At Stein Roe, Simpson managed separate accounts, beginning with individuals and gradually moving toward institutions. Stein Roe did offer mutual funds, though Simpson did not work on them. The strategy for the separate accounts was narrowly confined. An investment committee created a model portfolio, and the separate accounts were expected to follow it. Simpson followed the model portfolio, but had a tendency to concentrate the managed accounts more than the model portfolio dictated.45 He stayed seven-and-a-half years with Stein Roe, and was made a partner. He was concerned that the partners were much more interested in the size of their slice of the pie than in trying to grow the whole pie.46 He told a good friend from Princeton that he was open to making a change. The friend introduced him to Shareholders Management, a mutual fund management firm in Los Angeles.47 Shareholders Management was headed by “fund wizard” Fred Carr, a darling of the market during the go-go years in the 1960s, when the fad was for performance mutual funds.48 Shareholders Management was one of the hottest. Under Carr’s guidance, Shareholders’ Enterprise Fund had soared 159 percent from 1967 to 1969, and the fund’s assets had ballooned more than fiftyfold, to $1.7 billion.49 Carr was a “gunslinger,” a market timer who dove in and out of the shares of small, rapidly growing stocks.50 A Business Week magazine profile in 1969 said of Carr that he “may just be the best portfolio manager in the U.S.”51 Carr offered Simpson a role not managing the hot mutual funds, but the separate accounts. Simpson would have to take a cut in base salary, but received a substantial option package. He accepted, and so in 1969, he became one of the first partners to leave Stein Roe.52
Simpson moved his family, now with three children, to Los Angeles to join Shareholders Management under Carr. While Shareholders Management had been for several years regarded by the market as an unusually gifted investment team, all was not as it seemed. Carr had bought a lot of “letter stock” – stock not registered with Securities and Exchange Commission (SEC), which cannot be sold to the public, meaning that it is extremely illiquid – for the Enterprise Fund. This strategy had done very well as the market ran up, but the long bull market soon collapsed, and investors in Carr’s Enterprise Fund were slammed, leading to large-scale redemptions. Compounding the problem, there was virtually no market for sales of the unregistered letter stock needed to meet the redemptions. Simpson’s timing was unlucky. He had joined in September 1969, the absolute top of Shareholders Management’s run. One month after his arrival, the losses in the Enterprise Fund were so bad that Carr was forced to resign, and cashed in his equity in the funds as he left.53 Though he had been hired to run managed accounts, Simpson was tasked with managing part of the Enterprise Fund. He quickly found that he didn’t fit into the Shareholders’ culture. “I viewed myself an investor, and they were trading-oriented,” he says.54 At lunch one day, one of the firm’s lawyers asked Simpson, “Do you realize how screwed up this place is? They’ve done things that are not on the up and up, and, if you want to maintain your reputation, it would be a good idea to leave.”55 Simpson resigned shortly after. He had been at Shareholders’ Management for just five months. He was 33, with three children, and he had just moved to Los Angeles. Though he had some opportunities in Chicago, he decided to see what was available on the West Coast.
After a brief search, Simpson settled on United California Bank to help start an investment management business and be second-in-command in the investment area. That new business was eventually spun out into a separate company called Western Asset Management, and became a subsidiary of Western Bank Corporation.56 Simpson stayed at Western Asset Management for nine years as head of portfolio management, and then director of research.57 Western Asset Management was successful, but Simpson found it difficult to operate in a big banking environment. The chairman of Western Bank Corporation wanted to make him CEO of Western Asset Management, but said he would only do it if Simpson promised to stay on. The chairman forced the resignation of the former chief executive, and Simpson was made the new chief executive of Western Asset Management. Though he stayed on for three years, he found the management role chafed him. He yearned to do something entrepreneurial. Friends of his wanted to set up some kind of investment management company with him, but he wasn’t sure.58 The experience with Shareholders Management had a transformative effect on Simpson, wholly changing his perspective on investment.59 Shareholders Management taught him about the importance of business risk, and started him on the road to value investing.60 During his time at Western Asset Management he was able to think, developing his investment philosophy, both on a personal and a company basis. He began to embrace value investing. His philosophy evolved dramatically when he ran the research department and he moved toward a more concentrated value investment approach. And then GEICO came calling.
In the 1970s, most insurance companies held a broad portfolio of bonds, counting on diversification to minimize risk, and little in the way of stocks. They also held a high proportion of the portfolio in government bonds, which, during the period of high inflation in the 1970s, had led to sizable losses for most portfolios.61 Before Simpson arrived in 1979, GEICO was no exception. He would radically change GEICO’s course. The agreement Simpson had struck with Byrne allowed the new investment chief to put up to 30 percent of GEICO’s assets in stocks.62 At the time, most property and casualty insurers limited stock holdings to about 10 percent of assets.63 The agreement also allowed him to hold concentrated positions.64 Simpson went to work as soon as he arrived, slashing the company’s bond holdings and rebuilding the stock portfolio in a limited number of names.65
Wary of Byrne’s reputation for micromanagement, Simpson had made it clear he was to be solely responsible for managing GEICO’s investments. “The more people you have making decisions, the more difficult it is to do well,” he said.66 “You have to satisfy everybody.”67 Neither Buffett nor Byrne were to interfere with the portfolio.68
Simpson’s instincts about Byrne were right. After he had been at GEICO for more than a year, he went away for a week on vacation. Byrne took the opportunity to buy some stocks for the portfolio. When Simpson returned, he immediately sold Byrne’s positions. Byrne asked, “Why would you do that? They were good ideas.”69
Simpson replied, “If I’m going to be responsible for the portfolio, I’m going to make all the decisions.”70 From then on, Simpson made his own decisions, essentially working autonomously.71 Describing the arrangement in 2004, Buffett wrote,
You may be surprised to learn that Lou does not necessarily inform me about what he is doing. When Charlie and I assign responsibility, we truly hand over the baton – and we give it to Lou just as we do to our operating managers. Therefore, I typically learn of Lou’s transactions about ten days after the end of each month. Sometimes, it should be added, I silently disagree with