Managing fed's portfolio carries high risk, low return

Those picked to oversee assets face potential conflicts, low pay

Oct 19, 2008 @ 12:01 am

By David Hoffman

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Mutual fund managers are ex-pected to take the reins of the government's soon-to-be-built portfolio of troubled mortgage-related securities, but some industry experts claim that it is a job fraught with much risk to the managers for little return. The primary risk involves potential conflicts of interest. "Treasury is not exactly an arms-length investor in these securities," said Ed Yardeni, president and chief investment strategist of Yardeni Research Inc. of Springfield, N.J. "It may tell the managers when they want them sold, and that's not information that should be passed to other portfolio managers." As a result, managers may have to dedicate staff members to the government's portfolio, a prospect that doesn't thrill some financial advisers.

<b>Ed Yardeni:</b>
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Ed Yardeni: "Treasury is not exactly an arms-length investor in these securities." (

"Would Bill Gross be expendable to head up this effort?" asked Scott Kays, president of Kays Financial Advisory Corp., an Atlanta-based firm with $150 million under management.

Mr. Gross, chief investment officer of Pacific Investment Management Co. LLC in Newport Beach, Calif., has said publicly that he would make his services available to the government for free if necessary.

"I think that [the potential for conflict] could be a real problem," Mr. Kays said.

The Department of the Treasury has yet to name the asset managers who will be responsible for managing the portfolio part of the government's $700 billion rescue plan. But Pimco is considered one of the front-runners, along with bond heavyweight BlackRock Inc. of New York.

Pimco was selected last week to serve as asset manager for the Federal Reserve's commercial-paper-funding facility.

Under the CPFF, the Fed will finance the purchase of unsecured and asset-backed commercial paper from eligible issuers through its primary dealers. The CPFF will finance only highly rated, U.S. dollar-denominated, three-month commercial paper.

The CPFF is intended to improve liquidity in short-term funding markets and thereby increase the availability of credit for businesses and households.


Pimco may be able to handle that. But managing a portfolio of troubled mortgage-related securities on behalf of the government may stretch it and other asset managers too thin, industry experts said. Money managers who are selected to run the portfolio might not have enough staff members to deal with the massive amount of money that will come from the Treasury, Mr. Yardeni said. That won't be a big issue if the managers involved are going to be compensated handsomely for managing the portfolio — money they could use to hire new employees. But in all likelihood, compensation will be low, Mr. Yardeni said. That is bound to make a difficult task even more difficult.

<b>Darlene DeRemer:</b> Managers might
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Darlene DeRemer: Managers might "misprice" the securities.

There is a risk that asset managers will "misprice" mortgage-related securities, said Darlene DeRemer, a partner with Grail Partners LLC, a Boston-based merchant bank that specializes in the investment management industry.

Such securities are illiquid right now, which makes coming up with the right price difficult, she said.

Determining that price, however, is critical, because no one wants to be seen as even unintentionally gouging taxpayers, Ms. DeRemer said.

There is also the problem of measuring performance.

Under most circumstances, asset managers are evaluated against a benchmark.

The government's portfolio of troubled assets "may be benchmarked to established [indexes] but more likely will be measured by a dashboard of custom metrics linked to Treasury's policy goals," according to a request for proposals issued by the Treasury Department on Oct. 6.

Those goals are to provide market stability, ensure mortgage availability and protect taxpayers.

At the same time, "the portfolio's credit and market risks will be managed to limit the potential for capital losses," according to the RFP.

"Multiple goals can be handled, but there needs [to be] much more clarification as to the relative importance of each goal," said David Myers, an assistant professor of finance at Lehigh University in Bethlehem, Pa. Previously, he was a senior analyst at Frank Russell Co. in Tacoma, Wash.

That may be true, but the benefits of being seen as part of the solution to the market crisis is too great for asset management companies to pass up, said Don Phillips, managing director of fund research company Morningstar Inc. of Chicago.


"I think firms need to look at the bigger picture," he said. "This is not just, 'Here's a business opportunity'; it's an opportunity to rebuild trust in the financial services industry."

Mutual fund managers largely sidestepped the subprime-mortgage mess, but because of a few notable exceptions, the entire industry is tarred, Mr. Phillips said.

Those exceptions included massive losses as a result of subprime exposure in funds offered by Memphis, Tenn.-based Morgan Keegan & Co., a subsidiary of Regions Financial Corp., and The Charles Schwab Corp. of San Francisco.

Both Morgan Keegan and Schwab were hit by class actions stemming from those losses.

Whether star managers such as Mr. Gross will be available to provide the same level of support to Pimco's investors if the firm is tapped to run at least a portion of the government portfolio of troubled assets is a concern, Mr. Phillips said.

Of potentially more concern, however, is what will happen if such managers don't step up to the plate.

"If we don't get confidence back in the system, it doesn't matter what a smart money manager does," Mr. Phillips said. "If confidence doesn't come back, the whole system is frozen."

As an adviser, you would rather see your portfolio managers focused solely on the portfolios for which you hired them, said Mark Balasa, financial adviser and co-president of Balasa Dinverno & Foltz LLC of Itasca, Ill., which manages $1.5 billion in assets.

But if managing a portfolio of mortgage-related securities "falls into their wheelhouse in terms of what they do every day, it probably shouldn't be an issue," he said.

E-mail David Hoffman at


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