Four years ago when we created Marcellus’ business plan, Charles Ellis’ superb book on the Capital Group, ‘Capital: The Story of Long-Term Investment Excellence’, was an invaluable resource for us. As the only global fund management house which has truly managed to hold its own in an era characterised by the rise of index funds, Capital’s story has several interesting implications for other active asset managers like Marcellus as Brooke Masters explains in this article.
Ms Masters begins the piece by explaining the unusual construct Capital uses to manage its $2.1 trillion dollars of assets under management: “What the managers had in common, says Jody Jonsson, a 32-year veteran of Capital and a management committee member, was a “belief that you must have the conviction to wait out a market that doesn’t favour your investing style. It takes incredible courage [ . . . ] We brought them both in to help our next generation of investors understand how we manage money and why we respect and need their individual investment approaches.”
Her comments reflect an unusual philosophy that has turned Capital into the world’s largest active fund manager, with $2.1tn under management as of the end of June. Its funds are run by multiple people, but instead of reaching agreement, each is encouraged to stake out a different position. That means one part of Capital is often selling shares in a company even as another is buying — and some managers within the same fund may be bearish while others are bullish…
Insiders argue that this structure is what has allowed Capital funds to grow larger than competitors with a single star manager or traditional committee. With more people running money, the funds track a broader range of companies. Decisions to buy and sell are less likely to disrupt the market than if the whole fund shifted its position. Bonuses are based on long-term investment results without regard to assets managed.”
The results have been excellent (which is why Capital has been able to run in this unusual fashion for so long): “The long-term results have been excellent for decades. All but one of its 18 equity mutual funds have beaten their benchmark since inception by an average of 150 basis points annually, even after fees are deducted. The company controls about 8 per cent of US mutual and exchange traded fund assets…Its collaborative culture, low fees and dedication to active stock picking make it a well-respected outlier in the increasingly cut-throat world of asset management…
Morningstar, the investment research group, gives 65 per cent of its funds four or five stars out of five. “They are the Microsoft of asset managers. They will not be the first movers but they will go to where there is demand,” says Tom Nations, the Morningstar analyst who follows Capital. “They have a very competitive line-up.””
So, what is the problem? Where is the serpent in this garden of Eden? Part of the challenge is an ageing customer base and part of it is renewed aggression of super cheap index funds: “Retiring clients are drawing down savings and its flagship products — equity mutual funds — are falling out of favour. Net equity inflows have been negative every year since 2016, bar 2018 when they were flat.
Buoyant markets may have kept its assets under management rising until this year, but 2022’s volatility hit hard: AUM slumped by 19 per cent and several flagship funds are having bad years. Competitors such as Vanguard and BlackRock, which offer exchange traded funds and ultra-cheap passive products that track indices, have grown much faster.”
So how is Capital dealing with these challenges?
Firstly, it is bulking up on index funds: “…the group launched its first ETFs in February, making its active investment strategies available to a new group of investors….Capital’s slow move into ETFs is also starting to pay off; it gives investors a way to put money in directly and has attracted more than $2bn in assets since the February launch. Nearly one-quarter of the firm’s assets are now in something other than a traditional US mutual fund, up from less than 5 per cent in 2015, and $163bn of net fixed-income inflows over the period have helped keep the firm growing — albeit more slowly than some of its biggest competitors. Total AUM have risen 62 per cent since 2015; Fidelity and Vanguard more than doubled.”
Secondly, Capital is strengthening its bond funds (ironically, because the scope for fund managers’ judgement is lower in bonds, such funds are less prone to disruption by index funds): “It boosted offerings of bond and “solutions” funds, which are popular for retirement and education savings…Rebalancing required strengthening bond products that had underperformed in the financial crisis. Capital has doubled the size of its fixed-income team since 2015 and redrew its bonus curves to make sure that portfolio managers are not motivated to take outsized risks. It also tweaked its methods to reflect differences between equity and credit investing. Bond portfolio managers still follow their convictions but must stay within parameters set by a leadership group. “That ensures we are all rowing in the same direction,” says Mike Gitlin (MKCG), head of fixed income.
Fixed-income assets under management have doubled to $470bn since 2015, putting Capital among the top global active bond managers.”
And thirdly Capital is pushing more aggressively into Asia and Europe: “The firm, which first tried to crack Europe in the 1960s, has been steadily building its non-US staff for years. Overseas headcount has more than doubled in the past decade. More than 20 per cent of last year’s $38bn in net new inflows came from overseas, even though 97 per cent of AUM are from North America.”
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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.
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