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October 04, 2004 01:00 AM

Illinois fund shuffles 45% of its $10.1 billion in assets

Minority brokerage dispute, asset allocation study spark change that includes more active management

Barry B. Burr
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    CHICAGO — The Illinois State Board of Investment recently made moves involving almost $4.6 billion and 14 managers.

    The board on Sept. 24 ended a longtime relationship with master custodian Northern Trust Co. and also dropped Northern Trust Global Investments as manager of nearly $2.8 billion in index funds, sweeping changes triggered because Northern misreported its use of minority brokerage firms, according to William Atwood, ISBI executive director.

    The $10.1 billion fund hired State Street Bank & Trust Co., Boston, to replace Chicago-based Northern Trust as custodian. It also hired three managers to replace NTGI: State Street Global Advisors, which will run a $789 million Lehman Government/Credit index fund and a $500 million Lehman Aggregate index fund; and RhumbLine Advisers LLC, Boston, a minority-owned firm, and Amalgamated Bank, New York, which will each run $750 million in S&P 500 index funds. Prudential Investment Management, Newark, N.J., subadvises the Amalgamated fund.

    At the same time, the board approved a restructuring that will move nearly $1.8 billion to active management, a result of an asset allocation study adopted earlier this year.

    Restructuring specifics

    Among the moves, the board:

    • approved a search for a manager to run $300 million in active international small-cap equity;

    • approved a search for a manager to run $100 million in mortgage-backed securities;

    • initiated an emerging minority- and women-owned managers program and hired three active domestic large-cap growth equity managers to run a total of $50 million;

    • hired New Amsterdam Partners LLC, New York, a minority-owned firm, to manage about $250 million in active domestic large-cap growth equities, replacing Geewax Terker & Co., Baltimore; and

    • hired Harris Investment Management Inc. and Chicago Equity Partners LLC, both in Chicago, and LM Capital Group LLC, San Diego, a minority-owned firm, to manage $170 million each in active domestic intermediate fixed income.

    Northern Trust has been the board's custodian for 20 years and its sole index manager for two years, but about nine months ago, staff noticed discrepancies in Northern's reporting on its use of minority managers. Board policy mandates that managers spend 15% of their commissions from ISBI trades with minority-owned brokerage firms. For fiscal 2003, Northern Trust reported generating $176,000 in total brokerage commissions for ISBI, including $41,000, or 23%, with minority firms. But according to Mr. Atwood, the staff discovered that Northern's transactions totaled $1.6 million, including $206,000, or 13%, with minority-owned firms. The issue caused the board to re-evaluate Northern and initiate searches for custodial and indexing services.

    "We did everything we could to try to keep them," said Mr. Atwood.

    ‘Disappointed'

    "We are disappointed to learn that the Illinois State Board of Investment has chosen not to retain Northern Trust for custody and investment management services," Richard Jurek, Northern Trust vice president-corporate communications, said in a statement. "It is important to note that the quality of Northern Trust's custody service and investment return performance never came into question.

    "As we have previously stated, Northern Trust provided ISBI with accurate data. Fundamentally, we believe that ISBI's concerns arose through a misunderstanding of that data," he added.

    In replacing Northern Trust, the board's other finalist for custodian was Bank of New York.

    For indexing, the board's finalists for equity were Amalgamated, RhumbLine, Bank of New York and SSgA, as well as NTGI. For fixed-income indexing, finalists were Lincoln Capital Fixed Income Management Co., Chicago, Amalgamated, Bank of New York and SSgA, as well as NTGI.

    The selection of RhumbLine and Amalgamated is pending contract terms, including agreement on a fee of 0.75 basis points, said Mr. Atwood.

    State Street's Lehman Government/Credit index assignment will eventually be reduced to some $500 million. The board plans to assign some $300 million from that fund to the three active managers hired for that asset class. The board also plans to allocate the existing $500 million in Lehman aggregate index funds to real estate.

    Under an asset allocation policy adopted earlier this year, the board is taking a more active approach to management.

    It plans to issue RFPs in the next few weeks in the international small-cap equity and mortgage-backed securities searches; it could hire more than one manager in each class.

    Funding for the international small-cap portfolio will come from reallocating among the board's international large-cap equity managers, Mr. Atwood said; none will be dropped. Funding for the mortgage-backed portfolio will come from reducing SSgA's intermediate fixed-income index fund. The board is conducting both searches for diversification and return prospects.

    Marquette Associates Inc., Chicago, which assisted the board in all the custodian and investment management changes, will oversee the searches.

    The board's emerging minority- and women-owned program involves firms with less than $400 million in total assets under management. The program is a board initiative to expand its opportunity with smaller minority- and women-owned firm, partly in response to Illinois House and Senate committee hearings over the last year urging more such usage by public pension funds in the state.

    Emerging program

    For the emerging program, the board hired for active domestic large-cap growth equity: Profit Investment Management, Silver Springs, Md., to run $20 million; Lynmar Capital Group Inc., Marlton, N.J., $20 million; and Howland & Associates LLC, Lutz, Fla., for $10 million.

    Outside of that initiative, but in the same asset class, the board added $10 million to the existing assignment of Buford Dickson Harper & Sparrow Inc., St. Louis, a minority-owned manager, raising its portfolio to $20 million. It also could add $10 million to $30 million to Holland Capital Management LLC, Chicago, a minority-owned firm, increasing its portfolio to $250 million to $270 million.

    Funding for New Amsterdam and the additional funding for Holland will come from Geewax Terker, which managed $324 million and was terminated for performance. Calls for comment were directed to John Geewax, chief investment officer, who couldn't be reached.

    New Amsterdam will continue to run an existing $270 million active domestic midcap growth equity portfolio.

    In addition to its new active domestic intermediate fixed-income portfolio, Harris Investment Management will continue to run an existing $150 million active high-yield portfolio. The firm's $197 million in core fixed-income was dropped, the proceeds helping to fund the new active fixed-income portfolios.

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