Hedge strategy pays off in last quarter money sweepstakes.

Hedge strategy pays off in last quarter money sweepstakes

The No. 1 money manager in the Southland for the last quarter of 1989 was Beverly Hills-based Statistical Sciences Inc., which posted a 4.75 percent gain on its portfolio in the period, compared with a 2 percent increase by the Standard & Poor's 500 index.

In the No. 2 slot was downtown Los Angeles-based Chase Capital Management with a 4.33 percent return on its equity portfolio, followed by Capital Guardian, the huge Los Angeles money manager with $35 billion in assets, which achieved a 3.63 percent quarterly return on its bond portfolio.

Statistical Science used a "hedge" program to achieve its winning results.

"We simultaneously go long and short, primarily on New York Stock Exchange issues, in our hedged portfolios," said John D. Gottfurcht, president of the company. "You won't get all the profit in an upmove, but you are also protected in a downmove."

Going "short" is the practice of "borrowing" and then selling stock at the current price. If prices go down, the short seller buys the stock at the new, lower price, and gives the stock back to the lender.

One can hedge in a bull market by going short on certain stocks. If the market collapses, the short positions make money, balancing losses.

The quarterly survey of Southland money managers is done by PaineWebber Investment Management Group, a Los Angeles-based arm of the New York brokerage house.

But simple, quarterly returns are far from a complete method for measuring money manager performance, said Edward Holl, senior vice president with PaineWebber Investment Management.

For the purposes of this quarterly survey, Holl ranks money managers by four criteria: 1) simple, total return in the latest quarter; 2) five-year total return, annually compounded; 3) the amount of reward-to-risk in the manager's portfolio; 4) value added by manager performance.

The first two criteria may be the only standards that matter to many stock market watchers. The returns include capital gains and dividends on all accounts under management for the single quarter and five years ended Dec. 31, 1989.

The phrase "on all accounts" is important; many managers report only a few accounts to standard ratings services, and are likely to select better-performing ones. PaineWebber seeks to ascertain the performance of a manager's total portfolio. Only managers willing to have their performance independently scrutinized were allowed into the survey.

Additionally, returns are tabulated after management fees are subtracted.

First place in the five-year category, among all types of managers, goes to San Diego-based Nicholas-Applegate, which posted a 25.53 percent annually compounded return. An investor who gave Nicholas-Applegate $1000 five years ago would have $3116 today, before inflation and taxes.

At Nicholas-Applegate, which has $2 billion under management, the emphasis is on "bottom-up" research, in which 30 to 50 good stocks and convertible bonds are identified for accumulation, said Fred Applegate. "We are growth stock specialists. We like companies with good earnings record which we think can be sustained." By and large, Nicholas-Applegate stays fully invested, and does not try to pick turnaround candidates or foreign stocks, said Applegate.

In the No. 2 spot in the five-year category was Chase Capital, followed by West Los Angeles-based Campbell Reed, with a 21.9 percent annual return, in the third slot.

As a group in the five-year period, Southland money managers did not score particularly well when measured against market averages. Of the 41 equity and balanced managed accounts surveyed, only seven topped the 20.3 percent five-year annually compounded gain of the S&P 500. Numerous academic studies have found that money managers, as a group, are unable to beat market averages.

PaineWebber's third criterion for rating managers - the measure of reward-to-risk over the five-year period - is a bit more complicated than simple total return.

Some portfolios have virtually no risk, such as those invested in short-term government bonds. Of course, such a portfolio would have a smallish annual return of about 8 percent - modest reward, if little risk. There is little volatility in the value of a portfolio invested in short-term government bonds.

Other portfolios, such as small-capitalization, growth-stock funds, could have higher total returns, but are also subject to greater declines in value, as became manifest Oct. 19, 1987, Black Monday. The same has been true recently for high-yield junk bond funds.

Ultimately, risk is measured by the degree of volatility in a portfolio, explained Steven Arnold, senior vice president at PaineWebber.

"The value of a short-term government bond portfolio will fluctuate little - thus little risk - but the value of a portfolio of chancier investments will fluctuate a great deal," said Holl.

What is desired, of course, is a high ratio of reward to risk, and that is measured by PaineWebber's reward-to-risk coefficient.

The top managers by this criterion were, in a tie, the U.S. Trust Co. of California in downtown Los Angeles, and Santa Barbara-based STW Fixed Income Management firm, which both earned high marks on their bond portfolio.

U.S. Trust, which delivered a 12.23 percent annually compounded return to investors in the five-year period ended Dec. 31, looks to high-quality corporate and government bonds with maturities of 10 years of less. "We are basically risk-adverse," said Robert Raney, managing director at U.S. Trust. "We don't think anybody can predict interest rates."

The No. 2 manager in this category was a tie between Nicholas Applegate and Capital Guardian, followed by the downtown Los Angeles offices of Merus Capital in third. Merus has had a long record of achieving gains with relatively little risk.

The Consulting Group also measures managers by a criterion called "value added."

The value-added criterion measures a manager's return compared with what the manager would have been expected to achieve given the amount of risk he or she assumed.

By this criterion, Nicholas-Applegate was the No. 1 in five-year period ended Dec. 31, 1989, achieving a 5.46 percent rating on the value-added scale. That means Nicholas-Applegate generated a return that 5.46 percent greater that what would be expected, given the amount of risk, or volatility, in the Nicholas-Applegate portfolio. The No. 2 and No. 3 managers by this criterion were Merus Capital and Capital Guardian.