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Doyen of money managers
'NO investment organisation in the world has ever done so well for so long for so many clients as The Capital Group Companies," wrote Charles Ellis, the renowned author and expert on investment management, in his 2004 biography of the firm Capital: the story of long term investment excellence.
Some of the shine embodied in that statement wore off after the global financial crisis of 2008. From 2008 to 2010, Capital funds underperformed. Redemptions rose, turnover among investors nearly doubled from traditionally around 15 per cent to 30 per cent, partly because of the growing popularity of passive index funds and exchange-traded funds (ETFs), which as an active manager, Capital did not offer.
But Mr Ellis' earlier assessment remains broadly valid; Capital's track record over the long term is still stellar. More investment managers still want to work at the Capital Group than at any other asset management company. Indeed, the company was profiled again in Mr Ellis' 2013 bestseller What it Takes which studied five of the world's top professional firms and what sets them apart from their peers.
Established in 1931 and headquartered in Los Angeles, privately owned Capital Group is one of the world's largest global asset managers. It has more than US$1.4 trillion in assets under management, some 50 million accounts, 200,000 distributors and some 7,300 staff spread across 24 offices around the world, including six in the Asia-Pacific - in Hong Kong, Singapore, Tokyo, Mumbai, Sydney and Beijing. It is also by far the world's biggest investor in emerging markets and even has the world's biggest emerging market private equity fund.
Capital Group's 69-year-old chairman, Jim Rothenberg, who has served for 45 years in the company, is one of the doyens of the money management business. He is breaking from tradition in granting an interview. The group has historically shunned the media. It does not advertise and is known to have issued barely half a dozen press releases in its 84 years of existence.
"We've had a history of trying to keep out of the spotlight and remain somewhat quiet," says Mr Rothenberg, in a conference room at Capital's sparsely furnished offices in One Raffles Quay.
Part of the reason, he explains, is because people at the firm prefer to keep a low profile. "There are a lot of names that you wouldn't have heard of, but some of them have investment records which, during their time, have been as good as any I have ever seen. So, it's been more the style of the people, which has been adopted by the firm."
But then the environment changed. First, the regulatory environment got tougher since the global financial crisis. "We felt compelled to be more vocal about some of the directions (regulators) are taking," says Mr Rothenberg. "Because for the most part, these are bank regulators trying to apply bank regulatory standards and beginning to talk about imposing those standards on us."
Active vs passive investing
The other big change is what he calls "the active-passive debate", that is, the debate over whether it is better for investors to invest with "active" fund managers such as Capital, who pick selected stocks, or "passive" managers such as the Vanguard Group, who simply invest in index funds and ETFs.
"Because if we don't speak, only one side is talking. Somebody has to take up the other side," he points out. "Many of our brethren competitors in the investment world haven't been willing to do that, so we felt we'd better step up the discussion and put out the other side of the story."
The advocates of passive investing include heavyweights such as the founder of the Vanguard Group John Bogle as well as Nobel laureates William Sharpe and Eugene Fama. Mr Fama was the originator of the so-called "efficient market hypothesis", which holds that asset prices incorporate all available information. He suggested that since active managers don't have better information, they can't generate better returns than what an investor can get by passively investing in index funds or ETFs. The game of trying to time the market is unwinnable, according to this thesis.
As the head of one of the biggest active managers in the world, what is Mr Rothenberg's answer?
"Part of my answer goes back to when I was in business school during 1968-1970," he says. "Some of the people who taught me at the time were the inventors of some of these theories about random walks and the idea that active management couldn't outperform, or that information was broadly known. One of the fascinating things about people like Bill Sharpe is that they went into the active investment management business. In fact, there were a number of folks who contributed to the philosophical underpinnings of passive investing who then all went into active management. If you invented this theory, why would you do that? Maybe there's more money in active management, I don't know why. But it's interesting.
"The other thing is this: The theory says, collectively, all active managers in the mutual fund business can't outperform the market. But since active managers represent something like 75 per cent of the market, it's not a very heroic statement to say that 75 per cent don't outperform the 100. I think you could prove it mathematically that it would be impossible for the 75 per cent to outperform the 100 all the time.
"What they cannot say - because it can be so easily refuted - is that an individual manager, over reasonable time periods, can outperform. What they then fall back on is to say, well, it's too hard for the average individual to find that person. And to that, we say: 'That's interesting. We manage about US$1.3 trillion of mutual fund assets in the US, so some people have been able to find us without too much trouble'.
"We are not advocating that active management is better than passive management. What we are trying to say is that there is a possibility that active management has value. They can't refute that."
He also points out that if the passive theory was right, investment legends such as Warren Buffet, Peter Lynch and George Soros could never exist.
"Another thing they say is that it has gotten harder to outperform. I think that is true. Information has become much more democratised by the Internet. So yes, it's not easy to outperform. Yet, there are organisations that have done it, and done it over long periods of time.
"So we just want to be that other force out there in the debate, since we have a good data set behind us. We think there's another point to be argued."
The Capital System
What then, does it take for an investment manager to outperform over the long term?
"The first thing when you talk about the long term is that you must have an organisation that's built to last," says Mr Rothenberg. "So since the 1950s, we have used an approach to managing money which we call the Capital System. It's really a system of multiple managers working in portfolios. So in essence, over time, the results that we've achieved were never achieved by one person. They were achieved by a sequence of people."
Most investment management firms use one of two approaches to manage portfolios. One is to use individual managers, the other is to rely on investment committees. The idea of having multiple managers running a single portfolio was to get the best of both worlds: high conviction ideas get put into practice, and there is diversity of ideas as well. Moreover, portfolio managers get satisfaction and are accountable. And with more managers, funds can be bigger, and fees lower. The system has generally worked well for the Capital Group.
But isn't Capital missing out on "star" managers - such as the legendary Peter Lynch of Fidelity or even a Warren Buffet? "It's not that stars are bad, and we have had quite a few stars," says Mr Rothenberg. "But they tend to be more volatile. Stars don't perform in and out, every year, with the same efficacy. Clients are interested in lower volatility than what stars often produce. So it's not that we don't have stars, we just harness and package them together. And they don't all perform each year the same."
What Capital Group's approach comes down to in the end is talent and how it is managed. "Of course the other underpinning is that you've got to know a lot about what you're investing in. If you believe in passive investing, you know nothing about what you're investing in. So we've built over time, a very extensive global research capability, both at macro and micro levels, with a huge emphasis on industries and companies.
"Those are the ingredients: talent, how we put it together, the Capital System and this belief in extensive research."
But why then did the Capital Group underperform during 2008-2010 and what has the organisation learned from that experience?
"We've always been heavily oriented toward growth and income, not just toward growth," Mr Rothenberg explains. "In 2008, a lot of high-yielding companies were in the financial services industry. We didn't anticipate the degree to which there would be trouble in the financial services sector. The funny thing was that our fixed income folks did anticipate this, but the communication didn't get across the divide as well as it should have. That was our biggest error. I remember there was this 27-year-old who was doing research related to fixed income. And this young guy wrote a piece about a page and a half long saying, you know, there never can be a Triple A sub-prime piece of paper. Somehow that didn't get across to the equity guys.
"We've spent a lot of time since then ensuring that our fixed income folks and our equity folks talk to each other and even do joint research. Equity analysts tend to focus on the income statement, fixed income analysts tend to focus on the balance sheet. We make sure those two get put together all the time."
Mr Rothenberg spends much of his time thinking about trends emerging over the next three to five years and their implications for investment strategy. One of the big trends he is focusing on is ageing and retirement.
"In the US, Japan, Europe and other countries in Asia, the demographics are shifting. We're looking at the needs of retiring or retired investors. We have been doing a lot of work in the US and increasingly outside the US on what kinds of products and services most address the needs of these people."
It's not a straightforward issue, he explains. "There's a tendency to think that there's this moment when you retire and your asset mix shifts. The problem with this view is that if you're a couple and you retire at 65, there's a high probability that one of you will live till 85 - so that's a 20-year horizon. That's beyond what most people think about from an investment perspective. But what it should suggest to you is that you can't just go from wherever you were when you retire to fixed income. Because if you do that, and inflation is at all like the past, you're going to have some problems. We have tried to create products that move along a glide path.
"You don't go, boom, from equities to fixed income. You move from where you were to a more conservative equity piece, with some fixed income. As time passes, you shift to equities with some yield. We're looking for ways to bring some of those products to markets outside the US and find ways, with local partners hopefully, to distribute these products."
Another trend Mr Rothenberg sees relates to how investors will look at the global investment picture in a world where more companies operate globally. A lot of the current geographical distinctions that investors make - for example, whether they're investing in a US company or a European company or an emerging market company - are going to go away, he suggests.
"For example, when you buy Nestle, you're not really buying a European company in terms of its business. The question is not what is the mix of assets by domicile but what is the mix of assets by revenue." Thus, the Capital Group is trying to figure out how it needs to position its offerings to investors.
The fact that China is a major force will also change the way investors look at the world. "We're going to be faced with the idea that China will have the largest or second largest market cap in the world. So how will Morgan Stanley restructure its indices? Does it make sense to think about US, developed markets, non-US, and emerging markets, or should it be US, China, other emerging markets, Europe and Japan as a way to think about the world?"
As for his view on China and its prospects, Mr Rothenberg offers a cautious opinion. "It's very hard to reconcile the public data with the probable reality," he says. "The published data says the economy grew at 7 per cent, but when you look at real data, you find that iron ore shipments, coal shipments, electricity production - all the real things - are down to a level more consistent with 3 per cent growth."
"They also do have an issue with their labour force. They can't reverse their one child policy very quickly. In truth, by around 2020, the population dynamics of the US will be better than the population dynamics of China - although China still has a lot of labour that is not in the cities." Overall, he concludes: "I wouldn't rule out that China will play a very big role in coming years and be a force to reckon with."
A thoughtful - you might even say, cerebral - personality, Mr Rothenberg is a voracious reader. He once told The Harvard Gazette (Harvard was his alma mater, and he majored in English literature before he went to business school) that the study of literature is good training for making long term decisions based on imperfect information. What did he mean?
He explains: "The one thing I've observed is that with the study of literature, you understand the notion that there is no single answer, no single conclusion that you can draw when you read a poem or a novel. You have to build a case, based on your own perceptions and your own ideas - and have to justify your case. You have to also recognise that it's not the answer, it's an answer. I think that whole frame of mind - recognising that there are lots of facts, lots of data, conclusions and inferences that can be drawn, but there are often non-answers - that's a very useful mindset for the investment management business. Because there often aren't a lot of answers and we are inherently making decisions without perfect information.
"The other thing that you begin to realise when you read a lot of literature, is there is a lot of meaning to behavioural finance. People and personalities have a great deal of influence, both at the company level and in the marketplace. If you read literature, you see a lot of that."
He talks about what he read on the plane to Singapore.
"I read a book that a friend of mine gave me called Boys in the Boat. It's about the University of Washington boat crew that rowed in the 1936 Olympics, and much to the chagrin of Adolf Hitler, won the gold medal. It's a fascinating book to read because it talks about the personalities of these individuals and the notion that an eight-man crew is not necessarily the strongest eight individual oarsmen. It's how you put that group together and how that group has to work as one, how they have to trust each other. It's a lot about collaboration."
Mr Rothenberg points out the big lesson in the story of the Olympic champions of the 1936 US rowing team for his business - which is probably true for many others as well.
"Among investment analysts," he says, "there's sometimes a tendency to ask: 'how do I maximise my own bonus' as opposed to 'how do I maximise the outcome for the firm'."
JAMES F ROTHENBERG
Chairman, The Capital Group Companies, Inc
1968: AB (English) Harvard College
1970: MBA with distinction, Harvard Business School
Holds Chartered Financial Analyst qualification
1970: Joined Capital Group; served in various positions, including as equity investment analyst and president and director of Capital Research and Management Co
Other positions held:
Treasurer, Harvard University (2004-2014)
Chairman of the Board of Directors, Harvard Management Company
Director, Huntington Memorial Hospital, Los Angeles, California
Director, California Insitute of Technology
Governor, Investment Company Institute (global association of regulated funds)