As Chairman and President of GE Investment Corp., John Myers rides herd over the corporate behemoth's massive pension and institutional investment arm with an innate conservatism that is serving GE, and its pensioners, quite well amid today's turbulent markets. But also with a probing mindset and independent streak that defies homogenization in the herd, both of which he recently shared in this Q&A.
I read recently that the mammoth GE pension fund you oversee deftly avoided most of the misery in techs. How in the world did you manage to sell 'em, while running billions upon billions of institutional money, John?
Well, let's make it clear where we did it, first of all. GE Asset Management is currently managing $116 billion. That's before Honeywell, which is going to add another $20-$21 billion of pension fund and 401(k) assets. But the largest part of that $116 billion is in the GE Pension Fund: $48 billion. That is where we do the asset allocation and where we lightened up on techs [earlier]. But then we also have about $28 billion of assets that we manage for other pension funds. For example, earlier this week, we got a $2 billion order from Prudential -they'll be including our research product among their flagship retail equity fund options. This Prudential order actually is for what we call our "research portfolio," where we do a sector-neutral strategy with our research analysts picking the best stocks within their sectors. We've been doing that same thing, internally, for about eight years, with a very strong track record of comfortably outperforming the S&P.
Via stock selection? In markets in which that wasn't supposed to matter?
Absolutely. We just launched that product for the outside world within the last 60 days. But all of our outside portfolios mirror what we do for GE. Our pitch is, "Invest side-by-side with GE." What we're doing for our portfolios in the pension fund, we'll do for our clients. Our asset base breaks out like this: $64 billion in U.S. equities, $26 billion in fixed income, $14 billion in international, and $7 billion in private equity and real estate. So we've got a pretty substantial presence in almost any asset class that you look at. Then, if we look just at the pension fund, the roughly $50 billion where we are the fiduciaries doing the asset allocation, we're probably 50 percent U.S. equities, 20 percent international equities, and five percent or six percent private equity. Of course, then we manage within the asset classes, according to our investment philosophy: basic, fundamental, bottom-up stock selection. We're not a momentum-driven, flavor-of-the-month-type investor. I'd say that, in the last couple of years, it hasn't been easy. But our results have been pretty strong. We've actually exceeded the S&P with that philosophy.
What's that mean, in numbers?
Oh, roughly 300-400 basis points better than our various benchmarks, pretty much across all of our equity portfolios.
This is a politically incorrect question, I presume, but how much of that outperformance do you owe to the tailwind you've enjoyed from your pension fund's overweight position in the shares of General Electric?
Clearly, that has contributed a good portion of the outperformance, but even taking that out, we've done well in every period. Our recent performance has been driven by our tech underweight, GE overweight and stock selection. Basically, by our research. Especially, this year, in our value strategy, our growth strategy, the concentrated portfolio that we use, which we call our special value strategy.
And unlike a lot of mega-pension funds, you use very few outside managers…
Right. We tend to use outside managers only in an area where we don't have a particular expertise or experience. For example, small-cap stocks in the U.S. We outsource that. We also outsource the hedge fund-type investments that we make. Those are more of an asset allocation or diversification-type move. You know, you want to be in hedge funds, in down markets.
Assuming they really hedge.
Sure. But that's what ours do. I mean, Lee Cooperman, for example, is 1,500 basis points ahead. Art Samberg's Pequot has been just extraordinary. So we have some pretty strong managers in that sector. You see, that's a way that we have really leveraged GE's investment presence. Because what we're looking for when we invest with a Lee Cooperman or an Art Samberg is clearly above-market performance, first and foremost. But we're also looking for idea sharing. And you know what? It works two ways. Because, for instance, we're a real-time user of all this new technology. Even if we are a so-called "old economy" company. As users of this new technology, we can have a dialogue with Art about what we're seeing; and of course, he (and his organization, which I think is the best technology research group anywhere) can give us his views on market valuations and the latest developments in technology.
Are you implying that you followed your friends in the hedge funds out of the techs earlier this year?
No. That takes us back to your original question about how and why we made that move. I think it had more to do with us being a part of General Electric – and the fact that our asset management organization is not housed in the treasury organization. We report as an operating business directly to the Office of the CEO. So a lot of it came about through my presence on Jack's Corporate Executive Council, where we meet every quarter for two days and talk about the state of our businesses globally: The operating trends that we're seeing. How the economy is doing. In effect, it's a quarterly reminder that we're part of an operating company that is like a microcosm of the global economic world. It provides real-time information for us that we can use as investors. But we were never into the WebVans or any of the large B2C companies. We just didn't believe they had a sustainable competitive advantage as a value-added proposition. A lot of what they were articulating was motherhood. But the market also missed something else. Something nobody was talking about when these things were going on – capital availability. They assumed that the capital was always going to be available.
Not to mention, practically free.
And that the markets were always going to be healthy and that they could always go back and raise more capital in equity offerings.
And why not? People were virtually killing each other to get into an IPO, so why worry about a shortage of capital?
Precisely. On the other side of the web, the B2B side, however, we recognized that, Hey, this stuff is going to be utilized as "old economy" companies transition themselves into the new era – change the way they go to market. Many of the companies involved in infrastructure development are changing the old company model. The Ciscos, the Oracles, the Sun Microsystems, the EMCs. So, although we were underweight in technology overall throughout most of the last five years, we were overweight in these companies. But earlier this year, we started to look at valuations, even for the good companies, that were just getting to levels that you couldn't support.
What, you doubted that "No price is too much to pay for Cisco?"
Well, I did an interesting analysis earlier this year, for the GE Board. I took Cisco as my example, saying it is arguably one of the best technology companies in the world. It has benefited from the explosive growth of the Internet infrastructure, it has executed superbly, it's very profitable. But what is it worth? That is the question. At the time, it was selling at about 132, had estimated EPS of $1.16 and a P/E multiple of 114. The market cap was $453 billion. I said, "Look, let's just say that you're going to get a 15 percent a year return on that." Now, at 114 times earnings, you're going to want to earn a lot more than that! But that's all we assumed for purposes of this analysis. Which means that in 10 years, the market value of the company (assuming that 15 percent annually) is going to go to $2 trillion. But then, Cisco, throughout the last 10 years, has been diluting…
Constantly.
That's right, by making acquisitions and by handing out stock options to its employees. Its split-adjusted share total has been up 8 1/2 times since 1990. I'm going to be conservative again and say, "Let's just assume they double. That's $4 trillion of market value." Now, if I take nominal GDP and grow that to 2010 at six percent to seven percent a year, I end up with Cisco's market value, at that point, amounting to 27 percent of GDP. And the earnings required for it to have a P/E of 40 times in 2010 would be $100 billion, while their earnings today are $2.6 billion and the whole tech sector is earning $60 billion. That analysis was really the basis – the place where we started to say, "This is getting silly." So our tech cutback was really more of a cutback in our overweighting in the really solid tech infrastructure superstars. What we were saying is that we now have a valuation theme: trees don't grow to the sky. So there has got to be some recognition of that and a correction. Now, Cisco has actually held up relatively well. I mean, it's 53 today, after a split, so it's at the equivalent of 106; so it's only down 25 percent. But I think you look at almost any of the other ones that I mentioned and find they are off anywhere from Lucent's 77 percent to Nortel's 56 percent, Intel's 41 percent, Dell's 58 percent, Apple's 75 percent, Hewlett-Packard's 47 percent.
Still, didn't you run into a lot of institutional resistance to lightening up your positions in the mega-techs? You were already underweight in the tech sector overall.
No. I think because the decision was very consistent with our fundamental investment philosophy of growth at a reasonable price. And bottom-up stock selection. That's who we are. Of course, this was not only a top-down-driven decision. It was also bottom-up from our portfolio managers. When they were developing their models, they had to ask how they could justify holding those stocks. You always have your target price. Once the stocks were through those, the question became, "How long do you hang on?" Around mid-year, we started taking some dollars off the table in those companies. Obviously in hindsight, I would have liked to have taken even more off the table. But from a relative standpoint – we're believers in the old adage that you can lose more money by not being in the market when it recovers, than you can make by getting out of the market; trying to time it. So we're not market timers. We are sector allocators.
Okay, but I heard so many other investment managers, people running billions, complaining bitterly early this year that even if though they were personally scared to death by the market's, or an individual stock's valuation, they were handcuffed, institutionally. Had no choice but to stay true to their styles. Yet you run pension money for perhaps the ultimate corporate institution, and you were selling.
Well, where I think we are a little different than a lot of institutional managers is that the strategies that we sell to outside investors are the same that we manage for General Electric, where we're a principal with a long-term focus. Because the GE pension is such a significant percentage of our assets, we are not afraid to sell a stock we can't justify within our valuation criteria or to not offer a product we don't believe in ourselves.
You're saying you manage differently because those billions aren't all Other People's Money?
Because we are principals. For example, look at high-yield funds. During the mid- to late-'90s, when we had falling interest rates and narrow spreads, if you were in high-yield funds, you did better than in any other fixed income sector. Now, if we were acting solely on the influence of external market forces, we would have established a high yield capability at that time. But as a principal, our assessment has always taken volatility into account and so we have not been major players in the high-yield market. We have basically held to the philosophy that if we're going to take excess risk, we'll take it in equities, where we can also reap excess rewards.
Switching gears, John, there's been a lot of discussion in some quarters about what the marketplace of the future should look like…
If you go back, oh six months ago. A lot of the magazines were talking about all these e-brokers and alternative exchanges: E*Trade, Ameritrade, Archipelago, etc.
Not to mention putting the NYSE on the endangered species list.
Exactly. And guess what? People were looking at those exchanges and thinking they were getting a bargain because they were paying only a couple of cents per share to do their trades. But they never factored in execution costs. What price were they paying for the shares and how were they getting executed? After-hours trading was in many cases a joke.
The investor is, in effect, paying an enormous service charge for being able to trade when the major market was closed…
And getting lousy execution. Yet he feels good because he was paying five cents to execute the trade rather than going through a regular broker or going through Schwab and getting an execution in a marketplace that had liquidity. Our view has been that the New York Stock Exchange has a pretty good model. You've got a designated appointment from 9:30-4:00, where everybody shows up. You're going to get, if you know what you're doing, the best execution when there is a lot of liquidity, especially when you're dealing in size. Much better than basically showing up after hours when there's little or no liquidity.
Pretty simple, isn't it?
Basic. We can't get anything done in size after regular market hours. The specialist system does serve a purpose, in terms of market stability; making sure that there is an orderly market. After hours, there's nobody doing that. So yes, if you want to trade at 7:00 at night while you're sitting at your kitchen table, that's fine. It might be convenient. But you had better recognize that most probably you're not getting the same level of execution because the big boys aren't there at 7:00 at night trading in any volume. By contrast, there exists today, through Schwab and all the other discount brokers, the ability for individuals to pay a few cents a share and go into the market – the New York Stock Exchange – and piggyback on the big guys. Because when the big guys are in the market, the retail investor isn't disadvantaged. In fact, he's advantaged because he's getting the same price that I'm getting when I'm in the market. When I'm not in the market, who's on the other side of the transaction?
That hasn't been as widely appreciated as it might be.
But the pendulum is swinging. I think the last big article I saw cast the New York Stock Exchange, as "The Big Survivor." There's a smile on Dick Grasso's face again.
We suspect that Nasdaq isn't about to give up. And that the regulators won't completely lose their populist tilt.
It will be sorted out. I think there will be a place for things like after-hours trading, for those people who want it. I just think that the non-traditional business will amount to a lot less than people thought it would, even six months ago.
Thanks, John.
Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co. LP, Greenwich, Conn., welling@weedenco.com
