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ZEUS ASSET MANAGEMENT, INC.

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In January 1998, John Abbott, the director of research at Zeus Asset Management, Inc.,
reflected on the changes that had occurred during his two and a half years at Zeus. He was quite
pleased with the recent performance of Zeus funds and the companys relationship-oriented
approach to money management for individuals with high net worth. Yet, he wanted to ensure
that both the investment-process and performance-evaluation measures that he had implemented
at Zeus would continue to provide superior returns. Abbott also wanted Zeus to outperform the
relevant indices, not only on an absolute basis, but alsoand more importanton a riskadjusted basis. He pondered which indices and models Zeus should use in the future.
The Company

tC

Zeus Asset Management was founded in 1968 in Atlanta, Georgia, by Tim Landon and
Jerry Schneider. As the privately managed asset market evolved, the need for modern portfolio
management became apparent. In response to the employee retirement income acts (ERISA)
deregulation, Zeus emerged as an independent, employee-owned, money-management firm that
serviced both institutional and individual investors. With more than $1.7 billion in assets under
management, it was one of the largest private investment-counseling firms in the Southeast. The
firms investment philosophy was based on the belief that superior investment results could be
achieved over many years by following a conservative, risk-averse, quality-oriented approach to
investment management.

No

Zeus was well known for its commitment to relationship-oriented client services. All
individuals associated with managing and administering accounts at the firm were readily
available in person or by phone to discuss issues with clients. Each employee was dedicated to
pursuing the clients investment objectives and judiciously managing their portfolios. The staff
totaled 37, with 10 in portfolio management, 4 in research, 2 in trading, 3 in marketing, 4 in MIS,
10 in administration, 2 in support, and 2 in operations. Zeuss experienced staff of investment
professionals was responsible for the stewardship of the investment process.

Do

Teamwork was at the core of Zeuss strategy. More than 75% of its investment
professionals were CFAs (chartered financial analysts) and had received their MBAs from top
This case was prepared by Professor Yiorgos Allayannis. This case was written as a basis for discussion rather than
to illustrate effective or ineffective handling of an administrative situation. Copyright 1999 by the University of
Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
sales@dardenpublishing.com. No part of this publication may be reproduced, stored in a retrieval system, used in a
spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or
otherwisewithout the permission of the Darden School Foundation.

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business schools. Portfolio decisions were made by an investment committee comprising

analysts and portfolio managers. Similarly, administrative decisions evolved from teams of
account administrators. As a senior portfolio manager stated, Having one finger is useless when
you consider the power of five fingers in a fist. One testament to the firms strength was
employee length of service, which averaged more than seven years. The investment professionals
at Zeus were all seasoned veteransthe average age was 44who had been through at least
three recessions or major downturns of the market and had an average of 18 years of investment
experience. By contrast, at Fidelity Investments, the largest asset-management firm in the world,
portfolio managers had an average of five years of investment experience, all of which had been
during the most impressive bull market in the countrys history. The average age of the portfolio
managers at Fidelity was 26.
The Clients

tC

The firm had more than 250 institutional and individual clients that subscribed to its
investment philosophy. Zeus had a minimum requirement of $2 million for individually managed
accounts. For those clients, the firm customized portfolios according to those clients investment
objectives and, in particular, their risk and return profile.1 Clients that did not meet the minimum
required amount were invested in one or more of the mutual funds offered by the company. Of
the assets under management, 45% were separately managed individual portfolios, 12% were
mutual funds, 31% were separately managed institutional portfolios, and 12% were common
trust funds. For the separately managed institutional assets, Zeus managed 49% for foundations
and endowments (for example, schools and hospitals), 4% for insurance companies, and 47% for
corporations.

Do

No

The individual investors at Zeus were typically risk-averse, high-net-worth clients. Zeus
screened its clients according to their investment objectives, and accommodated those who
wished to grow their assets over the long term and, at the same time, avoid excess volatility in
their portfolio. Usually, high net-worth clients also had special requirements for their portfolios
with regard to taxes, liquidity, legal restrictions, timing of distributions, diversification,
investment horizon, and other unique characteristics that had to be managed according to their
investment objectives. For example, a Pepsi executive might have legal constraints as to what
was bought and sold in her portfolio. In addition, if her annual bonus depended on the sales of
soft drinks, she could not invest any additional money in Pepsi or other soft-drink companies.
The risk of the soft-drink industry was tied into her current compensation, so any further
allocation of the executives portfolio to this industry segment would undermine the
diversification of her overall assets.

There was an increasing need for individually managed accounts, as attested by the Wall Street Journal; see
Managed Accounts Lure More Investors Who Are Looking beyond Mutual Funds, Wall Street Journal, 30 April
1998.

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Special attention was also paid to tax issues, given the clients holding period and profile.
In general, high tax-bracket investors would not want the same securities that low tax-bracket
investors might find attractive. For example, tax-exempt municipal bonds with low pretax yields
might be very attractive to high tax-bracket investors but not to low tax-bracket investors. In
contrast, a U.S. Treasury bond would generate high taxable income to high tax-bracket investors;
when compared with a lower yielding but tax-free investment, the after-tax yield on the tax-free
investment would earn more money and a greater return for high tax-bracket investors.2

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Each portfolio had to be managed in the context of the clients entire estate, so that the
strategy coincided with their overall goals. High tax-bracket investors might want to emphasize a
portfolio based on capital appreciation as opposed to a portfolio that generated dividend or
interest income. If the current capital-gains tax bracket (28%) was lower than the investors
current marginal tax bracket (40%), then deferring the realization of capital-gain income would
be more valuable to the high tax-bracket investor. Those investors might seek to invest in growth
stocks that would yield lower dividends, but have a greater chance of capital appreciation. For
the low tax-bracket investor, it would be more beneficial to earn a higher cash flow taxed at a
rate less than the capital-gains rate. Given the 12% difference between the highest current
income-tax bracket and the highest current long-term capital-gains tax rate and the 20%
difference at the next capital-gains rate, security selection could make a noticeable impact on the
return of an investors portfolio. Zeus specialized in building portfolios for clients who had those
characteristics and who were interested in building relationships based on trust, integrity, and
stability.
The Firms Mutual Funds

Do

No

Zeus had an array of mutual funds to meet the needs of clients who wished to invest in a
specialty fund or who did not meet the minimum requirements for an individually managed
portfolio. Mutual funds were more efficient for some clients because of the economies of scale in
trading and transaction costs. Custody costs, management fees, administrative fees, and
brokerage costs were spread over all the mutual-fund shareholders, making it less expensive
relative to what the typical client would be charged. The mutual funds included an equity fund, a
bond fund, a municipal bond fund, an international equity fund, a balanced fund, and a shortterm bond fund. The municipal bond fund was developed for buying power and efficiency. By
pooling clients money and buying bigger lots, the portfolio manager could buy municipal bonds
at more attractive prices and be offered more attractive bonds by dealers. Some clients might
have municipals as only a small portion of their entire portfolio. Instead of each portfolio
manager specializing in the municipal-bond market, one portfolio manager had the sole
responsibility for that market and could more efficiently manage the municipal bonds. The job of
the individual portfolio manager was thus to determine how much of the portfolio should be

For example, for an investor in a 40% tax bracket, a 4.5% municipal bond would be more attractive than a 7%
Treasury bond because, after being taxed at 40%, the Treasury bond would end up yielding 4.2% [7% (1 40%)].

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allocated to municipal bonds, and then have the municipal bond manager invest that portion of
the portfolio.

Table 1 summarizes the performance for the equity, bond, and balanced mutual funds,
since inception and during two subperiods as depicted by the total annual return. Total returns for
relevant benchmark indices for the same period are also shown.
Table 1. Mutual fund performance versus respective index.
Fund
Return
16.26 %
8.37 %

Index
Return
20.18 %
11.95 % S&P

Index
Return
17.15 %
10.13 %

Equity (subperiod 2)

6/1/95

12/31/97

24.44 %

28.72 %

24.38 %

Bond (since inception)

Bond (sub1)
Bond (sub2)

1/1/91
1/1/91
7/1/94

12/31/97
6/30/94
12/31/97

8.16 %
6.96 %
9.37 %

8.86 %
8.42 % Lehman
9.29 %

Balanced (since
inception)
Balanced (sub 1)
Balanced (sub 2)

5/1/90

12/31/97

11.66 %

12.48 %

5/1/90 9/30/93
10/1/93 12/31/97

8.60 %
14.82 %

12.01 % Lipper Balanced

12.94 %

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Start
End
Date
Date
Equity (since inception) 12/1/92 12/31/97
Equity (subperiod 1)
12/1/92 5/31/95

Lipper
Growth

The equity fund and investment process

No

The equity mutual fund, which started on December 1, 1992, was a medium to large
capital-growth fund (more than $1 billion) that mimicked the institutional growth-stock portfolio.
As the cofounder, Tim Landon, stated,
The investment objective is to seek long-term growth of capital through
investments in a high-quality portfolio of stocks, whose earnings are expected to
grow at above-average rates. It is designed for clients who desire the same
overriding investment philosophy of individually managed portfolios but who
need economies of scale.

Do

A client with less than $2 million to invest might not be able to become sufficiently diversified
by the 30 to 35 stocks in a typical portfolio.3
3

To properly weight the portfolio among stocks and sectors (assuming that the average stock costs $50), one
needs an average of about 1,000 shares per stock. If we multiply that number by the minimum number of stocks to
achieve diversification (30 to 35), we arrive at a $1.5-million to $1.75-million investment.

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The equity fund, from its inception until May 31, 1995, had an annualized return of
8.37% versus the S&P 500 Index with 11.95% and the Lipper Growth Index, which earned
10.13%. One of the main reasons that the equity fund underperformed both indices during this
period was that the fund followed a weak cash policy, over- or underweighted in cash, depending
on the valuation of the market. Given that this was a growth fund, the core holdings were not
tightly monitored to fit the investment objectives, containing stocks from other disciplines such
as value.

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At the end of this period, a new director of equity research was hired. He developed both
a new process to screen stocks and a stricter investment policy to manage the equity portfolios,
thus enhancing the monitoring and controlling of core holdings.

In particular, Zeus began screening a universe of 2,000 stocks for quality, capitalization,
and liquidity. Growth screens identified stocks for superior earnings momentum relative to an
established universe and its own history. Those screens also checked for sustainability of
earnings and eliminated stocks that had negative changes in forecasted earnings because, when
sell-side analysts adjusted their forecasted earnings expectations downward, this usually had a
negative connotation for a growth stocks price performance and overall risk profile. Finally,
risk-reduction screens eliminated overvalued stocks, relative to the industry, on the basis of the
price to earnings ratio and expected returns.

No

tC

Once the portfolio candidate list had been established, a fundamental research review for
individual stocks was conducted. In particular, analysts and portfolio managers combed financial
statements looking for such danger signals as aggressive accounting policies, as compared to
industry peers. Large write-offs to key assets, unorthodox off-balance-sheet financing, and
unrecorded liabilities buried in the footnotes are just a few red flags we look for, said research
analyst, Robert Jordan. In addition, the investment professionals made due-diligence trips to
company plants and headquarters to interview managers and discuss their long-term strategicgrowth plans. The goal was to find financially strong, fundamentally well-positioned companies
that traded at reasonable prices and add them to the portfolio. Some of the funds top holdings
included such growth stocks as Avon Products, Schlumberger Limited, Tyco International,
Equifax, and General Electric.

Do

With its more focused process, the equity fund had recently begun to evince
characteristics similar to those of the Lipper Growth Index. In the second subperiod, the equity
mutual fund outperformed the Lipper Growth Index. Specifically, from June 1, 1995, until
December 31, 1997, the equity mutual fund earned an annualized 24.44% versus 24.38% for the
Lipper Growth Index.
The bond fund

The bond fund sought to maximize total return (current income and capital appreciation)
in a way that was consistent with the preservation of capital. This was done through an actively
managed portfolio of high quality, fixed-income securities. The fund managers made maturity

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and sector decisions, which struck a balance between market timing and sector analysis. The
bond managers shifted the duration (weighted term to maturity) of the portfolio between short-,
medium-, and long-term horizons, depending on the shape of the yield curve and their
expectations for where the best total return could be made. Also, certain sectors (for example,
mortgage-backed bonds, floating-rate notes, closed-end funds, asset-backed securities, and
corporate bonds) were bought to take advantage of the additional yield for the extra risk these
instruments carried vis--vis same-maturity government bonds. Because preserving capital was
paramount, the fund maintained a minimum average quality rating of AA or higher at all times.

The balanced fund

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Since its inception on January 1, 1991, the bond fund had had an annualized return of
8.16%, compared with the Lehman Index return of 8.86%. From its inception to June 30, 1994,
the fund returned 6.96% versus 8.42% for the Lehman Index. Since July 1, 1994, the funds
performance improved greatly, returning 9.37% versus 9.29% for the Lehman Index. This
improvement could be attributed to portfolio specialists concentrating on each sector,
thoroughly scouring each one, and finding attractively priced securities. In addition, the use of
powerful computer models helped identify arbitrage opportunities in different sectors of the bond
markets. Portfolio managers also began to combine different securities (a practice known as
bond-synthesizing) to create coupon and maturity payments that were higher yielding than an
equivalent risky bond.

tC

The balanced fund sought long-term growth of capital and income through a diversified
portfolio allocated among high-quality equities and fixed-income securities. The common-stock
allocation typically ranged between 50% and 75% of fund assets. The fund could invest not only
in stocks and bonds, but also in securities across all market sectors (for example, convertible
bonds, preferred-series stock, and other hybrid debt and equity instruments). The balanced funds
objective was to minimize risk while generating competitive returns over longer periods.

No

Since the inception of the balanced fund on May 1, 1990, it had returned 11.66% versus
12.48% for the Lipper Balanced Index. From inception to September 30, 1993, the fund achieved
an 8.60% return versus 12.01% for the Index. In contrast, since October 1, 1993, the fund earned
14.82% versus 12.94% for the Lipper Balanced Index.

Do

Clearly, the balanced fund benefited from the changes in the investment process for the
equity and bond portfolios. Zeus levered its expertise in stock and bond management to construct
portfolios within client-specified, asset-allocation guidelines, and adjusted them over time as
market conditions changed. The portfolio managers, however, made strategic asset allocations,
not short-term, market-timing moves. Zeus believed that short-term moves generally proved
unsuccessful because of the high costs of turnover and the low probability of continued success
in making such predictions. Strategic allocation shifts were made when risk or return measures
were at extreme levels. For example, when equity valuations were at extremely high values
based on historical norms, the portfolio managers would shift the balanced fund to hold more

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bonds. When an equity correction occurred, the fund would then gradually shift back into
equities, which provided better risk-adjusted returns.
The international equity fund

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The international equity fund sought to invest in a diversified portfolio of companies

located outside the United States. Zeus established the fund to provide further diversification for
its clients. Historically, adding international securities to portfolios increased returns while
reducing the volatility of the portfolio because of the relatively low correlations between the
markets. Because Zeus specialized in the domestic equity and bond markets, it hired an adviser
to manage this fund. Bohren International Advisors was a long-established independent moneymanagement firm dedicated to international investment management. Since the inception of the
international fund on May 1, 1996, it had returned 5.8% versus 0.03% for the Morgan Stanley
World Index.
The Decision

Do

No

tC

John Abbott was convinced that several insights could be gained by examining the
performance of the various mutual funds at Zeus on a risk-adjusted basis: it would help the
company establish its internal rules regarding the level of risk and return that portfolio managers
should deliver and, at the same time, would make the firm even more attractive to its relatively
risk-averse clientele. He started putting together a list of measures that had to be examined first
and jotted down some of their pros and cons.

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