Bill Fouse: Chairman of the executive committee, Mellon Capital
I was so convinced there had to be a better way to manage money that I actually formally recommended to the trust investment committee at Mellon Bank that Mellon start an index fund.
What drove me out of Mellon Bank was this fascination I had with modern portfolio theory and security analysis and stock price movement. I had been fiddling around with the work of John Burr Williams, who wrote "The Theory of Investment Value," a book that was well ahead of its time. He spelled out the basis for thinking that a dividend discount model was the way to understand stocks, that the only thing a stock gave, in the final analysis, was the dividend.
When I took these ideas to the head of the trust department (Lloyd Peterson) at Mellon in the spring of 1970, I felt like Archimedes. I was to be hit over the head with a baseball bat. Lloyd Peterson said: "Goddammit Fouse, you're trying to turn my business into a science."
When I realized my career at Mellon was over, I said to myself, "I know someone in San Francisco who's pretty much interested in the same thing I'm interested in" -- Mac McQuown, who had an effort going on in the management sciences department (at Wells Fargo) to answer the question of what should be Wells Fargo's response to the revelations of modern portfolio theory.
When I arrived at Wells Fargo in the fall of 1970 they were already in discussion with a group of young turks at Samsonite Corp. about doing something innovative with Samsonite's pension fund. It was a family-owned company at the time. One of the Schwayder boys went to (University of Chicago), the bastion of this new theoretical view, and came home to work for the family company and said to his Dad: "Do you realize we have our pension fund invested in mutual funds? That's wrong."
And so their quest was for someone who was applying modern portfolio theory to the management of pension assets.
The problem was finding somebody. (They called Bill Sharpe, who said): "I don't think anybody is doing anything, but I can tell you some people who are thinking about doing something." That, I think, is how the Samsonite team got in contact with (Wells Fargo's management science department).
. . . It turned out that Samsonite wanted something a little riskier than just the S&P, so it ended up we were to manage for Samsonite this equally weighted New York Stock Exchange strategy, and Wayne Wagner and Larry Cuneo (now at Plexus Group) wrote an operating manual, which was how what was then the financial analysis department was supposed to manage these assets, with rules on trading the securities and all that.
(The portfolio was started, with about $6 million, on July 1, 1971.)
The next idea out of management sciences was to lever the market, controlling the risk level that you targeted very painstakingly by the amount of borrowing you did. They put together something called the Stagecoach Fund, and it was trotted out and marketed around the country. . . . They didn't get sufficient subscriptions, it was such a wild idea . . .
I think, for the bank's own pension fund, maybe in '72, we started managing an S&P 500 index fund, and then when the Stagecoach Fund was scrapped, there were a handful of subscribers who were interested in doing the next best thing, which was to invest in an index fund. One of the people I remember keenly was George Williams at Illinois Bell Telephone Co.
George came to us and said: "I'll put some Illinois Bell money in if Wells will increase its participation in the fund so that we're now 50-50."
So the Illinois Bell Telephone Co. became the first outside participant in an S&P 500 (index fund).
What I instituted at Wells was a very elaborate dividend discount model framework, and I also instituted a risk-control approach. It forced diversification across beta deciles, growth categories and capitalization size. This was, in effect, optimization on the back of an envelope, before there was software to do such things. It was a way of controlling risk vs. return.
When I asked the management sciences department for their recommendation for an econometrician to help us with what we were doing, they recommended a young fellow named Barr Rosenberg. Barr Rosenberg actually got his start, and got his interest in what he ended up doing as his main thing, coming to work for my little group.
When McQuown found out that I had introduced the dividend discount model to the financial analysis department, he about came out of his tree because he thought I was off on something that was invalid. His interpretation of Modigliani and Miller's paper was that dividends didn't matter. So he tried to get me separated from Wells Fargo on that basis, and I brought in people to testify on my behalf. My stalwarts were Jack Treynor and the fellow from Chicago who subsequently got the Nobel Prize, Merton Miller. My job was saved.
So indexing was off and running.