DENVER -- The Denver Public School Employees' Pension & Benefit Association combined its small-capitalization and midcap equity allocations to create a new small-mid category.
In doing so, the $2.2 billion pension fund has erased the troublesome, shifting line between small-cap and midcap stocks.
Darrell Allen, investment officer, said the move affected about half of the fund's more than $600 million domestic equity portfolio. Four managers were terminated, two incumbents were given more money and one new manager was hired.
"We wanted to expand the capitalization range to give the managers a larger pool to fish from," said Mr. Allen.
"Right now, the good small companies grow so quickly that (managers) can be forced to sell all their good companies. We hope this change gives our managers a chance to outperform."
The restructuring also will eliminate some manager fees, Mr. Allen noted.
"Small-cap stock performance has been so lousy for so long," said Roz Hewsenian, vice president, principal and senior consultant at Wilshire Associates Inc., Santa Monica, Calif. Exposure to a broader area can cover performance problems and managers can be eliminated to save money, she said.
But Denver's move is not one she is recommending to clients. Ms. Hewsenian thinks asset categories can be valuable if maintained within the right boundaries.
Style drift might be part of an investment strategy, said David Brief, a consultant with Ennis, Knupp & Associates in Chicago. The most common style drift occurs when market changes provide a manager with an opportunity to buy something outside of the portfolio's general capitalization range.
"Few managers fall into tightly defined categories. We've never advocated these separations. The segmented approach makes sense if you have segmented markets, but in a perfectly integrated market like the U.S. equity market, it can be somewhat arbitrary," he said.
Mr. Brief said he advises clients to take a substantial core index position, such as the Wilshire 5000, which "covers everything."
"If you have a good chunk of your U.S. equity invested that way, then you can have a small group of managers hired for their value added rather than their style. And you don't have to be as picky about their style, but rather find complementary managers and not rigidly label them. Your index fund is your anchor and serves as your diversification," Mr. Brief said.
He pointed out that the correlation between midcap growth and small-cap growth during the last 20 years was 0.93%. The correlation between midcap value and small-cap value was 0.95%.
What Denver did
In its restructuring, the Denver fund has placed $100 million each in small-mid growth, small-mid value and small-mid indexed strategies.
The number of management firms handling small-cap and midcap equity was reduced to three from five.
Gone are small-cap managers Friess Associates Inc. of Greenville, Del.; Donald Smith & Co. Inc. of Paramus, N.J.; and Emerging Growth Management Co. and Dresdner RCM Global Investors, both of San Francisco.
The Boston Co. Asset Management LLC, Boston, will remain with Denver Public Schools, managing the small-mid value portfolio. It previously had managed the fund's $22 million midcap portfolio and $60 million in small-cap equity.
Essex Investment Management Co. Inc. of Boston was hired to manage the small-mid growth allocation.
S&P 400 allocation
The Standard & Poor's 400 indexed allocation goes to Deutsche Asset Management-America, which also manages a large-cap indexed equity portfolio for the pension fund.
No concise performance benchmark for the small-mid category exists, Mr. Allen said, so managers will be compared to the S&P 400 index, the Russell midcap and other peer groups.
"But there's the full understanding that none of those represents fully what we're looking for, which is outperformance," he said.
The remainder of the fund is invested in international stocks, 15%; corporate bonds, 25%; private equity, 5%; real estate equity, 10%; and mortgages, 15%.