Giving analysts the chance to invest money has become a key retention tool and, in some cases, a money-spinner at research-driven money management firms like T. Rowe Price, MFS and Janus.
Executives at those firms say giving research analysts the chance to put their best ideas in a portfolio is a virtuous circle: Theres an employee retention and attraction dimension to the product, allowing analysts to gauge the value of their work, participate in the growth of assets and simultaneously signal portfolio managers about the strength of their convictions, said Michael Roberge, executive vice president and chief investment officer, U.S. investments with Boston-based MFS Investment Management Inc.
Such strategies arent risk free poor performance could raise questions about a firms broader prospects. We keep a close eye on analyst-led funds as one proxy for the health of the firms offering them, said Andrew Gunter, an analyst with Chicago-based Morningstar Inc.
James P. Goff, director of research with Denver-based Janus Capital Group Inc., said ahead of his firms July 2004 launch of an institutional best ideas strategy, colleagues had plenty of debates about whether a potential stumble by the strategy would amount to an indictment of Janus research.
Encouraged by two years of data showing analyst picks outperforming the Russell 1000 Growth index for every sector, Janus executives decided a sector-neutral portfolio that would live or die by its analysts stock selections was a natural for a firm whose culture is all about research, Mr. Goff said.
And in February 2006, when veteran portfolio manager David J. Corkins left Janus, Mr. Goff and his analyst team stepped in as managers of the Janus Mercury Fund renamed the Janus Research Fund. For the 12 months through Sept. 7, the fund posted a 27.2% gain to $4.5 billion, putting it in the top 3% of large cap U.S. growth equity funds tracked by Morningstar.
Some firms best-ideas portfolios have struggled. The Putnam Research Fund, a $685 million large-cap blend offering by Boston-based Putnam Investments, has posted returns below the Morningstar median returns on the one-, three-, five- and 10-year basis through Sept. 7, while the $24.5 billion Global Research Equity strategy offered by Boston-based Wellington Management Co. has trailed its benchmark for the past four years.
Putnam spokeswoman Laura McNamara noted the sector neutrality of the research fund can leave it at a disadvantage to funds taking sector bets in markets where certain industries, such as energy and basic materials in recent years, are strongly outperforming. Moreover, the Morningstar category includes multicap funds, which again can leave a strictly large-cap strategy such as Putnam Research at a disadvantage when small- and midcap stocks are outperforming, she said.
Wellington spokeswoman Lisa Finkel wasnt immediately available for comment.
Pension consultants warn against being too quick to reach broad conclusions based on whether a firms analyst-led strategies are waxing or waning. Theres some merit to the idea that a money-losing best-ideas portfolio might spell trouble for a firms other strategies, but portfolio construction which could result in unintended bets or bad sector allocation also has to be taken into account, said Jeff Gabrione, Chicago-based head of manager research, Americas, with Mercer Investment Consulting.
Morningstars Mr. Gunter credits MFS decision from 2003 to eschew sector bets by keeping each sectors weighting in line with MFS Researchs benchmark S&P 500 index weightings for helping turn the strategy around. With 16.9% for the year through Sept. 7, a full 2.5 percentage points ahead of the benchmark, the strategy is in the top 15% of large-cap blended funds in the Morningstar universe, up from the top 30% for the past five years and the top 78% for the 10-year period.
T. Rowe and Janus also keep sector weightings for their analyst-driven strategies in line with their benchmark weightings.
Among best ideas products, however, the more risk-controlled offering by Baltimore-based T. Rowe Price Associates Inc. has garnered the strongest interest from institutional clients in recent years. According to Atlanta-based data provider eVestmentAlliance, the Structured Research strategy launched by T. Rowe in mid-1999 pulled in net inflows of $2.8 billion in 2004, $1.3 billion in 2005, $3.8 billion in 2006 and roughly $400 million for the first half of 2007, helping buoy its assets under management to $15.1 billion.
A bit more juice
Todd Ruppert, president and chief executive officer of T. Rowe Price Global Investment Services Ltd., said the strategy, designed to have a tracking error of less than 175 basis points from its S&P 500 benchmark, has managed to outperform in both rising and falling markets, regardless of whether growth or value equities have been in favor.
The sharp pickup in demand for the strategy since 2004, both at home and abroad, was helped by its reaching a three-year track record just as many institutional investors were moving to get a bit more juice from passively managed assets, and others with big allocations to enhanced quantitative strategies were turning to T. Rowes fundamental-based strategy as a source of uncorrelated returns, Mr. Ruppert said.
MFS Mr. Roberge said his firm runs its U.S. equity research offering to be in the active space, with tracking error of between 250 and 500 basis points. The strategy has been more retail focused, but the changes instituted in the past four years could raise its profile among institutional investors, he said.
With Janus institutional strategy just reaching its three-year mark, it too could begin showing up in more searches. Mr. Goff said while the strategy has just $100 million in client assets, it is currently in searches for mandates with more than a combined $1 billion in assets.
While the eight percentage points of outperformance by Janus research strategies over the past year may conjure up images of the torrid returns the firm enjoyed during the late 1990s that went bust with the technology bubbles collapse, Mr. Goff said his analyst team learned lessons from that experience. The Janus research product is diversified, with the top 10 of its roughly 120 holdings accounting for only 17% of the portfolios assets, and outperformance in each and every one of the eight sectors into which Janus divides the market. With systematic risk controls in place, were not getting there because we have five to 10 massive holdings doing well, he said.