Pension funds continue to hire small-cap equity managers, despite the 10-year underperformance of small-cap stocks relative to large caps.
In fact, some money managers have been able to increase their small-cap assets under management.
Eager Manager Advisory Services tracked 201 placements for domestic small-cap mandates in 1998 representing assets of $6.5 billion -- slightly more than 10% of all placements Eager tracked last year. So far this year, small-cap hires account for less than 10%.
Dimensional Fund Advisors in Santa Monica, Calif., had $17 billion in institutional small-cap assets at year-end 1998, of which $6.5 billion was in the value style. Five years ago, DFA had only $6 billion total in small cap, with about $615 million in small-cap value stocks, according to company data for Dec. 31, 1993. About 50% of the growth is appreciation, DFA officials said.
"I wear the cape with the red S," joked Rex Sinquefield, DFA's chief investment officer and a founder of the firm.
"We've gotten a lot of new accounts in the last few years in the small- and midcap value areas. We think it's because there is more precision to what we do.
"Through us, clients can get more reliable exposure to value effect and size effect. If you compared our product to a Russell 2000, we'd be more 'valuey' -- if I can use that word -- and smaller in average cap size. We are able to demonstrate that any given population of alleged value managers has very little value exposure," Mr. Sinquefield said.
Equity assets continue to be allocated to small-cap stocks even though there is no clear evidence the asset class is bouncing back.
The Standard & Poor's 500 stock index already is trouncing the Russell 2000 this year -- the S&P is up 4.96%; the Russell 2000 down 5.42% for the quarter ended March 31.
"You have to look back 25 years to find real profits from small cap," said small-cap manager Theodore Aronson of Aronson + Partners.
"The time frame needed to earn a return on that investment keeps being pushed farther and farther into the future," said Greg Young, an Atlanta-based consultant for William M. Mercer Investment Consulting Inc. "We used to tell clients that all they basically needed was a five- to 10-year time frame."
Sticking with models
Pension funds, it appears, have stoically stuck to their asset allocation models.
"We've all diversified away from the S&P 500," said Walter Koziol, director of investments for the $13.3 billion Illinois Municipal Retirement Fund, Oak Brook, Ill. About 27% of the fund's $5.4 billion in equity assets is allocated to small-cap growth and value stocks.
"We're slightly overweighted in small cap, but it's been our consistent approach since the mid-'80s. We take a long-term view of the market. We're not trying to time it or anticipate," Mr. Koziol said.
Pension executives continue to reallocate money to small cap, and some are even getting into the asset class for the first time.
"Things are so cheap now, I expect the pension funds will take an even greater interest," said William Wykle, a lead portfolio manager for the institutional small-cap growth portfolio of BlackRock Inc., New York.
The BlackRock portfolio was up 2.96% for the quarter ended March 31 and returned 7.38% for the year ended Dec. 31, according to data from Standard & Poor's Micropal. The Russell 2000 growth index -- BlackRock's bogey -- was down 1.68% for the quarter and returned 1.23% for the year.
The S&P 500 returned 28.6% in 1998, compared with -2.5% for the Russell 2000; for 10 years, the S&P was up a compound annualized 19.2%; the Russell 2000, 12.9%.
Yet the median small-cap manager outperformed the Russell 2000 benchmark by 220 basis points in 1998, according to Mercer's 30th annual investment performance survey. The outperformance was predominantly among small-cap growth managers, said Mercer consultant Louis Finney.
The median equity manager underperformed the S&P 500 by 13.5 percentage points in 1998, one of the widest margins ever, according to Mercer. And the median small-cap manager returned -0.4%, compared with the S&P's 28.6%.
A few examples
Small-cap stocks' poor performance isn't keeping some pension investors from expanding into the area.
* The $9.2 billion Kansas Public Employees' Retirement System, Topeka, is in the process of hiring a new small-cap manager to increase its small-cap exposure to 15% of total assets from 4%. Funding will come from rebalancing. The change was initiated following an asset liability study last summer, said Scott Peppard, assistant investment officer.
* Officials at the $393 million City of Miami Beach (Fla.) Fire & Police retirement plan recently hired their first small-cap manager, Wellington Management Co. of Boston, to manage a core small-cap portfolio of up to $10 million. Officials said they wanted to diversify the plan's investments.
* The $267 million Bucknell University endowment in Lewisburg, Pa., terminated small-cap manager Furman Selz Capital Management LLC in New York, and put two small-cap managers in its place -- Skyline Asset Management, Chicago, and Emerging Growth Management Co., San Francisco.
Some active small-cap managers have been replaced with passive small-cap portfolios. The $650 million Ohio State Highway Patrol Retirement System, Columbus, recently terminated George D. Bjurman & Associates, Los Angeles, as a small-cap growth manager and put the $50 million mandate into a Russell 2000 index fund run by State Street Global Advisors, Boston.
Pension funds have not expressed alarm about small-cap investments, said Howard Crane, senior consultant at Frank Russell Co., Tacoma, Wash.
"Clients are not deserting this asset class or getting out of the game due to recent performance. In fact, most small-cap managers have outperformed the small-cap benchmark," Mr. Crane said.
He has participated in seven small-cap placements during the past six months, and performance problems were not the main driver. In most cases, the fund replaced an existing manager because of staff turnover or a change in the investment process at the investment management firm, he said.
True to their style
Small-cap managers don't seem to be resorting to style drift to save themselves, said Steve Hardy, owner of Zephyr Associates Inc., a creator of style analysis software. At Pensions & Investments' request, Mr. Hardy examined a composite of various manager styles to determine the level of drift.
"If anything, it looks like these managers are becoming even more consistent in their styles. It seems they are doing what they are supposed to be doing," Mr. Hardy said.
Now is the time to knock on doors if you're a small-cap equity manager, said Timothy Dalton, chief executive officer of Dalton, Greiner, Hartman, Maher & Co., New York.
DGHM has about $50 million in small-cap assets under management out of $1 billion in total assets, which include microcap, midcap, core and technology equity investments.
The firm just hired C.P. Eaton & Associates, a Rowayton, Conn. third-party marketing firm, to shake the trees for clients.
"This is the cheapest these stocks have been since 1975, which was the turning point in the cycle that launched an eight-year bull market," Mr. Dalton said.
"I can't tell you when the bell is going to go off, or how long the small-cap bull market will last, but the interest level is very high now."
Large-cap allocations have grown beyond the desired level at some pension funds, with small-cap allocations sometimes falling below the target, Mr. Dalton said.
"Getting people to pull the trigger and commit more assets is difficult, because everyone wants to time it precisely. They don't want to go in while Cisco and Microsoft lead the pack. The fear of being too soon may delay a major shift in assets, but it's going to happen," Mr. Dalton said.
DGHM's small-cap strategy posted an 18.9% annualized return from July 1994 to December 1998, compared with 15% for the Russell 2000 index for the same time period, according to company data.
