies that were not yet public was a very different
^^
Thirty years
tered
women
later,
Newton
discipline,
has taken a leading role in establishing a "safe house" for bat-
in Jackson Hole,
Wyoming, where he and
^^Jim Martin had space in Capital's
offices,
his wife, Gloria,
now
live.
but was seldom there. Upbeat and gregarious,
he was remarkably well connected throughout the technology community. Although he
was not necessarily a great Valentine's estimate,
securities analyst,
he truly understood technology and, in
made "hundreds of millions of gains
helpful to Capital analysts. Martin
is
quoted
for clients"
as saying: "It's
2i
Don
and was often very
jungle our there
—and
those
guys in Silicon Valley are animals^
Don Valentine
describes
Schimpff sarcastically
as "a true
nineteenth-century Visionar)^'!"
C A
134
tar
P
1
TA
L
removed from Capitals focus on deeply researched value
ing in major, publicly-owned companies. ^^
compensation
that the
for venture capitalists
ent in structure, magnitude, and
compensation
Newton
It
was
invest-
also recognized
would be very
differ-
method of determination from
the
at Capital.
the Board meeting sadly sure
left
it
was
all
over for ven-
But when he got to his office, The caller was JBL. "Don't get down about that discussion. Chuck can get way too conservative sometimes. He didn't really mean what he seemed to be saying. I think we're on the right track." Lovelace counseled Newton that it would ture investing at or through Capital.
the telephone was ringing.
be important to understand Schimpff and the problem with venture capital investing, as
Schimpff saw
it,
so they could prepare a stronger
case for going ahead.
The
subject of venture capital investing
came before
the board
again in a few months. That interim was used by JBL to achieve the
two process objectives he cared deeply about: The subject would be well
and thoroughly discussed
cratic.
—and
the decision
would be demo-
At about the same time, JBL, always a venturesome investor did two deals with his
at heart,
When venture
own
capital investing
money.^^
was again on the agenda, the vote
was divided. Schimpff again voted "No!" and Jon Lovelace abstained, saying he was ital's
analysts
still
concerned about venture investing distracting Cap-
and portfolio counselors from
their
main mission of in-
vesting for the mutual funds and for clients of Capital Guardian Trust.^^
The
directors agreed that Capital should not use clients'
^^At approximately that same time, examination of the public record of American Research
&
Development (AR&D)
—
the celebrated venture investing
Business School Professor General Georges Doriot investing was
Equipment, large risk
than the
no Golconda. Except
AR&D's
of investing
S&P
for the fluke
long-term portfolio return
company
—would have shown
started
of investing almost accidentally
—without any adjustment
in illiquid investments in
by Harvard
that venture capital in Digital
for the obviously
new, untested companies
—was no
better
500.
^^One, simply because he liked Jerry Sanders, had him paying Advanced Micro Devices' first
payroll out of his
own
pocket.
^^Jon Lovelace never did invest with Sequoia.
Acquisitions
money to
to build
go ahead,
its
knowledge of venture
should invest
it
its
own
and Start- Ups
investing. If Capital
135
wanted
name
dollars in Sequoia,^^ the
chosen for the venture fund. But would Capital make the necessary financial
commitment? Maybe.
Before raising any
such
as
money from
Shanahan and Newton, must
outsiders, the inside advocates,
provide a significant starter
first
pool of capital themselves. This was not easy
ment
when
professionals were not particularly well paid
JBL took
worst part of a major bear market.
Capital's invest-
and
was the
it
the lead as an investor;
Shanahan, Martin, and Newton together put up $15,000; and JBL arranged to add corporate funds from Capital to reach the $1 million
minimum. ^^
The
investments were not
first
second. Sequoia only got
vanced Micro Devices
Don
investments,
—
all
money
its
One
failed
back. But the third
and on
a
became Ad-
a spectacular success. Afi:er the first three
Valentine became the principal investment
took up Capital's role
ager; Valentine
winners:
as general partner in
management; and the name was changed
man-
venture
to Sequoia Capital.
^^
The initial fund-raising strategy for Sequoia included raising money from pension clients of Capital Guardian Trust. But in
^^
Don Valentine and Gordon
agement Services
—
Russell were, until fairly recently,
the consulting unit through
employed by Capital Man-
which JBL advised such companies. JBL
—and saw
way
wanted
to keep this subsidiary alive
do
This arrangement also allowed Valentine and Russell to participate in Capital's em-
this.
and busy
the link with Sequoia as a
to
ployee benefit package. ^^
At the
closing,
Shanahan
ruefully recalled years later,
"One
'investor'
was reported
be in an airplane over Texas. After waiting for two hours for him to land and nothing,
him
we decided
to
go ahead.
We
never heard of his landing
to us to
hearing
still
— and never heard from
again."
^'The arrangements with Valentine were worked out by Ned
Newton and Shanahan.
Bailey,
who was
a lawyer
and
Bailey,
on points
for several years
set
out by
an understudy for
Schimpff, spent several years in Personnel, which he then headed. Later, he served as chair-
man
of Capital Guardian Trust.
new
business sales presentations ever: a series of slides of Capital's investment professionals
with
his voice-over describing their
were
many
He
also
(see
Chapter
9)
one of the most
and each had impressive
credentials, the slide
forever. Prospective clients got the message: Capital
talented investment professionals
effective
academic and professional achievements. Because there
professionals at Capital
seemed capable of going on
produced
and
a
had
show lots
of
remarkable commitment to proprietary research.
— CAPITAL
136
1970, venture capital investing was not considered an appropriate
investment by most pension funds.
was
capital investing
"No
clear:
The
reaction to venture
initial
way!"^-^
And true to his word, Schimpff was actively opposed. As chairman of Capital Guardian Trust, he would not allow the concept to be marketed to
"his" institutional clients.
support was moot
as far as
Newton's and Shanahan's solid
marketing was concerned because they
had none of the personal contacts needed
would overcome the cautious
case that
tional investors.
The
first
institutional investor lion,
and
—
for very nearly too long a time It
None
Then, Bob Kirby of Capital Guardian Trust jumped
on how
make
to
—only
invested $3 mil-
expecting other institutional investors to follow. ^"^
series
a
reluctance of large institu-
was the Ford Foundation.
troduced Valentine to a
make
to get a hearing to
did.
He
in.
in-
of large institutions and coached him
the venture capital proposition credible
sive to institutional investors.
Their joint
efforts
and persua-
were successful
but not for an excruciatingly long time. As the months went by
without other institutions joining that
its
in,
the Ford Foundation, feeling
outsized 60 percent participation was per se imprudent, very
nearly withdrew.
General Electric Pension invested
Fortunately,
$3 million and then Alcoa, Armco, and Yale University in
—
so Ford remained.
^^As Valentine
recalls,
SchimpfFwas
^'^Two other investors Teijin Ltd.
^^For close
actively
opposed and Ned Bailey gave passive
for $1 million apiece
But these were not considered
many
—and
—
joined
years, the relationship
—were
Capital
Management
resistance.
Services
and
special
and
"institutions."
between Capital and Sequoia has been
has produced investment gains of several hundred million dollars. Sequoia
Capital has sponsored numerous partnerships
fund open
all
^^
to
—and
for
many years,
each had a cloned side
key Capital Associates without the customary carried interest charged to
other investors for Sequoia's services. Both Capital and Sequoia have been careful to avoid
any
conflicts
invest in
of interest with their respective firms. Capital does not allow individuals to
IPOs or
in the
pre-IPO
final
rounds of private market funding, or
private equity (such as venture capital), if
funds might want to invest. Relations were not always
easy. (After
able professional cooperation, personal friendships,
and
management winced over
a
in early-stage
any of the Capital Group Companies' mutual over 20 years of remark-
great wealth creation, Capital
1995 Sequoia brochure that made an unexpected reference
to
Acquisitions
As Valentine put
30 years
it
and guidance on pitching Sequoia Capital
cessfiil
venture
organizations,
and
would be no
hundred other com-
or Yahoo! or five
become one of Americas
capital
137
"Without Bob's introductions
institutional investors, there
—and no Cisco
panies." Sequoia has
later:
and Start- Ups
largest
and most sue-
investors
wanting to
participate in Sequoia's funds are "on allocation" because so many-
and potential investors want
past
any new Sequoia
to participate in
venture capital fund. Capital Associates interested in venture investing have enjoyed
how
very substantial successes. But the expected insights into vest in
what might be learned ferability to
is
later, "to
believe that
in venture investing
would have any real
trans-
are very, very different!
At
The
Capital, our busi-
based on fees and continuing relationships with investors: Ven-
ture capital large
enthusiasts
our work in investing in mature public companies.
two kinds of investing ness
"We
mature companies have not materialized.
were terribly naive," Shanahan observes 30 years
to in-
is
all
about deals and
transactions.
The
differences are
and absolute."
Sequoia's linkage with Capital
and asked
for a retraction. Valentine,
who had
permission in advance and can be "tough on task," was not quick to Later on, the
compromise proposed and accepted was
Valentine personally absorbed half of the cost.)
to rewrite
and
make
not requested a correction.
reprint the brochure;
CHAPTER
9
CAPITAL
GUARDIAN TRUST
COMPANY
NOTES FOR READERS Few developments are more favorable
to the
success of an enterprise
than being the active and effective beneficiary of a profound restructuring of
an important
tional investing in the
industry.
Such a restructuring occurred
1960s and 1970s v/hen a
endov/ment assets were pulled out of the
institu-
in
flood of pension
traditional
banks and
and
insur-
ance companies where they had been accumulating. Corporations, states, and universities went looking for organizations they believed could deliver superior investment results.
large institutional funds
were looking
for close
with small groups of highly talented investors
working relationships
and
safety of dealing with large, long-established,
These
felt
and
no need
for the
well-capitalized
organizations that had dominated institutional investing. They were
dismissed as "too bureaucratic."
139
I40
A p
c:
r
1
A L
were looking
Institutions
new
who
schools
were
organized
to
market investment performance and worked hard
And
results.
breed: dynamic
young, hungry, and exciting professionals from the best
firms of
business
new
a
for the best of
these clients
were prepared
to
achieve
beat-the-
achieve superior
to
pay high
fees to get
what
they wanted.
had
Serendipitously, the unit Capital traditional
Capital participated
suddenly searching
in
for
Company— became
on
to
winning investment managers. great to be lucky— particularly by
it's
— Capital
the right place at the right time
prove that
it's
not
by which
the vehicle
the extraordinary surge of institutional assets
Proving once again that in
established to provide
investment counseling services to wealthy individuals—
Capital Guardian Trust
being
just
enough
just to
be
Guardian
Trust
lucky.
Like most of the investment firms that surged forward
on the flood
banks and insurance companies. Capital
tide of assets leaving the
Guardian woefully underestimated
the importance of having the right
organizational design, staffing, and investment procedures. nearly prepared for the loss of control
come
folios
and coherence
and
bear market of
1
973
to
1
974
on
inflicted
was
It
that
with exponential growth, followed by the disruptive
that the serious
went
not
would
damage
clients' port-
client relationships.
Capital Guardian not only missed the Nifty
was allowed
to float free
strategy, staffing,
from
its
Fifty
stock market;
parent organization
and process. As was
structure,
in
virtually certain to
it
happen,
it
stumbled badly. Capital Guardian
wonder Surely,
is
that the
was asking
damage was
a principal reason
sonal confidence clients ple
at
Capital
for
its
for trouble
got
lots
of
it.
The
not even worse or longer lasting.
survival
somehow
— and
was a combination
continued to place
in
Guardian — and the staying power
of the per-
a few key peoof
the
parent
organization.
While Capital Guardian was it,
certainly not alone,
too" explanations are no excuse for
agement
at Capital
was focused on
"others did
what happened. Senior man-
the mutual fund business
and
Capital Guardian Trust
paid
far too
Capital Guardian
brought
Most
Trust.
into the Trust
Company were new
to
Capital and to each
off in different
and
contradictory ways. Instead of working closely with Capital's
house research analysts, they
on
relied
calls
from
their pals
own
in-
on Wall
fundamentals, they got caught up
solid research of long-term
go-go era's
that
on
often
making independent investment decisions based
Instead of
Street.
at
of the senior investment nnanagers
They didn't work together: They took
other.
141
what was — and was not— going on
attention to
little
Company
misbehaviors: chasing
trite
in
popular stocks and
reaching for short-term investment performance. The quality of
in-
vestment decision-making deteriorated badly. Fortunately, Capital
management
the
after real
had
the executive leadership required to put
of Capital
harm had been done.
sources to integrate the Trust
and
the
Guardian
good
luck to
It
into strong
had
also
Company
the organizational re-
parent organization
into the
have the stock market
hands, but only
turn favorably at just the
right time.
Rising like a Phoenix from
moving from strength than
rebuilt
its
to greater strength
franchise
a strong leader
near self-destruction — and eventually
its
in
United
the
States
investing.
institutional
in
— Capital
Guardian has more
where
Affiliated
it
now
is
institutional
in-
vestment companies within the Capital organization have established important businesses
in
the United
gaining strong businesses pore,
is
investment business differs most from the mutual
institutional
business
in
Individual investors folio
Europe, Australia, Singa-
continental
and Canada.
The fund
in
Kingdom and Japan — and are
the
role
of
client
relationship
expect— and get— very
managers who manage
their
little
management.
contact with the port-
mutual funds. Institutional investing
completely different: Clients expect and get an extensive and inten-
sive service from both portfolio
managers and professional
relation-
ship managers.
The most successful large investments
in
institutional
investment managers have
made
dedicated, senior-level relationship managers.
For years, Capital did not
come anywhere near keeping pace
with
142
c:
A P
A
V
I
I.
the competition. After years of dismissing the importance of superior relationship
management
and doubting
with clients
the effectiveness of
ever working closely and cooperatively with investment consultants,
become a leader
Capital Guardian has
and
plines of client service Still,
tal
in
other countries)
creasing competition
complementary
disci-
relationship development.
Capital Guardian (and
like all institutional investors,
counterparts
the
in
Capi-
profoundly challenged by the
is
investing.
in institutional
its
In
in-
the United States, the
proportion of public stock market transactions represented by the decisions of professional investors has
gering
90 percent— in
most active
New
institutions
a single generation.
now do 50
York Stock Exchange. This
tough to beat by much. As (in its
tive
many
variations)
gone from
is
investment managers
just
And
percent of
percent to a stag-
1
the
all
largest
and
transactions on the
tough competition
is
50
beat and very
to
a result, the alternative of passive investing
an increasingly pervasive challenge
— including
to all ac-
Capital.
Capital will also be challenged by the difficulties— as well as the opportunities
— in
developing an
institutional
business that consistently
serves multiple national markets with a multiproduct capability. Con-
and small-cap
ceptually, that multiproduct capability includes large-cap
equity
in all
the major markets
and
in
the
emerging markets plus high-
grade and high-yield corporate and government debt around the world plus private equity
in
in
both developed and developing
countries— worldwide. This broad array of capabilities ered into a series of geographic and economic differences plexity will
in
competition, regulation,
and
even more important challenges
management and
will
be
domains— each
culture.
present important challenges for effective
vestments and
every market
The
resulting
management for
leadership at Capital and at any of
deliv-
with
comof
in-
organizational its
global com-
petitors.
Capital continues to define perior investment results
in
its
professional mission as achieving su-
each asset
class. Curiously, this definition
leaves out the most important part of achieving superior long-term sults for clients:
re-
wise investment counseling on appropriate objectives
w-
Jonathan
Bell Lovelace,
founder of Capital. (Photo
credit-.
Elson-Alexandre.)
Dinner meeting with Dr. Lionel D. Edie, 1950s.
Clockwise from upper left:
Jules
Hoffman,
Chuck Schimpff, Coleman Morton, Jonathan
Bell
Lovelace
(JBL), Lionel D. Edie. {Photo
credit:
Drucker-
Hilbert Co., Inc.)
CRMC
meeting, 1950s. Left to right: Harleston (Hardy) Hall, Jules Hoffman,
Jon Lovelace
(JL), Al
Reno Renfrew.
{Photo
Drasdo, credit-.
Sr.,
JBL,
Chuck Schimpff, Marjorie
Weaver Photo
Service.)
Fisher,
Ward
Bishop, founder
of
American Funds
Distributors, 1969. (Photo
credit:
Curtis Studios.)
American Funds meeting with JBL, 1973. Front row: Bob Lindstrom, BL,
Graham Holloway, Jack
Turner.
[Photo
credit-.
Bill
Bagnard,
H. Lee F^ooper, Photographer.)
Sr.,
Key people
in
the Capital investment group, mid-1970s.
Clem Tiampo and Bob
Wally Stern,
JL,
Egelston, around 1964.
and David
Fisher, 1979.
{Photo
credit-.
Roger Marshutz Photo.)
Left to right:
Bill
Howard Schow, {Photo
credit: Bill
Newton, Marjorie
Fisher,
Inge Andenow, Bob Cody, Varie.)
David
Fisher, JL,
Dan McMeekin,
Cathy Ward, 1981.
Left to right:
Jim Zukor, Walter
Fairfax,
Jim Zukor and Jim Ratzlaff, 1975.
Ned
Bailey, 1967.
{Photo
credit-.
Leigh Wiener.)
Jim Fullerton, 1971 {Photo
credit:
H. Lee Hooper, Photographer.
Left to right: {Photo
credit:
Gordon Crawford,
Peter Darley Miller.)
Paul Haaga,
Cathy Ward, 1996.
M
if
M
kl^^iA Ken Mathysen-Gerst.
{Photo
Joe Beles.
credit-.
©
Ken
Rogers, 1981.)
Nilly Sikorsky, Robert Ronus, Thierry Vandeventer, 1979.
{Photo
credit:
Ives Debraine.
Ray
D'Elia,
Jim Rothenberg,
Bob Kirby,
Gordon Crawford, 1981.
Gregg
Ireland, Karin Larson,
Ken Griswold, Jim Dunton, Don Conlan, mid-1970s.
Facing, around table from (Photo
credit: Bill
Varie.)
left: Bill
Grimsley, Karin Larson, JL,
Bill
Hurt, David Richards.
Edus H.Warren,
Jr.,
1984.
Jim Martin (center)
and Dick Barker
company
(right)
on
visit in
the 1980s.
{Photo
a
credit:
David {Photo
Fisher, credit:
Karin Larson, and
Andy
Peter Darley Miller.)
Barth, 1994.
Alan Wilson,
Gene
Stein,
Donnalisa Barnum, 1994. (Photo
credit:
Peter Darley Miller.)
John Seiter (standing) with
CGTC marketing associates.
(Photo
credit: Bill
Varie.
4
4
Jim Rothenberg, 2002. iPhoXo
credit:
©
David Zaitz
Photography.)
Mike Shanahan and JL, 2002.
{Photo
credit-.
©
David Zaitz Photography.
Capital Guardian Trust
and
capable of achieving each
the asset mix most
Developing demonstrable
objective.
challenge to the investment Capital
Personal Investment
needs of wealthy growth and
in
management
in
investor's realistic
important v^ork
this
profession
143
in
is
a
general and to
particular.
in
Finally, the
should
skill
Company
is still
now be
families, less
than
has
$10
Management
not,
until
unit,
which serves the
recently,
achieved much Greater success
billion in total assets.
achievable with a reorganized approach
the United States, but also
in
— particularly
every region or nation around the world
where great wealth accumulates.
# THE CRASH OF
a speeding sports car played a key role in the
start-up of Capital
Guardian Trust. The driver was badly
in-
jured, but not killed.
Bob Kirby
explains: "After
Harvard Business School,
the investment business with Willis
Scudder, Stevens
&
Clark's office, in
and
but others
at the
my
someone could cover
^
—because
I'd
us. I
when
I
called in to ask if
account responsibilities for 30 days or
broken eight
ribs
and would be
in the hospital for
Christy, after ing. (Willis
visit
them
Stanford, it
as a
correspondent of
& Clark—which meant receiving copies of Scudder's research reports and
being welcome to
High School,
we
loved sports car rac-
Investment counselors organized by Paul Willis and Dean Christy
Scudder, Stevens
which became
firm were not enthusiastic.
"This came to a head one day in 1965,
so
got into
Los Angeles. Pretty soon,
found we had an unusual question among ing,
Christy,^
I
in
Boston and
New York City. Bob
Kirby went to Long Beach
and Harvard Business School, and then worked
at Willis
and
acquired the business of Charles White where young BCirby had been work-
and Christy was
later
combined
into Scudder, Stevens
&
Clark.) Kirby re-
signed and joined Capital. Having experience in the traditional investment counseling business, Kirby expected
—and was expected—
to develop Capital's individual investment
management business. He never got a chance to do that because the institutional investment management business soon became the real opportunit)^ and Kirby's good-humored "aw, shucks" style
was
a natural hit.
C A
144
V
A
r
\
when
awhile. That's
up
either
I,
ital
Occidental
at
should decide: give
chose to give up at
my job
Occidental Life."
Newton had Scudder? Hold on! We
"Are you leaving
Life:
I
to ask his advice because
have something for you here
was taking
I
that
was offered a position
I
Newton
Bill
me
to
my avocation.
or
because
Kirby called
may
was explained
my vocation
at least in part
worked
it
at Capital."
At
Cap-
just this time,
a serious look^ at organizing a trust
company
up
vehicle to use in the long, slow process of building
as a
a private in-
vestment counsel business with wealthy individuals.^ Soon, Kirby joined Capital, specifically to help set up this seling
arm
—mostly
for high-net-worth individuals and, perhaps, a
few hospitals and colleges
southern California.
in
"'Money management' Kirby. "There
new investment coun-
didn't really exist before 1960," explains
was no such thing. The big banks had
and focused on custodianship
—not on
beating the
the
all
S&P
money
500 or any-
thing else." Trust companies were traditionally expected to protect the funds entrusted to their care, produce a reasonable income, and
watch out
for the individual beneficiaries.
With
to be great investors.
pension trusts didn't look
But they were not expected
their personal trust experience,
that different or difficult for the banks to
all
do. In fact, pension trusts looked
much
were tax-free and very long term
—and did not
^
Dick
Staver, a
easier to
manage because they involve the unusual
first came up with the idea of starting a trust comColeman Morton, who passed it along to Chuck SchimpfF. the law firm of O'Melveny & Myers, who said he was quite
popular insurance man,
pany and pitched Schimpff asked
managing
his idea to
a friend at
sure the proposition
would never
get the necessary regulatory approvals
from the
state
of
California.
^Stuart
MacLaren had
cessfully cleaning
left
Scudder
a
few years before to join Capital.
up the back-office operations, and had
merits of an independent trust company.
He
just
He
began by suc-
completed a study of the
clearly identified the
main business problem:
In the individual coimseling business, the largest clients were usually also the oldest.
when
gested by the clients attorney heirs
And
those clients died, their estates went into probate for delivery to a bank trustee sug-
might know
little
(who usually got
or nothing about
counselor had done, over
many years,
to the investment counselor.
So
it
all
reciprocal business
the great investment
for the deceased
was not very hard
get the heirs to switch over to the bank.
and would
for the
bank
from the bank). The
work
feel
no
the investment
particular loyalty
to stimulate anxieties
and
Capital Guardian Trust
found among personal
personalities rate
The
trust beneficiaries.
of return assumptions^ were low and
all
that a
Company
145
actuarial
manager had
to
do
was buy long maturity bonds that would meet or beat the actuarial assumption and
was "mission accomplished."
it
Investment performance was being discussed for the
When
first
time.^
these discussions included the records of the major banks
and
more than
dis-
insurance companies, their performance records were appointing.
The
typical pension
fund was 75 percent in long-term
bonds, and with postwar interest rates repetitively
been going
down
for years. ^ In addition,
bank
rising,
stocks. Consequently, the
bought the
trustees
conservative, blue-chip stocks with large dividends
bonds had
— not
growth
investment results of the banks were
ously below average, whereas mutual fiands, like Investment
pany of America, had quite favorable investment
how
Corporate directors began asking pension fijnd was
—and were stunned by
funds, originally organized to provide
Com-
records.''
company's
large their
The pension
the answer.
some
seri-
fringe benefits,
cumulated vast amounts of money: Pension fiand
assets
had
ac-
were often
equal to the net worth of the whole company! Pension funds were
not only large, they were underperforming, and this was hurting the
company because larger annual contributions had to be the pension fijnd to make up for the poor results. To reduce
sponsoring
made
to
these costs, pension fund executives
wanted much
better investment
performance.
made each year to a pension fund, the make reasoned assumptions about such variables as the rate of re-
^In determining the requisite contribution to be consulting actuar\' will
turn on investments and the inflation in the wage base, estimate the prospective pension liability,
and estimate the amount of contribution required each year
requisite assets.
An
increase in the rate of return assumption
to
accumulate the
would reduce
the annual con-
tribution required to fund future pension payments. ^
A.G. Becker and Merrill Lynch were
^Interest rates
had been
—
rising
so
just organizing
bond
prices
performance evaluation
were
—
falling
tween the Treasury and the Federal Reserve to stop holding help the government finance Capital took
mutual fund
World War
—
to avoid
services.
1952 accord be-
rates at artificially
low
rates to
II.
on two accounts with performance
fees
since the
fees,
but most
any questions about comparative
fees
equity.
were aligned with the
146
C:
A
P
TA
I
L
blame the creation of
"I
whole performance' business on
this
Jack Dreyfus," says Kirby. "Because in the late 1960s, Jack was the
guy
first
—with
Avenue Subway
around and growl
to look
for investment organizations
evitable that they
—
telling
the Lexington
everybody what
had gotten." As pension funds began looking
great returns Dreyfus
Investment
coming up out of
the Dreyfus Lion
with good performance,
it
was
would notice the outstanding long-term record of
Company of America.
"In 1965," recalls Kirby, "opportunity was literally thrust
came from General
us: It
alize the
ing that
in-
Mills." General Mills decided to conceptu-
pension fund not if more
upon
as a cost center,
were earned on the
but
as a profit center, argu-
assets already in the
pension fund,
the expense of annual contributions to the pension fund could be re-
duced, producing a direct increase in reported earnings. So Polk went
board of directors and made a well-documented
to the General Mills
presentation with the conclusion that the pension fund should be
managed
in a
more imaginative way. He won
and sent
the day,
a
team
out to study the records of investment managers to find the very
They were impressed by
best.
by
^
mutual funds. ^ In
Capital's
Henry
was
Dayton
was
in
ing
WW
came
who
Porter,
cer's father,
at
1965, a few years before Capital
late
led the team, explains,
a local industrialist
"Bo
Polk, General Mills' Chief Financial Offi-
know General Ed Rawlings when he logistics for the Army Air Corps durof General Mills when Bo Polk was hired. When he
and had gotten
to
Wright-Patterson Airbase developing
and Rawlings was
II,
the long-term record of results achieved
to General Mills, the
CEO
company needed major changes
in
all
aspects of management to
convert from an amalgamation of local and regional flour millers into a consumer products
company with and
management.
professional
—what we now
different
Harvard Business School
to
our discipline and language.
come and I
any
capital in the
market
—
to analysts
so
I
efits
or
liabilities,
—
making changes.
We
—
used financial analysis as
—
at least in part
because
it
program
coming
we came up with
We
comto
into prominence.
the idea that pension funds were a set of fixed ben-
with pools of assets being accumulated to pay those benefits; so
increase the investment performance,
pension obligations.
for a
had had no need
got acquainted with Wall Street just as institutional in-
vesting and institutional research were
"At General Mills,
join in
started off to build an investor relations
pany that had never before talked raise
He was expected and authorized to be creative He hired me over the telephone from
change agent.'
call a
we could
if
we could
cut back the annual costs of fiinding these
would simply convert the way we defined our pension problem
— Capital Guardian Trust
Company
147
Guardian Trust was established, they found Kirby heading up the
new
separate account group at Capital
and
said,
"We've studied your
record and we'd like you to be one of our pension fund's investment
managers!"
Kirby knew the language of investment counseling, was an experienced portfolio manager at an organization with superior long-
term
and wanted
results,
to build his business.
He
also recognized
the profound difference between an elderly mortal's $5 million ac-
count, which
would have such complexities
as taxes, beneficiaries,
and low-cost "favored holdings," compared with a perpetual corporate
pension fund that was tax-free and could be managed for
alone. Kirby also understood the difference
results
between a $5 million
ac-
count that would be depleted by spending and eventually terminate versus a
$50 million fund
that could be expected to
continue forever. Iv'Vd
bought an
buy the
rest
initial
position of 10 per-
— but —and took our
the stock ran up three-
some pleasure
profit."
then. Capital was at least linked w^ith ''international." "Borax Consolidated was a
By
The Pan-American Fund was
foreign
company and we'd been
at least
would have been. That meant, of course," laughs Morton,
involved.
"that
international
—
we must be
great
or
The Paley Report, forecasting severe shortages in various come out and was attracting attention to investing in natural resources globally. So with solid support from Ward Bishop, in 1961 w^e took over International Resources Fimd (which was a combination of several small natural resource funds) and added what we euphemistically were then calling 'Human Resources' and got into international investing." Morton shakes his head and smiles ruefully, "Our adventure was
experts at international investing!
had
minerals,
just
—
—
not to
last
\trf long."
Hired to work with Coleman Morton on International Resources Fund, Harr\'
Seggerman played
a key role in the initial period.
international oil companies, including the
As an
Dutch and
oil analyst,
GA.
he was soon covering the
Anracted by the
British internationals.
long-term investment opportunities of investing internationally, he migrated easily from being an
oil
analyst to being an international analyst.
and contributed importantly International Resources
Seggerman covered Japanese companies
to Capital's being, in 1959, the first institutional investor
Fund
—
to invest significantly in Japanese stocks.
to recognize that Japanese insurance
His
initial
companies were significantly overstating reserves
therefore substantially understating earnings. This was
when
—
via
coup was
—and
Japanese bank shares sold at 3
times earnings and their dividends yielded 9 percent, and Nomura's salespeople were on such tight expense budgets that Capital left
Capital "well
Fund
(a joint
joined seas
known and
would buy them lunch.
well recognized."
and
for
Difificuit to
many years
work
with,
Seggerman
successfully ran
The Japan
venture of Prudential Bache, Paine Webber, and Nikko Securities). In 1969, he
Fidelirv-
Investments where he started Fidelity Pacific Fund, that company's
investment venture, and was \'ice Chairman of Fidelirv until 2001. (He died
first
over-
later that
CAPITAL
lyo
In 1955, with the International Resources Fund, Capital
one of the
first
American
became At
institutions to invest internationally.
Morton's'^ urging, Capital acquired the
Natural Resources Fund and
its
management company of
companion. Natural Resources of
Canada, and merged them together. Unfortunately, Capital
failed to
study the shareholder base, which included large numbers of very
made
small shareholdings. This
and
the fund very expensive to administer
service.
Small
as
it
was
—and
despite
its
persistent losses
—
^JL
would
insist
on keeping the
international effort going through the long, lean years
that followed.
As Fisher explains with obvious appreciation, "Jon
fought the battle for international in the early Capital
become
began with Ken Mathysen-Gerst,^^ a
International
Dutchman wanting
sixties."
on
to focus
international investing as a
way
to
personally and professionally independent. In the spring of
made
1962,^^ the decision was
an office in Europe, ^^
to establish
primarily to monitor the international operations of U.S. corporations, fice
but also to track their European competitors.
was expected
year, at 73,
The Geneva
of-
to find international stocks that Capital's U.S.
while serving as president of International Investment Advisors, a hedge fund in-
vesting in South Korean securities.)
1968, Morton
'^In
capitalizing
left
Capital again to try a venture: International
on the "hot
of continuing war
holes" discovered in the
risks in the
Middle
Red
Sea.
It
you can make your way out here
mer" and then joined Capital ther II),
worked
for Royal
to
would be
to California
in this
on your own,
way by Jim
you're hired
—
Shell (and
no matter what developed
participated in this meeting in
fa-
result,
he
as "too
obvious and not really Europe" and both
because "the other country would not like
quate; but he could improve his French in
(Some
said
it
Geneva and the
was the proximity
in the world.
New York City. it";
Dutch, he rejected the Netherlands; Belgium would not do since
was.
sum-
was imprisoned by the Japanese during World War
'^Mathysen-Gerst had ruled out London
Germany and France
it
Fullerton,
for the
time in 1959. Born and raised in Indonesia, where his
able to survive
JBL and Coleman Morton
Geneva
at
hold Dutch, Swiss, and American passports simultaneously. This gave him
assurance that he '
—aimed
1970 because
he had lived for awhile in Mexico and served in the U.S. Marine Corps. As a
was entitled '
Dutch
ftill
in
East.
'"Ken Mathysen-Gerst began with a 1958 summer job offered "If
Geo Marine
was liquidated
to
city
good skiing
and although he was
his
French was inade-
was centrally located, so
that convinced
Gerst to pick Geneva. Others point out that the airport was close to the
city.)
Mathysen-
Global Investing
mutual funds could invest
in.
more than 10 percent of
its
States in the early
1960s
—
Investment
iji
Company of America had
portfolio invested outside the United
a full
25 years before such investing was
considered "okay." This was a level far higher than most mutual
funds would even consider, so Capital was developing what would later
be a unique record of investing internationally and getting
good
results.
Unusual early
tal's
as
was, the conceptual foundation supporting Capi-
it
commitment
to international investing
and international
research was strong. Price/Earnings multiples abroad were obviously lower, particularly in early
high
level.
1962 when the U.S. stock market was
at a
This valuation bargain was attractive to a long-term value
investor like Capital. In addition, the decisive competitive advantage
more and more American companies was coming from
for
business outside the United States.
^^
And,
competi-
as international
tiveness increased, Capital's research analysts
wanted
to
their
know
the
foreign competitors firsthand to gauge the long-term prospects for
American corporations competing
Ken Mathysen-Gerst, with Jon tal
International.^^
in global markets.
Lovelace's support, initiated Capi-
"Both loved numbers,"
"but
recalls Nilly Sikorsky,
they were never close personal friends. Mathysen-Gerst was almost incapable of showing his feelings for others or making normal personal
attachments."
'^For example, today, Wal-Mart
is
no.
1
in
Sao Paulo,
Brazil,
and no. 2
in
Buenos
Aires,
Argentina. ^"^
After his heart attack,
JBL made an annual
with his wife to the
trip
added Geneva, often staying long enough
so he
ft)r
UK,
France, and
at least three sequential dinners:
Italy;
one
at
Ken Mathysen-Gerst's home, one at Thierry Vandeventer's home, and one in a hotel where JBL would be host. Not only could these small dinners include everyone, there was considerable interim telephone
and correspondence contact.
Thierry Vandeventer joined Capital in 1963 after graduating ftom Harvard Business School. cern
—
He
as
set aside offers
ftom
J. P.
Fullerton impressed Vandeventer, Gerst.
It
Morgan and Chase, which gave
his father cause for
con-
did the unsavory general reputation of "financial Californians." Jon Lovelace and Jim
who had
took place in a cab ride from
only one half-hour interview with Ken Mathysen-
New
York
where Ken was catching a plane to Washington.
City's
midtown
Yale
Club
to
La Guardia,
172
c:
A
p
1
Initially,
r
A L
the
Geneva
"office"
A real office finally opened in Tax
terest Equalization
was
1963
—
snufi^ed out
est in international investing.
The
Mathysen-Gerst's garage J ^
in
the
all
same year
that the
hope of any American
In-
inter-
dismal outlook for international
Fund being
investing was symbolized by International Resources quietly
new
merged into Investment Company of America.
Jon Lovelace sustained Capital's ternational business despite losses ^^ plus a lot
more than 20
to
its
Lovelace gave Capital the
vital
committed
and
tional, in retrospect,
it
made
all
who
to global investing.
irreplaceable advantage of time
an international investor with what became a
may
of results. Although his leadership
in-
years of continuous
of dissatisfaction from those in Los Angeles
couldn't see the merit of staying
in place as
commitment
strategic
real
record
not have seemed entirely
ra-
the difference: Lovelace had a strong
sense of the potential importance of international investing.
David
Fisher was the energetic entrepreneur needed to build the business, particularly for investing in the Capital's international
emerging markets
commitment
led
it
(see
Chapter
11).
to develop in the late
1960s what soon became the global standard for measuring international investment results: the
the
EAFE
Index (EAFE
combined stock markets of Europe,
The
Australia,
is
an acronym for
and the Far
came from
original initiative to develop the requisite database
Chuck
Schimpff,
who
sponsible, fiduciary
East).
believed that to invest internationally in a re-
manner and know whether
portfolio counselors
were truly adding value. Capital must have an objective and impartial
'^To provide enough capital for operating expenses, Morton and Lovelace authorized and
solemnly signed a $50,000 Letter of Credit ries,
so
Hardy Hall and
that "authorization,"
bank account
in
his secretary,
—but they were not
Hazel
authorized signato-
With
open the
initial
in the line:
They
Mathysen-Gerst was off to Geneva. Waiting
in line to
June 1962, he could hear the wails of others ahead of him
were closing their accounts and bemoaning their large market question kept coming to his mind: '^'
officially
Lazell, signed the official authorization.
While operating
losses
were
real,
"What am
I
Over and
doing and what have
I
over, the
same
gotten Capital into?"
measuring them would have conflicted with Lovelace's
determination to stay away from "profit-center accounting." expenditures "investments."
losses.
He
preferred to consider these
I
Glo bat In vesting
Standard for comparison. the necessary data
EAFE was created for that purpose. Most of
had never been collected or organized
In addition to providing an objective Capital's internal
EAFE
173
management,
measurement of
1970 the firm would
in
before. results for
distribute the
index and the supporting data externally as Capital Interna-
tional Perspective^^ to help cover the large costs being incurred in
Geneva.
"It's
doubtful that
Ken
really trusted
Jon to continue to sup-
port the company's paying for the Geneva office expenses year after
who
acknowledges Shanahan,
year,"
EAFE
for establishing the
another pragmatic reason
recalls
"Composing and compiling
index:
the data
'^"In the very early years, local stockbrokers were used to provide custody for the mutual funds' securities. Later, since
Chase Manhattan Bank was
key people on both sides had personal
Capital's
European custodian and
was only natural that Chase would be invited
ties, it
to co-venture Capital International S.A.,'' explains Thierry Vandeventer.
Mike Shanahan
continues, "Chase was our international custodian and, in those days, our stockbroker, too.
With
their
custody
fees plus 'courtage' (a trading tax
we were doing was more
business
Nilly Sikorsky
which Chase could benefit from), the
them than
profitable to
it
was to
us."
would soon be doing most of the often-laborious work of finding,
and organizing the extensive data required and was principally responsible
lecting,
ducing what became widely
known and
col-
for pro-
respected as Capital International Perspective. Nilly
Sikorsky was born in Egypt. As a Jew, her father had had to leave Egypt
when
tensions be-
tween Arabs and Jews became more and more serious in the 1950s. In Switzerland, he be-
came
a leading dealer in Iraqi rugs. "Before
Sikorsky, "our family early 1960s,
I
was, of course, very
needed a job to stay in the in the newspaper, so Year, but
I
we were
forced to leave Egypt," explains
was very wealthy. Then we had nothing. As a university student in the
was going
Mathysen-Gerst,
leftist
university.
to take
who was
cember 25th has no meaning
and quite
it."
We
interested in socialism.
Only one advertisement
for part-time
all
were.
I
work appeared
Sikorsky planned to start working after the
New
not above using people, said, "Given your religion, De-
for you.
Why not
start that
day?
We
have urgent work to get
done before year-end!" vision of how to develop the
"The
took care of the
details."
EAFE
index was
all
Ken's," recalls Nilly Sikorsky. "I
Thierry Vandeventer understood the necessary mathematics and
conceptualized an effective
way
to design the
EAFE
Index based on structured sampling of
the major stock markets of the world, matching the sample to the Universe teristics as size,
industry,
Memorial
know,
I
clarifying his
a practice
own thought
of explaining
process. Everything
He could see that China would be a great power, and that gold And Ken was the first to know that the economies of the world
learned from Ken.
would not all
way of working out and
on such charac-
Institute consultants also as-
—and made
things to others as a
would
(Battelle
Sikorsky continues, "Ken was a true visionary
sisted.)
I
and country.
stay at $40.
necessarily
must become global."
become
interrelated
and then integrated
—
so investors
and investing
174