1 Survival and Performance of Pension Fund Money Managers Janis Berzins Charles Trzcinka Indiana University T. Daniel Coggin UNC Charlotte Acknowledgment and disclaimer: The authors are grateful for the assistance of the Virginia Retirement System, and The Mobius Group. The opinions in this presentation are solely those of the authors.

2 Why Study Institutional Money Managers? Definition: An “Institutional Money Manager” is a Manager who is not covered by the Investment Company Act of 1940 They manage more money for fewer clients – Institutional managers are larger than mutual funds and their customers typically have more money than the managers: The average minimum investment in 2003 for our sample is $8.9M. While the average account size for a mutual fund is about $28,000 in 2003 according to the Mutual Fund Factbook, Investment Company Institute. They are less regulated –managers do not own the securities they manage –beyond what is required by clients there are no reporting requirements, no diversification requirements, no restrictions on leverage or fees, no advertising rules –ERISA rules apply to the client, not to the manager All Previous Studies have small samples, survivorship bias and selection bias.

3 The Mobius Survey of Institutional Money Managers The Mobius Group,(located in North Carolina) surveys money managers every quarter. The 1,000 or so clients of Mobius use the data in their search for better managers. The clients are: pension fund sponsors, endowment funds, investment banks, consultants, mutual funds and high net worth individuals. If a manager does not fill out the survey there is a “high probability” that the manager will not be included in a search If the manager gives inaccurate information there is a “high probability” that the market will penalize the manager June 1993 Survey –871 Domestic Equity Portfolios managed $0.66 trillion in 79,280 accounts 608 active managers with $0.49 trillion in 62,559 accounts 25 passive managers with $0.02 trillion in 486 accounts December 2003 Survey ( actual institutional portfolios only ) –2058 Domestic Equity Portfolios managed $2.55 trillion in 412,909 accounts 1889 active managers with $2.30 trillion in 395,907 accounts 68 passive managers with $0.18 trillion in 1,138 accounts

4 Data Quality Checks Economic Quality Check: Mobius’s products must meet the market test. Data is their only product. –Consultant data only receives an internal check and is not sold publicly –Data of Mobius and its competitors receives internal and external scrutiny. Empirical Quality Checks –10 Mobius Managers were used by Virginia Retirement System: Mobius Returns Match the internal records of the VRS –Compare worst decile Mobius Managers with worst decile Piper Managers 50 Common Managers in Decile Returns Identical –Revision of History between each survey (for whole data base )

5 Hypotheses Can Managers add value? –Lakonishok, Shleiffer and Vishny (LSV) argue that the money management industry is a “cottage” industry riddled with agency costs –Coggin, Fabozzi and Rahman (CFR) conclude that money-managers add substantial value over “style” benchmarks –Christopherson, Ferson and Glassman (CFG) conclude persistence of poor performance (negative alphas) but not of good performance. Bad managers survive If LSV are correct about agency costs there will be an effect on performance: –Managers are measured by factors other than returns. (e.g. supplying “style” stories). This means survival bias should be low or negligible. –Loadings on factors will be non-stationary as managers change portfolio weights to match client perceptions.

6 The Money Manager Universe Portfolios must meet the following screens: The portfolio reports gross returns for at least one quarter –Net returns are less commonly reported. Managers use fee schedules with break points and the % charged clients depends on the size of the account –Managers routinely give discounts. The manager includes terminated accounts in the portfolio’s return. –Manager can simply report the return of all the accounts under management at the end of the period, not at the beginning. –Portfolio returns can be restated for terminated accounts. The manager has full discretion over the account

7 The Mobius Universe of “Institutional” Money Managers of Domestic Equity

8 Flexible Regression Model Following Kalaba and Testfatsion(1989) –assume and E(ε t ) = cov(ε t, ε t-k ) =0 and Var(ε t ) = σ 2 –assume the initial density g(β 1 ) is constant(diffuse) and choose those coefficient values that maximize the conditional expectations E(β t |y 1,…,y t ) algorithm models two sources of error: –measurement error (the usual regression error): –dynamic error: (the result of changing betas) –Kalaba and Testfatsion show that the collection of all possible {sse,ssd} is bounded away from the origin by an envelope. To estimate a point on the envelope they propose minimizing a weighted sum γsse + (1- γ )ssd –smoothness in beta changes is used in the estimation algorithm, simulation evidence suggests the model is robust against large shifts in beta.

9 What we think the tables show… The survival rate, defined as the number of quarters a portfolio exists, is lower than in the mutual fund industry and depends on the date the portfolio is created There is equally-weighted average survivorship bias of 31.4 basis point bias per quarter in gross return and an asset weighted bias of 6.4 basis points. They beat the SP500. –The mean SP500 alphas are 65 basis points per quarter and a median 26 basis points per quarter. These managers are using size, book-to-market and momentum to earn a higher return than the SP500. If managers are penalized for taking momentum bets, alphas are negative. The average time-varying alpha is smaller than the OLS alpha. SP500 alphas are much more volatile than Fama French alphas. The market beta and book to market betas appears constant and size betas vary over time.

10 Survivor Returns Less Non Survivor Returns (not in the paper)