The Case for Whole-Stock Portfolios

Abstract

For more than 20 years pension and endowment funds have used multiple active investment managers with complementary styles to manage their U.S. common stocks. Theory tells us that the approach—diversifying with active managers—is suboptimal. Evidence presented by the author supports the theory, indicating that the strategy has underperformed by the margin of its cost, which is approximately 1.2% per year. Passive management is one solution, and passive allocations have risen steadily for 20 years. Many funds, however, demonstrate reluctance to pursue a purely passive approach. The author recommends that those funds consider employing one or more whole portfolios in managing their active U.S. equity assets. Successfully employed in managing fixed income and international equities, whole portfolios embrace the totality of the opportunity set represented by the asset class. Whole portfolios allow investment managers to make a broader range of relative–value judgments than occurs under the multiple–specialist model. At the same time their use frees the client from having to manage the collective style of several active managers, eliminating in the process fairly arbitrary and rigid boundaries within the active equity portfolio. Using whole portfolios is also conducive to hiring fewer managers, an important step in avoiding “closet indexing.”