May 20, 2005, 9:11 a.m.
Conviction Can Create Performance
Cutting, running, and dumping are for short-term thinkers.

In 1984 I joined a New York-based mutual fund company as the supervisor of equity-fund managers and other professionals who handled most institutional equity portfolios. The company is well known for growth-stock investing and has a history that spans centuries. Fortunately for me this opportunity became available because investment results were being squeezed by the Fed’s tight money policy of early 1984, when the fed funds rate went from 9 percent to almost 12 percent. Fed policy got the blame — from June of 1983 through June of 1984, the firm’s growth-stock composite fell more than 15 percent as compared to the S&P 500 index decline of 4.6 percent — putting the firm in the sixty-fifth percentile among institutional growth-stock managers. The firm’s growth mutual fund dropped 20 percent over that same one-year period, a truly dismal performance.

Or was it?

As one could imagine, firms specializing in managing growth stocks came under intense scrutiny during this period and many institutional investors decided to move on to other investment styles. As a result of disappointing performance, portfolio managers found themselves making unanticipated client trips to discuss the firm’s commitment to a growth strategy.

One of those trips involved a company that has been in the news — MCI Communications. In 1984, my employer was one of a number of investment managers for the MCI pension plan. The portfolio manager assigned to MCI’s pension plan asked me to accompany him to a meeting with the company to explain our firm’s recent performance and our outlook for growth stocks.

I remember that meeting as clearly as if it happened yesterday. We went to Washington, D.C., the corporate headquarters of MCI, and were ushered into a dark room with a large round table with about twenty MCI executives. As we sat down, a gentleman from across the table wasted no time in getting to the purpose of the meeting:

You are the growth managers, right? Do you realize that you are, by far, the worst performing of our pension-fund managers? Are you going to sit there and tell us that you plan to continue to do what you have been doing?

At this point in the conversation, my knees began knocking under King Arthur’s round table. I suddenly felt a sense of foreboding and imagined the two of us being ushered back out the door with one less pension plan to manage.

Since we were committed to being growth managers, our answer to our assailant’s last question was: “Yes, we are committed to growth stocks.” In response to our answer, the gentleman replied:

Well, we happen to believe that you are on the right track and, since you are demonstrating your commitment to a growth strategy, we are going to double the amount of money you manage for us.

Imagine that — a pension-plan sponsor with conviction who put money into an investment strategy that had substantially underperformed.

Some five years later I was reviewing the MCI account, and I went back and calculated the performance of the MCI portfolio since the meeting. The results indicated that MCI’s portfolio increased 20 percent per year for those five years, becoming one of the firm’s best-performing institutional portfolios.

Newspapers today are crammed full of articles bemoaning the unfunded liabilities of corporate pension plans. Decisions by companies such as United Airlines to dump their under-funded pension plans on the taxpayer belie the supposed professionals who get paid a bundle to grow these plans consistent with long-term funding requirements. Meanwhile, sophisticated mutual fund companies and institutional investors are dumping good portfolio managers for short-term under-performance. But maybe its time for these short-term decision-makers to revisit the value of conviction, as well as the critical importance of a long-term time horizon for investing.

The management of MCI in the mid-1980s is a perfect example of this. They had the conviction to go against prevailing trends and view a stock market sell off, especially in growth stocks, as an opportunity to improve the funding status of the MCI pension plan.

Oh, and by the way, that growth mutual fund I mentioned earlier, the one that dropped 20 percent in that one bad year, grew at a 15.8 percent annual rate for the five-year period ended June 1989 — about twice the long-term rate of return of the S&P 500.

— Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and principal of Victoria Capital Management, Inc.

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