UVA-F-1232

ZEUS ASSET MANAGEMENT, INC.

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
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 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.
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. Eachemployee 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.
Teamwork was at the core of Zeuss strategy. More than 75 percent of Zeuss investment
professionals were CFAs (chartered financial analysts) and had received their M.B.As 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
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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 veterans the average age was 44 who 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 assetmanagement 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 portfolio managers at Fidelity was 26.
The Clients
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 their
investment objectives and, in particular, their risk and return profile.1 Clients that did not meet
the minimum-amount requirement invested in one or more of the mutual funds offered by the
company. Of the assets under management, 45 percent were separately managed individual
portfolios, 12 percent were mutual funds, 31 percent were separately managed institutional
portfolios, and 12 percent were common trust funds. For the separately managed institutional
assets, Zeus managed 49 percent for foundations and endowments (e.g., schools and hospitals), 4
percent for insurance companies, and 47 percent for corporations.
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 would 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, April 30,
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
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 percent) was lower than the
investors current marginal-tax bracket (40 percent), then deferring the realization of capital-gain
income would be more valuable to the high-tax-bracket investor. These 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 percent difference between the
highest current income-tax bracket and the highest current long-term capital-gains-tax rate and
the 20 percent 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 these characteristics and who were interested in building relationships based on trust,
integrity, and stability.
The Firms Mutual Funds
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
2

For example, for an investor in a 40 percent tax bracket, a 4.5 percent municipal bond would be more
attractive than a 7 percent Treasury bond because, after being taxed at 40 percent, the Treasury bond would end up
yielding 4.2 percent [7 percent (140 percent)].
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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
Start

End

Fund

Index

Index

Equity (since inception)

Equity (subperiod 1)
Equity (subperiod 2)

Date
12/1/92
12/1/92
6/1/95

Date
12/31/97
5/31/95
12/31/97

Return
16.26 %
8.37 %
24.44 %

Return
20.18 %
11.95 %
28.72 %

Return
17.15 %
10.13 %
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 %
9.29 %

Lehman

12/31/97
9/30/93
12/31/97

11.66 %
8.60 %
14.82 %

12.48 %
12.01 %
12.94 %

Lipper Balanced

Balanced (since inception) 5/1/90

Balanced (sub 1)
5/1/90
Balanced (sub 2)
10/1/93

S&P

Lipper Growth

The equity fund and investment process

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.
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
The equity fund, from its inception until May 31, 1995, had an annualized return of 8.37
percent versus the S&P 500 Index of 11.95 percent and the Lipper Growth Index, which earned
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 this number by the minimum number of stocks to
achieve diversification (30 to 35), we arrive at a $1.5-1.75-million investment.
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10.13 percent. 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.
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. These 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 industry, on the basis of P/E
ratio and expected returns.
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 with 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 the research analyst Robert Jordan. In addition, the investment professionals made duediligence trips to company plants and headquarters to interview managers and discuss their
long-term strategic-growth plans. The goal was to find financially strong, fundamentally wellpositioned companies that were trading 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.
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 percent versus 24.38
percent 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
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-,
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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 (e.g., mortgagebacked 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.
Since its inception on January 1, 1991, the bond fund had had an annualized return of
8.16 percent, compared with the Lehman Index return of 8.86 percent. From its inception to
June 30, 1994, the fund returned 6.96 percent versus 8.42 percent for the Lehman Index. Since
July 1, 1994, the funds performance improved greatly, returning 9.37 percent versus 9.29

percent 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.
The balanced fund
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 percent and 75 percent of fund assets. The fund could
invest not only in stocks and bonds, but also in securities across all market sectors (e.g.,
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 of time.
Since the inception of the balanced fund on May 1, 1990, it had returned 11.66 percent
versus 12.48 percent for the Lipper Balanced Index. From inception to September 30, 1993, the
fund achieved an 8.60 percent return versus 12.01 percent for the Index. In contrast, since
October 1, 1993, the fund earned 14.82 percent versus 12.94 percent for the Lipper Balanced
Index.
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
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 percent versus -.03 percent for the Morgan
Stanley World Index.

The Decision
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.