TAKING RISKS WITH THE RICH ROBERT ELLIOTT OF BESSEMER TRUST MANAGES MONEY FOR FOLKS LIKE GEORGE BUSH. WHAT'S HE DOING FOR THEM? WOULD YOU BELIEVE STOCKS AND REAL ESTATE?
By LAWRENCE A. ARMOUR; ROBERT ELLIOTT

(FORTUNE Magazine) – If you aren't a member of the ruling class but would like to invest like one, read on. The $13 billion Bessemer Trust, which describes itself as a financial and investment adviser to individuals of substantial wealth, was founded in 1907 to steer the descendants of Carnegie Steel's Henry Phipps over the financial shoals. Now the firm also manages money for ordinary folks--provided they have $5 million to invest--a group that includes former President George Bush, 45 CEOs of FORTUNE 1,000 companies, and a handful of ex-Treasury Secretaries (Don Regan, Nick Brady, and Lloyd Bentsen).

Are they getting their money's worth? Bessemer's average equity account was up 22.8% in 1996, a virtual dead heat with the S&P 500, but its three- and five-year gains of 18.4% and 11.9% trailed the S&P's 19.7% and 15.2%. Yet Robert Elliott, vice chairman of Bessemer's investment policy and strategy committee, says his firm can add value over time, partly because its clients can afford to take more risks in nontraditional or alternative equity investments. The following are some of the risks Elliott plans to take.

Rob, if I plunked $5 million on your desk today, what would you do with it?

Before I did anything, I'd draw up a written set of guidelines that would reflect your objectives. Despite the fact that our clients have money, we have to educate them about the market. Most people who come to us today have expectations based on the past two years, which is a problem. Our basic assumption is that we will revert to the mean in terms of equity market returns.

Translated into English, that means...

That we don't think annual equity returns of 16% and 17% are sustainable over time. We do think annual returns in the 10% to 12% range are.

Does that mean we're in for a correction?

Possibly, but based on expected earnings and no P/E expansion, we see the market growing 8% to 10% this year.

Hold on. If you're telling me you're looking for 8% to 10% in the market, and that's in line with what you see as a sustainable return, why don't I just give my $5 million to an index fund?

A lot of people are doing just that, and we'd be the first to acknowledge that many money managers have not outperformed the averages over the past few years. But we believe in active management, and we believe we can add value over time.

Through the nontraditional or alternative investments you mentioned?

Partly. Real estate, venture capital, buy-outs, hedge funds, and the like typically produce returns substantially in excess of the 12% we'd expect from traditional equities, and it's an area in which we'd place maybe 15% of a client's assets.

Take me through a typical buyout.

In the 1980s the game was to leverage a company to the hilt and then break it apart. It's different now because institutions won't lend 90% to 95% debt money. They make buyers put up 25% to 35%, so the leverage doesn't work. The game today is to grow a company by using the buyout as a platform for a buildup.

An example would be Overhead Door, which we bought at the depths of the recession in 1990 when homebuilding was in the tank. We took the company private, brought in new management, cut costs, did an add-on by acquiring a name-brand garage-door-opener company called Genie, and built earnings to the point where it could be sold. The initial exit strategy called for taking Overhead public, but we wound up instead selling to a Japanese company.

What was your return?

Our cost was $95 million. We got $392 million on the sale, which works out to a 33.8% annual return on our investment. Most buyouts are done with pro forma expectations of at least a 30% return. In venture deals it would be more like 50%.

Because the risk-reward ratios are different?

Yes. Venture capital is higher risk because you're in the very early stage of high-growth areas. The typical profile here is to have two, maybe three home runs, three or four that totally wash out, and the rest that don't do much of anything, which is why you have to be with good people. We're able to give our clients access to the best venture capital and buyout firms, which are typically difficult to get into.

What's the story with Bessemer's real estate fund, which has declined 1.4% annually since 1988?

We made the mistake of thinking real estate was not going to have quite the down cycle it had in the late 1980s. The overbuilding encouraged by taxes, leverage, and unfettered lending by institutions just got out of hand.

Is it time to be looking at real estate again?

Yes. There's not a huge growth in the number of jobs, but it's enough to create some pent-up demand in terms of rent rolls. You've obviously got to pick your markets and properties carefully, but we're bullish about real estate.

Where else would you put my $5 million?

Common stocks. Assuming 15% of your money goes into alternate investments, we'd want 50% in large-cap U.S. equities, 10% in small and mid caps, and 25% in international equities. We'd put one-third of your money immediately into large-cap names we think represent good value, and we'd look to do the second and third tranches over a three- to six-month period. If the market had a 5% to 10% correction during this period, which is a possibility, we'd accelerate the big-cap stage-in and get fully invested pretty fast.

We'd be a bit more aggressive in the small- and mid-cap markets because of the underperformance in that sector last year, and we'd get our international money to work fairly quickly. Foreign markets have not run as much as the domestic ones, and, with 30 to 35 markets to pick from, there are lots more investment opportunities abroad.

Is Japan, a wonderfully contrarian bet, on your list?

Yes. The Japanese market may continue under pressure for a while, but the combination of the government's apparent commitment to deregulate the financial system and prospects for an earnings rebound have created an opportunity to reenter the country. We recently took positions in Mitsubishi Motor, NTT, Fujitsu, Matsushita Electric, Sankyo, and NKK.

What else is on your international hit list?

We have about 35% of our portfolio committed to Europe, with our biggest relative allocations to some of the smaller markets. We like Allied Irish Bank and Bank of Ireland, which should benefit from the strong Irish economy. Elektrim is the largest engineering group in Poland. Our Spanish favorites are Sevillana, an electric utility, and Vallehermoso, a property company that sells at a 40% discount from asset value.

We have positions in Telebras and Telefonica, the holding companies for Brazilian and Argentine telecommunications companies. We are in Citic Pacific, which owns interests in infrastructure plays like Hong Kong Telecom and Masau Telecom. We own Philippine National Bank; Wespac Banking, an Australian bank that's just gone through a restructuring; and Lend Lease, one of Australia's leading financial services companies.

What's happening back home in small- and mid-cap areas?

Our biggest commitments are in technology, where we have 27% of our funds, and consumer cyclicals, at 16%. Our two top technology choices are Boston Technology, in network-based, value-added telecommunications services, and Digital Microwave, which designs, manufactures, and markets high-performance microwave radios for short- and medium-haul communications. Its products are capable of carrying voice, data, and video signals at 45 megabits per second.

Borders Group, the country's second-largest book retailer, is working to position itself as a quality media retailer offering the broadest merchandise assortment in a given marketplace. Our other consumer favorite is Viking Office Products, a full-service retailer that doesn't compete with Staples and Office Depot on price because it provides more services and deals with a more professional market. Viking has been showing annual growth throughout Europe of better than 20%, with Germany, Ireland, and Belgium growing in excess of 50% a year.

What are your big-cap favorites?

The emphasis is on technology, consumer nondurables, and financials. We've focused on the leaders in each field. Hewlett-Packard, Intel, Microsoft, and Compaq Computer in technology, Procter & Gamble, Avon Products, and Gillette in the consumer area, and Chase Manhattan and Citicorp as the large money center banks with strong balance sheets and consumer banking franchises.