Jerry BramlettEBRI Policy Forum

May 8, 2008

The Future of Active Asset Managementfor Defined Contribution Plans

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• Alpha– The sum total of alpha is zero– Seeking alpha: a zero sum game in which one investor can achieve gain only

at another investor’s expense– Alpha is mostly random

– The term “alpha” is often misused• Alpha cannot be produced, mined or harvested• The concept of “portable alpha” is key example of the term’s misuse

• Beta – The value that the “real economy” creates

• Market appreciation of stock• Income (e.g., dividends, coupon payments on bonds, etc.)

– Beta may not represent the return that the investor is seeking but it will always be what the market delivers – no more and no less

Alpha vs. Beta

It is hard for the average investor to see through the statistical fog and easy [for them to be] fooled by randomness. But small investors really ought to

worry about cost. – The Economist, April 2008

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• Alpha has become increasingly hard to capture for the average DC plan sponsor– 10,000 hedge funds, 14,000 mutual funds and thousands of separate account

managers all looking for mispriced assets or arbitrage opportunities • creates enormous competition • drives up the cost for finding any inefficiencies that can be exploited

• The cost of money management has skyrocketed over the last couple of decades effectively erasing above-market returns

Chasing Alpha

“The hunt for alpha seldom recovers the cost of the expedition.” - The Tao of Alpha (Tammer Kamel, iluka Hedge Fund Consulting

“If the present level holds for the next decade … total intermediation costswould come to a staggering $5 trillion. Then think about these cumulativecosts relative to the $16 trillion value of the US stock market and the $12 trillion value of our bond market. Those costs would represent an astonishing 18 percent of that value.” – John Bogle, Black Monday and Black Swans, 10/07

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• Zero Alpha

– No attempt is made to achieve returns above the actual return produced by an asset class

– The focus shifts to the secondary level of portfolio management – asset allocation

The Zero Alpha Approach

“Approximately 94 percent of variability of a fund's investment return is due to asset allocation.”

- Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower, Determinants of Portfolio Performance," Financial Analysts Journal,July-August 1986, Follow-up study, "Revisiting Determinants of Portfolio Performance: An Update," 1990 Working Paper, 1986, 1990

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• Dramatically lower costs – 1-3% depending on the investment vehicle, trading level, and the fee charged by the alpha-seeking manager

– These lower costs, after a lifetime of saving, can add 40-60% to an individual’s retirement income

• Guaranteed market returns

• No revenue sharing

• No “style drift” – enhances the effectiveness of the asset allocation overlay

• Enhanced transparency (there is not much to look for)

• Bullet-proof from a plan sponsor/fiduciary perspective

The Advantages of Zero Alpha