The Billion-Dollar Boys

By Charles P. Alexander

A new breed of money managers shake up once staid pension funds

Few people have heard of Dean Le-Baron, but thousands of Americans unknowingly depend on him for a large part of their financial security. From a computer-filled command post on the twelfth floor of the Federal Reserve Bank building in Boston, LeBaron manages more than $10 billion of other people's money. Every day, LeBaron and his competitors make stock and bond transactions that can earn, or lose, millions of dollars for their clients. Their decisions can shake markets and send the prices of individual stocks into orbits or nosedives. For their skill and nerve, they receive salaries that sometimes run well into seven figures. LeBaron belongs to an elite corps of independent investment managers entrusted with an ever enlarging share of the pension funds for American workers.

The size of this pool and thus the power that the money managers wield have grown prodigiously. In 1950 pension funds held $17 billion. Today they are a $1 trillion treasure trove. By 1995 the total is expected to reach $3 trillion. Through these funds, some 60 million Americans own about 30% of all the equity capital in U.S. corporations. That makes a mockery of Karl Marx's prediction that capitalism would end in revolution as fewer and fewer people owned the means of production.

Until a few years ago, banks and insurance companies handled most pension money. Almost as cautious as gnomes guarding caves full of gold, the bankers tended to favor bonds and the safest stocks for retirement funds. During the inflation-plagued 1970s, however, many corporations, unions and local governments became unhappy with the returns they were getting on pension money. Increasingly, they turned to mavericks like LeBaron, who promised to outperform the banks by buying and selling a broad range of securities more aggressively.

Before long, the new money managers had impressive track records to back up their boasts. A survey by the Frank Russell Co., a pension-fund consulting firm, showed that over the past ten years, independent investment advisers have earned an average annual return of 12.6% on the money in their care, while banks could muster only 8.3%. As a result, the independents' share of the tax-exempt fund business, which includes pension and profit-sharing plans, has ballooned since 1975 from 20% to 37%, ahead of the banks' 35% and the insurance companies' 28%. Upstart independent firms Like Alliance Capital Management in New York City, Capital Guardian Trust in Los Angeles and LeBaron's Batterymarch Financial Management in Boston have become serious challengers to such pension-fund giants as Prudential Insurance, Equitable Life Assurance Society and Citibank. One example of the trend: General Motors plans to reduce the portion of its $17 billion of pension funds handled by banks. The company says it will hire more nonbank managers to improve its funds' performance.

The independents charge $100,000 to $200,000 annually to manage a $20 million fund, in contrast with the $50,000 that a bank typically asks. Naturally, clients who pay the high fees are demanding. Says Peter Vermilye, an industry pioneer who built up Alliance as an independent pension-fund manager before joining Citibank as chief investment officer: "If you cost more, you have to show you can walk on water."

In trying to do so, money managers run the risk of drowning. Fayez Sarofim, an Egyptian-born pension-fund adviser based in Houston, did remarkably well for his clients in the mid-1970s by holding stocks of international oil companies. But when oil prices started sagging in the 1980s, so did the market value of Sarofim's investments. He has lost several big clients and perhaps $1 billion of the $9 billion or so he was managing.

The new emphasis on performance has made the pension business intensely competitive. Says Dave Williams, chairman of Alliance: "We're hired, fired and retained on the basis of our investment results." He admits that his company once lost Monsanto as a client after managing its pension fund for only six months. The industry's mortality rate is high. Though hundreds of new investment advisers set up shop every year, the total number of competitors dipped slightly, from 6,041 to 5,760 during 1982. Predicts Citibank's Vermilye: "Over half of these new firms will not be around in five years."

The new pension-fund managers are an eclectic group, displaying a spectrum of styles and strategies. Some rely chiefly on computers and charts, while others are more likely to trust their seat-of-the-pants judgment. Their personal pleasures range from collecting art to racing cars. A look at some of the leaders:

Dave Williams, 51. Since replacing Peter Vermilye in 1977 as chairman of Alliance, the largest independent pension-fund advisory firm, Williams has more than tripled the assets it manages, from $5 billion to $18 billion. His company has grown so big that every morning it holds a long-distance staff meeting: a teleconference with portfolio managers and analysts in seven offices from San Francisco to London. While many competitors try to make quick profits by moving funds in and out of the stock market, Williams relies less on timing. He concentrates on picking promising stocks and tends to stick with them, even during market downturns. His specialty is research into the effects that economic conditions may have on industries. "We look at the world from the bottom up," he says. Over the past three years, his stock portfolio managed to stay 20% ahead of the Standard & Poor's 500 index.

A transplanted Texan with an M.B.A. from the Harvard Business School, Williams says that "art collecting is my great sickness." Alliance's Manhattan headquarters resembles a museum, its long corridors full of drawings and etchings by such American masters as Winslow Homer and Edward Hopper. While working as a chemical engineer at Esso (now Exxon) in 1959, Williams started a collection of Saudi Arabian stamps.

Dean LeBaron, 49. President and sole owner of Batterymarch, LeBaron is a notorious contrarian, who loves unloved stocks. He buys securities when they are cheap, hoping that they will stage big comebacks. In early 1982 his firm invested $500 million in 250 companies threatened by bankruptcy because, he said, "those that did not go broke would more than make up for those that did." He was right: during the economic recovery and bull market, the $500 million has grown by 93% to almost $1 billion.

More than other money managers, LeBaron has tried to make stock picking a science. He and his staff test out the performance of hypothetical investment plans on a cluster of Prime computers. Once a strategy is chosen and programmed into a machine, the electronic wizard chooses what stocks to buy and sell without further human meddling. Says LeBaron: "Other companies use computers as adjuncts to people. We've turned that concept around and put the computer in charge." The computer has done well, beating the Standard & Poor's 500 index by an annual average of 6% over the past ten years. As new clients have flocked to Batterymarch, the pool of assets it man ages has grown from $42 million in 1973 to more than $10 billion. LeBaron's personal income is at least $8 million a year.

On weekends, the free-spirited LeBaron gets away from the intense pressure of his work by speeding through the countryside around Boston on a Honda motorcycle or one of his two Yamahas. He may be the only pension-fund manager to have read Zen and the Art of Motorcycle Maintenance.

Robert Kirby, 57. In one way, the chairman of Capital Guardian is the most reckless of the independent money managers. For decades, Kirby has been a weekend race-car driver. In 1963, he crashed a Porsche Carrera in Dodger Stadium, breaking eight ribs and puncturing a lung. Though now silver-haired, he still occasionally pilots sports cars in competitions at Sebring.

In managing Capital Guardian's pension-fund pool of $8 billion, Kirby has been more cautious, sticking mostly to stocks in the biggest companies. Capital Guardian's portfolio has never run far ahead of the S & P 500 stock index, but has also rarely dipped below it.

Some of Kirby's decisions have paid off spectacularly. Over a period of three years beginning in 1979, Capital Guardian bought 10 million shares of Ford Motor, even though the price of the stock was diving from the 40s to a low of 16. Says Kirby: "We took a lot of flak from clients for buying a stock that was headed south." But when Ford bounced back to the low 60s last year, Capital Guardian earned a $300 million windfall. Sometimes it takes as much nerve to "argue with the market," observes Kirby, as it does to climb behind the wheel of a racer.

Robert Day, 40. As chairman of the Trust Company of the West in Los Angeles, Day runs a uniquely democratic shop. He and five other managers each control one-sixth of the company's $3 billion stock portfolio. The men can buy or sell the stocks in their portions of the pot as they see fit. In that way, the company does not bet everything on one strategy. Says Day: "We use six different minds on the same problem. We're a committee that designs a horse instead of a camel." Over the past decade, the Trust Company of the West has beaten the S & P 500 index by an annual average of at least 2%, but last year the company fell behind somewhat. Reason: the managers failed to switch money fast enough from high-technology shares, which were big gainers early in the bull market, to stocks in basic industries like steel that came on strong later in the rally.

Day is particularly knowledgeable about petroleum stocks. In 1981, he had enough savvy to sell off energy shares from his portfolio before the oil glut drove down their value. Day, however, still has a huge personal stake in the industry. Through his mother, Willametta Keck Day, he is one of the heirs to the Keck family's holdings in Houston's Superior Oil, a 25% share worth about $5 billion.

Anthony Forstmann, 46, and Joel Left, 48. The two partners in Manhattan- based Forstmann-Leff Associates are known in pension-fund circles as "the flashy ones." They wear designer suits, travel around the U.S. in Learjets and chauffeured Mercedes-Benz limousines and own Thoroughbred horses.

While bullish on high living, they tend to be bearish about managing their $4 billion portfolio. By switching from stocks to bonds in a timely fashion, they were able to outdistance most of their competitors during the market slides of 1974, 1977 and 1981. Last year, however, their performance was lackluster. Ever the pessimists, they underestimated the length of the stock rally and sold out too soon.

About 98% of all pension money goes into the securities of the 1 ,000 or so U.S. corporations that have market values of $1 billion or more. But a trickle of retirement money is flowing into shares of young, fast-growing companies. A group of small pension-management firms, known in the trade as boutiques, specializes in the high-risk, high-reward strategy of investing in growth stocks.

Among the most successful of the boutique managers is David Booth, 37, who operates out of a small, 19th century brownstone in Brooklyn Heights, N.Y. Since launching a company called Dimensional Fund Advisers in 1981, Booth has recruited 45 clients with pension funds containing $750 million. He invests mostly in the stocks of the 300 smallest companies listed on the New York Stock Exchange and the bottom 400 of the American Stock Exchange. Over the first ten months of 1983, the return on Booth's investments was a phenomenal 46%.

Gregg, McKay, Knight & McKay, a pension boutique based in Avon, Conn., earned about 38% last year on $244 mil lion invested in fledgling firms, many of them high-technology ventures. Says Roy McKay, 40, one of the partners: "We are trying to be investors rather than trad ers. That's how the great families made money in the past. There's an electronic revolution going on, and it's generating vast opportunities for the creation of wealth."

Spurred by increased competition and helped by the bull market, pension-fund managers are achieving their best results in years. As recently as the late 1970s, concern was rising that hundreds of company pension plans might eventually run out of money as more and more employ ees retired. Now those fears are fading.

Pension experts estimate that U.S. corporations currently have $100 billion more in their retirement funds than is necessary to meet expected obligations. By creating new rivalries in a once complacent indus try, the independent pension-fund man agers have made it easier for companies to ensure the financial futures of their workers.

-- By Charles P. Alexander. Reported by Frederick Ungeheuer/New York

With reporting by Frederick Ungeheuer/New York