Audit: County's fund managers lost out to the Dow, but beat S&P.

Audit: County's fund managers lost out to the Dow, but beat S&P Private sector money managers hired to invest Los Angeles County's $7.3 billion pension fund have delivered mediocre results in the past five years, reveals a much-delayed county-commissioned study released last week.

Over the five years ended Dec. 31, 1986, county fund equity managers, as a group, generated annually compounded returns of 19.94 percent, exclusive of fees, according to San Francisco-based investment advisory firm Callan & Associates Inc.

That return was lower than the 22.47 percent annual increase recorded for the Dow Jones Industrial Average, but marginally above the 19.82 percent annually compounded hike of the Standard & Poor's 500 index, over the same time period.

"Well, at least our money managers beat the S&P 500, that's better than most money managers," comments Simon Russin, trustee for the Los Angeles County Employees' Retirement Association.

The county fund's bond managers, as a group, delivered a similar so-so performance, according to the 18-month Callan study. In the same five-year time period, bond managers generated 18.90 percent annually compounded returns exclusive of fees, compared with 22.51 percent annual hikes of the Salomon Bond index, and 17.28 percent of the Shearson Lehman/American Express Government Agency/ Corporate bond index.

In 1986 however, L.A. County equity fund managers have rallied a bit, and beat the market by a 19.36 percent to 18.55 percent spread.

The county fund's equity managers at the end of 1986 were Capital Guardian Trust Co., Loomis Sayles & Co., Massachusetts Financial Services Co., Security Pacific Investment Management, and Stein Roe & Farnham. The money managers were Brown Brothers Harrison & Co., Capital Guardian, CMB Investment Counselors, Criterion Investment Management Co., Massachusetts Financial and Morgan Guaranty Trust Co.

The money managers were paid an aggregate of $5.3 million in fees in fiscal 1986, according to the county's budget documents. (At year-end 1986 the money managers had $5.79 billion of county funds under management. That amount has since swelled due to interest, dividends, and capital appreciation.)

The Callan Associates study, commissioned in October of 1985 and initially expected by some fund trustees to take six months, was slowed down due to auditing problems encountered with the custodian of much of the fund's money, Security Pacific National Bank. Security Pacific National Bank acts as custodian for much of the county fund's investments, while the Security Pacific Investment Management, a separate arm of Security Pacific Corp., also acts as a money manager for the county fund.

As a result of the audit, Calland determined that Security Pacific National Bank had shortchanged the county $2.14 million in interest payments on fund-owned mortgage-backed Government National Mortgage Association (Ginnie Mae) bonds from April 1, 1981 to June 30, 1986.

Despite the difficulties, the fund's board of trustees decided to re-award custodial duties to Security Pacific National Bank, a contract worth about $420,000 a year.

A "stronger" contract, which more specifically delineates how and when interest payments on the Ginnie Mae bonds should be credited to the county fund as been signed, says Susan Taha, spokeswoman for Security Pacific.

The bank has added experienced staff to its custodial department, as well as new computer hardware and software. Taha says the improvements are part of general bolstering of the custodial department, and not a specific response to problems associated with the county's funds.

Last year, then L.A. County Treasurer Richard Dixon informed trustees by letter that Security Pacific had followed "common industry practices" in handling the fund's money, and that in no case did the bank "unjustly enrich itself" through its accounting practices.

Nevertheless, fund trustee Russin says he wishes Security Pacific weren't retained as custodian, and now that the Callan study has been released, "I'm concerned about Massachusetts Financial on their equities, and CMB Investment Counselors on their bonds, they are the worst performing ones. I want to really look at whether we want to keep them as managers."

Massachusetts Financial equity managers have generated only a 16.96 percent annually compounded return on their portfolio of county pension funds in the five-year period Callan measured.

CMB Investment Counselors achieved a 16.34 percent annually compounded return on their bond portfolio, vs. a 22.51 percent return indicated by the Salomon bond index.

The unimpressive performance of the county fund managers isn't surprising, say proponents of two separate schools of stock market analysis.

According to the first school, few if any money managers can consistently beat the market. The stock market is very efficient, says Dennis Draper, professor at the University of Southern California School of Business Administration. "Money managers don't outperform the market in a consistent manner," says Draper. "There is not sufficient value added to their service to warrant their fees."

Large public pension funds should invest their billions in stock market index funds, which are comprised of the stocks underlying the indexes, says Draper. The existing S&P 500 index funds are an example and the investment fees are lower, says Draper.

The second school of thought holds that some money managers can beat the market, but that L.A. County hasn't selected those managers. Instead, for equities it has selected one poor manager -- Massachusetts Financial -- two good managers in Loomis Sayles and Steinberg and two very average managers in Security Pacific and Capital Guardian.

According to a special study done on behalf of the Los Angeles Business Journal by The Consulting Group of the downtown brokerage house Bateman Eichler, Hill Richards, Capital Guardian and Security Pacific Investment Management, might as well get married and call themeselves "Mr. and Mrs. Average" so typical are their investment performances and styles.

In a survey of 20 major area money managers, Security Pacific and Capital Guardian rated 11th and 12th respectively in terms of total return on portfolios managed in the five-year period ended Dec. 31, 1986. The two money managers rated even lower when the relative riskiness of their portfolios was measured. "Those two money managers are spread out and so large you might as well just invest in the market," says Edward Holl of The Consulting Group.

Some say pension funds should get rid of money managers who dont't deliver superior performance. "If your money managers don't beat the market, then you should get new money managers," says Mark Tobin, vice president and investment management consultant with E.F. Hutton Inc. offices downtown.