JEFFERSON CITY, Mo. - The $13.3 billion Missouri Public School Retirement System has completely restructured its investment management, boosting equities - domestic and international - and indexing, hiring 10 new managers and installing an unusual flat fee arrangement.
Under the latter, designed to counter high management fees, managers agree to run a fixed percentage of the fund's assets for a flat fee that does not increase as the market value of the manager's portfolio increases.
Fund executives did a top-to-bottom review of the fund's management beginning in summer 1995.
"We want to do this right, and we have no sacred cows," was the mandate put forth by the trustees in revamping the fund, said M. Steve Yoakum, executive director.
As a result of the changes:
The fund's allocation to fixed income was slashed to 47% of assets from its previous 70% to 75% target.
Its U.S. equity allocation climbed to 38% of assets from 20%, and non-U.S. equities skyrocketed to 15% of assets from 3%.
Only one outside manager remains from the nine in place a year ago; 10 other managers were hired, as was a new domestic and global custodian.
Passive investing, not used before, now accounts for 42% of the overall assets. About 45% of U.S. equities are indexed, as are one-third of non-U.S. equities and 40% of U.S. fixed income.
And in using passive investing - coupled with novel manager search techniques and a limited amount of managers - the fund limited its overall investment management fees to about 10 basis points (net of securities lending income).
Fees are similar to what the fund paid under its old structure, but that was a mostly buy-and-hold fixed-income strategy, which traditionally commands lower fees.
The Missouri school fund's new U.S. equity managers are: State Street Global Advisors, Boston; Ark Asset Management Co. Inc., New York; Brinson Partners Inc., Chicago; Alliance Capital Management L.P., New York; Dimensional Fund Advisors Inc., Santa Monica, Calif.; and Thomson, Horstmann & Bryant Inc., Saddlebrook, N.J.
Previously, U.S. equity managers were Boatmen's Trust Co., St. Louis; Dalton Greiner Hartman and Maher, New York; Denver Investment Advisors, Denver; and Loomis, Sayles & Co. L.P., Pasadena, Calif.
Its new non-U.S. equity managers are: State Street Global; Bank of Ireland Asset Management (U.S.) Ltd., Greenwich, Conn.; and Oechsle International Advisors, Boston.
Those firms took over for Capital Guardian Trust Co., Los Angeles, and Scudder, Stevens and Clark Inc., New York.
New U.S. fixed income managers are State Street Global; Boatmen's, the sole incumbent; NISA Investment Advisors L.L.C., St. Louis; and BlackRock Financial Management, New York. Previous managers were Boatmen's, Loomis and United Missouri Investment Advisors Service, Kansas City, Mo.
State Street Bank & Trust Co., Boston, won the custodial job from Boatmen's.
Although many pension funds negotiate manager fees, officials took an unusual fee negotiation approach: They negotiated fees with about 40 potential finalists before presentations were made.
"That's where your leverage is at its peak," said Mark A. Caplinger, senior investment officer.
Terms were final and were included as part of the decision-making in hiring managers. Fund officials asked for bids on a flat fee investment management arrangement over a three-year period with adjustments for inflation.
Mr. Caplinger said asset-based fees, which the fund had used until now, don't make sense. "I don't want to pay you more because you did what we paid you to do in the first place" - provide a return on assets, he said.
Contracts for active managers call for fixed-dollar payments to manage a set percentage of the fund. If assets grow or fall, pension officials will have to adjust assets to keep them ly one of the most interesting and challenging projects I've ever worked on," said Michael Beasley, managing director for Strategic Investment Solutions, San Francisco, who assisted with the changes.
Previously, trustees were primarily familiar with managing assets based on book value accounting methods, which resulted in the 70% allocation to bonds, Mr. Yoakum said.
But with changes in governmental accounting standards, market value-based accounting would be adopted, uncovering the wide swings in value that could occur in a portfolio highly concentrated in longer-term bonds.
The changes began with educational retreats for trustees in summer 1995 geared toward emphasizing a total return approach; trustees were shown investment possibilities available to the fund.
While for the most part, longer-term bonds had been a good investment for the fund, Mr. Yoakum explained that the fund was one of the most aggressively managed in the country from a diversification standpoint.
And following a 50-year liability projection, fund officials realized they could take on some additional risk, given the fund's 90% funding ratio, Mr. Yoakum said.
"We're concentrating more on risk now, and we're more diversified," he said.
After an asset allocation review, the new allocation was created, which included a heavy dose of indexing.
The manager selection process began, but with the focus more on risk than return.
The underlying goal was to meet its 8% actuarial return with the minimum amount of market risk. "If you manage those risks, the returns will follow," Mr. Caplinger said.
Trustees purposely rejected less easily monitored asset classes such as real estate and private equity. "Under current expected returns scenarios, we can't justify it," Mr. Yoakum said.
The manager selection process was unusual. The fund and its consultant each used the same set of goals and standards, but different data bases, to separately narrow their manager choices to 25 firms each. About 75% to 80% of the firms were the same, Mr. Beasley of SIS said.
Then the two groups compared results. The goal was to keep bias from coloring the process.
The two separate lists were then winnowed down separately to a group of semi-finalists, about four times more as would be hired eventually.
Each manager on the combined list of semi-finalist was visited on site by representatives from the fund and SIS. Contracts were negotiated at that point, which might have increased the work, but ultimately resulted in lower fees, Mr. Caplinger said.
Based on the on-site visits, officials from the fund and SIS evaluated the managers, and, based on those evaluations, finalists were chosen.
The last step for fund officials will be deciding how to handle rebalancing of assets, Mr. Yoakum said.
The changes also apply to the $1 billion Non-Teacher School Employee Retirement of Missouri, which is managed with the larger fund.