In his March 31 letter to the editor, William F. Sharpe objected to me referring to the standard mean/variance optimization approach used in pension plans as the Sharpe model in my March 17 Other Views commentary. My apologies to Mr. Sharpe if my article contributed to a distortion of his views. That name was chosen because Mr. Sharpe's name is closely associated with the idea that risk is best measured by total variance. Most people in the industry know that it was Harry Markowitz beginning with his paper in 1952, along with work further developed by Mr. Sharpe, that established this concept of investment risk.
What many people don't know is that Andrew D. Roy, also in 1952, developed the shortfall risk theory as a variation of mean/variance optimization. Martin Leibowitz is most closely associated with applying the shortfall risk theory within the context of pension plan investing, where it became known as surplus optimization. Although both Messrs. Markowitz and Sharpe have written on the use of surplus optimization in pensions, the approach is most closely identified with the name of Mr. Leibowitz.
My commentary compares and contrasts two approaches to pension plan investing that I refer to as the Sharpe model and the Leibowitz model. My full report on which the commentary is based is at www.lotsoff.com under the title "Paradise Lost: The Contribution Holiday is Over."
I regret that identifying Mr. Sharpe with current industry practices contributes to a narrower view of his work. It fails to do justice to Mr. Sharpe's efforts on behalf of the practice of surplus optimization. I am a grateful beneficiary of his work in that my first exposure to surplus optimization was through the 1990 article Mr. Sharpe referred to in his letter.
My purpose and the result of the report was not to suggest that Mr. Sharpe's approach contributed to the industry's losses, but to provide a shorthand reference that would resonate with investment professionals. I hope this explanation at least partially corrects for what was missing in the stark contrasts presented in my P&I commentary.
David A. Hershey
Consultants and conflicts
I was encouraged to see that you have kept the audit of the Hawaii Employees Retirement System and its investment consultant, Callan, in your editorial crosshairs (Editorial, "Subpar fund and audit," March 17). As you pointed out, the specific problems brought to light by the audit are endemic of the pension industry as a whole.
Last July and September, the Department of Labor's ERISA Advisory Council held hearings on the subject of fiduciary education and training, and many of the topics covered in your editorial were addressed by the various industry experts who provided testimony.
As I was about to testify, the chairman broke the ice by informally introducing me to the rest of the committee. Reading my bio, he noted I had spent eight years as a military pilot and asked, tongue-in-cheek, what my military background had to do with fiduciary responsibility. My response was that I survived the experience because I had detailed checklists, and that the problem we have today with investment committees and their consultants is that we have no checklists.
The industry has not defined the specific practices that detail a prudent process for investment fiduciaries. As a result, trustees do not have the means to measure how well they are meeting their fiduciary responsibilities. The lack of defined industry practices also makes it difficult to determine whether a hired investment consultant is properly fulfilling the requisite role. In the case of Hawaii, the application of defined industry practices would have lent more credibility to the auditor's findings.
The references to Hawaii's investment consultant's conflicts of interests warrant more attention. The pay-to-play schemes (where money managers are paying upwards of $250,000 a year to various consultants) are not merely a conflict of interest - they're a serious breach of fiduciary responsibility.
Clients often are paying higher fees and expenses for investment management because the consultants they hire are reluctant to squeeze the golden goose (the money managers in their pay-to-play schemes).
The consultant's searches often are tainted because preference is given to money managers that participate in the schemes. The notion that the consulting firm maintains "ethical walls" between the manager search committee and manager analysts simply is not true.
The consultant is not likely to suggest that a poor-performing money manager be replaced, when that manager is part of the pay-to-play scheme.
Investment committees that are not provided specific guidance on their duties and responsibilities (not provided checklists) and that are served by pay-to-play consultants often end up with considerably higher "lost opportunity" costs and settle for subpar performance - the one finding that is undisputed in the Hawaii audit.
Donald B. Trone
Foundation for Fiduciary Studies
The student of trading
Your March 31 editorial "The academic of trading" was great. I had the pleasure of taking a class titled Trading & Exchanges with Larry Harris in May at the University of Southern California. The book mentioned in your editorial was in its final draft and covered many of the aspects that portfolio managers, analysts and traders should know.
The academic side of trading is much different than what people would expect. In fact, many of my fellow MBAs, who had experience trading securities, expected this to be an easy class. It was far from easy. I would recommend this book to anyone involved in the investment management industry. Whether one is on the buy side, sell side or academia, a fundamental understanding of market microstructure will only help to make the markets more efficient. And besides, where else can you learn the legend behind where the terms "bull" and "bear" markets originated?
first vice president
Insight Capital Research
Walnut Creek, Calif.