SALEM, Ore. - The Oregon Investment Council is planning to revamp its $9.7 billion in fixed-income assets, including outsourcing $6.7 billion in internally managed bonds and possibly $2.4 billion in indexed bond assets over the next few years.
The overhaul affects domestic fixed-income portfolios managed on behalf of the $34 billion Oregon Public Employees Retirement Fund and the $2.4 billion State Accident Insurance Fund. Assets from about 10 other smaller entities managed by the Oregon treasury staff also are affected.
The council plans to hire three or four bond managers early next year to manage roughly 30% - some $2.5 billion - of the pension fund's $8.3 billion total bond exposure. It has not decided whether any of the insurance fund's $1.4 billion in internally managed bond assets will be reallocated in the first round of changes. A second round of bond mandates is expected later in the year.
Meanwhile, the council is making changes in other asset classes for the state pension fund:
* Some $700 million of the fund's $6.5 billion international equity assets were rebalanced. Nomura Asset Management USA Inc., New York, was terminated, while portfolios managed by Clay Finlay Inc., New York, and Rowe Price-Fleming International Inc., Baltimore, were reduced. A passive international stock portfolio managed by Barclays Global Investors, San Francisco, was the main beneficiary of the change, although Oregon will look at adding an active international manager next year.
* The fund's overweighting to domestic small-cap stocks was trimmed to 40% of the Russell 3000 index from a double weighting. This week, fund officials will discuss from which small-cap managers to take money and where to reallocate the assets. BGI again might be the winner.
* The council also will discuss restructuring the pension fund's $1.6 billion real estate equity program. Under a plan put forward in August, Oregon fund officials proposed hiring specialist real estate managers for office, industrial and apartment properties, while switching from directly owned retail properties into a passively managed REIT program. That discussion has gone back to "square one," said W. Dan Smith, director of investments.
But it's the plan to revamp the bond portfolio that represents the biggest set of changes.
The shift stems from the upcoming retirement of William S. Unverzagt, senior fixed-income investment officer. Mr. Unverzagt will be eligible for retirement in two years' time although no definite departure date has been set, Mr. Smith said. It's hard for public funds to hire and retain talented investment professionals, he said.
As of Sept. 30, the pension fund had $5.3 billion in domestic fixed-income assets managed internally, with $2.4 billion run by BGI in a domestic indexed bond portfolio.
Another $1.3 billion is invested in international bonds, of which $605 million is managed internally while Merrill Lynch Mercury Asset Management and Rogge Global Partners PLC, both of London, split the balance. No plans have been made yet for the international bond portfolio.
The active domestic bond portfolio has performed well against its benchmark - the Lehman Brothers Government/Corporate Bond index - over extended periods, Mr. Smith said.
What's more, the portfolio has a long-term bet against mortgages, although it does include high-yield and, more recently, some emerging market debt.
"The portfolio has always been sort of duration-neutral, we don't make interest-rate bets. The value-added has come from credit plays," Mr. Smith said.
Doesn't reflect universe
In a presentation to the council a year ago, officials from Frank Russell Co., Tacoma, Wash., said the bond exposure does not reflect the size of the entire bond universe, especially given its underexposure to mortgages.
As a first step, the council has added mortgages and international bonds to the strategic benchmark, replacing the Lehman Brothers Government/Corporate index. The new benchmark is a 90/10 split of the more comprehensive Lehman Brothers U.S. Universal Bond index and the Salomon Brothers Non-U.S. Bond index unhedged.
A year ago, Frank Russell officials had recommended initially outsourcing $2.25 billion to four generalist bond managers and two dedicated high-yield managers, with assets taken from the internally managed portfolio and the indexed bond portfolio.
Oregon officials, however, prefer selecting generalist managers first and perhaps later expanding their briefs to high-yield bonds.
"If we find generalists who can demonstrate they can do high yield, we would prefer to do that," Mr. Smith said.
Sources said contenders include BlackRock Inc. and Morgan Stanley Dean Witter & Co., both of New York; Standish, Ayer & Wood Inc. and Wellington Management Co., both of Boston; and Western Asset Management Co., Pasadena, Calif.
Mr. Smith declined to comment on firms under consideration.
A second round of bond mandates may be handed out sometime next year, depending on where the gaps are in Oregon's lineup, Mr. Smith said.
BGI's future in doubt
Because of the expected outsourcing, Russell officials believe the passive portfolio no longer would be needed to provide diversification. They recommended reducing over three years BGI's then-$1.2 billion indexed portfolio to a $200 million index fund that tracks the Lehman Brothers Aggregate benchmark, purely to provide liquidity.
Mr. Smith said this issue has not yet been decided, but fund officials likely will reduce BGI's mandate.
Meanwhile, Frank Russell officials suggested hiring three or four bond managers to run $1.4 billion in now internally managed bonds for the State Accident Insurance Fund.
Russell consultants suggested cloning the pension fund's bond strategy for the insurance fund, using two of the same three bond generalists. Mr. Smith said the issue has not been resolved but officials hope to use the same set of managers.
The consultant also recommended keeping the Lehman Brothers Aggregate Intermediate index as that fund's benchmark, but adding a component that reflects the fund's $669 million investment in convertible bonds managed by Froley, Levy Investment Co., Los Angeles.
Foreign equities rejiggered
Meanwhile, the Oregon pension fund rebalanced its international equity strategy in August, reallocating $717 million.
According to minutes of the meeting, Nomura was terminated as manager of a $380 million international equity portfolio because of poor performance. A Nomura official did not return phone calls.
Meanwhile, Rowe Price-Fleming's $750 million portfolio was trimmed by $220 million, and Clay Finlay's $467 million was reduced by $117 million. Of those assets, $543 million was shifted to a passive international fund managed by BGI, while $154 million was reallocated among Driehaus Capital Management Inc., Chicago; Sanford C. Bernstein Inc., New York; and TT International, London.
Concerns over performance by international managers Acadian Asset Management, Boston, and Clay Finlay, as well as emerging markets manager Montgomery Asset Management LLC, San Francisco, were voiced at the August meeting.
Acadian, manager of a $356 million international stock portfolio, was downgraded by Russell to a "two" ranking from a "three" after three years of median or bottom-quartile performance, according to minutes of the meeting. Frank Russell has advised clients of Acadian to evaluate managers to replace the firm.
"The underperformance of value has been a challenging headwind for us," said Churchill Franklin, executive vice president at Acadian.
According to minutes from the August meeting, Gloria Reeg, managing director-consulting at Frank Russell, said Clay Finlay retained a positive rank, "however, confidence is eroding and the long-term outlook is not positive."
A spokeswoman for Clay Finlay said the firm is Oregon's top-performing manager and said the firm's mandate was reduced to bring it in line with the fund's other international managers.
Added Mr. Smith: "We're a little bit more sanguine" about Clay Finlay than the Russell consultants.
Meanwhile, Montgomery, manager of a $134 million emerging markets equity portfolio, was kept under review. Recent changes to address performance issues had only recently been initiated, the minutes said. Montgomery officials did not respond to requests for comment.