STAMFORD, Conn. -- The success of GTE Investment Management Corp.'s strategic partnership network of money managers ensures it will become a major part of the new pension plan created with the merger of GTE Corp. and Bell Atlantic Corp.
Launched five years ago with four money managers, the partnership network has returned 17.4% on an annualized basis -- more than nine percentage points above its expected return, said T. Britton Harris, president of GTE Investment Management, which runs GTE's $18 billion defined benefit plan.
Mr. Harris designed the program, picking four money managers with whom to have "strategic relationships." He defines these as key long-term suppliers able to provide a full range of customized, reliable global investment products.
The four firms -- Morgan Stanley Dean Witter & Co., Goldman Sachs Asset Management, J.P. Morgan Investment Management Inc., all of New York; and Grantham, Mayo, Van Otterloo & Co. LLC, Boston -- collectively were given 30% of GTE's pension assets. They now manage $5.92 billion for GTE.
GTE Investment Management executives determine the benchmarks and the risk tolerance level, but designate a permissible range for every asset class. Global equities, for example, can range from 65% to 75% of the portfolio.
The money managers then have discretion to set their own asset allocations and make their own security selections within those guidelines. They meet monthly to review the asset allocation and change it frequently to react to market conditions. They have 11 asset classes from which to choose.
"We may not agree with their allocation and might override it elsewhere in the overall fund to maintain our own long-term asset allocation," Mr. Harris explained. The long-term allocation, which has been in place since the 1970s, calls for 70% equities, 25% fixed income and 5% cash.
Harvard Business School wrote up GTE's program as a case study at the time and teaches it every year as part of its investment management curriculum.
Year-end asset merger
SPN's success means the merged company, to be called Verizon, will incorporate it, said Mr. Harris, who will become president of what will be a combined investment management company. He expects the $90 billion in total pension assets to be merged by year's end.
Until the merger is completed, Mr. Harris won't decide which strategies will be continued and which will be dropped. But the plan is to use the best ideas from both companies, and SPN was one of GTE's best ideas, he said.
It's likely that the program will be expanded by adding more partners and/or more assets. Currently, one-third of the GTE pension plan is in the program, and that probably would be extended to become one-third of the new pension fund, he said.
Coincidentally, the four strategic partners of GTE also manage money for New York-based Bell Atlantic, noted Robin L. Diamonte, managing director, research and strategic relationships for GTE Investment Management.
After the merger, Mr. Harris also plans to do an exhaustive analysis of the benchmarking system. His three-year goal for the program is to outperform its benchmarks by 150 basis points a year, more than double the 70 basis points it achieved annually over the past five years.
The remaining 60% of GTE's pension assets are equally divided between internal and external management. And around 8% of those assets are invested in private markets. Private equity activity has been in a "maintenance mode," awaiting the merger, Mr. Harris said.
Fund performance good
Overall, the total GTE pension fund also did well, ranking in the 25th percentile of the Callan Large Plan Universe of pension plans over $1 billion, both over the past five years and for the one-year period ended Dec. 31.
"When beginning the program five years ago, we had concerns that the managers who outperformed would do so because of incremental risks they might take, but they outperformed at the lower risk level of their peer fund, as ranked by Lipper," Ms. Diamonte said. "There was also the worry that GTE would be forfeiting strong performance in some asset classes, but the opposite happened."
The aggregate partnership ranked in the 16th percentile of all global flexible funds over the five-year period. All the partners posted returns above the median global manager and three of the four firms delivered returns in the top quartile. And the results were achieved with no incremental risk, Mr. Harris said.
The program added value in eight of the 11 asset classes and the portfolios outperformed the median manager in eight of the 10 comparable universes.
The importance of asset allocation cannot be underestimated, Mr. Harris said. As of the end of March, SPN underweighted global equities by 1%, balancing it with a slight overweighting in cash; favored international over domestic equities and bonds; significantly underweighted U.S. equities; emphasized small- over large-cap U.S. equities; and placed a 4% bet on emerging markets.
The best and the worst
The best performing asset classes in the program over the five-year period were the U.S. small-cap growth portfolios, which returned 34.9% a year, 19.8 percentage points above their benchmark, the Russell 2500 Small-Cap Growth index; U.S. large-cap growth, which returned 32.5% annually, 2.1 percentage points above benchmark, the Russell 1000 Large-Cap Growth index; and emerging market debt, which returned 26.1%, 9.7 percentage points above its benchmark, the EMB index.
Value strategies and U.S. bonds hurt performance. U.S. large-cap value returned 19.9%, which was 2.4 percentage points below its benchmark Russell 1000 Large-Cap Value index, while U.S. small-cap value returned 13.2%, 4.7 percentage points below its benchmark Russell 2500 Small Cap Value index.
"If everyone outperforms, then you're not diversified. Anyone who owned value during this period suffered," Mr. Harris said.
In addition to investing in the right strategies at the right time, the program also succeeded because of the managers' dedication and willingness to do something non-traditional and stick with it, Mr. Harris said. "They had a desire to improve and to understand in detail what was working well."
One of the biggest challenges was dealing with the changes at the partnerships. There were major top-level executive shifts at J.P. Morgan and Morgan Stanley, but both firms made a big effort to get the new person up to speed quickly, Ms. Diamonte recalled.
"We made them aware that a change in personnel is no excuse for a lull in performance," Mr. Harris said.
"Our four partnership firms were all survivors, but there were enormous changes in the money management business in the last five years, and I don't think anyone expected that level of change when we started.
"The challenge was keeping people focused on delivering beneficial results as their worlds changed. I think the partnerships helped remind them of that."