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Capital: The Story of Long-Term Investment Excellence [Hardcover ed.]
 0471567043, 9780471567042

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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.

No

part of this publication

form or by any means,

may be

reproduced, stored in a retrieval system, or transmitted in any

electronic, mechanical, photocopying, recording, scanning, or otherwise,

except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through

MA 01923,

(978) 750-8400, fax (978) 750-4470, or on the

web

at

payment of the

Rosewood

appropriate per-copy fee to the Copyright Clearance Center, Inc., 222

Drive, Danvers,

www.copyright.com. Requests

the Publisher for permission should be addressed to the Permissions Department, John Wiley

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1 1 1

NJ 07030,

(201) 748-601

1,

fax (201)

to

&

748-6008, or online

at

http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this

book, they make no representations or warranties with respect to the

accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose.

extended by

may

herein

services, shall

be

sales representatives or

written sales materials.

not be suitable for your situation.

The

The

publisher

is

No warranty may be

created or

advice and strategies contained

not engaged in rendering professional

and you should consult a professional where appropriate. Neither the publisher nor author liable for

any

loss

of profit or any other commercial damages, including but not limited to

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For general information on our other products and services please contact our Customer Care

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Ellis,

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www.wiley.com.

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