It might not sound good on paper. Leave a really good job at a bank and start your own boutique investment firm when you’ve got kids in school. Come up with an investment philosophy that depends on income growth during years when bond income is shrinking and dividends are falling out of favor. Start your firm just before Saddam Hussein invades Kuwait and the market plunges.
Such was the forge Bahl & Gaynor was made in. William Bahl and Vere Gaynor, friendly rivals in the institutional asset market in the 1980s, had been talking about hanging out their own shingle for years when in 1990 they finally did. Bahl had been CIO at Northern Trust (before that at Fifth Third Bank) and Gaynor was a managing director at the Cincinnati office of Scudder, Stevens & Clark.
They had a lot in common. Both were children of doctors, but veered away from medicine. (One time in the emergency room intake, Gaynor saw a friend separated from his ear by a windshield, and that was enough for him.) Both wanted to live in Cincinnati, where Bahl grew up, an easy place to live with a conservative-mindedness about money, where several large financial companies are domiciled. An apocryphal Mark Twain quote suggests Cincinnati would be the best place to live during the end of the world, since everything happens there 20 years behind everything else.
But it was perfect for what they were trying to do. (Bahl says the first stock he ever bought was Cincinnati Financial; he purchased 100 shares for $1,800 of summer earnings. “It’s done great,” he says. “Probably the highest paid summer job I ever had.”)
Since the launch, they’ve built a firm with some $12 billion in assets under management or advisement, divided between high-net-worth families and institutional investors. Like everybody else, they suffered a poor revenue year in 2009 during the financial crisis, but at about the same time, they broke open doors on the distribution platforms at Northern Trust, Goldman Sachs, Merrill Lynch and UBS. Their $2.7 billion in assets under management in 2009 mushroomed into $7.4 billion by the end of October 2014, and some $5.3 billion in assets under advisement, says Scott Rodes, a firm principal and portfolio manager.
The firm now has 35 employees, 15 portfolio managers and over 300 client relationships with 2,500 accounts, charging fees on assets under management.
Dividends, Then And Now
The germ of the idea was born in 1983 or ’84, says Bahl, when the two future partners had a conversation. People had suggested they ought to work as a team, and they wondered if there was a void to be filled managing their wealthy families’ money more holistically than they’d been doing—a concept of long-term investing with personal service. They figured clients weren’t getting this from banks, where the investing wasn’t stressed, or from other investment management firms, where there was no service philosophy.
“We figured, if we can keep [clients’] income higher than their lifestyle, they’ll never go broke, and if we can grow income faster than their lifestyle, which is a challenge, they will never go broke.”
The two were able to build business with clients from their old firms, families with long-standing holdings in good companies that needed to be diversified. The first Gulf War came a month after they opened their doors, and it took a while to get their salaries up to where they were, but soon enough the market was up and running through the 1990s.
The two founders were similar, but also different in the right ways. Bahl was a hands-on managerial type, Gaynor was a vision guy. Together they worked on a dividend philosophy, says Bahl, one that depended on families having a certain amount of wealth already (their minimum is $600,000) and a much longer time horizon—something more akin to a foundation’s, perhaps. This philosophy eschews the consumption of principal.
“With yields on financial instruments today where they are, a million dollars doesn’t buy what it used to,” says Bahl. “Ten years ago, you could get $50,000 or $60,000 of income off a million-dollar bond portfolio. Now you might get $15,000 or $20,000.”
The goal is for clients to live off their income, and for that income to grow 6% to 8% a year, so that it doubles within a decade. In two decades, he says, the clients really see that compounding work, and by the third decade, “you’re doing an Irish jig.” As part of that effort, the firm offers needs-based assessment, looking at cash-flow analysis for retirement, education funding, etc., and also makes assessments for what clients will need for trusts and estate planning, long-term care, liability insurance and disability. This analysis of cash flow and long-term needs (for clients whose average age is between 55 and 60) is all put through the prism of the strategy focused on dividends.
“If you’re a client who’s with us for 20 years, you should have at least four times as much income as you had when you started,” says Gaynor. “But for 10 years, it may be a bit difficult.”
“The Midwest is innately conservative,” he says. “Especially, Cincinnati is really one of the epicenters of dividend growth investing, because you have companies such as Procter & Gamble, Cincinnati Financial … that have grown their dividends for extended periods of time, and that becomes ingrained in the culture of the city because lots of people have either made or preserved their fortunes by owning those types of companies.”
Bahl takes a company like Johnson & Johnson as representative of the kind of names the firm owns—well managed, with an ethos to grow its payout. Some investors may get frustrated by its tendency to outperform the market for nearly a decade and then go sideways for the next, but Bahl views it differently. “What’s happened since 1990 is that the dividend on Johnson & Johnson has gone from 16.5 cents a share to $2.60 a share on today’s stock. The stock has gone from $8.50 in 1990, split-adjusted, to $109.” Over time, that yield is huge, he says, and owning a bunch of companies with similar philosophies allow the firm to help clients exceed lifestyle needs.
While it might seem like the dividend strategy would mean ignoring a lot of the S&P 500, Bahl and Gaynor say that more companies have come around to the dividend ethos, so that companies like Cisco and Microsoft that used to be off the radar are now dividend payers.
The tech boom posed probably the biggest challenge to the firm, say the two, since the anti-dividend environment challenged the company’s core philosophy. It was a much more difficult time for the firm than even its first year in business.
“1998, 1999 were years in which we didn’t look very smart,” says Bahl. “These companies that were growing extremely quickly all had good balance sheets but none of them paid a dividend. It was a much more challenging school of thought—that dividends were old-fashioned, were passé, that the focus of investing should be on capital appreciating only. Anybody who focused on income might as well be in the buggy whip business.”
The market return in one of those years was nearly 20%, while the firm scored a limp 2%, says Bahl. But that market return was a lot less rosy if you consider that only a few companies—including Microsoft, Oracle and Cisco—were driving it. The tech boom turned into the tech bust, and many of the companies, like Johnson & Johnson, that hadn’t looked so hot before suddenly looked a lot better.
To Sell Or Not To Sell
The company’s huge accumulation of assets has meant big fish circling around it. Up until five years ago, the two founders owned about two-thirds of the firm, and according to Scott Rodes, who joined in 2001, the matter came to a head.
“Over five years ago, when Bill and Vere did own the majority of the shares, there was that issue of how we were going to transition the ownership,” says Rodes. “There were a couple of other financial institutions that were looking to purchase Bahl & Gaynor. And we had to sit down and discuss those at the time. They were time consuming and not really productive.” The bottom line was that nobody thought a sale would help the clients. The culture of the firm and its dividend philosophy would likely be polluted.
The two founders finally made an offer to transition a large percentage of their ownership to the other managers over a period. The firm has hired four new portfolio managers this year; managers are generally offered ownership stakes after a year with the firm. The two founders’ stake is now down to about 38%.
Bahl and Gaynor still run the ship, though, and not every decision is popular. Bahl says five years ago, the firm thought of launching its own mutual fund. Bahl says he was in the weeds working through the assumptions and numbers, going down that road to a launch. But the expenses, the regulatory scrutiny and the need for committed capital were working against them.
“Vere came to me late in the game and said, ‘We have no business being in the mutual funds business. The distraction of our people as well as the dollars you need to commit. So we elected then to make a pretty painful decision not to go into mutual funds and it was one that was not popular here in the firm among the money managers. But it was one of those things when he came in, 20 seconds into the conversation I said, ‘You’re right.’” (The firm eventually went on to subadvise two mutual funds instead.)
Losing A Friend
Rodes says that breaking down the doors at the distribution platforms has helped transform the firm from a regional heavyweight into a national brand. The financial crisis actually helped the firm, whose relative performance made it stand out in the truly awful year of 2008.
“Relative performance does sell on the institutional market, so that helped kind of drive [sales] in 2009 and 2010,” he says. The boutique aspect of the firm made it a better pitch to platform partners like Merrill and Northern Trust. “After the first one, a logjam kind of opened up; others fell in line.”
To the extent the firm was a national brand though, it was helped along by a familiar face in the media: Matthew McCormick, a Bahl & Gaynor portfolio manager and pundit who often appeared on Bloomberg and CNBC. McCormick helped the firm get on the national platforms, and he was a hard-charging, outspoken mouthpiece for the firm who could articulate its vision in the media.
In early September, while the other partners were sitting down at a meeting, Gaynor got the call that McCormick had died of a heart attack shortly after a jog. “Matt had a level of intensity uniquely suited to the institutional marketplace,” says Gaynor. “He was an Irishman and lived life the way Irishman do. He was full of life, full of fun, intense and loved people.”
Rodes says he sat next to McCormick for 10 years and went to basketball games with him. “The only two words that weren’t in his lexicon were ‘no comment,’” Rodes says. “He had an opinion on everything.”
The bench at the firm is deep, however, and a new portfolio manager recently joined to look after McCormick’s bailiwick, which was banking.
The Slow Lane
Bahl says that Cincinnati offers life in the slow lane—an ability to get home from a football game in 30 minutes, not an hour, and for similar reasons, the town has not suffered the same vicissitudes that the rest of the economy has over the past 15 years.
“Being in the Midwest, we don’t get hit with the big swings,” says Bahl. “So, for example, while housing prices went down in Cincinnati, they didn’t go down nearly as much as they did in Florida or other hot real estate markets. So your highs and lows tend to be much more moderated here.”
And whether Mark Twain’s quote is true or not, the city is similar to what it was in commerce 25 years ago, Bahl says. “It’s a remarkably stable town. It’s also interestingly a town where kids move away to go away to school and their first jobs, but they tend to come back. Both Vere and I are experiencing that with friends of our kids.”