The bottom-up investing practices of a $300 bn institution
Ask a certain Baby Bell for its oldest, biggest shareholder. Quiz an investment banker about the best media investor in the business. Get the IRO of a pharmaceuticals giant to name her favorite fund manager. The answer is the same every time: Capital Group.
Yet the various arms of giant Los Angeles-based Capital Group Companies, with a total of over $300 bn under management, are all but invisible to the public eye. Rarely do Capital Research & Management, Capital Guardian Trust or Capital Research International appear in the headlines, or the back pages of the newspaper for that matter.
'We are probably the largest unknown money management firm in the industry,' confirms Richard Havas, New York-based senior vice president and portfolio manager for Capital Guardian Trust Co and Capital Research International.
That Capital has stayed out of the limelight is astounding. Consider its clout: over a 66-year history, the employee-owned organization has built up more than $200 bn in mutual funds and another $100 bn in assets managed for pension funds and other institutions.
Behind the scenes is a monumental research effort. Some 90 percent of Capital's assets are invested in equities, driving the firm's 190 fiercely fundamental analysts and portfolio counselors to make upwards of 15,000 research visits to companies in more than 60 countries last year. At least $100 mn was spent just on research in 1996, and one visitor to Capital's Los Angeles research library estimates its list of holdings would fill several telephone books.
'What distinguishes us from most bottom-up stock-pickers is that we are truly bottom-up stock pickers,' says Havas with only a hint of irony. 'We do virtually no sector or theme work, but make decisions on a company-by- company basis, thoroughly kicking the tires.'
Perhaps it's that thoroughness that makes Capital the favorite of the IR profession. 'They really do their homework,' enthuses the pharmaceuticals IRO.
So why all the shyness? Why hide behind a 'media stone wall', as Havas calls it? The answer is as multifaceted as Capital: 'It's not a strategy, it's a lack of strategy,' ventures Chuck Freadhoff, assistant vice president in the fund business management group at Capital Research & Management Co (CRMC) in Los Angeles. 'All we want to do is manage money.'
Above all, he explains, Capital is loath to attract 'hot money': hair-trigger investors jumping in and out according to the quarter-to-quarter results of the mutual fund performance derby. 'We don't want to be in the fishbowl with Fidelity,' Havas adds.
'We avoid the star system, or having one person represent the firm in the media,' Freadhoff continues. 'People ask us what Capital's view is. In fact, we don't have just one view. With our multiple portfolio counselor system, no single individual speaks for a particular fund, and if one person retires then the fund doesn't really change.'
This unique 'multiple portfolio counselor system' is Capital's hallmark. The idea is to avoid the volatility and star mentality of individually-managed portfolios while encouraging the kind of creative thinking that can be smothered in a committee. The way it works is that each fund's assets are divided among several portfolio counselors with another segment - as much as 20 percent - assigned to research analysts. The portfolio counselors are said to be 'generalists' who select from a wide range of investments, while the analysts are 'specialists' who buy and sell securities among a limited universe of companies that they follow. CRMC, which manages mutual funds, and Capital Guardian Trust Co, which invests institutional assets, each have separate pools of portfolio counselors.
Unlike a committee, which would operate by consensus, each portfolio counselor at Capital operates independently and invests his or her portion as if it were an entire fund. That means they can invest in companies they really like and understand, and don't have to wander away from that universe just for the sake of diversifying. Diversification is achieved through combining the different portions in one whole portfolio.
Havas admits this is a 'very messy system' from an IRO's perspective. One company might find itself visited by several Capital analysts and portfolio counselors each of them different responsibilities. For Capital, too, the system is complex to administer and requires customized computer systems to coordinate all the different viewpoints that go into making up a fund's holdings. 'But over time we've found that this system returns a better-than-index return with lower-than-average volatility,' he explains.
Capital says the unusual system lets portfolio counselors act on their strongest convictions with the quickest response time. Still, to ensure orderly procedures and controls, an investment committee acts as a 'check and a balance' to make sure buying and selling decisions are consistent with each fund's objective. CRMC's committee is a professional blend of legal, accounting, compliance and fund management executives.
Freadhoff emphasizes that despite the independence of portfolio counselors, there is intense sharing of information 'not just between stock analysts in the same location, but between fixed-income and equity analysts and between different offices around the world.'
So e-mail and conference calls, supplemented with daily fax sheets blasted around the globe, keep Capital's many tentacles informed - research offices in Los Angeles, San Francisco, Washington DC, New York, Atlanta, London, Geneva, Singapore, Hong Kong and Tokyo. Take AT&T's recent ill-fated talks with SBC Communications: as soon as the news broke, telecom analyst Brad Vogt left a group-wide voicemail on the matter, promising to follow up after a chat with AT&T's CFO.
Havas underlines the importance of Capital's network: 'We have globally integrated research,' he says. 'For instance, we'll check out how Royal Bank of Canada looks next to Barclays Bank or Australia's Westpac Banking Corp. The most powerful electronic tool we use is Lotus Notes for analysts to exchange information with each other.'
Capital is also supported by one of the world's largest databases of financial information. The ubiquitous Morgan Stanley Capital International (MSCI) World Index was developed by a subsidiary of Geneva-based Capital International, Capital International Perspective. The unit compiles both the World and EAFE (Europe, Australasia and Far East) indices along with other national and regional MSCI indices. In addition, they produce Morgan Stanley Capital International Perspective with market information on some 4,100 companies, including 1,400 from emerging markets.
Overall, Capital is one of the largest US investors in non-US equities, with more than $90 bn in global and non-US portfolios. Capital's research in emerging markets over the last decade has led to over $9 bn in assets invested in nearly 40 emerging markets. A major part of this is the Emerging Markets Growth fund, organized in 1986 by the International Finance Corporation, an arm of the World Bank. Starting out with just $50 mn from 13 institutional shareholders invested in four markets, the fund now has more than 300 investors and around $5 bn invested in over 200 securities representing 30 countries.
Because Capital portfolio counselors act autonomously, they don't always have to agree with each other. In fact each one is expected to stamp their portfolio with a different strategy and style, giving strength and diversification to the whole fund. They do, however, share two things: fundamental research and a long-term perspective. They're encouraged in their long-term commitment with a compensation scheme based on a four-year cycle. Capital says its managers ask: 'Where will this company be in five or ten years?' not 'Where will this stock be in three or six months?'
'That's another reason why IROs like us: we really get to know the company and we stay in contact,' says Freadhoff, citing last year's low 19.5 percent turnover in CRMC's largest fund, the $36 bn Investment Company of America. Overall, Capital holds each stock an average of five years.
The determining factor for these confirmed bottom-up stock pickers is value, with portfolio counselors and analysts considering every prospective investment from a range of different angles: management, financial strength, resources, products and services, operating environment, future earnings and dividends stream.
Along the way, they meet with economists, government officials and industry specialists. They even interview customers and suppliers, while sifting through company reports, financial statements and trade publications in a variety of languages. Capital boasts that while it uses many of the traditional Wall Street sources of information, it's not dependent on them. Instead, through its research, resources and contacts, it generates - and closely guards - virtually all the information used for investment decisions.
Overseas, Capital's multi-layered research lends itself well to the complexity of global investing. Often, several Capital staffers look at the same investment from different perspectives, making joint calls on companies, competitors and suppliers. They consider currency fluctuations, changes in regulations and accounting methods, cross- border technology transfers, differences in patent laws, and potential R&D results.
Looking for Money-Makers
When it comes right down to it, there's nothing like looking management in the eye. 'Probably the most presumptuous idea is that we can evaluate management after seeing them for 45 minutes or one hour,' Havas admits. 'But that's what we have to do, for better or for worse.'
Over Havas's eleven years with Capital Guardian Trust and Capital Research International, he has learned to quickly size people up and determine whether or not they are 'money-makers.' 'We place a huge emphasis on the quality of management. It's a paramount issue and really makes the difference in the long term.' He says he spends 30-40 percent of his time talking to companies' management, whether on the road, on the phone or in Capital's offices.
'We try to find people with a track record of making money, and corporations that are in a position to handle growth going forward,' says Havas, who carefully tracks the motivation of individuals. 'Maybe ten years ago a CEO was driven, excited and his sole interest was making money. Now he's more interested in sitting on a lot of boards and serving the community. That's fine, but he's not out there making money for me.'
A change in management is a red flag for Havas: 'Clearly, when a company is in crisis and they change managers, that is when real value arises. But you want to see the new management right away to assess them.'
An important factor is a company's capital cycle, and a buying opportunity arises when a company moves from a heavy capital expenditure program to a sustainable period of free cashflow. 'At that point, earnings tend to accelerate and positive things like big dividends and share buybacks begin to come into play,' Havas says.
He also focuses heavily on the way companies manage their capital. 'This sort of thing is going to make a huge difference over the next ten to 15 years,' he says. 'How does management balance share buybacks with acquisitions? Do managers really understand the risks involved in buying something they don't really know compared with buying something they know well?'
Despite his focus on company management, Havas says many companies - particularly small caps, of which Capital owns $10 bn worth - don't pay enough attention to their annual reports. 'Sometimes I will look at a small company, and I don't have a clue who they are. But their annual report is just fluff and superlatives that tell me nothing about their business; it lacks any real heart-to-heart message. Other companies put out serious documents that tell me something real - how they think their markets are going to grow and how much share they're going to get, for example.' His advice: 'Go ahead and save money on glossy paper, but give me some real information.'
As for annual meetings, Havas attends to buttonhole mid-level executives and get a feel for what they're like. 'From the gossip, we may know who's going to be the next group of managers. The annual meeting is a good opportunity to meet some of those people on an informal basis.'
'Over-promising and under-delivering is death and destruction for any company, especially a small-cap,' he concludes.
With that rejoinder, Havas returns to his work in a hotbed of investment ideas. Capital Group may not hog the media spotlight, and it may not take out full-page ads in the Journal. But its portfolio counselors and analysts are welcome in the throne rooms of the world's chairmen and CEOs - not to mention heads of state. Few bottom-up investors are so comfortable at the top.
- Capital Research & Management Company (CRMC)
Manages more than $200 bn in US-based mutual funds
- American Funds Distributors
Distributes the CRMC-managed mutual funds through stockbrokers
- American Funds Service Company
Services American Funds shareholders
- Capital Guardian Trust Company
Manages around $100 bn for over 425 large accounts, including more than 35 of the top 100 US pension funds. Some $50 bn is managed for non-US clients. Also manages assets for high-net-worth individuals through its Personal Investment Management division
- Capital Guardian Research Company
Provides investment research for Capital Guardian Trust Co's portfolios
- Capital Group International
Manages funds for overseas clients through four companies:
- Capital International SA (Switzerland) was formed in 1963 to manage assets from non-US accounts. Its data-gathering arm produces the MSCI World, EAFE and regional indices.
- Capital International Ltd (UK) manages institutional portfolios and mutual funds for non-US clients.
- Capital International KK (Japan) provides international diversification for Japanese investors
- Capital International Inc (US) manages the $5 bn Emerging Markets Growth Fund
- Capital Research International
Provides research on non-US companies primarily to Capital's institutional or international investment management companies
- Capital Strategy Research
Provides information on broad economic trends and political developments for all of Capital's investment management companies
- Capital Group Research
Provides computer, statistical and other investment-related services
- Capital Group Companies Inc
Provides centralized administrative services
Capital Research & Management portfolio counselors and analysts may labor beneath of a cloak of secrecy as far as the media are concerned, but the companies in which they invest become well acquainted with these bottom-up stock pickers.
- Entertainment & Media: Gordon Crawford, Los Angeles
- Telecoms: Brad Vogt, Washington, DC
- Emerging Markets: Victor Cohn, Los Angeles
- Autos: Darcy Kopcho, Geneva
- Oil & Gas: Mike Kerr, Los Angeles
- Technology: Andrew Suzman, New York