Capital Faced With Foreign Cold Spell
When pension funds and other large investors sought a hot hand in foreign stocks in the 1990s, many of them put their money with Los Angeles-based Capital Group Cos.
The company’s stock-picking prowess in the U.S. market already was well known. And by the start of the last decade, Capital had become the world’s biggest investor in emerging-market countries, as its far-flung managers scooped up shares in banks in Brazil, cellular phone companies in China and detergent makers in India.
As “globalization” became the watchword of the ‘90s, billions of dollars poured into Capital’s foreign investment units. The company didn’t disappoint investors: It racked up spectacular returns -- 71% in its flagship account in one year alone.
But in the last few years, Capital’s hot hand with foreign stocks has cooled. Since 2000 the companies’ foreign returns have mostly lagged behind their benchmark indexes.
Some unhappy institutional clients have bolted, and many who remain are asking what has gone wrong at the world’s ninth-largest money manager, where overseas holdings made up more than 40% of the firm’s $814 billion in assets at the start of the year.
It’s a “delicate moment,” for Capital, says Jon Bauman, executive director of the Teachers’ Retirement System of Illinois pension fund, which has $600 million in foreign stocks with Capital. Bauman’s fund has put Capital on its so-called watch list because of performance shortfalls.
Some clients are less diplomatic in their assessments.
“We used to talk about how great they were, and now all we talk about is how they’re our worst performer in the foreign-asset class,” said one frustrated pension fund director, who asked not to be named.
It isn’t surprising for a money manager to hit a rough patch. Usually, however, the reason isn’t a mystery: A firm may have gambled too heavily on a losing market sector, for example, or talented strategists may have abandoned ship.
In Capital’s case, neither the company nor its clients have been able to isolate a root cause of the firm’s relative slump with foreign stocks.
It’s no small concern for David I. Fisher, the executive who has overseen Capital’s foreign investment operation from its fledgling days in the early 1980s.
“Clients would feel better if we could say, ‘We’ve looked at the numbers and it’s that person’s fault. And we fired that person and hired this person,’ ” Fisher said in an interview last week in his West Los Angeles office.
But “that person,” he said, doesn’t exist.
Adding to the enigma is why Capital’s principal foreign stock mutual fund for individual investors, the EuroPacific Growth fund in the firm’s American Funds family, has performed markedly better over the last three years than its average foreign blue-chip stock account for institutional clients.
The mutual funds and institutional accounts are managed by different teams. But they share the same basic stock- picking disciplines, notably a research-intensive “value” orientation and a long-term approach to investing.
Perhaps what has most distinguished Capital has been its refusal to settle for being an index-hugger -- a money manager that views success as performance that hews close to benchmark stock indexes. Capital’s portfolio managers have been encouraged to follow their hunches and take educated risks in search of above-average returns. Their compensation always has depended on beating market indexes, Fisher says.
That approach has won the company devoted fans, and is one reason many of Capital’s institutional clients are torn about pushing the partner-owned firm to make dramatic changes in its operations. They don’t want to risk disturbing a business model that has produced tremendous returns over the last four decades.
“Historically, Capital has gone through periods of underperformance and then come back with a vengeance,” said David Kushner, deputy director of investments at the San Francisco City and County Retirement System, which has the bulk of its $930-million foreign stock portfolio managed by Capital.
“They have a long-term track record that is almost without peer,” said Michael Rosen, a principal at Angeles Investment Advisors, a pension consulting firm in Santa Monica. “This is an organization that has earned the benefit of the doubt.”
Indeed, some U.S. institutions that want to be invested in foreign stocks say this might be a better time to be hiring Capital than firing it.
The Washington State Investment Board signed Capital in June to manage about $480 million in blue-chip foreign shares, said Joe Dear, the pension fund’s executive director.
“They have a very impressive organization,” Dear said of Capital. As for the firm’s performance in recent years, “if you’re only picking on performance, you’re doing your [investment] selection looking in the rearview mirror,” instead of looking ahead, he said.
The 65-year-old Fisher, one of the senior partners who has helped build Capital from a firm with less than $12 billion under management in 1980, doesn’t minimize the recent performance numbers. But he says he reminds clients that the data should be viewed with perspective.
An ‘Unrepeatable’ Year
Capital’s hot streak with foreign stocks in the late 1990s was capped by a blowout 1999, when most markets worldwide were rocketing in the final surge of that decade’s bull market.
The mostly blue-chip core foreign stock portfolio of Capital Guardian Trust, the company’s primary U.S. institutional investing unit, soared 71% in 1999. By contrast, a widely used index of big-name foreign stocks, the Morgan Stanley EAFE index (for Europe, Australasia and the Far East), rose 27% that year.
“I remember saying to people that our numbers that year were unrepeatable -- a once-in-a- career happening,” said Fisher, who chairs Capital Guardian. “And nobody believed me.” In 2000, he said, “a lot of people hired us” because of the late- 1990s performance.
He describes Capital’s foreign stock returns since 2000 as “mediocre -- they’re disappointing to us.” Even so, he said, “they’re not terrible.”
But institutional investors, much more than individual investors, focus on relative returns rather than absolute returns. What matters to pension funds and other big-money clients is how a manager performs compared with a benchmark index. In bull or bear markets, beating the index is what counts.
That is where Capital is falling down. The average return on the firm’s core institutional account of foreign shares has significantly beaten its benchmark EAFE index in just one year since 2000.
By contrast, that core account trounced its benchmark in four of five years from 1995 through 1999.
Similarly, Capital’s main emerging-markets stock account has lagged behind a Morgan Stanley emerging-markets index every year since 2001. Capital had beaten that index from 1996 through 1999.
Capital’s struggle with foreign stocks has become front-page news in institutional trade publications such as Pensions & Investments magazine, which recently tallied some of the pension funds that have dropped the firm -- including the Hawaii Employees’ Retirement System, the Ohio Police and Fire Pension Fund and the Pennsylvania Public School Employees’ Retirement System.
So far, most Capital clients appear to be staying put. “We don’t see this as a panic situation,” said an executive at a major pension consulting firm who requested anonymity.
Michael Travaglini, executive director of the Massachusetts Pension Reserves Investment Management Board, which has $930 million in foreign stocks with Capital, said the board “hasn’t made any definitive decision about what to do,” despite “sub-par recent performance.”
It is helping, some institutional investors say, that Capital executives have been more forthcoming this year about steps they are taking to try and boost their portfolios.
Fisher said one concern was that too many of Capital’s vaunted in-house analysts, who operate from offices worldwide, had since the late 1990s shifted from being regional specialists to thinking about stocks on a global scale.
That may have led to missed stock opportunities at the regional level, he said.
“We are encouraging people who are doing well with a regional specialization to stay focused on that,” said Andrew F. Barth, the 43-year-old president of Capital Guardian.
The company’s global research team also had been “spending less time on medium to small companies than we should have” in recent years, Fisher said. “That was not a conscious decision, but I think what happens is analysts want to focus their attention on those places where they can have the broadest impact. And it’s big companies where you can have the broadest impact.”
Yet smaller companies that blossom can produce outsize gains for a portfolio. To find more of those ideas, Capital has hired more small-stock specialists, Fisher said.
The company also has come to accept that so-called quantitative portfolio research -- comparing companies and stocks by factual data, such as sales trends and price-to-earnings ratios -- can be useful, Fisher said.
Historically, Capital has preferred to rely on qualitative research, meaning the intuition of its analysts and portfolio managers about individual companies. But Fisher said he now believes that quantitative research leads to “a better understanding of the bets we’re making.”
Some clients have been asking questions that Capital has heard many times before, Fisher said. For example, could it be that the company simply has too much money to worry about?
Capital’s answer with its institutional accounts and its mutual funds has long been that there’s no reason to limit the amount it manages -- as long as it’s willing to spend whatever is necessary to have the best people directing its clients’ assets.
Calling the Shots
As a privately held firm, the company doesn’t answer to anyone but its own employees and its clients. Capital has always had a reputation for sacrificing its own short-term profit to ensure long-term growth of the business.
In “Capital,” a corporate biography published this year, author Charles Ellis wrote that Jon Lovelace, the son of Capital’s founder and the firm’s guiding force since the 1950s, insisted that the company continue to expand its foreign investing business in the 1960s and ‘70s, even though many of his peers said the then-tiny business wasn’t worth the time or expense.
It was Lovelace who gave Fisher control of the foreign investment unit in 1981.
Although Capital today is trying to return to market-beating form by tweaking its operations, Fisher -- eyeing a world where foreign stock opportunities are mushrooming in places including India and China -- says the company won’t make drastic changes in its staff, its team approach to picking stocks or its long-term investing focus.
Some of Capital’s foreign stock clients fear that the company’s streak of weak performance could make it more risk-averse, with the effect of hurting returns in the long run. The worst that could happen, they say, is for the company to decide that index-hugging isn’t such a bad strategy after all.
Fisher vows that won’t happen.
“I wouldn’t want to be anywhere where the definition of success is hugging the index,” he said. “The idea of having mediocrity as a goal seems really strange to me.”
