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©Elliott R. Morss All Rights Reserved


Some of us are foolish enough to think we can make money by purchasing individual stocks. And knowing what the big investors are doing should help. I review what the big investors are doing below. My conclusion: there is still hope for the small investor.

Pension Funds

Pension funds are big investors. Pensions and Investments (P&I) estimates that the 1,000 largest pension funds have $8.3 trillion invested. Table 1 indicates that a little more than half of these are government/non-profit pension with the balance being private firms.

Table 1. - Largest Pension Funds: Govt./Non-Profit and Private, 2013

Source: Pensions and Investments

Pension funds rarely make their own investments: they find others to share the blame when things go badly. And in most cases, their investment committees hire consultants who in turn help them decide which investment managers to hire - more blame deflection. This type of arrangement put the consultants in a key decision making position. And needless to say, investment managers do what they can to curry favor with the consultants.

How Pension Funds Operate - Calpers

We hear a lot about the California Public Employees' Retirement Systems (Calpers). With assets of $273 billion, it is second only to the Federal Retirement Thrift ($375 billion) in size among pension systems. It has eight primary committees: Investment, Pension & Health Benefits, Board Governance, Finance & Administration, Risk & Audit, Performance, Board of Administration, and Compensation & Talent Management.

It recently reported that it has $31 billion in private equity investments with another $10 billion committed. Over the next 5-10 years, it plans to cut back on the number of private equity companies it has invested in from 389 to 120.

Sounds reasonable; managing investments in 120 PE firms should be easier than managing 389.

In 2013, Calpers' administration expenses were $590 million. A significant portion of these costs went to investment management. Did the pensioners get their money's worth? What if instead of incurring a huge amount of investment management fees it had invested in a couple of indices? In Table 2, the investment performance of Calpers is compared with the S&P 500. The Table also includes my estimate of Calpers administrative costs going back 10 years.

Over the last decade, Calpers compound annual return was 5.56% with $4.4 billion in administrative costs. The compound annual return of the S&P was lower (4.20%). Calpers outperformed the S&P over that period largely because the S&P went down further than Calpers in the global depression. Of course, this is not really a fair comparison: pension funds do not invest all their assets in equities; they would also put money in fixed income assets. And a fixed income index investment would have cut the overall losses.

How about the most recent 5 years? The S&P handily outperformed Calpers in each year. The S&P had a compound annual return of 10.7% versus Calpers' 6.8%. And over those 5 years, Calpers' administrative costs were $2.4 billion. You draw your own conclusions.

Table 2. - Calpers and S&P 500 Returns, 2004-13

Sources: Calpers and Yahoo Finance

The Investment/Money Management Industry

This management industry is huge. Pensions and Investments3 estimates the 500 largest are managing $68.3 trillion. That means only 10% of their business comes from pensions: but $8.3 trillion is significant - at a 1% fee, the income from pensions fees would be $83 billion annually, a tidy sum.

($68 trillion is a large number, but the actual global total for money managers is considerably larger. To qualify for the P&I survey, a manager must have pension clients. In addition, managers can decline to participate. For example, The Carlyle Group with more than $185 billion in assets, chose not to participate.)

Table 3 breaks down investment managers by country of origin. No surprises: the U.S. dominates with European nations and Japan following at a distance. The last column on the right is interesting. It is the ratio of money being managed divided by the GDP of the country of origin. The Swiss ratio is very high. In earlier times, their banks used "client confidentiality" to attract clients. After UBS was caught red-handed providing tax evasion strategies to U.S. clients, Switzerland agreed to share U.S. client information with U.S. authorities. South Africa also has an extremely high ratio. The Europeans established banking in South Africa back in 1800s, largely to facilitate the export of commodities. With this starting point, South Africa has become the dominant banking center for the African continent. Note how low the ratios are for China and India: there is a great potential for financial management growth in these countries.

Table 3. - Investment Managers by Country of Origin

Source: Pensions and Investments

How did these managers get so large? There were numerous starting points that include having started as banks, insurance companies, financial custodians and mutual funds. Following the 2008 U.S. bank collapse and the passage of Dodd Frank, a number of large banks sold off a significant portion at least their institutional money management business.

What Are The Managers Promoting?

P&I is loaded with investment manager ads to attract pension funds clients. Mellon will "optimize your collateral". OFI Global claims that "taking risks is not the same as using risk". American Century promotes "target date portfolios" and says "your choice of a glide path makes all the difference". The Capital Group takes this one step further: "inside our glide path is another great glide path". AllianceBernstein warns that "even a well designed default can weaken over time." Vontobel tells us that "Quality can pay off". The list goes on.

After reading through these and other ads one thing stands out: the specific names of companies whose equity and debt are actually purchased are never mentioned. Instead, we get investment categories and strategies. Far better to talk categories/strategies than companies whose fortunes might turn bad for unexpected reasons.

The most talked-about categories include: global, international, emerging markets, international, domestic, large cap, mid-cap, small cap, fixed income, high yield, value, real estate, timber and other commodities, energy, finance, microfinance, health, industrial, information technology, telecom services, utilities, private equity, hedge funds, funds of funds, multisector, alternatives (primary buyout, venture capital, mezzanine, distressed debt), passive and actively managed. There are more. One wonders how soon before there are more investment categories than actual investment vehicles.

And then there are strategies. These change over time. "Asset allocation" came in many years back. And just before the '08 global depression, we heard a lot about strategies employing asset-backed securities. Since the collapse, strategies to minimize risk have understandably blossomed. And to get a better understanding of a risk minimization strategy, I decided to follow up with INTECH that touts "managed volatility".

Managed/Low Volatility

(Many of the quotes in this section come from a P&I Advertising Supplement.)

Adrian Banner, Ph.D., INTECH's CEO and Chief Investment Officer asks: "Why are you taking 15% to 20% volatility to get the equity market premium when you can get it for a lot less volatility?" According to Banner, all strategies in the low volatility space target a similar benefit: reducing portfolio volatility with a goal of reducing drawdowns. He says that "in a compounding world," reducing drawdowns should enable equity investors to match the compounded return of the market benchmark at greatly reduced risk.

I wanted to learn more, so I sent Dr. Banner the following:

"I read with care your pamphlet mailed to P&I clients today. It was nicely done, BUT while 'managed volatility' has a nice ring to it, I got no sense from what you wrote what it actually means."

I then learned there are numerous interpretations of its meaning.

According to Dr. Jennifer Bender, Vice President in Applied Research at MSCI Inc.: "Minimum volatility is the same as minimum variance, as variance is just the square of volatility. The minimum variance strategy is a portfolio of stocks with low correlations to other stocks."

According to Ryan Taliaferro, Director of the Managed Volatility team at Acadian Asset Management, "There are a lot of terms, some of which are equivalent. But they also have hidden 'gotchas' where strategies that you think would be the same could actually be different." He points to different implementations of strategies with the "minimum variance" label: "You would think minimum variance and minimum volatility would deliver the same portfolio and get you to the same place. But what's lurking underneath the surface is that you can wind up with different portfolios depending on how a manager applies prudential constraints."

In response to my question to Banner, I got a response from Soonyong Park, the Chief Institutional Strategist for Janus/INTECH: "Let me define what we mean by 'Managed Volatility'. Traditional long-only equity managers will target a level of risk and attempt to generate as much return or excess return as possible. Low volatility equity managers, on the other hand, will attempt to lower the portfolio risk as much as possible. The Managed Volatility approach combines both. We define the Managed Volatility approach as the one that:

1. Dynamically reduces volatility over changing market regimes;

2. Targets return as well as risk reduction;

3. Takes advantage of manager skill to accomplish 1 and 2."

After reading over supplemental documents Park sent me, I responded: "I read over the documents you sent with some care. In essence, your argument boils down to the claim that stocks with lower volatility also have higher returns. The evidence you cite for this is provided by Ernesto Ramos of BMO. Hard to believe: you are arguing there is a major and lasting market imperfection: lower risk stocks do better than high risk stocks."


Acadian's Taliaferro: "Lower-risk stock portfolios should earn lower average returns, and higher-risk portfolios should earn higher average returns, as compensation for risk, but in real-world markets we see exactly the opposite."

MSCI's Bender: "Researchers have empirically confirmed that this idiosyncratic behavior [higher yields with lower risk] exists-and it appears to exist even after controlling for other well-known performance factors." She says that even after controlling for size, value, momentum, liquidity, leverage and a wide range of other factors, "one still sees residual performance that is unaccounted for."

The evidence nearly everyone cites comes from BMO's Ernesto Ramos. According to Ramos, the evidence shows that cap-weighted benchmarks do not trade off risk and return in an efficient way. As evidence, he points to equity performance over 40 years, broken out by volatility quintiles within the S&P 500 Index. The lowest two quintiles by far have the highest compounded return. The lowest volatility quintile has delivered the highest alpha (i.e., beta-adjusted return), with a whopping 12.6% absolute spread over the highest-volatility quintile.

Hard to Believe

My Question: If you can get higher returns for lower risk, why would not the investment gurus buy up all such investments causing their prices to increase and eliminating their return edge over other investments? To explore this further, I sent another e-mail to Park and got the following response.

Park: "Thank you for your e-mail and sharing your skepticism over the superior performance of lower volatility stocks over higher volatility stocks….Counter to most in the industry, we do not ascribe (actually, we are quite indifferent about the existence of low volatility anomaly) to the low volatility anomaly - that low volatility stocks as a group exhibit higher risk-adjusted returns than higher volatility stocks as a group; rather, we believe that the superior risk-adjusted return is mostly due to stock volatilities and rebalancing effect that most people ignore.

Further, our focus is on the low volatility portfolio as opposed to portfolio of low volatility stocks, a subtle but important distinction; the former takes into consideration the stock level volatility as well as the interaction among stocks in a portfolio, the latter does not take into consideration the interaction among stocks in a portfolio. And this is the reason why the capitalization-weighted indices cannot be risk efficient is because they completely ignore the interaction or correlation among stocks in the index."

Elliott: Don't quite get the distinction Park is trying to make here.

Park: "In order to maintain a low volatility portfolio, one must systematically and regularly rebalance or reconstitute the portfolio; otherwise, the original portfolio will eventually drift away from the optimal low volatility portfolio. It is our belief that the systematic rebalancing of the portfolio is the source of superior return for the low volatility portfolio and not necessarily the low volatility stocks themselves."

Park concludes: "To reiterate, we (i.e. Intech) do not ascribe to the view that lower risk stocks do better than high risk stocks."

Okay. I guess I learned something but not sure what. I note that both Park and Taliaferro talk of regularly rebalancing the portfolio.

Taliaferro: "Managers must apply prudential constraints."

Park: "One must systematically and regularly rebalance or reconstitute the portfolio."

This means, at least to me, that in addition to keeping risks down, stocks and bonds are being bought and sold using other criteria. And if this is the case and Park does not ascribe to the view that lower risk stocks do better than high risk stocks, what is really left of the low/managed volatility strategy? I urge you to draw your own conclusions.


P&I is worth a read. It carries detailed news on pension and investment manager activities. Some are quite interesting/amusing. I can just see the pension fund committees sitting around with their consultants cooking up their investment strategies:

  • Santa Monica is searching for an investment manager for its Cemetery Perpetual Care and Mausoleum Perpetual Care Funds (Elliott - both undoubtedly growth industries).
  • The Louisiana Firefighters' Retirement System just hired two managers for "risk-parity" investments, alternative investments, long-term thematic macro views, venture capital, and fund of funds (Elliott - both "risk-parity" and "thematic macro views" sound interesting).
  • The Weymouth MA Contributory Retirement System is searching for an unconstrained fixed income manager and a closed-end value-added real estate manager (Elliott - wonder if an unconstrained manager could manage a closed-end fund).

P&I also reports on manager misdeeds:

  • The British Financial Conduct Authority has fined State Street U.K. $37.7 million for deliberately overcharging 6 clients $20.2 million.
  • Seven MassMutual employees have filed a class action lawsuit against their employer, alleging that company officials "selected and retained almost exclusively their own proprietary funds" for the plan in order to make a profit.

Investment Implications

Buy the investment managers. If they can minimize fines for defrauding and other financial crimes, they should do well: pensions and other financial assets are growing and will need managers. Table 4 lists the largest 10 investment managers along with the 500th in the P&I/Towers Watson World 500 survey. They are probably all good investments.

Table 4. - Largest and Smallest Investment Managers, 2013



Assets (in bil.$)


BlackRock (BLK)




Allianz Group (OTCQX:AZSEY)




Vanguard Group*




State Street Global (STT)




Fidelity Investments*








J.P. Morgan Chase (JPM)




Bank of New York Mellon (BK)








Deutsche Bank (DB)




Polaris Capital*



* Unlisted

Source: Pensions and Investments

Source: Who Are The Big Investors? What Do They Buy?