Of barbells and muscular portfolios


The confusion you face as a mutual fund investor, sorting through conflicting advertising claims and the proliferation of fund choices, reflects confusion in a fast-growing money-management industry where competitors are groping for profitable sales strategies.

But there are signs that professional money managers and big-ticket investors are reaching a consensus on a rational structure for effective, cost-efficient portfolio investing. Evidence comes from the institutional side of business, which invests money for pension funds, endowments and other giant investment pools rather than for retail mutual fund buyers.

The message: Less is more.

Institutional fund management and retail fund management differ in many ways, but they compete for investing talent and track each other closely in the quest for successful investment and asset-gathering techniques.

"There is a trend towards using a smaller number of managers in conjunction with a core of index-fund-oriented, passive investments surrounded by very active managers," said Richard Brody, executive vice president and head of equity investing for PPM America, an arm of British investment giant Prudential Portfolio Managers (no relation to Prudential Insurance Co. of America).

Brody is paying attention to the preferences of U.S.-based institutional investors these days. His Chicago-based equity management team previously invested on behalf of PPM's non-U.S. clients, but the firm recently launched a drive to sign up U.S. clients.

"There's a lot of pressure on money managers right now to look more like the index, because the index has been so hard to beat," he said. "But I think that's going to backfire, because clients want managers that look different than the market."

The image coming into focus is a barbell, with the bulk of a portfolio passively tracking market indexes in the United States and other countries. At the edges of the portfolio are more volatile, riskier debt and equity strategies designed to boost returns over the passive strategy.

"The [investment management] market is moving in two directions, one towards specialty products -- specialized international investments, direct equity investments, venture capital, hedge funds, real estate and high-yield fixed income," said David Eager of Louisville, Ky.-based Eager & Associates.

"On the other side, it is moving towards exposure products. The investor primarily wants to get exposure to a market at low cost and is not looking for a lot of value-added management. Indexing continues to gain share, and in our view will continue to do so for some time."

Overseers of giant pension funds and endowments have found that the process of selecting and monitoring a host of traditional investment managers, each declaring a distinct investment style, is a costly substitute for simple index investing.

Giant investment management companies are finding that attracting ever more dollars by sponsoring a wide range of traditional investment techniques reaches a point of diminishing returns.

Profit margins have been falling for the past three years among the largest institutional portfolio managers, according to Eager & Associates surveys.

How Wall Street's giants rectify the problem of diminishing returns will influence enormously the nature of investment products and services offered to investors in the years ahead.

Professional investors make their money by collecting a percentage fee of the money they invest for clients. For many managers, the cost of providing the service is fairly stable, so each new dollar gathered is more profitable.

But at some point, high costs of expanding the business, especially the cost of introducing trendy investment products to attract new clients, soak up much of the new dollars gathered.

"The larger investment firms have a proliferation of investment products to find market opportunities," said Eager.

"If a firm has 50 products, I would bet 35 of them are a drag on earnings. The resources it takes to manage them are greater than the revenue they're producing."

Meanwhile, many of the biggest pension funds and endowments are cutting back their internal staffs that select and monitor traditional investment managers, Eager said. They are looking for single management firms that can meet more than one need with a volume discount on the fee being charged, he said.

"It's going to be a mistake to have a low value-added quasi-index fund" run by active managers, Brody said.

The passive/active barbell approach threatens to eliminate legions of middle-of-the-road fund managers who assert a distinct investment style but in fact chase popular market benchmarks.

Many high-net-worth investors have embraced the barbell concept, said Eager, but "I think it could take a while to trickle down" to the level of most investors.

Pub Date: 1/03/99

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