SEI Investments
Teleconference Meeting
November 9, 2000
3RD Quarter Performance Review
Robert Aller:
Welcome everyone to the SEI Investment’s Client Conference Call on Third Quarter
Performance. The objective of today’s call is to help you better understand the SEI investment
process and it’s results, and more importantly, to use this information in a meaningful way in the
servicing of your clients. Joining me today is a who’s who list from our Investment
Management Unit including our Chief Investment Officer, Rob Ludwig, and the heads of our
Equity and Fixed Income teams.
To briefly outline today’s call, Rob will lead off and will open up with a review and perspective
on our overall performance and the appropriate use of benchmarks as a comparative measure of
that performance. Then Pete Young, the head of our US Equity Team, will cover that area of the
market, followed by Mike Hogan of International Equity and Vicki Malloy, the head of our
Global Fixed Income Team. Now I’d like to turn it over to Rob Ludwig.
Robert Ludwig:
The other day I had an advisor in and I asked him how things were going, how their client
reviews were going, how their clients feel about all the market volatility. This advisor told me
that all their clients felt great, and I asked him what the reasons were. He said that the clients
have the impression from watching the media and reading the popular press that the stocks as
measured by NASDAQ are off 40%, and they’re right. They were very surprised and very
pleased to know that they were actually making a little bit of money this year with their
investment in the SEI portfolios. So, again, we’re reminded about the benefits of diversification.
I feel like a broken record on these conference calls but I think we have another good quarter to
really see the benefits of diversification. For all your clients who wanted technology and growth
stocks in their portfolio of course we now have a value stock, the outperforming growth stocks.
Year-to-date we have asset class providing a benefit. So far this year, the U.S. market is up
about 2%, bonds are up about 7%. So bonds are mitigating the risk of equities and providing a
cushion against market volatility as we have discussed over and over.
We’re also having a very good year relative to market indices. For example, our Institutional
Growth and Income portfolio, our Global Growth and Income portfolio and our Growth and
Income portfolio, our Domestic, Global and Institutional moderate risk portfolios, are all
outperforming year-to-date in a range of between 34 and 150 basis points after fees. In fact, if
we look at those models for one year, 3-year and 5-year, each of those time periods for each of
those models, we’re outperforming relative to market indices. It’s also instructive to look at the
5-year performance of these models as each one has outperformed by between 34 and 47 basis
points after fees. Let’s put this into some kind of context. Our long-term outperformance
expectation is about 150 basis points before fees. We think this is the realistic expectation of the
value added by skillful security selection in a balanced portfolio. How did we derive that
expectation? If you look at the long-term spreads between median and top quartile managers,
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for 10 years and longer, you’ll find that the spread is approximately 150 basis points. That’s
how we set our expectation for manager skill. Now if we look at our investment portfolios, as I
indicated, we have outperformed by about 40 basis points in each of those models for 5 years.
When we add back the approximately 100 basis points in fees, we’ve outperformed before fees
in these models by approximately 140 basis points, which I think is remarkably in line with our
long-term alpha expectations. If our year-to-date performance holds up through the remainder of
the year, then our Institutional Growth and Income Portfolio for example, will have
outperformed 4 out of 5 years and the Global Growth and Income will have outperformed 5 out
of 6 years. This is the consistency that we engineer through our portfolios of highly
differentiated, sub-style specific managers who concentrate their portfolios and enhance return
through security selection.
Let me address the question that I get most frequently, and that question is why are we
underperforming the Morningstar blended benchmarks? First of all, everybody should know by
now that we construct and manage our portfolios around market indices. They are by far the best
representation of the manager opportunity set. At any point in time, we know what securities are
in the index, we know what the characteristics of those securities are, and we can design
investment strategies that we expect to do well over time. Unfortunately manager universes
simply do not have these attributes. We don’t know what their characteristics are at any point in
time. You can’t design investment strategies around median managers. The construction
methodology of the manager universes suffer from many of the flaws that we have discussed at
our various conference calls in the past. Not that market indices don’t have drawbacks. Perhaps,
most importantly, they don’t include management fees, transaction costs, custody costs, record
keeping costs and on and on. This is one of the primary benefits of using manager universes
instead of market universes. Now, over long periods of time we would expect to do well against
pure universes, even though we design our portfolios around market indices. If you take, for
example, the 5 year period ended September, our domestic Equity Portfolio has outperformed
these Morningstar blended benchmarks by 2%. But because of what I’ll call the vagaries of
universe construction, we can experience the divergence of return between the performance of
indices around which we base our strategies and the performance of these pure universes. For
example, in 1997, the indices outperformed the Morningstar pure universes by about 5%. This
year, the index is underperforming their peer universe by about 2 ½ %. So, over short-term
periods we can experience this divergence between the returns of indices and Morningstar
universes. Over longer periods of time we expect to do well. Over shorter periods of time since
we construct our portfolios around benchmarks we’d expect to do even better against them. We
understand the problem that you have in communicating this to your clients. We think it’s a
short-term problem. As I indicated, it happens from time to time. It’s really not anything that
we have an awful lot of control over, the performance of averages. We do have a lot of control
over the performance of our portfolios relative to indices and that’s really what our entire
investment process is oriented around. But we do appreciate and understand the communication
problems that this creates. We’ve done a lot of thinking about it and what I’d like to do is turn it
back over to Bob Aller for a few minutes to discuss where we are on that topic.
Robert Aller:
We have pretty frequent debates or discussions around here regarding benchmarks, and what is
more appropriate for your clients. The 2 choices are basically from a quantitative standpoint, the
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market indices, collection of benchmarks or peer group collection. We’d like to get some
feedback from you. Before we even get to that, the whole discussion regarding performance and
benchmarking should start, before you ever get to quantitative benchmarks with your clients, it
should start with an overall measure of are they on track to meet their goals? If they established
a goal with you to retire by a certain age, accumulate a certain amount of wealth, the real
question is: are they on track to meet that overall goal or objective? That is not about basis
points, difference in return or standard deviation. Are they on track to meet the goal that you
have put in place and is that plan delivering? That should be where you start the discussion.
The second place you should go before you ever get to quantitative benchmarks is back to the
investment policy statement, which are provided by us on each of our models. You will see in
100% of the cases over all time periods that the models that you’ve constructed for your clients
(i.e. the standard SEI models) are well within the expected range of returns of those models. In
fact, most of the time, they’re above the expected return and even in a short-term period like the
last year, they’re very very far from the potential bottom end or range of return of those models.
So that discussion is about whether their timeframe has changed? Has their tolerance for risk
changed? Did they not understand that in any one-year period they may get a return that looks
like this. If they’re uncomfortable with that or if their overall timeframe has changed that’s a
discussion around portfolio structure or expectations. So, that’s an excellent place to go next.
The third measure then is the quantitative benchmarks. And again, Rob briefly discussed the
pros and cons of each. We have been using the Morningstar benchmarks on the quarterly
performance reports because they do include the cost of investing, i.e. the mutual fund expenses.
They are recognized by investors as sort of a third party objective yardstick. But the
disadvantages are that the universes or the categories are not always clean, and then they’re
never consistent with the way that we manage money to market specific indices.
I would like some immediate feedback from you. We are getting ready to launch an enhanced
performance reporting package that will go out to your clients. This is the time to get feedback
from you about whether or not you believe that the Morningstar category averages that we
currently use are the most appropriate benchmarks or market indices such as the Russell 1000,
2000, EAFE, etc. are more appropriate for your clients. I’d like to get that feedback by having
you e-mail Stan Kutler here at SEI. His e-mail address is skutler@seic.com You can send him a
one word e-mail: Morningstar or market indices. We will tally your votes. Again, there are
good reasons to use both. There are limitations to both, but we are talking clients and client
communications here. We want your opinion on what you want to represent to your clients visa-vis this quarterly performance report.
Robert Ludwig:
We have some very exciting changes in our investment team. As you know, we invest globally.
We have clients all over the world. We’re expanding our investment team globally. We have
been staffing an office in the UK and now have 7 investment professionals in London. We have
an employee in Hong Kong and we’re starting to build an office there. We’re very excited about
the expansion of our investment group overseas and opportunities that that creates for identifying
managers who we might not otherwise have access to or be able to find from here in
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Philadelphia. I’d like to turn it over to Pete Young, who heads up our U.S. Equity Strategy
Team.
Peter Young:
I’ll discuss 2 topics: performance and then changes that have recently occurred in our U.S.
Equities portfolios. I don’t think a call ever goes by that we don’t spend some time on
performance, so that’s what I’d like to start with. Actually that will lead us into a little bit of a
discussion around some of the changes that we made in late September, early October.
As we look at performance across U.S. Equity year-to-date, we’re up about 220 basis points
relative to the Russell blended benchmark. Relative to the more broad, Wilshire 5000 index,
which we struggled against somewhat last year, this year we’re up even more relative to the
Wilshire than we are to the Russell. We’re up about 450 basis points relative to the Wilshire
indices. A lot of that relates to some of the very high growth IPO kinds of stocks that drove that
benchmark last year and have caused it to suffer somewhat this year.
So, in summary, at a very high level, we’re very pleased with our overall U.S. Equity
performance. We’re up over 500 basis points relative to the benchmark in large cap growth.
That strategy continues to click along quite well. In small cap value, where we struggled in 1999
and even in the first quarter of this year, we’re now up over 200 basis points relative to that
benchmark. A lot of the structural changes that we made in 1999 that we felt really positioned
the fund quite well have clearly played out this year. Small cap growth had a very strong year in
1999 and it’s had a very strong year in 2000. We’re up over a 1,000 basis points relative to the
benchmark there. Also in small cap growth, a couple of the manager changes that we made in
1999 have played out quite well this year: the addition of Sawgrass Asset Management in April
of 1999, and then the exchange of Furman Sayles for Mazama in December of 1999. Both of
those have played out well. They are our 2 top performing small cap growth managers year-todate. While it’s a very short time period, we’re quite pleased with the results and we continue to
look at all those areas to see if there are ways that we can improve.
Two of the areas that we have struggled and addressed lately are large cap value and taxmanaged large cap and the issues are one and the same for both. It’s the value exposure in taxmanaged large cap that has hurt. The two managers that overlap between those two portfolios,
Sanford Bernstein and Mellon Equity, have struggled. Sanford Bernstein, who manages money
in the very deep value area of large value, has had a very difficult 2 years. As we’ve looked at
that performance, we believe that the majority of it is a sub-style issue as opposed to some sort of
a change at the organization or poor stock selection. Deep value is extremely out of favor, and
with the mass liquidations that we’ve seen of large cap value equities over the last 2 years, I
think that has exaggerated the underperformance even more. Mellon Equity has also struggled.
Having spent quite a bit of time with Mellon over the last 12 months, one of the things that
we’ve noticed as we compare them to other quantitative managers, is that most quantitative
managers have struggled in this environment. We don’t believe that that fully explains the
underperformance on their part, but to a large degree, we believe that it does. Part of our feeling
there is that it relates to the very high level of volatility that we’ve seen in the U.S. Equity
markets between growth and value. Quantitative processes that are somewhat dynamic can’t
adapt to that necessarily over very short periods of time. We’ve spent a lot of time with both of
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these managers and still have the conviction that they are the right managers for the strategies,
and obviously we’ll continue to go forward with them.
Many of you have probably heard a number of our presentations about large cap value and the
large cap value benchmark being the Russell 1000 value. There has been a pretty dramatic
change over the last 2 years especially in the most recent Russell rebalancing in July.
Specifically, as growth has outperformed value by such a dramatic margin, the way the
benchmarks are constructed has actually forced a number of what traditionally would be
considered growth stocks down into the value benchmark. Where we would say that our
managers made active decisions to be somewhat more value oriented relative to that benchmark
over the last year and a half, recently that became more systematic. What I mean by that is, as
you know, we manage style neutral portfolios to whatever benchmark. We got to a point, as with
this most recent reconstitution, that we could no longer use the three building blocks of Mellon,
Bernstein and LSV to be completely style neutral to the benchmark. That’s because the
benchmark changed so dramatically. The managers did not. We saw this coming and that’s why
with the research project that we started in the year we have been looking for a relative value
manager to address that area of the market. If you want some specifics on what is that area of
the market, it’s a lot of healthcare stocks, consumer staple stocks, telecom, media, and it’s some
of the more growth oriented financials like investment banks and mutual fund companies as well
as brokers. Those are areas that a traditional value manager is going to have a tough time finding
securities that they’re going to want to own. In the last couple years, however, those stocks have
continued to go up. I would say that that has been a disadvantage to us, but only until more
recently did it become significant enough that we needed to move and close that out.
So, we have made some manager changes. We’ve added Iridian Asset Management within large
cap value. They are a relative value manager. They play in that area of the market that I just
described - they do own quite a bit more healthcare. They own a lot more in the communications
area, specifically telecom, and they’re also fairly heavy arms of media stock. They own a
number of the wireless players, they own Verizon and Nextel, they own GM Hughes, the satellite
provider and SBC Communications, which is the old Southwestern Bell. In media, they own
USA Networks, Newscorp and Liberty Media. All of those are names that a traditional value
manager would struggle owning, but within their process that looks more at relative valuations, it
certainly makes sense. So we thought that they were an excellent addition to the fund. One of
the things that we wanted to make sure of is that over time, they would not necessarily invest in
the same areas that a Sanford Bernstein or an LSV would, which would maybe even magnify the
issues that we had seen in large cap value. The one thing that we’re extremely confident of is
that Iridian will almost never overlap with Bernstein in any way. They really claim two totally
different areas of the market. Again, that comes back to what a strong fit they are.
We have also added a relative value manager to the Tax-Managed Large Cap Fund, but you’ll
notice that it’s a different manager. We chose to add Equinox as opposed to adding Iridian.
Equinox is a much longer-term holder of securities. What leads them to relative value exposure
is the fact that they buy stocks when they’re clearly value stocks but they will hold them for a
long period of time to allow that full opportunity to play out. That fits very well within a taxmanaged strategy. There’s a lot of natural tax sensitivity. They run a very concentrated
portfolio. We felt that the after-tax return with Equinox would be somewhat higher in the Tax-
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Managed Fund. Where Iridian we think is a great fit in large cap value, they’re much higher
turnover. They really had no interest in managing taxable money and didn’t want to do anything
in reference to tax management. So that was kind of the rationale behind two different additions
to the portfolio.
The other change is that we’ve added a 6th manager in small cap value. This is not so much a
situation of having identified a new sub-style. Chartwell Investment Partners, who has come in,
will absorb some of Boston Partner’s weight in the fund over time. They both are somewhat
relative value managers, but frankly we’re out of capacity with Boston Partners and we need to
be able to continue to flow money to that area of the market. We though Chartwell was an
outstanding addition along those lines. The other thing that you’ll notice if you look at the
weights in the fund is that we have reduced Mellon Equities’ weight in small cap value. That
was very conscious. That was because we believe that in Chartwell we have a very high Alpha
manager. Also, they have been able to get significant capacity. Mellon we believe is a
somewhat lower Alpha manager, still appropriate for the fund, but given the capacity in the
Alpha potential with Chartwell, we thought that that was a much better way of utilizing that
weight in the portfolio.
Lastly, I’ll mention the launch of the Tax-Managed Small Cap Fund. The fund went live on
November 1st. We launched it with five managers, two of whom currently manage money in the
other SEI’s small cap strategies, LSV and Sawgrass, and then 3 new managers—DJ Green, a
value manager; McKinley and Loomis Sayles, both on the growth side. I think the key thing to
focus on here is the structural differences with our current small cap strategies. We think that a
lot of the tax benefits that come to the client in the portfolio are the structural differences.
There’s a different benchmark. It’s benchmarked against the Russell 2500 instead of the Russell
2000 benchmark. It is also a combination of growth and value inside the same fund. What that
allows for us at SEI is to have a lot more flexibility in being able to do some of the tax
management that we cannot currently do with small growth and small value being separate
pieces. A good example of that would have been in 1999 when small growth outperformed
value by such a huge magnitude, there were a number of losses in the small value portfolios that
we really couldn’t manage between the two. We couldn’t take losses in value and balance that
off in growth as separate pieces, but with this new fund being combined into one, we have that
ability. So, that’s where a lot of the tax efficiency will come from. At the manager level there
are different degrees of tax management that go on based on the investment processes. Some of
these processes are naturally very tax efficient. Others, Loomis Sayles, for example, are an
extremely aggressive growth managers. They will play in the IPO area of the market. They will
be less tax efficient than the other managers, but we felt we need this exposure in the fund in
order to not dramatically underperform in a market like last year. So again, different degrees of
tax sensitivity but overall we think it’s an outstanding way to access small cap in the most taxmanaged manner possible.
Mike Hogan:
I want to touch base on the International Fund and the Emerging Market Fund. I’ll start with the
performance of each fund and then talk about some exciting structural changes that we have
going on.
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I want to comment on the overall international equity markets, which this year are actually down
significantly as I’m sure you’re all aware of. The EAFE markets, which are the large developed
markets outside of the U.S. and Canada, are off almost 12% this year. Most of that decline in
the market has been concentrated in cyclicals and in the technology, media and
telecommunications stocks around the world. Some of the slowing has been impacted by a sharp
rise in oil prices. Many of you know that oil had somewhat of an impact on the U.S. economy,
but since oil is dollar dominated, it’s had a much larger impact on economies outside of the U.S.
since the dollar’s actually been quite strong this year. A lot of companies and people in Europe
for example, have taken a hit much higher than what we’ve had to face in the U.S. So, oil has
had a major impact on some of the non-U.S. economies and it’s certainly had an impact on the
overall economic conditions there as well as the cyclical type companies that operate in those
environments. We’ve also had some concerns internationally about slowing growth in the U.S.
The U.S. has been the engine of world growth for most of the 1990’s and the potential slow in
the U.S. economic activity, partly driven by a Federal Reserve policy and partly as a result of
higher oil prices, has certainly played a role at least in the psychology of investing outside of the
U.S. And then the third thing that’s had an impact is the strong dollar itself. SEI runs nonhedged portfolios, which means that we do not try to control the risk of movements in the dollar
relative to other currencies. But in environments where the dollar is steadily rising, that’s going
to tend to hurt performance for U.S. investors investing abroad. Then of course the flip side is
true as well, when the dollar is weakening, that will tend to give a bogey to U.S. investors for
international investing. This year the dollar has strengthened significantly against the European
markets, and that has played a role in the relatively poor performance of the non-U.S. asset
classes. But I just want to reiterate our commitment to international investing. The U.S. is only
part of the global economy and it’s also only part of the global capital markets. We still believe
in a commitment to non U.S. diversification and that exposing your clients to the broadest
opportunity set available in securities is your best way to meet their long term investment goals.
Moving to the performance of SEI’s International Equity Fund. This is the equity fund that
invests in the large developed economies outside of the U.S. but it does not include strategic
commitments to the emerging markets. This fund has underperformed it’s stated benchmark by
about 200 basis points this year after all fees have been taken out. The reasons for that are that
we’ve had some aggressive sector positioning at the manager level in telecommunications stock
and information technology stocks, which have taken a bit of a hit this year internationally.
They’ve particularly sold off in the second and third quarters of this year. Two of the managers
in this strategy though, Oechsle and Capital Guardian, which have a very long perspective in
their investment horizon, have taken significant positions in both the telecommunications and the
information technology stocks. Because they believe in a long run, these are the areas around the
world that are really going to generate the long-term cash flows. Last year that also helped the
fund outperform the benchmark by 13%. So we’re underperforming 2% this year. Some of it’s
because of the tradeoff in these sectors, but our managers with the long-term view are sticking
with those positions.
Also, relative to peer group, our telecommunication bets also help us explain peer group
performance. Last year we outperformed the peer groups by a little bit more than 3%. This year
we’re underperforming the peer groups somewhere around 2%. A lot of that is coming from our
information technology and telecommunications positioning. We made out well last year with
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these and we’re giving a little bit back this year, but these are bets that our managers are sticking
with.
As far as some structural changes that we have going on in the EAFE fund, we’ve got a major
restructuring I would say going on in the regional Asian part of the portfolio. Historically, that
piece of the portfolio has been managed by a firm called SG Pacific, a firm located in both Japan
and Singapore, and they typically run a more growth oriented investment process, investing in
the Asian markets. They’ve performed very strongly for our strategies. They’ve been a big
value added over the time we’ve had them in the program. But we have been somewhat
concerned about their emphasis on risk control. Typically in our portfolios we would prefer to
control the risk at the overall fund levels by combining managers that have very distinctive
investment processes that tend to complement each other. But SG’s investment process tends to
be more applicable to people who are running single manager Asian products. So, SG was doing
a lot of it’s own internal risk control that we felt over time was potentially having a negative
impact on our long-term stock selection Alpha. So, over the past year we have worked very hard
to try to bring in 2 managers that we think could replace SG and bring a much more focused
emphasis on adding value through stock selection. Then by combining them with the other
managers in the strategy we would handle the risk control. Those 2 firms, one was Martin Curry
which is an Edinburgh based firm that specializes in more of a value oriented process. This firm
believes that the best way to find great long-term investment is to find firms that initially can
actually manage their financials. So they do a lot of work on the integrity of both the income
statements and balance sheets to get their universe screened down. Once they find companies
that have been able to develop very strong financial statements, they’ll then go forward in trying
to find firms that look like they have great long run cash flow generation potential. They’re
quality at a reasonable price, but from our perspective, they tend to bring more of a value
characteristic to the Asian part of the portfolio.
Jardine Fleming is the other manager that we’re bringing in to this area. We’re really excited
about Jardine Fleming for a couple of reasons. Number one, we are probably the first firm in the
United States to bring them into a strategy. That’s really an outcome of the agreement that they
had with T. Rowe Price who owned a significant portion of Jardine Fleming. Part of that
relationship precluded Jardine Fleming from marketing or selling products to U.S. investors. So,
Jardine Fleming was very well known outside of the U.S., but almost completely unknown
within the U.S. Recently, Chase bank bought out the controlling interest from T. Rowe Price and
Jardine Fleming has just recently gained access to the U.S. market. I believe we were the first
U.S. investment house to visit with Jardine Fleming, and I’m almost positive that we were the
first ones to actually hire them. As we go on our Asian search we ask firms within the markets
that we’re looking at who their biggest competitors are. Throughout Singapore, Tokyo and Hong
Kong, which are the areas that we canvass for these Asian managers, Jardine Fleming, more than
any other firm, came up as the single largest competitor in the markets. Most firms in Asia view
Jardine Fleming as the firm to beat in Asian equity investment. They have one of the deepest
analytical teams of any firm we visited. The experience and the energy on the team are almost
unmatched. We’re real excited by both bringing in Martin Curry and Jardine Fleming. We think
their focus on stock selection is going to help increase the overall Alpha potential of the product.
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Switching over the emerging market area. Unfortunately I have to give you some bad news on
the overall emerging market asset class as well. That’s down almost 21% this year. A lot of that
is reflective of a flight to quality globally. Obviously the emerging markets are usually the first
to get hit. Last year the emerging markets were up almost 70%. This year they’re down 21%.
So, over the previous 2 years, you’re actually net net. You’re up quite strongly but there is some
give back this year from what we experienced last year. As far as the performance of SEI’s
funds, this year we’re down about 330 basis points relative to the benchmark after we take out
fees. For the one-year in total, we’re up about 30 basis points relative to the benchmark after
fees. I want to focus my performance comments on performance this year relative to the
benchmark. SEI, because of its multi manager structure, has had a very difficult time getting
direct local access into 2 markets in the emerging markets, and that’s Taiwan and India. Because
of our multi-managed structure and because of the vagaries of the regulatory bodies in both
Taiwan and India, they don’t understand the structure and investment vehicle that’s multi
managed. It’s made it very difficult to get the registration necessary to have local access in those
markets. Because of that, we have had to invest in what are known as ADR and GDR vehicles.
These are vehicles that investors outside of the local market can use to gain access to the local
market.
I want to stress, though, that this is an unrewarded source of risk in the portfolio. Some years the
ADR and GDR premium is going to work in our favor. Some years it’s going to work against
us. But within all our portfolio construction exercises, we are always trying to eliminate, or at
least control to the greatest extent possible, unrewarded sources of risk. So this year we brought
in access to a new investment vehicle called a equity linked warrant. This acts similarly to an
ADR or a GDR, but it doesn’t carry the traditional ADR or GDR premium or discount; which
effectively means that over time, this should help give us a portfolio that more closely mimics
the local representation without giving us some of this unrewarded sources of volatility we’ve
had with the ADR and GDR premiums. We also are aggressively pursuing both India and
Taiwan to try to get regulatory authority to have our portfolios directly in those markets. To the
best of my knowledge, no multi-managed fund has yet gained access to those two markets
because of the regulatory constraints.
The other thing that has hurt our performance this year relative to the benchmark is our
technology bias. Most managers in the emerging markets today tend to have a focus on growth.
A lot of people that believe the only reason that you invest in the emerging markets is for
growth, but that’s not a philosophy that SEI has. We have always been somewhat cognizant
about the growth bias that we’ve had in the emerging market fund. Last year that helped us out
and we outperformed the market strongly. This year it’s hurting us a little bit. But what we’ve
done to try to control that unrewarded source of risk is to bring in a dedicated, very deep value
global emerging manager, the Boston Company. The Boston Company is going to be a strong
addition to the team. They have a very focused product that’s added significant value through
stock selection over time, and they are a very strong complement to some of the more growth
oriented managers in the emerging fund, particularly Nicholas Applegate. So, we’re excited to
get Boston Company in. This continues to show the evolution of the emerging markets in
general. Four or five years ago we would not have been talking about stylistic managers or
trying to manage stylistic risk, but over the last year and a half or so, we’ve noticed more and
more managers with disciplines that are more stylistically different. We’ve also noticed
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investment style in general having a bigger and bigger influence on the risk within the emerging
markets. So, just to stay timely with the markets and to continue to evolve as the markets do,
you’re actually watching our product evolve into more stylistically differentiated managers and
more a stylistic control of risk.
The other change that we’re making in the emerging market fund is the replacement of
Coronation and Credit Suisse. Coronation Asset Management was our South African specialist.
They were brought into this strategy back in 1996 because when South Africa was originally
brought into the benchmark, it was impossible to find managers outside of South Africa that
actually had any experience in the market. South Africa had been excluded from the global
market due to apartheid. So, when we initially took our strategy into South Africa, we did it by
hiring a South African based equity specialist, and that was Coronation.
In order to get active access the European markets, we hired Credit Suisse because they had one
of the largest, most focused, most dedicated set of resources in the emerging European markets
that we could find at the time. The two things that have transpired over the last year or so to
raise our concern about Coronation and Credit Suisse had to do with some changes in the
markets in general. First of all, in 1998, there was a sharp retrenchment in the emerging
European area, particularly led by a big sell off in Russia. That was sort of the impetus for the
collapse of long-term capital management. But with the big decline in the emerging European
markets, a lot of managers that had dedicated resources in that area have not been able to
maintain them because of the decline in assets that they’re managing in those areas. Credit
Suisse is one of those managers. We originally hired them for their very deep resources, but
since the decline in the emerging European markets in 1998, Credit Suisse has pulled significant
resources from this mandate, and that’s been a relatively large concern to us. On top of that,
their lead portfolio manager has actually been promoted and he now is no longer directly
involved in the product. We felt that instead of waiting around to find out if the team that they’re
replacing him with is going to be as good, we would move on to someone who has a more
proven product.
And finally, the combination of Credit Suisse and Coronation has left a structural hole in our
product. We had nobody actually directly covering the Israeli market at the regional level. Israel
has become a major force in the emerging markets, particularly on the technology side. So we
have recommended the replacement of Coronation and Credit Suisse with Schroeders.
Schroeders brings a dedicated emerging European and South African team that also covers the
Israeli market, so it fills our structural problem. Schroeders also has their team integrated into
their broader global emerging product, so they’re able to maintain significant amount of
resources in this mandate. We believe that they’re going to give us a much broader mandate
with a broader perspective, but they’re also going to give us a much more focused product on
stock selection. So we think overall the replacement of Coronation and Credit Suisse with
Schroeders is going to both improve the structural integrity of the product and also bring a
significant addition from the stock selection point of view.
Vicki Malloy:
Through the year, the year-to-date basis as well as a longer term period, the global capital market
has really favored the SEI portfolio construction process and in the major areas where we focus
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our diversification efforts. The first being across the broad asset classes, such as equity, fixed,
domestic and global. That’s where fixed is really shining this year particularly. Second, within
the specific fixed asset class exposures year-to-date, U.S. core and emerging debt have very
strongly added to return, as well as diversified the risk of behavior of that particular asset class.
Thirdly, across and within the investment styles, fixed income is in the high yield area, the U.S.
core and the emerging debt exposure of the portfolio. So, I’m going to be discussing
performance of the fixed income portfolio in this context.
First, from the broad asset class perspective, the global fixed income markets have continued to
provide a risk cushion particularly year-to-date, and excess return relative to the global equity
markets. Emerging debt and U.S. core fixed income or municipals for the taxable investor have
maintained their year-to-date ranks as the top performing global asset classes, and exposures to
these asset types have very handsomely paid off. As of 9/30/00, emerging gains almost 14%.
The U.S. core and municipal markets gained over 7% and 5% respectively. As a result, they’ve
outpaced the U.S. broad equity market by about 11% and 5%. Emerging debt and core have also
continued to substantially outpace the international equity by 26% and emerging markets by 19%
versus emerging equity with emerging debt at 34%, and core, U.S. investment grade core
Lehman aggregate type portfolio by 27%.
Secondly, within the broad fixed income and asset class, our structural diversification across the
fixed income asset types have strongly benefited year-to-date performance. This is driven
primarily by the strength of the emerging debt markets and followed by the U.S. investment
grade markets.
Finally, our style of discipline within each fixed income asset type continues to provide a much
more predictable stream of return. Specifically within the U.S. core fund, our allocation to a
lower tracking error or more risk controlled issue selection sub-style across mortgages and
government corporates that is practiced by BlackRock on the mortgage end and R.W. Baird on
the government corporate end. R.W. Baird is a former firm co-team. They’ve also served to
both enhance return, and return the tracking error or the volatility of that excess return, versus if
we had completely allocated the fund to the higher tracking or sector rotation sub-style practiced
by Western. This fund has strongly outperformed the index year-to-date and it’s continually
ranked in the top quartile within the Morningstar peer universe.
Within the High Yield Bond Fund, we have the higher tracking error, higher Alpha concentrator
style or sub-style, which is managed by Nomura. We added that in the fourth quarter of ’99, and
year-to-date that’s added over 1.8% to return and has strongly offset the negative return of the
core high yield sub-style that’s managed by Credit Suisse in the portfolio. This core high yield
sub-style has been very out of favor in this market environment, which is characterized by a
much higher correlation to the U.S. equity market. Given the very low tolerance in the U.S.
equity market for any company-specific negative news, that spillover has very much affected the
high yield market, and the core high yield market specifically.
So the end result is that the High Yield Bond Fund is essentially flat to its benchmark and
maintains a very solid above median rank versus the Morningstar universe. Now given that this
Morningstar universe includes funds that have invested a substantial portion of their assets into
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emerging debt over the last year and a half to two years, and the substantial increase of gains that
emerging debt has provided for the year, this fund continues to very strongly meet our
performance expectations.
And finally the Emerging Debt Fund. The core emerging debt style that is exercised by Solomon
Brothers Asset Management in the fund focuses on deriving the bulk of its return from country
selection and then sector and issue selection within country, after that country selection decision
has been made. On a year-to-date basis, the overweight to Venezuela and Russia in particular
have been the largest drivers of return as these oil exporting countries have benefited from the
aforementioned noted rise in oil prices. In addition, there has been quite a bit of success in each
of these country’s debt exchange transactions that have really boosted return and fundamentals
within those exposures. So, Solomon’s country selection skill has led the fund to essentially
match the substantial market return of this asset class and maintain its solid high second quartile
ranking versus the Morningstar peer universe.
So, all in all, SEI’s multilevel diversification benefits the three areas across the asset class. So,
the fixed benefit cushions the equity volatility as of late. Secondly, within asset class, so the
exposures across emerging debt and core benefit within the fixed component. And then thirdly,
across and within the investment styles. So that sub-style benefit within core and the particular
multi-style benefit within the high yield portfolio, and then the broad country selection style
within the emerging debt have all proven out very strongly year-to-date. These benefits are
reflected in the end result in the performance of the institutional fixed income portfolio, which
has outperformed the Morningstar blended index by over 1% on a year-to-date basis.
Summary
Robert Aller:
To summarize the call, I think what you ought to take away is that you can set realistic
expectations with your clients, utilizing investment policy statements and by relating their actual
performance to the market. We have a great example this year of the value of diversification.
You should measure your clients’ progress versus their overall goals and objectives. That’s
really all they care about. Understand the limitations of quantitative benchmarks well enough to
explain their shortcomings to your clients. And again, our long-term performance regardless of
what you compare it to on both our funds and models is excellent. Despite that, we have made
many many good changes that you can talk to your clients about regarding changes to the
structure of the portfolios, the implementation with sub-advisers in those areas and examples of
how in the past when we’ve added managers or changed structure, those are now coming around
and providing value. .
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