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August 09, 1999 01:00 AM

TWICE AS MANY: REBALANCING, NEED FOR DIVERSIFICATION LEAD FUNDS TO BOOST MIDCAP SEARCHES; CONSULTANTS SEE LOTS OF INTEREST, BUT NOT REALLY THAT MUCH ACTION

Ricki Fulman
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    Pension funds have stepped up midcap equity manager searches this year, said consultants and money managers. While some managers said they have seen twice as many midcap searches in the first part of 1999 as in 1998, consultants said the increase hasn't been that big.

    The reasons for the searches vary: some are replacements for existing midcapitalization equity managers; others are additional allocations that result from rebalancing; and still others are new strategies at pension funds.

    The $22.2 billion Arizona State Retirement System, Phoenix, hired its first two active U.S. midcap managers in the second quarter. "We thought we should be market-cap weighted in that sector," said Paul Mattson, senior investment officer. "We had a passively managed allocation to midcap before, but never had active midcap managers."

    A year ago, the system hired its first active small-cap manager to expand its portfolio. And this year it further broadened its investments by adding active midcap, while retaining the passive midcap. It hired Conseco Capital Management, Carmel, Ind., and Mellon Equity Associates, Pittsburgh, to each run $200 million in active core midcap funds.

    Half of the pension fund is allocated to U.S. equities, and 4% of the fund is allocated to midcap equities, Mr. Mattson said.

    So far, the system has funded almost half of the midcap allocation. It might give more to the current managers, depending on the outcome of an asset allocation study that is to be completed in October.

    The Teachers' Retirement System of Louisiana, Baton Rouge, in the second quarter hired four firms to actively manage $700 million in U.S. midcap funds.

    "We always had midcap, but were underweighted," said Dan Bryant, chief investment officer of the $10.3 billion pension fund.

    As contracts expired, the system decided to rebalance and to replace some managers, which resulted in a new midcap allocation of $1 billion, double what was invested previously in the asset class, he said.

    The system committed $200 million apiece to Ariel Capital Management Inc., Chicago, and Valenzuela Capital Partners Inc., New York, for midcap value strategies; and $150 million apiece to Forstmann-Leff International Inc., New York, and Seneca Capital Management, San Francisco, for midcap growth strategies.

    The system terminated midcap growth manager George D. Bjurman & Associates, Los Angeles, which was managing $100 million; and midcap value managers NM Capital Management, Albuquerque, N.M., which had $150 million; and Fleet Investment Advisors, Boston, which managed $165 million for the system, all for performance reasons. Warren De Kinder, vice president at Bjurman, said he was sorry the system terminated the firm. Fleet spokeswoman Jody Burke said the firm would have no comment. No one from NM Capital returned calls by press time.

    The rest of the funding came from existing large-cap growth managers STI Capital Management, Orlando, Fla.; Fleet Investment Advisors, Boston; and Furman Selz Capital Management LLC, New York, who were each cut back $125 million as part of the rebalancing process.

    In addition, the system also added its first passive midcap allocations, hiring RhumbLine Advisers, Boston, to run $50 million in a growth fund and $100 million in a value fund.

    In Indianapolis, the Indiana State Teachers' Retirement Fund also recently hired its first midcap managers, on the recommendation of consultant Callan Associates, said Robert Newland, chief investment officer.

    The $5 billion system began building its first equity portfolios in 1997, after the state constitution was amended to permit investments in the stock market.

    "Callan suggested that we put 15% of our U.S. equities into midcap and another 15% into small-cap stocks," Mr. Newland said. The system hired Conseco to run $25 million and Putnam Investments, Boston, to manage $35 million in midcap growth funds; Franklin Portfolio Associates LLC, Boston, to manage $35 million in a midcap core fund; and Valenzuela to manage $35 million in a midcap value fund.

    Smaller sponsors

    Several smaller plan sponsors also hired midcap managers during the second quarter.

    Peter Thompson, director of institutional marketing at Ariel Capital, which uses only value strategies, said the firm has handled more midcap business this year than ever before.

    "We were in a handful of searches last year, and in about 40 so far in 1999," he said. "Part of that is due to stepped-up marketing efforts. In addition, our performance has been really strong and we have a 10-year track record now, which is important to many clients."

    Recent awards include $25 million from the $603 million endowment fund of George Washington University, Washington, a new allocation; $20 million from the $407 million Metropolitan Atlanta Rapid Transit Authority, also a new allocation; and $20 million from the $410 million Anchorage (Alaska) Police & Fire Retirement System, a replacement.

    Midcap comprises 30% of the $3 billion in total assets Ariel has under management for institutions.

    Mr. Thompson said 70% of the searches he's been seeing are first-time searches. "They often result from rebalancing out of large cap. They (pension funds) are too scared to put their money into small cap, or they already have small-cap exposure and are unhappy about poor returns, so they start to hire midcap managers."

    At Conseco Capital, which invests only in midcap stocks, business is also way up, said Tom Meyers, director of marketing. He has noticed a lot of plans have been considering small-cap or midcap strategies because their large-cap allocations have swelled and they're concerned about overvaluations.

    Fewer mandates

    Mellon Equity Associates has seen new midcap mandates slow this year. "It was very strong in 1998 and is continuing into 1999," said Dave Penz, director of sales and marketing. "We added 11 clients for midcap in 1998 and four so far in 1999."

    Running midcap money presents a unique challenge, Mr. Penz said. "Good midcap companies grow and become large-cap companies. The best example of that last year was America Online, which was capitalized at $20 billion at the end of 1998 when it was removed from the S&P Midcap index and put into the S&P 500 index.

    "It was a tough decision for managers whether to continue to own that stock as it grew out of the midcap definition. But most who didn't have it in their portfolios lagged the S&P midcap benchmark."

    He added many smaller sponsors have been choosing midcap when diversifying out of large-cap, because such stocks tend to be less volatile than small-cap equities.

    That was the case at Hood College, Frederick, Md. Treasurer Thomas Berger, who oversees the college's $80 million endowment fund, said that as the endowment grew, the investment committee decided to add new asset classes.

    "Before, we just had large-cap growth and value funds," Mr. Berger said. The investment committee decided to expand into midcap rather than small-cap stocks. It recently hired Miller Anderson & Sherrerd LLP, West Conshohocken, Pa., to manage $10 million in a midcap growth fund; and Wedge Capital Management LLP, Charlotte, N.C., for a $5 million midcap value fund.

    Despite all of this activity, many consultants say that while there is a lot of interest in midcap, hirings are not necessarily on the increase. Several said they were involved in the same number of searches in 1998 as they are in 1999.

    "We have been in about six searches each year," said John DeMairo, senior vice president at Segal Advisors Inc., New York.

    At Callan Associates, San Francisco, midcap search activity is up a little from last year, said Sheila Tansey, vice president.

    "We hear a lot of talk about the class, and part of that is because many new products have become available in the past couple of years. But all the talk doesn't always lead to action."

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