Pension funds more patient with their money managers

Plan sponsors are less quick to pull the trigger on poor performing investment managers, a new survey by Fidelity Management Trust Co., Boston, shows.

"Plan sponsors have more patience in manager terminations," said Joanna Bewick, senior vice president in Fidelity's strategic services team. "There are lower turnover rates."

She said this survey finding suggests that knee-jerk reactions to manager underperformance could actually be detrimental to the plan.

In addition, the survey found that plan sponsors have become more flexible in their investment manager hiring practices. "They're more open to managers who have short track records or no track records," Ms. Bewick said. "And when they hire a manager, they're less likely to give risk constraints such as tracking error bands."

The online survey was completed by 125 of the largest U.S. public and corporate pension plans in terms of assets. And beginning Oct. 4, Fidelity will hold a series of eight roundtables with plan sponsors to discuss the findings.

This shift in the hiring and firing of managers is in context of a broad move by plan sponsors to boost returns in a low-return environment, Ms. Bewick said.

"Plan sponsors understand they have a whole new landscape and need to be open to new strategies in both traditional and non-traditional spaces," she said. "They are looking at whatever they can find to close the gap between assets and liabilities."

Chris Meyer, chief investment officer at investment consultant Fund Evaluation Group, Cincinnati, said greater flexibility toward money managers could help plan sponsors close that gap.

"If a manager is skillful in stock selection and they can move between growth and value, why limit them to (investing in) nine style boxes that Morningstar or a consultant came up with?" he asked. "You might go one step further and allow them to short or use derivatives if they're truly skillful at identifying stocks that are going to outperform or underperform."

He said that given the current low-return environment, plan sponsors need to diversify their assets to meet their return goals.

"Plan sponsors are looking to expand alpha opportunities," he said. "The best thing to do is to diversify as much as possible so they don't have all their eggs in the traditional baskets of U.S. stocks and bonds."

But David Katz, a partner at Rocaton Investment Advisors LLC, Norwalk, Conn., said greater flexibility by plan sponsors could be a double-edged sword.

"On the one hand, I agree that flexibility is the key," he said. "If you are hiring smart people with some sort of value-added or unique insight, then you want to give them room to do what they do best. That aside, you don't want a manager to change stripes and you want to make sure they're appropriately benchmarked."

Both consultants agreed that plan sponsors taking longer to terminate managers made sense.

"We have always encouraged clients to be thoughtful about terminations," Mr. Katz explained. "If there's a period of underperformance — even significant underperformance — but if all the reasons why you hired that manager are still true, termination may not be warranted."

Mr. Meyer added that a knee-jerk termination for underperformance is equivalent to chasing performance and that "bad performance doesn't necessarily mean the manager's doing a bad job."

One other major result from the 2004 survey is plan sponsors' concern — especially among corporate plans — about the regulatory environment, according to Ms. Bewick.

"Mark-to-market accounting is viewed as a real threat to defined benefit plans," she explained. "If you're no longer allowed to smooth your asset value — if you have to mark to market — there'll be much more volatility on the asset side of the balance sheet. In turn, that perhaps could require more contributions. There's really a perception that mark-to-market accounting will cost the plan sponsor."

Chris Keating, Fidelity's executive vice president in charge of sales and consultant relationships, added that the requirement to mark to market could accelerate the current trend of companies moving away from defined benefit plans toward defined contribution plans.

Fidelity's 2004 plan sponsor survey is the third such poll the firm has conducted. Since the first survey in 2002, the firm has followed up with a series of round-table discussions across the country with plan sponsors to discuss the results.

"It's hands off," said Mr. Keating. "We don't talk Fidelity product at all. This is our own form of research and development."

"People are willing to share ideas on how to address problems they have and we sometimes end up with very spirited discussions," Mr. Keating said. "That's been a constant from the beginning."

The first survey and ensuing meetings focused on pension fund accounting and the impending funding crisis. The second, in 2003, focused on what plan sponsors were doing to address the crisis.

"This year we looked at who survived best the perfect storm" of rising pension liabilities and declining assets "looking forward based on who survived best over the past five years and asking what are the things they were looking at in terms of preparing for the next storm," Ms. Bewick said.

She added that more than $1 trillion of pension fund assets are represented by the survey respondents and round-table attendees combined. Survey respondents cover more than 7% of plan sponsors with assets of more than $200 million and about 20% of plan sponsors with assets of $2 billion or more.