MISHAWAKA, Ind. - The $1.1 billion National Steel Corp. pension fund, considering doubling its 10% exposure to international equities, has run into a barrier: How does a medium-sized pension fund deal with ever more complex investment strategies?
A proposal now on the drawing boards would lead National Steel to double its foreign stock exposure and revamp its core-satellite structure for investing in international stocks.
Under the proposed strategy, National Steel's international indexed strategy would convert to an actively managed portfolio, while its three regional portfolios - which overlap greatly with the passive mandate - would be switched to small-cap mandates. In addition, an emerging markets mandate may be added. Plus, officials have yet to decide how to deal with the fund's growing currency exposure.
The problem is that the proposal extends beyond the fund's internal expertise - especially now that its main author, former analyst Jim Goergen, has left National Steel for a new role in the research area of Asset Consulting Group in St. Louis.
National Steel's pension staff was made up of Mr. Goergen and William McDonough, manager-treasury operations, both of whom have other corporate responsibilities.
National Steel's dilemma illustrates how far a small staff at a medium-sized pension fund can go in expanding pursuing an innovative investment strategy.
International investments clearly are important for the pension fund, which is 81% funded. While contributions will help make up the underfunding, investment performance also is critical.
"Whatever we can do to enhance the value of the fund, we will do," said Mr. McDonough.
The pension fund's first step into international markets started with a 1989 asset/liability study that recommended allocating 10% of total assets into international stocks to achieve greater diversification.
Under the strategy adopted, fund officials hired Wells Fargo Nikko Investment Advisors, San Francisco, to manage an index portfolio that tracked the Morgan Stanley Capital International Europe Australasia Far East Index. The original allocation was not disclosed, but that portfolio now makes up 40% of the fund's $110 million international equity exposure.
Hired to manage a Pacific Basin ex-Japan portfolio was Baring International Investment Ltd., London, while Fuji Bank & Trust Co., New York, which also serves as lead lender for National Steel's parent, NKK Corp., won a Japan-only mandate. Oechsle International Advisors, Boston, was picked to manage a European equities mandate.
Because Japan made up 61% of the EAFE at that time, National Steel officials decided to slash its Japanese stock target in half; Pacific Basin equities were boosted to about 40% of the index and European equities made up the balance.
The strategy, however, ran into a number of difficulties. For one thing, the regional managers greatly overlapped with the passive broad-based strategy, giving the pension fund a high degree of concentration in the same stocks.
And while the decision to halve the Japanese allocation was conscious, the increase of the Pacific Basin mandate was more by accident than by design, Mr. Goergen said. Still, that decision has served the fund well: in 1993, the Pacific Basin portfolio increased 98%, compared with 102% for the index.
In addition, the fund severed its relationship with Oechsle in the third quarter of 1993, moving the assets into a European index portfolio managed by Wells Fargo on a temporary basis.
Meanwhile, benefit increases granted workers under a new collective bargaining agreement and a lowering of the pension fund's discount rate by 150 basis points shifted the fund to an 81% funding ratio from 98%. Given the gap in time since the 1989 asset/liability study, fund officials last year asked Towers Perrin in Pittsburgh to update the analysis.
Fund officials put in a 20% cap on the amount that could be allocated to foreign stocks. The study, when it arrived, recommended boosting the international equity allocation to that limit.
Internally, Mr. Goergen proposed retaining the regional approach, but suggested several other changes. He called for switching the EAFE portfolio to an actively managed portfolio. Also, he suggested switching the regional managers to small-cap regional mandates with a value orientation, and limiting their overlap with the broad-based portfolio to 10% of assets. He also proposed adding an emerging markets mandate.
With regard to currency exposure, fund officials decided a 10% exposure to international stocks does not warrant a currency manager, but a 20% exposure might.
But to what extent the exposure should be hedged, and whether to allow the regional managers to handle currency management or to hire a separate currency overlay manager, has not been determined.
While the solution appears elegant, it would stretch National Steel's resources to implement the strategy. One issue is that international managers - not to mention small-cap specialists - rarely categorize themselves by value or growth strategies.
The upshot is that fund officials probably will seek small-cap managers at first, and implement a value strategy with time, Mr. McDonough said.
Another issue is whether Mr. Goergen will be replaced. "Clearly, if we don't replace Jim, we will need to seek some help from the consulting community," Mr. McDonough added.
National Steel officials also face finding appropriate benchmarks against which they can measure performance. International small-cap indexes are not readily available; regional benchmarks probably will be adopted.
For the total international exposure, the fund probably will use the EAFE weighted by gross domestic product, which effectively cuts Japanese exposure in half, Mr. Goergen said. The same index would be used if an overlay manager is hired.
The entire strategy, however, has yet to be presented to the pension fund's investment committee, which has undergone some change in the wake of management changes.
"We're evaluating. We have a strategy on paper and are going to present it to the committee," Mr. McDonough said.