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UVA-F-1140 CAMFAX, Inc.
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UVA-F-1140
CAMFAX, INC. Don Bennett, vice president of Planning and Research for the pension fund of Camfax, Inc., was reviewing his notes from the meeting he had had with Fred Pere of Bondi, Bishop, and Baker, Inc. (BBB) last Monday, October 4, 1994. He knew that later in the day he would have to make a recommendation to the board concerning a reallocation within the bond part of the portfolio. Bennett needed to reduce the domestic portion of the portfolio from 25 percent to 20 percent and increase the international bond allocation from 1 percent to 6 percent. This would primarily involve a reallocation of funds from the U.S.-indexed part of the fixed income portfolio. In addition, assuming he decided to make this change, he needed to recommend the form that this reallocated investment should take. Given the recent performance of the bond portion of the portfolio, Bennett knew some major changes were in order. Before making his recommendations to the board, however, Bennett first needed to meet with William James, chief investment officer, to explain his conclusions. Camfax Pension Fund Camfax, Inc., was a large, publicly traded corporation with over 70,000 employees. All its employees were served by a pension plan. Since the company had grown steadily over the years, employee ages were more or less evenly distributed between the ages of 22 and 65 years, with the average age being approximately 45 years. Camfax was consistently profitable and was considered a leader in its field. Most analysts rated the company very highly for its performance and conservative management practices. The company’s high standards were reflected in its pension fund. The pension was fully funded due both to management commitment and to the above-average returns, which the portfolio had experienced for the last couple of years. The management of Camfax remained committed to the pension fund and was looking to the portfolio to generate annual returns in the range of 8 to 9 percent in the coming years. At the end of September 1994, the pension plan had over $14 billion in assets. Exhibit 1 shows the allocation of those assets at the end of September 1994 and 1991. Generally, the allocation in 1994 was 26 percent bonds, 62 percent equities, and 12 percent other. Compared with 1991, the portfolio’s asset allocations in 1994 were smaller for bonds, but there had been a substantial increase in the international allocation. This was especially true for the international This case was prepared by Robert M. Conroy, Professor of Business Administration. It was written as a basis for class discussion rather than to illustrate effective or ineffective handling of an administrative situation. Copyright 1998 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to
[email protected]. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Darden School Foundation. Rev. 12/03. ◊
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UVA-F-1140
equity portion, which increased from 8 percent to 17 percent. In addition to the increase in the international component, the fund also shifted away from indexed portfolios to actively managed ones. This shift reflected William James’s belief that through diversification the fund could select outstanding fund managers and increase performance without increasing risk. Now the fund was being asked to consider a similar reallocation for the fixed income part of the portfolio. BBB’s proposal would result in a significant increase in the international part of the portfolio and at the same time would reduce the indexed allocation. In the past, the pension portfolio had generally performed well. Exhibit 2 reports returns for different segments of the portfolio and their corresponding indexes. The index for the equity portion of the portfolio was the S&P 500 and the index for the bond portion was the Lehman Brothers Government/Corporate Bond Index. For the overall portfolio, the blended index was based on 75 percent in the S&P 500 and 25 percent in the Lehman Brothers Government/Corporate Bond Index.1 Both the bond and equity portions of the portfolio had done extremely well from 1989-1993 relative to the indexes, but 1994 had been a very bad year for the markets in general and bond markets in particular. This recent poor performance had impelled Camfax to reevaluate the philosophy underlying the asset allocation of the portfolio. Recently, Bennett had been approached by one of the domestic bond portfolio managers, Fred Pace of BBB. BBB had been managing approximately one-third of the domestic bond portfolio (5 percent of the total portfolio) for the past eight years. In the past, this firm had been a top-performing bond manager. Exhibit 3 shows the performance of BBB compared with the Lehman Brothers Government/Corporate Bond Index. Average durations2 are also reported. In general, the firm’s approach was to match the duration of the index, relying on superior research to enhance performance. Pace believed that significant inefficiencies were present in the domestic bond market and that superior research could lead to superior performance. He believed that the performance of the fund over the last 10 years supported this approach. However, he also believed that the U.S. market was becoming more efficient, and high returns were going to be much harder to come by without substantially increasing risk. As such, BBB was advocating a change from the domestic bond market to the international bond market, which they believed was less efficient. The net effect of this change would be to increase the proportion of the fund managed by BBB. Bennett was also considering another alternative for international diversification. World Fund, Inc., offered a non-U.S. government index bond fund. In the past, the pension fund had not considered this type of investment, but given the fact that they were considering an increase in the allocation to international bonds, World Fund seemed to be a viable alternative to BBB.
1
The Lehman Brothers Government/Corporate Bond Index is the most widely used measure of the returns to an unmanaged bond portfolio. 2 The averages are taken as of December 31 in each calendar year.
