CFA Institute

Pension Fund Perspective: On South AfricaAuthor(s): Patrick J. Regan and Douglas A. LoveSource: Financial Analysts Journal, Vol. 41, No. 3 (Jun. - Jul., 1985), pp. 14-16Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478837 .

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0 E EPatrick J. Regan Pension r**~~~~~~~ Perspective ~~~~~~V.P., BEA Associates, Inc.

The policy of apartheid in South Africa has prompted considerable social protest in the United States, and some university endozv- ments and public pension funds are using their investment portfolios to force U.S. companies out of South Africa. In prior years, portfolio managers might have been instructed to sell the stocks of companies that did not sign the Sullivan Principles, which are intended to provide better work- ing conditions and economic equality for black employees of those companies. But in 1985 the cry is "divestment," requiring portfolio managers to eliminate stocks of all companies that do business in or with South Africa.

Below, Douglas A. Love tells a tale with some compelling facts about the effect of di- vestment on portfolio management relative to the market (S&P 500). Doug Love is a Vice President at BEA Associates, with re- sponsibility for investment research, port- folio management and new product devel- opment. He was thefounder and Chairman of Buck Pension Fund Services.

On South Africa by Douglas A. Love

It was late in the afternoon of a golden Vermont October day. A farmer was herding his blue-ribbon cow, Betsey, across the road to the home barn, when a speeding car approached around the corner. The driver braked mightily, but to no avail. The car collided with Bet- sey, and Betsey fell, stunned and bruised, to the side of the road.

The driver leaped from the car, stut- tering exclamations and explanations. He hadn't seen them. He'd been rush- ing to the assistance of some worthy cause to the south. He'd tried to stop. All he could finally say, however, was, "Gee, I hope I didn't hurt your cow."

The farmer, who had not uddered a word to this point, lifted his gaze from the pathetic sight of the cow by the road and met the driver's eyes:

"Well, if you done her any good, I'm willing to pay you fer it."

The link between this scene and the issue of South African divestment is provided if we identify our farmer as the portfolio manager, sadly survey-

ing the wreck of his prize portfolio. The driver, of course, was in a hurry to do some good in the world. But good, like lunch, rarely comes without cost.

In the case of South Africa, the so- cial benefits of divestment must be weighed against hard dollar costs. Among these, at the corporate level, are the expenses required to demon- strate compliance with the Sullivan Principles. But there are social costs as well. Many American and South Af- rican leaders recognize that American businesses are among the best agents for effecting positive change in South Africa. What social costs will be in- curred if divestment hinders their ac- tivities in this area? One of the many ironies of the divestment issue is that entities supporting progressive social change would themselves be divested under even the least stringent rules employed so far.*

And what of the costs in the invest- ment management arena itself? States and localities that have investigated the issue estimate that divestment costs

some $13 million per $1 billion of plan assets for initial transactions and 0.50 per cent per year in subsequent equity performance. It is the fund benefici- ary, of course, who bears the charge. The city of Dallas, for one, has con- cluded that:

"Investment decisions should be based solely on whether they are prudent and profitable.... The funds belong to employees and re- tirees. It is no longer city money and it is not fair to require employees and retirees to bear the brunt of a polit- ical problem.... Apartheid is a valid issue, but it is not going to be settled by the employees of the city of Dal- las." Our fable of the cow and the car can

bear the weight of some embellish- ment on this point. Famous doctors Rosenberg, Rudd and Wagner are flown in from California to diagnose Betsey's condition and prescribe treat- ment. Using the latest technology (portfolio quadratic optimization pro- gramming), they find that, by pushing here and tugging there, Betsey can be made to look very much like her old self. Moreover, in simulating her new self relative to her past behavior, they find only minor differences. The farmer, however, remains skeptical:

"She may look the same. She may even move about the same. But will she cost the same to feed? And will she

*Those companies that have not signed the Sullivan Principles include the American Broadcasting Co., the Associated Press, CBS, The Christian Science Monitor, The Los Angeles Times, National Broadcasting Company, National Public Radio, Newsweek, The New York Times and The Washington Post.

00h

FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1985 n 14

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Table One South Africa and the S&P 500

S&P 500 South African Issues S&P 500- S. African Issues

Market Market % of S&P 500 Market Value % of Value Value Value % of

Economic Sector Number ($Bil) Market Number ($Bil) ($Bil) Number Number ($Bil) Market

Consumer NondurablelServices 151 3,150 28.1 40 1,314 41.7 26.5 111 1,836 27.3 Durables 40 594 5.3 11 365 61.4 27.5 29 229 3.4

Industrial Technology 33 1,323 11.8 9 933 70.5 27.3 24 390 5.8 Energy 36 1,760 15.7 7 617 35.1 19.4 29 1,143 17.0 Basic Industry 157 2,298 20.5 41 1,027 44.7 26.1 116 1,271 18.9

Interest Rate Related 83 2p985 18.6 6 229 11.0 7.2 77 1,856 27.6

Total 500 11,210 100.0 114 4,485 40.0 22.8 386 6,725 100.0

Stock Category

Growth 120 3,823 34.1 40 2,289 59.9 33.3 80 1,534 22.8 Growth/Cyclical 130 2,903 25.9 21 790 27.0 16.2 109 2,114 31.5 Cyclical 155 2,091 18.6 33 874 41.9 21.3 122 1,210 18.0 Defensive 85 2,247 20.0 20 527 23.2 23.5 65 1,720 25.6 Other 10 146 1.3 0 ($6) -1.5 0.0 10 148 2.2

Total 500 11,210 100.0 114 4,485 40.0 22.8 386 6,725 100.0

Stock Size

Large Cap 50 5,101 45.5 25 2,948 57.8 50.0 25 2,152 32.0 Med Large 150 3,901 34.8 41 1,143 29.3 27.3 109 2,758 41.0 Med Small 200 1,939 17.3 34 346 17.8 17.0 166 1,593 23.7 Small Cap 100 269 2.4 14 48 17.5 14.0 86 222 3.3

Total 500 11,210 100.0 114 4,485 40.0 22.8 386 6,725 100.0

Beta 1.00 1.04 R-Squared 1.00 S&P Quality A - B +

give as much milk?" The doctors can only reply, "No."

Moreover, it was impossible to tell by how much feeding (trading) costs would be increased, and how much milk production (profitable trading opportunities) would be lost.

In fact, Betsey is a much altered cow. The medical chart (Table One) com- paring Betsey's new condition with her former self indicates that almost one- fourth of her parts (opportunities for trading profits) have been removed. These parts accounted for some 40 per cent of her weight. And of her 50 larg- est parts (most liquid shares), 27 parts, or close to 28 per cent of Betsey's for- mer weight, are now missing (see Ta- ble Two).

Portions of Betsey are mere hollows (major technology and growth stocks, and several key industries-Table Three). If she is standing still and just posing (a passive or index fund buy- and-hold strategy), Betsey can be made

Table Two Stocks Eliminated from Top 50

1* IBM 18 Philip Morris 35 Unocal 2* Exxon 19 BellSouth 36 Sun Co. 3* General Electric 20* Coca-Cola 37 Wal-Mart 4* General Motors 21* American Home Products 38* Johnson & Johnson 5 AT&T 22* Texaco 39* Dow Chemical 6 Shell Oil 23* Ford Motor 40 Superior Oil 7 Std. Oil-Ind. 24 GTE 41* Abbott Labs 8* Eastman Kodak 25 Bell Atlantic 42* Phillips Pet. 9 Sears Roebuck 26 Ameritech 43* Pfizer

10* Std. Oil-Ohio 27* Reynolds Ind. 44 Digital Equipment 11 Chevron 28 Nynex 45* Tenneco 12* DuPont 29* Bristol-Meyers 46* Boeing 13 Atlantic Richfield 30* Merck 47* Rockwell Intl. 14* Mobil Corp 31* Amer. Express 48 Santa Fe/So. Pac. 15* Hewlett-Packard 32 Southwestern Bell 49 Emerson Electric 16* Minn. Mining Mfg. 33 Pacific Telesis 50* SmithKline 17 Procter & Gamble 34 USWEST

*Eliminated Stock

to appear quite respectable (although still not very good). However, to get her moving, in her condition, is an ex- pensive affair (in terms of transaction costs).

The farmer must point out, finally, that "since the fateful day, Betsey can

only be entered in shows against other cows that have been hit by cars."

The driver's counsel was most as- suring. Some milk must be spilt in the pursuit of social goals. Better it be spilt where it is not highly visible for other counsels representing taxpayers, do-

FINANCIAL ANALYSTS JOURNAL / MAY-JUNE 1985 U 15

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Table Three Percentages of Key Industries Eliminated

S&P 500 % of Value Industry Eliminated

Industrial Equip. 99 Banks 97 Photographic 93

Chemicals 87 Drugs 87 Conglomerates 86

Tire & Rubber 85 Office Equipment 84 Motor Vehicles 81

Int'l Oils 76

nors, future students and private shareholders to cause trouble. The fact that it would be difficult to put a dollar figure on Betsey's altered condition, and that henceforth her performance would be unrelatable to common stan- dards, would assure much protective ambiguity.

Our fable has been pushed far enough; too far, perhaps. Among the benefits of ownership is the right to use assets for any cause, personal or social, within the law. What intro- duces substantial complication into the South Africa issue is the vestiture of management rights in owner repre- sentatives, or "fiduciaries." As a professional investor and a fiduciary, I cannot honestly say (for a fiduciary must also do what is right) that Betsey can possibly be as good as she was. I can use a powerful arsenal of modern portfolio management tools and in- crease resources devoted to research in order to keep Betsey performing up to her full potential. However, when- ever I review the performance of An- drea, Angela, Anne and the other cows in my herd that have not been struck by cars, some of Betsey's missing parts will have added to their performance (and a few, of course, detracted from it). Some of my herd is also, of course, without Cats, Tigers, bonds below BBB, options and futures; many are not. Subject to the ground rules, we are still going to run a great farm. But all else equal, I can't possibly help Betsey beat the rest of my herd that have all their parts intact. And if any drivers ask why not, or worse yet insist on comparing Betsey to other complete cows, I think I'll move to Vermont.

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Risk-return trade-off graph-points represent alternative portfolios (square "point" represents optimal portfolio of selected risk tolerance)

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A The Scientific Press 540 University Avenue, Polo Alto, CA 94301-1985, [415) 322-5221

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