In the investment management world, less has become more.
Fewer stock names, that is.
The realization that most of the stock market's performance remains concentrated in a narrow band of mainly technology-related stocks has nurtured an ongoing trend among pension plans toward hiring money managers that run concentrated portfolios of anywhere from five to 50 stocks.
Managers report increases in both interest and hires by plan sponsors this year for portfolios that contain their "best ideas."
Some of this year's concentrated portfolio converts are:
* The $3.4 billion Alameda County Employees' Retirement Association, Oakland, Calif., which hired TCW Asset Management Co. to manage a $50 million to $60 million concentrated portfolio;
* The more than $46 billion Pennsylvania Public School Employees' Retirement System, Harrisburg, which hired Security Capital Global Capital Management Group to manage $250 million in a concentrated real estate investment trust portfolio;
* The $1.9 billion Howard Hughes Medical Institute endowment, Chevy Chase, Md., which hired one unidentified large-capitalization concentrated manager and is still looking for a growth-and value-oriented concentrated manager;
* The $160 billion California Public Employees' Retirement System, Sacramento, which announced in August it will invest in "hybrid funds" -- market-neutral, strategic block, arbitrage and concentrated portfolios -- among other alternative strategies.
Late last year, the $5 billion West Virginia Investment Management Board, Charleston, gave $140 million each to Chartwell Investment Partners and Alliance Capital Management to manage in a concentrated strategy.
Consultants and money managers said the use of concentrated portfolios almost always accompanies or follows a move to indexing the bulk of equity assets and is one way sponsors are spending their "risk dollars" to gain excess return.
"Because of indexing, sponsors have more risk to `spend.' A lot of funds are changing their risk profiles now -- reducing the risk and cost for the bulk of the assets by moving to indexing or enhanced indexing -- and upping the risk a lot for a smaller amount of their equity assets. Concentrated portfolios are a completion play," said John M. Brown, managing director and chief of institutional management at Putnam Institutional Management, Boston.
John D. McClenahan, director of manager research at Ennis, Knupp & Associates Inc., Chicago, said he is seeing more plan sponsors hiring concentrated managers as part of an investment strategy that puts the bulk of equity assets -- 50% to 60% -- into the less costly passive or enhanced indexing. The remainder is placed into "satellite" strategies such as hedging, arbitrage, concentrated portfolios and market-neutral investments. They carry higher management fees but offer more potential for outperformance and are not closely correlated to market returns.
"If you're not going to hire a manager (whose style) closely tracks a benchmark, why not hire a manager who buys his 30 top names that produce most of the return and avoids the 70 others that aren't contributing as much? The days of managers actively managing a whole bunch of stock names -- 100 or so -- without consideration of how they are contributing to performance are over," Mr. McClenahan said.
Think like a big fund
David A. Russell, a senior consultant at Capital Resource Advisors LLC, King of Prussia, Pa., noted the roaring stock market has pushed many plans up over $1 billion, and sponsors and trustees have had to change their mindsets from those of mid-sized plans to that of large plans.
"And as plans get larger, they get more inclined to index," Mr. Russell said. "And generally when it makes sense to use indexing, the use of concentrated portfolios often follows."
INVESCO has had good sales success this year with its actively managed, concentrated value portfolio, attracting $200 million year to date, said Ed Mitchell, a global partner in INVESCO's Atlanta office.
International manager Clay Finlay Inc., New York, has seen "a discernible trend" toward concentrated international portfolios in terms of sponsor interest and hires this year, particularly from clients with significant core assets that are passively managed, said Francis Finlay, Clay Finlay chief executive officer, co-chair and president.
While he would not provide specific sales data, Mr. Finlay said almost one-third of the Clay Finlay strategy based on the Morgan Stanley Capital International Europe Australasia Far East index is now in concentrated portfolios. Clay Finlay's strategy concentrates client assets into 50 or 60 of its best picks from the 110 and 120 stocks it normally uses for its EAFE strategy, That strategy returned 28% year-to-date Sept. 30, compared with 8.75% for the EAFE index.
`Polarized demand'
Managers with broader investment strategies are starting to react to what Ennis, Knupp's Mr. McClenahan termed a "polarized demand" from sponsors for either concentrated or passive strategies by "moving to offer their 30 best ideas."
Jim McKee, a quantitative consultant at the Morristown, N.J., office of Callan Associates Inc., said he has been seeing managers -- especially value managers -- fan out their product offerings more broadly, moving to fill gaps in the risk spectrum to be able to respond to this "bifurcated demand." So managers that have had narrower portfolios are moving to broader enhanced indexing, and broader managers are moving to offer less diversified portfolios of 20 or 30 stocks, he said.
"The better managers are beginning to grapple with this subject now," said Christopher J. Acito, managing director of BARRA Strategic Consulting Group, Darien, Conn. "They understand it intellectually but are grappling with the specifics of parameters, criteria and style constraints in broadening their product lines.
"Those managers that have a very broad research capability, that will be ones who have credibility. It will be much easier for a company with the resources of Fidelity, for example, to pull this off, than it will be for a small manager with six analysts. It's safe to say that managers with broader portfolio strategies now will move more easily into offering concentrated portfolios than those who are more narrow now."
