The need for "MOM"

FCM is a Relative Value manager who manages stable value portfolios to produce attractive returns while preserving capital, consistent with the client's individual needs and preferences. Stable value investment guidelines should specify the targeted size of the liquid reserve, the buy and hold laddered core and the managed or "evergreen" synthetic segment of the portfolio, with further specifics on credit quality and diversification. The guidelines provide for us to actively manage the duration of the total portfolio, using our proprietary model that draws upon historical rate comparisons rather than forecasting the future course of interest rates. The investment guidelines should also accommodate the use of "MOM," management of managers. As discussed in detail in prior articles,

we purchase buy and hold fixed maturity products opportunistically to provide internal portfolio liquidity through frequent laddered maturities. Due to their historic 0.34% yield premium, low default rate and very high recovery rate, FCM employs a higher allocation to traditional GICs than synthetics in light of their relative value, while being mindful that due to the lower investment liquidity of each individual contract, the GIC segment must be very well diversified.

Actively managed "evergreen" synthetics, consisting of wrapped fixed income managed portfolios, offer industry and securities diversification, improved liquidity of the underlying securities and the potential for increased credit quality. But, it is critical to employ fixed income managers who have a demonstrated ability to outperform the unmanaged benchmark indices and who have the potential to overcome the GIC yield advantage mentioned above plus the 7 to 10 basis points of synthetic contract wrap fees. Given the fact that many conventional fixed income managers under-perform the benchmarks, and the importance of employing manager(s) who are successful in adding relative value rather than detracting value, since 1994 FCM has served as a manager of managers or "MOM" for the evergreen sector in our stable value portfolios. We draw upon our investment consulting heritage and carefully select fixed income sub-advisors, monitor them closely, and replace them when necessary. Moreover, since we do not employ any internal proprietary fixed income managers for evergreen portfolios, we eliminate one of the conflicts of interest between sources of fee income to which we might otherwise be subject.

FCM employs an extensive database published by a well-known national consulting firm and select highly qualified fixed income sub-advisors. There are over 27,000 different investment management products included in the database, which is updated every quarter, nearly 8,000 of which are fixed income products. Among others, our manager selection criteria include performance comparisons on both a net and gross of fees basis relative to appropriate benchmarks, total returns over various time frames, alpha and beta, as well as Sharpe and Information ratios. Next we create peer group comparisons of those managers who compare most favorably with the benchmarks. Additionally, style diversification is important for those clients whose portfolios are large enough to employ multiple active evergreen synthetic managers. For example, when we were recently retained to assume responsibility for a portfolio previously managed by another firm, our sub-advisor search process led us to retain three fixed income firms, each with outstanding historical results within their peer group, but with distinctively different approaches; one which has consistently added value by their astute selection of corporate bonds, another by focusing primarily on mortgage related securities, and the third through their sector rotation. For smaller clients, we may employ wrapped commingled funds. In addition, as "MOM," FCM performs due diligence on any finalist manager, and periodic visits are conducted as long as they remain in a client portfolio. Once a manager is selected for use, FCM performs a detailed quarterly analysis of the sub-advisors' results to gain an understanding of the under or over-performance of the managers within our active synthetic manager database. Sub-advisors are replaced as necessary if their relative value added declines.

In the absence of client preferences to the contrary, we invest approximately 35% of the total stable value portfolio in two or more different actively managed "evergreen" synthetic portfolios in recognition of their value added. The portfolios will have a duration target no shorter than the Lehman Intermediate and no longer than the Lehman Aggregate indices, which will be somewhat longer than the GIC component, but not so long as to cause undue volatility in crediting rate resets. As suggested above, our goal is to select sub-advisors with distinctly different fixed income management styles which in turn have different market cycles, so that through style diversification we can achieve less volatility for the evergreen synthetic component in total than would otherwise be the case with just one sub-advisor. In addition to our relative value approach, and our proprietary duration management model, a significant part of the reason for our outstanding performance record discussed elsewhere in this newsletter is that we serve as a "MOM." We have the flexibility to retain the very best actively managed "evergreen" synthetic fixed income managers, monitor their performance closely, and replace them as needed without the implicit limitations on our ability to make changes and fee-generated conflicts of interest if we were managing the same assets internally.