The past three years have ravaged most large-cap growth-stock pickers while leaving their large-value brethren relatively unscathed. So how is it that Equinox Capital Management, a well-regarded institutional large-cap value manager, finds itself in such difficult straits today?
Launched in 1989 by Ronald Ulrich, a Barton Biggstrained portfolio manager from Morgan Stanley Asset Management, Equinox has seen its assets shrink from nearly $13 billion in early 2000 to $5 billion at year-end 2002. Clients such as the Oregon Public Employees’ Retirement Fund have defected as performance has deteriorated. Last year Equinox returned 19.5 percent, versus a 15.5 percent return for the Russell 1000 value index and a 22.2 percent drop for the Standard & Poor’s 500 index. Equinox produced an average annualized return of 5.7 percent for the three years ending December 31, 2002, compared with 5.1 percent for the Russell index.
Currently, more than half of Equinox assets come from a sole -- albeit huge -- $3 billion subadvisory assignment co-managing the $20 billion Vanguard Windsor II Fund.
Mostly to blame is Equinox’s distinct flavor of value, known as “relative value,” a term made famous by Legg Mason’s star portfolio manager, Bill Miller. Relative value sharply contrasts with the more traditional discipline known as “deep value,” whose roots date back to its popularizers, Benjamin Graham and David Dodd. But Equinox has also been hurt by the fact that it has been downgraded by Tacoma, Washingtonbased Frank Russell Co., a powerful industry consulting firm.
Deep-value managers look for stocks that sport modest price-earnings ratios and seem attractive by other standard metrics (yield, price-to-book and price-to-cash-flow). They buy shares when they’re beaten down to the point where they carry little or no downside risk and significant upside potential. In contrast, relative-value managers will buy when a stock has room left to fall but seems attractively priced, relative to its industry peers or to its own historical share level.
“Relative value is basically a value portfolio with a strong helping of growth,” says Ronald Surz, founder of San Clemente, California, consulting firm PPCA, which specializes in performance evaluation. “That helped you in the late 1990s, and not surprisingly, it’s hurting you now.”
To wit: Last year, when Equinox produced its 19.5 return, the deep-value portfolios at Alliance Bernstein returned an impressive 0.40 percent.
A look at some of Equi-nox’s largest holdings in 2002 shows how relative value managers can get caught, as the old Wall Street saying goes, “trying to catch falling knives.”
Case in point: Equinox bought a significant stake in Bristol-Myers Squibb Co. in late 2001. Heading into 2002 the stock was trading in the mid 40s, with a trailing 12-month P/E of 18, down from the mid-50s during 2001 and well below its historical P/E of 25. That looked good to Equinox stock pickers, but it turned out that shares had further to fall. With profits under pressure the stock recently traded at 23, with a P/E ratio of 14.
Despite the problems, Ulrich is sticking to his guns. “We are extremely well positioned for when the style ultimately comes back into favor,” he says.
Of course, Equinox is hardly alone in its misery. Legg Mason’s Miller returned 17 percent in 2002, 1.5 percentage points worse than the Russell 1000 value index.
“Even the most disciplined relative-value managers were severely humbled in 2002,” says Brian Barish, president of Denver-based relative-value specialist Cambiar Investors. His firm, which manages about $1.5 billion, lost 17 percent last year. “Every measure of comparison in every sector failed to hold up. No style has worked.”
But Equinox’s rapid depletion in assets is only partly explained by the fact that its style became unpopular. Not only did the firm fall short of the Russell benchmark, it also fell out of favor with the firm’s influential consulting arm. The consultants downgraded Equinox three years ago when they felt that Ulrich was spending more time on the road marketing than in the office picking stocks. Frank Russell seized on the issue when performance started to decline, according to a source at the firm. (A company spokesman says it does not comment on specific managers.)
Ulrich, in turn, won’t talk about the Russell situation except to note that a number of large clients, including the Oregon retirement fund, came into the firm through Russell during the early 1990s. Several of these clients have dismissed Equinox over the past two and a half years.
One institutional client sticking by Equinox is Vanguard Group. Of Windsor II’s $20 billion, Equinox manages $3 billion. (Barrow, Hanley, Mewhinney & Strauss manages the lion’s share of Windsor II, roughly 62 percent.)
“Ulrich and his staff have done a solid job over the long term for shareholders,” says Jeffrey Molitor, Vanguard’s director of portfolio review. “Their style offers a nice compromise, and going forward we expect them to be well positioned.” In the past three years, Windsor II has had an average annualized return of 2.09 percent, compared with 5.1 percent for the Russell 1000 value index.
Another major client sticking by Equinox is SEI Investments, which uses the firm in its stable of value equity managers, alongside Sanford C. Bernstein & Co.
Says one SEI executive, “On a three-year basis Equinox isn’t so far from the Russell 1000 value index, just 60 basis points or so.”
“Managers tend to look extraordinarily good when what they do is in style,” Ulrich says. “And when the style goes out of favor, they then look extraordinarily inept.”
He adds: “We’ll be okay. Organizations don’t go from bright to dumb overnight.”
Head-hunting In the late ‘90s bull market, asset management firms tolerated their mediocre stock pickers. After all, the firms could barely keep a handle on the new money coming in the door, and average performance still meant double-digit gains. Today, of course, cash is headed toward the exit, and average returns translate into double-digit losses. Little wonder then that asset managers are taking a critical look at their stock pickers’ performance.
A new study from New Yorkbased executive search firm Russell Reynolds Associates reports that money management firms, faced with shrinking revenues and a third straight year of negative equity returns, have been relentlessly pruning average-performing portfolio managers. At the same time, they’re often seeking one or two proven replacements to lead the way back to respectable (read: single-digit) returns.
One industry consultant estimates that about 4,000 portfolio managers have been dismissed from major U.S. buy-side firms in the past 18 months.
“All through the ‘90s a lot of young guns were told repeatedly by the older generation, ‘Just wait until you’ve had to survive a bear market,’” explains Debra Brown, a senior recruiter in Russell Reynolds’ global investment management practice. “What we have found in the past year is that many of these thirty-somethings have either left the business or been let go.”
Adds Brown: “These are the one-dimensional, average guys [and gals] who knew how to do one thing: big growth. The first to go were the worst performers, technology and telecommunications investors, but now we are at the point where the average performers are also expendable.”
Among the hardest hit: the ranks of equity portfolio managers at MFS Investment Management, Nicholas-Applegate Capital Management, Putnam Investments and J. & W. Seligman & Co. -- all firms with a preponderance of growth-stock funds.
What are the longer-term implications of this thinning of the herd? Brown thinks that the younger generation of portfolio managers who do hang on to their jobs will be better prepared to run the business once the older generation -- men and women in their 50s -- starts to retire.
Adds Kenneth Phillips, longtime advisory board member at the Investment Management Consultants Association, a trade group representing pension consultants: “Firms will be aggressively competing for portfolio managers who survive this shakeout with good track records. Some of the managers will probably strike out on their own.”
For now, though, “the scary part is that none of those laid off can get hired,” says Michael Martinolich, a recruiter with New Yorkbased Cromwell Partners, which specializes in the asset management industry. “You can spot an average track record a mile away, and nobody wants to hire average.”
J. Nicholas Hurd, head of Russell Reynolds’ investment management practice, agrees. “The demand for outstanding investment professionals has not abated,” he says. “Firms are seeking individuals with proven management and leadership skills in addition to investment prowess. They want the cream of the crop.” Regardless of market cycle, that’s not easy to find. -- R.B.
