Read an Excerpt

Capital

John Wiley & Sons

Chapter One

NOTES FOR READERS

An investment management organization-like any professional organization-is profoundly dependent on the capabilities, character, motivations, and values of its people. And the attributes of the early joiners primarily determine the kind of professionals the firm will attract in future years. Once the die is cast, upgrading an organization is very hard. For an organization to upgrade itself at a later date is almost impossible. So, the founders and early joiners matter greatly.

Hundreds of investment management firms have been launched during the past 50 years. Collectively, their behavior in recruiting professionals confirms the grim validity of David Ogilvy's caution: "Only giants will hire giants. Ordinary men will hire men who are less than they are-and then those will go on to hire men of even less stature until the whole organization is replete with pygmies!" Creating and building and then sustaining a superior professional firm is always deliberate, continuous, and "unnatural"-unnatural in the sense that something new and different is being brought to life and built to last.

Jonathan Bell Lovelace and his son Jon Lovelace repeatedly demonstrated leadership in reaching out to bring exceptional people to Capital. By their persistent searching for strong people-repetitivelytaking the initiative to exploit "lucky" opportunities-they assembled a collection of talented professionals who worked well together. Capital became increasingly recognizable as a firm of unusually capable and congenial professional people: a good group to join.

The core group of individuals illustrates one obvious lesson and one not so obvious. The obvious lesson is that attracting and keeping highly motivated and talented individuals is essential in building a superior professional firm. The familiar keys to success are (1) persistent and imaginative recruiting; (2) consistently high standards for acceptance into the group; (3) uncompromising search for meritocracy in the distribution of rewards and responsibilities according to real contribution; (4) devotion to professional excellence and superior service to clients; and (5) genuine collegiality. In sad contrast, when hiring people, many start-up firms make expedient compromises that they later learn to regret and recruit too few real leaders to ever become a truly superior firm.

The less obvious lesson-but no less critical to success-is how deeply new firms depend on pursuing very thin threads of possibility to identify and then bring aboard those individuals who will later prove to be their exceptional and indispensable people. Although the retrospective view of history, with the outcome known, may make the steps along the way seem natural or even preordained, those who have led in the development of great organizations know how uncertain and fragile the early stages always are. As key people appear in the Capital story, readers might enjoy imagining the consequences for Capital if, among many other coincidences, Coleman Morton's father had not expanded his cement business into Alabama where he met Jonathan Bell Lovelace or Coleman Morton had not been sold insurance by Jim Fullerton or Bob Egelston had not agreed to see Jim Fullerton or Bob Cody had not gotten to know Jonathan Bell Lovelace in an aborted merger or Bill Newton hadn't noticed, in the Post library on Okinawa, how well investment managers were paid or Bob Kirby had not cracked his ribs racing cars or Howard Schow had not looked in through a window at Harvard or Ned Bailey had not decided to go to Virginia to follow Charlie Abbot or if Bill Hurt had not included Jon Lovelace in his luncheon group or if Bob Kirby and Dick Barker had not been flying across the United States on the same plane or Nilly Sikorsky had not needed a part-time job while in graduate school or Jim Rothenberg's classmate had not mentioned his name, and so on, and on. And what if individuals who were determined to find strong people had not pursued slight possibilities? As Madam Curie so shrewdly and famously observed, "Chance favors the prepared mind!"

In addition to organizing a core group of mutual fund investment managers, a set of significant decisions are made in this chapter: Jon Lovelace overcomes his thoughtful reluctance and accepts the leadership of Capital, where he then promulgates a three-way organizational mission of serving investment clients, Capital Associates, and Capital's owners-and begins a career as Capital's servant leader that will continue for four decades. Capital establishes itself as an important mutual fund manager, and the American Express and Anchor Group funds are taken over on what prove to be very favorable terms. The separately owned and managed mutual fund sales organization is brought into Capital. So is a faltering East Coast investment operation. Venture capital and international investing are initiated-the first outside the organization, and the second deeply within it-even though many at Capital would have thought international investing had no real place in a West Coast mutual fund organization struggling financially in a depressed investment market.

* * *

Even the most thoughtful observer would not have imagined the future in store for the modest 34-year-old in the brown business suit, gazing out at the uninterrupted prairie of the Great Plains from the window of his room on the Santa Fe Super Chief. It was 1929, and he was on his way to Los Angeles with his wife and 2-year-old son, where he would soon start a small firm that, by the end of the century, would become the world's leading professional investment management organization: the Capital Group Companies.

Jonathan Bell Lovelace had a rendezvous with the emerging profession of investment management. Raised in southern Alabama, where his family was active in timber, Lovelace trained to become an architect in two years' study at Alabama Polytechnic, later renamed Auburn University. One year later, showing a special aptitude for mathematics, he earned a master's degree while serving as instructor in architecture and mathematics, and as manager for a championship football team-and developed an enduring interest in team sports.

Enlisting in the U.S. Army for European duty in World War I, Lovelace encountered new concepts and new technologies. Because he knew trigonometry, he went into the artillery. A whiz at mental arithmetic, Lovelace joined a group that pioneered antiaircraft artillery, by solving the problem of hitting fast-moving targets. Lovelace provided the necessary calculations, and his was the first American artillery unit in France to shoot down a German plane. He mustered out as a captain.

During his service, Lovelace met new people with interesting new ideas, including Edward MacCrone. With their last names coming in alphabetical sequence, Lovelace and MacCrone had adjoining bunks in officer training camp and then on the troopship that took them to Europe. Their friendship, which began with this alphabetical accident, flourished during their service in the same combat unit.

Earlier, MacCrone had split from a firm that was a predecessor of Merrill Lynch to form E.E. MacCrone & Co., a small stockbrokerage in Detroit-then the equivalent in industrial creativity to today's Silicon Valley. He had the support of important clients like Walter Chrysler, W.C. Durant, and Stuart Mott of General Motors. Eddie MacCrone urged his thoughtful friend to get into the new and exciting field of investments as his firm's research statistician. MacCrone's proposition: "You'll pick the stocks for our customers' men to sell!" Lovelace had other plans, so he demurred. Jauntily, MacCrone assured him that such a position would be open if and when Lovelace were ever interested.

Noting that only one major building was constructed in the state of Alabama during the year he graduated, Lovelace resolved to leave architecture and make his future elsewhere. After the Great War, Lovelace ventured a brief stint in California: He and his brothers, Jim and Jay, bought a date ranch near the town of Indio. But the war's end also ended the sugar shortage that had contributed-temporarily-to the higher demand and favorable price level of dates. With a return to peacetime and normal pricing, the Lovelace brothers' venture in date growing soon faded.

In 1919, Lovelace decided to join Eddie MacCrone and moved East to Detroit. Lovelace quickly established himself as an "idea man," organized a small but effective research unit, and was one of the early pioneers in securities research. No GNP data was available; public companies disclosed very little data and only at their convenience; Moody's and Standard & Poor's did not yet publish; and the Dow Jones Average included only 20 industrials until October 1928. Finding the available data inadequate or out of date, Lovelace championed independent field research.

Lovelace and MacCrone had a series of disagreements over the amount of time Lovelace devoted to investment research. MacCrone wanted to concentrate on underwriting new issues-where the underwriting spread was a rich 15 to 20 percent and there were no bureaucratic delays-so he offered to pay for a new research organization if Lovelace would concentrate on the firm's underwritings. They agreed on a compromise: Research would be done Lovelace's way, and the firm's new issue underwritings would get full research coverage. As part of the arrangement, Lovelace, who enjoyed designing financial structures that worked well for the companies involved, agreed to help solicit corporate finance business.

His real enthusiasm during this period was in developing the investment trust business for individual investors of moderate means. This almost became the very first mutual fund in the United States. Lovelace had studied the Scottish investment trusts, whose sole purpose was to invest in other companies based on the concept that individual investors would fare far better by combining their investments, spreading the risk, and retaining professional investment management instead of buying individual stocks on margin through retail stockbrokers. Lovelace wanted to organize a similar investment company for American investors, and MacCrone eventually agreed. But believing that his firm deserved half the profits above a 6 percent return on investors' capital, MacCrone designed the new investment company with heavy leverage from debt and preferred stock. For each share of common stock bought by the public, E.E. MacCrone & Co. would get a perpetual warrant to buy an equal number of shares. The new investment company was named the Investment Company of America.

Before underwriting the company, Lovelace and MacCrone agreed to obtain at least some kind of approval for their new idea from a regulatory authority. The logical choice was to get the blessing of Michigan's Commissioner of Banking. But the commissioner was a conservative regulator who felt the state's banks already faced too much competition for their own good, so he turned down the investment company idea, saying: "Gentlemen, this is a very interesting idea, but if this thing is as good as you fellows think it is, it will take money out of the savings banks and we're not going to have that here, so I will not authorize it." Trying to get any official approval and resolving various design issues took several more months, so by the time Investment Company of America came to market as a Michigan trust on March 27, 1926, a Boston group's entry-Massachusetts Investors' Trust-had won the race to become the United States' first mutual fund. Following MIT's approval in Massachusetts, the banking commissioner in Michigan gave his approval to ICA.

The stock market was gathering momentum in the major boom of the 1920s, and Eddie MacCrone wanted to get extra gains from financial leverage by adding debt to the new fund's capitalization. Lovelace didn't want to incur the risks of financial leverage, but he lost that battle, leaving the new fund extra vulnerable to the market crash when it finally came.

MacCrone's firm did quite well at underwriting local industrial companies and organizing and sponsoring a series of closed-end investment companies-often concentrating investments in a specific industry or one region of the country. In 1928, E.E. MacCrone & Co. was prospering as a stockbroker. Most business executives anticipated a bright new era for the United States-and particularly for the stock market.

In a strong stock market environment, Lovelace prospered. He enjoyed considerable success as an investor and became a partner in E.E. MacCrone & Co. in 1924. Still in his early 30s, he was financially independent.

While others might have been carried away by the euphoria of the great bull market, Lovelace thought differently. Based on his research into market price versus true investment value, Lovelace was becoming increasingly concerned about what he considered excess enthusiasm among investors. In one calculation, he found that the stock market value of a major New York bank was nearly equal to its total assets-as if they didn't have any deposits or liabilities! Lovelace knew that this high stock market valuation was unsustainable.

In the summer of 1929, Lovelace became bearish on the stock market and sold most of his own stocks and bonds in August. He tried, unsuccessfully, to persuade MacCrone to become much more conservative. Unable to convince his friend, Lovelace took independent action. He withdrew from the stockbrokerage business and negotiated the sale of his 10 percent interest in E.E. MacCrone & Co. (Modestly, Lovelace would later confess he had not liquidated everything: Responding to his partner's request that he not visibly withdraw completely, he left some of his capital in the firm until year-end.) Fortunately, while the market broke sharply in September, it had recovered somewhat by year-end when Lovelace withdrew his capital. Then, over the next three years, stocks lost nearly 90 percent of their peak market value.

Having "retired" as a man of wealth at 34, Lovelace decided to move back to distant Los Angeles. As usual when traveling to California, he took the Super Chief.

In 1931, to develop the information needed for his various activities, Lovelace established a small investment firm in Los Angeles-Lovelace, Dennis & Renfrew-the nucleus of what would later become Capital Group Companies. Lionel D. Edie and Albert Hettinger-both had been with him in Detroit-wrote research reports for Lovelace's new firm.

Continues...

---

Excerpted from Capital by Charles D. Ellis Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

---