Market-neutral managers
I enjoyed reading the Nov. 30, page 3 article on long-short strategies by Vineeta Anand.
She highlighted a number of critical issues with regard to "market neutral" strategies. In truth, market neutral is a matter of degree. True market-neutral managers, at the limit case, would have zero alpha and only earn the short rebate.
So, returns to the manager would come, generally, from any unhedged market-related exposure and from their skill in selecting securities. Hopefully the former is negligible and the latter is primary.
Hence, the two critical questions to ask are "where does the manager have exposure" and "how good is their security selection process."
As she points out in her article, many managers have style exposure, intentional or otherwise, and may have other broad-based exposures. Additionally, sometimes the market moves against the selection methodology and returns suffer.
Obviously, a plan sponsor should be aware of such exposures and circumstances when the selection process may have difficulty.
We at Zacks Investment Management run over $200 million in quantitative-based market-neutral strategies. We are dollar neutral, beta neutral and sector neutral. We do have industry exposure and we do vary slightly in our security weightings. However, we believe that we have good information and a robust process to support our exposures and weightings.
In the third quarter we had a positive return of 2.4% and year to date, through November, we have returned 13.8% against a T-bill benchmark of 4.7%.
Having worked as an investment consultant, at a very large multiproduct firm and now at a smaller investment firm, I believe that market-neutral strategies, when well-executed, can bring great value to clients. The notion of "portable alpha" is very powerful and can provide an alternative to more traditional core-type strategies. Plan sponsors are just beginning to exploit this concept, and I believe it will see much broader acceptance very soon.
Bill Deuchler
Managing director
Zacks Investment Management
Winter Park, Fla.
High privatization fees
In his Dec. 14 Others' Views commentary, Robert J. Genetski is way off in his estimate that Social Security personal retirement accounts could be administered at an average cost of just $10 to $20 a worker.
The average cost would clearly exceed $300 a worker, based on what the market is actually charging today.
The November 1998 report of the Employee Benefit Research Institute cites both private and government surveys that show the average annual administrative cost of a 401(k) account is approximately $100 a worker; the average cost in a company with just 15 employees is close to $300 a worker. The current annual charges for 401(k)s by financial services firms, such as T. Rowe Price, Vanguard and Schwab, are approximately $300 a worker for companies with 10 employees and much higher for smaller companies.
For a universal 401(k) system, average costs would exceed $300 a worker because most private employers have fewer than 10 employees and 40% of employers have fewer than five employees. We are a nation of small businesses -- 6 million of them. So Mr. Genetski's "economies of scale" will never be realized unless small businesses merge into conglomerates that can spread the fixed costs over larger numbers of employees. That is the economic reality of today's marketplace; and government intervention, such as is advocated by Mr. Genetski and his sponsor, the Cato Institute, would not change it.
The cost of personal retirement accounts actually would be much higher than the costs of 401(k)s because:
(1) PRAs would be mandatory on the employer and/or employee, unlike the voluntary 401(k)s, and the compliance costs would be substantial;
(2) PRAs would include migratory labor and other temporary, part-time, retarded and illiterate workers who are not now in 401(k)s and who would require very expensive individual counseling and investment education; and
(3) the average income of workers subject to Social Security taxes is too small to make PRAs feasible. Forty-six percent of workers earn less than $15,000 a year. Assuming an average income of $20,000, of which 2%, or $400, is deposited in a PRA, the deposits would largely be eaten up by expenses; so there would be no net investment earnings.
Congressional appropriations of as much as $7.6 trillion might be needed over the next 40 years to provide PRA holders with the same return as the Social Security trust fund would have received from like investments. PRAs are doomed to failure because of intractable "smallness problems" -- small businesses and small average incomes subject to Social Security taxes.
Francis X. Cavanaugh
Public Finance Consulting
Chevy Chase, MD.
