Press Release
US Equity Markets Continue to Rise During Third Quarter
New York, NY, November 13, 2003 -- Equity markets continued to rise during the third quarter as investors became convinced that stronger economic growth is sustainable in the foreseeable future, leading investors to transfer fixed income and money market assets to equity options. The rise in the equity markets has been a welcome relief to both plan sponsors and participants, yet sponsors still face numerous issues, especially related to company stock as an investment option.
Mercer Investment Consulting's third-quarter 2003 Defined Contribution Universe Summary analyzes the governance issues surrounding the monitoring and communication of company stock to plan participants as sponsors navigate the delicate balance between their fiduciary responsibilities to plan participants versus their responsibilities to the company.
"As the market clearly continues to focus on plan governance, sponsors are faced with the challenge of developing and implementing a governance structure to properly monitor company stock," says Jeff Schutes, senior consultant and head of Mercer IC’s south unit. "The challenge is to develop a performance monitoring and evaluation process that meets the fiduciary standards implemented for other asset classes within the plan, yet factors in the unique nature of stock as an investment option."
While some communication to participants may be necessary, striking the proper balance between informing plan participants while taking into account other company stakeholders is a delicate challenge. On one hand, ERISA clearly states that fiduciaries must act on behalf of plan participants, yet as the sponsor of the plan, the health of the company is also clearly in the best interests of participants. In addition, the communication issue may be complicated by Department of Labor rules and regulations concerning investment advice and the fine line between investment advice and investment education.
The potential conflict of interest issue has led plan fiduciaries to reassess their monitoring and evaluation processes with regard to company stock. In a typical defined contribution arrangement, the plan sponsor hires, on a directed basis, a trustee whose responsibility is to execute decisions made by the sponsor. The sponsor retains the responsibility for monitoring investments and deciding what actions are necessary.
However, many sponsors have begun hiring trustees to act on a discretionary basis, which is most common among companies under distress from bankruptcy, regulatory investigations, or proxy battles. In this context, the discretionary trustee will render an objective opinion on the stock investment option based on their performance standards and time frames.
According to Mr. Schutes, "Other companies, while not in distress, have proactively adopted this approach to minimize any perceived conflict of interests. Yet even this approach does not completely eliminate potential conflicts. Rather, it seeks to minimize the conflict-of-interest issue since the trustee is hired by the company and may be reluctant to put forth a negative opinion."
Equity performance
Mercer's 2003 Defined Contribution Universe Summary analysis found a rise in equity markets during the third quarter, with the S&P 500 Index up 2.6%. Fixed income funds turned in a negative quarter as the Lehman Aggregate posted a loss of 0.1%. Money market instruments gained 0.3% while balanced funds, using a benchmark of 60% S&P 500/40% Lehman Aggregate, posted a gain of 1.6%. International equity markets outperformed domestic equities by 5.5% while returning 8.1% for the quarter.
Capital market returns remain solidly positive over the long term, aided by positive third-quarter results in all equity asset classes. Over a 10-year time frame, the S&P 500 Index returned 10.0%, while the Russell 2000 Index returned 8.3%. International equity markets produced a small gain of 2.9% over a 10-year time frame, although the asset class underperformed US equities. Over a 10-year period, the fixed income asset class produced a return of 6.9%, below large-cap equity returns over the same time period but with significantly less risk.
Mutual fund performance
During the third quarter, growth funds outperformed value funds, as the median large-cap growth fund returned 3.3% compared to 2.1% for the median large-cap value fund. The quarterly results continue the 2002 trend as the growth style continued to outperform value. The small-cap segment of the market followed the same trend as large-cap stocks, as the median small-cap growth fund outperformed the median small-cap value fund by a margin of 1.7%.
While the growth style appears to be in a cyclical upward trend relative to value, the swiftness of a market reversal can cause considerable anguish, Mr. Schutes notes. Remaining properly diversified, while difficult as one style outperforms another, is nevertheless a sound investment strategy.
The median large-cap fund equaled the performance of the S&P 500 Index for the third quarter of 2003, but underperformed the index by 190 basis points over the last year. Continuing a 2002 trend within the US domestic equity market, small-cap funds outperformed their large-cap counterparts for the quarter. The median small-cap fund returned 8.2% for the quarter versus 2.6% for the median large-cap fund.
The international asset class outperformed US equities for the quarter with a return of 8.1% and outperformed its US large-cap counterpart by a margin of 160 basis points over the last year. Global equities gained 4.8% for the quarter, but were held back by their US equity exposure as the asset class underperformed international equities by 330 basis points.
International equities continued to outperform domestic equities as the US dollar remains weak relative to other currencies. For investors who have patiently held their international equity allocation steady over the last couple of years in the face of poor returns, the benefits of diversification have finally proven them correct, Mr. Schutes notes.
The median core fixed income fund slightly underperformed the index for the third quarter by 10 basis points. After several years of stellar performance, the fixed income class was affected by the rise in interest rates causing a small loss for the quarter. However, fixed income assets still offer a favorable return risk profile and offer investors stability in a continuing volatile market environment.
About the survey
The Defined Contribution Universe Summary is published quarterly by Mercer Investment Consulting. The survey is intended to provide marketplace participants with summarized performance data for the most recent quarter and historical periods. Fund performance data are provided at the asset class and sub-asset class level. Fund universes are courtesy of Manager Performance Analytics (MPA), Mercer's proprietary manager database, using return data from Morningstar.
The Defined Contribution Universe Summary may be downloaded free of charge from www.mercerIC.us (registration requred). Please note: All performance is measured in US dollars, after investment management fees are deducted.
About Mercer
Mercer Investment Consulting is a leading provider of investment consulting services – such as investment strategy, including asset allocation, portfolio structure, investment policy, manager searches, and performance evaluation – to the fiduciaries of pension funds, foundations, endowments, and other institutional funds. Mercer Investment Consulting is part of Mercer Human Resource Consulting, which is part of Mercer Inc., a wholly owned subsidiary of Marsh & McLennan Companies, Inc., which lists its stock (ticker symbol: MMC) on the New York, Chicago, Pacific, and London stock exchanges.
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