Rothenberg

8 the raffles conversation THE BUSINESS TIMES WEEKEND SATURDAY/SUNDAY, JULY 11-12, 2015 q THE BUSINESS TIMES WEEKEND SATURDAY/SUNDAY, JULY 11-12, 2015 q the raffles conversation 9
‘N
O investment organisa-
tion in the world has ev-
er done so well for so
long for so many clients
as The Capital Group
Companies,” wrote Charles Ellis, the re-
nowned author and expert on investment
management, in his 2004 biography of the
firm Capital: the story of long term invest-
ment excellence.
Some of the shine embodied in that
statement wore off after the global finan-
cial crisis of 2008. From 2008 to 2010, Capi-
tal funds underperformed. Redemptions
rose, turnover among investors nearly dou-
bled from traditionally around 15 per cent
to 30 per cent, partly because of the grow-
ing popularity of passive index funds and
exchange-traded funds (ETFs), which as
an active manager, Capital did not offer.
But Mr Ellis’ earlier assessment re-
mains broadly valid; Capital’s track record
over the long term is still stellar. More in-
vestment managers still want to work at
the Capital Group than at any other asset
management company. Indeed, the com-
pany 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 distrib-
utors and some 7,300 staff spread across
24 offices around the world, including six
in the Asia-Pacific – in Hong Kong, Singa-
pore, Tokyo, Mumbai, Sydney and Bei-
jing. It is also by far the world’s biggest in-
vestor in emerging markets and even has
the world’s biggest emerging market pri-
vate equity fund.
Breaking silence
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 in-
terview. 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 exist-
ence.
“We’ve had a history of trying to keep
out of the spotlight and remain somewhat
quiet,” says Mr Rothenberg, in a confer-
ence room at Capital’s sparsely furnished
offices in One Raffles Quay.
Part of the reason, he explains, is be-
cause 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, dur-
ing 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 regula-
tors trying to apply bank regulatory stand-
ards 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 in-
vest with “active” fund managers such as
Capital, who pick selected stocks, or “pas-
sive” 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 invest-
ment world haven’t been willing to do
that, so we felt we’d better step up the dis-
cussion and put out the other side of the
story.”
The advocates of passive investing in-
clude heavyweights such as the founder of
the Vanguard Group John Bogle as well as
Nobel laureates William Sharpe and Eu-
gene Fama. Mr Fama was the originator of
the so-called “efficient market hypothe-
sis”, which holds that asset prices incorpo-
rate all available information. He suggest-
ed 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 man-
agement business. In fact, there were a
number of folks who contributed to the
philosophical underpinnings of passive in-
vesting who then all went into active man-
agement. 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 outper-
form the market. But since active manag-
ers represent something like 75 per cent of
the market, it’s not a very heroic state-
ment to say that 75 per cent don’t outper-
form the 100. I think you could prove it
mathematically that it would be impossi-
ble 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 aver-
age individual to find that person. And to
that, we say: ‘That’s interesting. We man-
age 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 man-
agement. What we are trying to say is that
there is a possibility that active manage-
ment 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 or-
ganisation 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 real-
ly 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 manag-
ers, the other is to rely on investment com-
mittees. The idea of having multiple man-
agers running a single portfolio was to get
the best of both worlds: high conviction
ideas get put into practice, and there is di-
versity of ideas as well. Moreover, portfo-
lio managers get satisfaction and are ac-
countable. 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 Rothen-
berg. “But they tend to be more volatile.
Stars don’t perform in and out, every year,
with the same efficacy. Clients are interest-
ed 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 underpin-
ning 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 re-
search capability, both at macro and mi-
cro levels, with a huge emphasis on indus-
tries 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 un-
derperform during 2008-2010 and what
has the organisation learned from that ex-
perience?
“We’ve always been heavily oriented to-
ward 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 ser-
vices 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. Some-
how 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.”
Emerging trends
Mr Rothenberg spends much of his time
thinking about trends emerging over the
next three to five years and their implica-
tions 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 retir-
ing or retired investors. We have been do-
ing a lot of work in the US and increasing-
ly outside the US on what kinds of prod-
ucts and services most address the needs
of these people.”
It’s not a straightforward issue, he ex-
plains. “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 prod-
ucts 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 hopeful-
ly, to distribute these products.”
Another trend Mr Rothenberg sees re-
lates to how investors will look at the glo-
bal 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 Eu-
ropean company or an emerging market
company – are going to go away, he sug-
gests.
“For example, when you buy Nestle,
you’re not really buying a European com-
pany in terms of its business. The ques-
tion is not what is the mix of assets by
domicile but what is the mix of assets by
revenue.” Thus, the Capital Group is try-
ing 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 sec-
ond largest market cap in the world. So
how will Morgan Stanley restructure its in-
dices? Does it make sense to think about
US, developed markets, non-US, and
emerging markets, or should it be US, Chi-
na, other emerging markets, Europe and
Japan as a way to think about the world?”
As for his view on China and its pros-
pects, 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 econo-
my grew at 7 per cent, but when you look
at real data, you find that iron ore ship-
ments, coal shipments, electricity produc-
tion – all the real things – are down to a lev-
el 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 com-
ing years and be a force to reckon with.”
Voracious reader
A thoughtful – you might even say, cere-
bral – personality, Mr Rothenberg is a vora-
cious reader. He once told The Harvard
Gazette (Harvard was his alma mater,
and he majored in English literature be-
fore he went to business school) that the
study of literature is good training for mak-
ing long term decisions based on imper-
fect information. What did he mean?
He explains: “The one thing I’ve ob-
served 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 infer-
ences that can be drawn, but there are of-
ten 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 real-
ise when you read a lot of literature, is
there is a lot of meaning to behavioural fi-
nance. People and personalities have a
great deal of influence, both at the compa-
ny 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 per-
sonalities of these individuals and the no-
tion that an eight-man crew is not neces-
sarily the strongest eight individual oars-
men. 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 les-
son in the story of the Olympic champi-
ons 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 op-
posed to ‘how do I maximise the outcome
for the firm’.”
vikram@sph.com.sg
PHOTO: SHAWN TEO
Doyen of
money managers
Jim Rothenberg, chairman of the Capital Group, talks about his firm’s unique style,
emerging trends in global markets and his love of literature. By Vikram Khanna
‘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.’
JAMES F
ROTHENBERG
Chairman, The Capital Group
Companies, Inc
Born 1946
Education:
1968: AB (English) Harvard College
1970: MBA with distinction, Harvard
Business School
Holds Chartered Financial Analyst
qualification
Professional highlights:
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)

Rothenberg

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