Style, skill and big spreads in returns
The front page of your Sept. 16 issue has an article titled "Bond market kaboom: Unprecedented: Huge gap between highest, lowest returns on top of `atrocious' second quarter."
As the big story stated, there is a 697 basis-point spread between the best (5th percentile) and worst (95th percentile) bond managers in the PIPER database. Even within the same style, this gap ranged from 200 to 300 basis points. That's a lot of basis points.
Any idea what the comparable figures are for domestic equity managers for the same period? Try 11,170 basis points overall, with intrastyle best-worst spreads ranging from 1,850 to 6,210 basis points. Sure stocks are riskier than bonds, so the range of returns ought to be larger than that of bonds, but 10 to 20 times higher is worth noting.
The accompanying table shows the ranges of opportunities available to managers with various styles for the year ended June 30. The table is constructed using Portfolio Opportunity Distributions, or PODs, which create all of the portfolios that could have been held in a particular style of management. The answer to the question, "What portfolios are in a POD universe?" is "All of them."
We continue to be reminded of the importance of investment style. Your Sept. 16 article reminds us further that these style considerations apply to both stocks and bonds. On the stock front, the table shows that small-cap value has been the best place to be during the past year, while growth stocks have gotten hammered.
Unfortunately, plan sponsors continue to repeat the chronic and costly mistake of confusing style with skill. A skillful growth stock manager probably lost a lot of money in the past 12 months, but a not-so-skillful small-to-midcap value manager probably performed quite well, thank you. Have your readers been hiring value managers recently? Firing growth stock managers?
San Clemente, Calif.
Funds of hedge funds
In regard to Charles J. Gradante's July 22 Other Views commentary, "Funds of hedge funds imprudent for fiduciaries": Fiduciaries can and do properly discharge their duties both with respect to making investments and delegation of investment decision-making - and may discharge them even more effectively - using a fund-of-funds structure. Funds of funds are common in the institutional marketplace and facilitate plan investments in venture capital and real estate, as well as hedge funds.
Under the Employee Retirement Income Security Act, any person who has authority to manage or control the assets of an employee benefit plan is a "fiduciary" of the plan. ERISA specifically recognizes allocations and delegations of fiduciary responsibilities. If investment management authority is delegated to an investment manager, the plan sponsor or other fiduciary who appoints the manager has a duty to monitor the manager. The manager - not the plan sponsor - has the duty to exercise due diligence and monitor individual investments. The manager's duty is no different from the duty that an investment adviser or consultant retained by the plan to supervise direct plan investment in such portfolio funds would have. The plan sponsor normally has no responsibility to exercise due diligence in selecting investments in downstream portfolio funds or in monitoring the activities of the managers of those funds.
Nothing in the Whitfield vs. Cohen case Mr. Gradante cites alludes to investments in funds of funds, much less suggests a departure from the basic principles of allocation and delegation of fiduciary responsibilities under ERISA. Indeed, a fund-of-funds manager whose core competency is in hedge funds is just the type of expert a plan sponsor could, and perhaps may be obligated to, consult to fulfill its fiduciary duties, as described in the Whitfield decision.
Funds of funds have served institutional investors well in a variety of areas for years. Notwithstanding Mr. Gradante's concerns, funds of funds can continue to do so, consistently with fiduciary standards.
William A. Schmidt
William P. Wade
Kirkpatrick & Lockhart LLP
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