Research-focused firms let analysts invest

Giving analysts the chance to invest money has become a key retention tool — and in some cases, a money spinner — at research-driven money management firms such as T. Rowe Price, MFS and Janus.

Giving research analysts the chance to put their “best ideas” in a portfolio is a virtuous circle: There’s an “employee retention and attraction dimension to the product,” allowing analysts to gauge the value of their work and participate in the growth of assets while simultaneously signaling portfolio managers about the strength of their convictions, said Michael Roberge, executive vice president and chief investment officer for U.S. investments with Boston-based MFS Investment Management Inc.

Such strategies aren’t risk free — poor performance could raise questions about a firm’s broader pros-pects. “We keep a close eye on analyst-led funds” as one proxy for the health of the firms offering them, said Andrew Gunter, an analyst with Chicago-based Morningstar Inc.

James P. Goff, director of re-search with Denver-based Janus Capital Group Inc., said that colleagues “had plenty of debates” about whether a potential stumble by the strategy would amount to an indictment of Janus research leading up to his firm’s July 2004 launch of an institutional best-ideas strategy.

Encouraged by two years of data showing analyst picks outperforming the Russell 1000 Growth Index for every sector, Janus executives decided a sector-neutral portfolio that would live or die by its analysts’ stock selections was a natural fit for a firm whose culture is “all about research,” Mr. Goff said.

And in February 2006, when veteran portfolio manager David J. Corkins left Janus, Mr. Goff and his analyst team stepped in as managers of the Janus Mercury Fund, which was renamed the Janus Research Fund. For the 12-month period through Sept. 7, the fund posted a 27.2% gain to $4.5 billion, putting it in the top 3% of large-cap U.S. growth equity funds tracked by Morningstar.

Some firms’ best-ideas portfolios have struggled. The Putnam Re-search Fund, a $685 million large-cap-blend offering by Boston-based Putnam Investments, has posted returns below the Morningstar median returns on one-, three-, five- and 10-year bases through Sept. 7, while the $24.5 billion Global Research Equity strategy, offered by Boston-based Wellington Management Co., has trailed its benchmark for the past four years.

Putnam spokeswoman Laura McNamara noted that the sector neutrality of the research fund can leave it at a disadvantage to funds taking sector bets when certain industries, such as energy and basic materials recently, are strongly outperforming the market. Moreover, the Morningstar category includes multi-cap funds, which again can leave a strictly large-cap strategy such as that of Putnam Research at a disadvantage when small- and mid-cap stocks are outperforming, she said.

A Wellington spokeswoman wasn’t immediately available for comment.

Pension consultants warn against being too quick to reach broad conclusions based on whether a firm’s analyst-led strategies are waxing or waning. There’s some merit to the idea that a money-losing best-ideas portfolio might spell trouble for a firm’s other strategies, but portfolio construction — which could result in unintended bets or bad sector allocation — also has to be taken into account, said Jeff Gabrione, Chicago-based head of manager research in the Americas for Mercer Investment Consulting Inc. of New York.

Morningstar’s Mr. Gunter credits MFS’ 2003 decision to eschew sector bets by keeping each sector’s weighting in line with those of MFS Re-search’s benchmark, the Standard & Poor’s 500 stock index, for helping turn the strategy around. With a 16.9% gain for the year through Sept. 7, a full 2.5 percentage points ahead of the benchmark, the strategy was in the top 15% of large-cap-blend funds in the Morningstar universe, compared with rankings in the top 30% for the past five years and the top 78% for the 10-year period.

T. Rowe Price Group Inc. of Baltimore and Janus also keep sector weightings for their analyst-driven strategies in line with their benchmark weightings.

Among best-ideas products, however, the more risk-controlled offering by T. Rowe Price Associates Inc. has garnered the strongest interest from institutional clients in recent years. According to Atlanta-based data provider eVestmentAlliance, the Structured Research strategy launched by T. Rowe in mid-1999 pulled in net inflows of $2.8 billion in 2004, $1.3 billion in 2005, $3.8 billion in 2006 and roughly $400 million in the first half of 2007, helping buoy its assets under management to $15.1 billion.

Todd Ruppert, president and chief executive of T. Rowe Price Global Investment Services Ltd., said the strategy, designed to have a tracking error of less than 1.75 percentage points from its S&P 500 benchmark, has managed to outperform in both rising and falling markets, regardless of whether growth or value equities have been in favor.

The sharp pickup in demand for the strategy since 2004, both at home and abroad, was helped by its reaching a three-year track record just as many institutional investors were moving to get “a bit more juice” from passively managed assets, he said. At the same time, Mr. Ruppert added, others with big allocations to enhanced quantitative strategies were turning to T. Rowe’s fundamentals-based strategy as a source of uncorrelated returns.

MFS’ Mr. Roberge said his firm runs its U.S. equity research offering to be in the “active space,” with a tracking error of between 2.5 and 5 percentage points. The strategy has been more retail focused, but the changes instituted in the past four years could raise its profile among institutional investors, he said.

With Janus’ institutional strategy just reaching its three-year mark, it too could begin showing up in more searches. Mr. Goff said that while the strategy has just $100 million in client assets, the company is searching for mandates with more than a combined $1 billion in assets.

While the 8 percentage points of outperformance by Janus’ research strategies over the past year may conjure up images of the torrid returns the firm enjoyed during the late 1990s that went bust with the technology bubble’s collapse, Mr. Goff said his analyst team learned lessons from that experience. The Janus research product is diversified, with the top 10 of its roughly 120 holdings accounting for only 17% of the portfolio’s assets, and outperformance in each of the eight sectors into which Janus divides the market. With systematic risk controls in place, “we’re not getting there because we have five to 10 massive holdings doing well,” he said.