EASY-DOES-IT INVESTING Paradigm's spin on index funds wins over big clients James E. Francis, president and CEO of Paradigm Asset Management Co., doesn't promise much when he bids for a pension plan's business. His goal is to beat a benchmark index by 1 to 1.5 percentage points a year. That may not sound like a lot, but many money managers fail to achieve it. It's what helps make Paradigm one of the hottest institutional investment shops around. Paradigm, which Francis started in 1990, is one of a handful of money managers offering ''enhanced style'' portfolios, a cross between a ''passive'' index fund and traditional ''active'' managers. Like index funds, these portfolios keep trading to a minimum and management fees low. But unlike with index funds, managers of enhanced style funds take small bets with measured risks to beat their bogey. ''There's a lot of interest in passive forms of management because of the poor performance of active management,'' says David Jack, a vice-president at Wilshire Associates Inc., a firm that advises large pension plans. ON THE CREST. Paradigm is riding the crest of that wave of interest. In November, the firm was chosen by the San Francisco City and County Employees' Retirement System to manage $280 million. A new $220 million account, expected to be announced soon, will push total assets under management to $1.4 billion (chart). Francis says he has his eye on 10 big funds that are looking to hire enhanced style managers. ''We could hit $3 billion this year,'' he says. ''We've got momentum.'' Paradigm could not vie for clients against megamanagers like Barclays Global Investors and Goldman Sachs Asset Management without a track record. For the five years ended Dec. 31, it finished in the top 20% of large-cap growth managers and the top 20% of large-cap value managers, according to Nelson's World's Best Money Managers. What also sells Paradigm is Francis himself, says Lawrence E. Davanzo, managing director of Asset Strategy Consulting, which advised the San Francisco fund when it hired Paradigm. ''He's young, he's a builder, and he's enthusiastic, and people respond to that.'' Paradigm doesn't do research on the companies in which it invests, but it closely watches those who do. For each style, such as large-cap value, Paradigm first identifies five to seven ''smart'' fund managers, and from their regulatory filings assembles a universe of 400 to 600 stocks. The next step is to run this universe through a ''factor model,'' a computer program that identifies the economic, fundamental, and industry characteristics of the stocks. ''It's those characteristics that drive the return,'' he explains. Then Francis uses an optimization program to build a 150-stock portfolio with those traits from that pool. Portfolios are rebalanced quarterly, and no stock makes up more than 1.5%. While Paradigm has exceeded its goals with large-cap portfolios, small-caps have been more difficult. From 1991 to 1996, Paradigm's small-cap value portfolio lagged the Russell 2000 Value Index by nearly six percentage points a year, while small-cap growth beat its hurdle by about the same. Francis says he has adjusted the screening process, and since late 1994, small-cap value performance is making its goals. Francis, 35, who is married and has two preschool-age children, is a native of Dayton, Ohio. A finance major at Atlanta's Morehouse College, he worked in marketing for IBM after graduation in 1984. He then had stints at Shearson Lehman Brothers Inc. and Oppenheimer & Co. before joining investment bank M.R. Beal & Co. in 1988 to launch a money management unit. Francis says he was impressed by studies showing that no more than 10% of a portfolio's return comes from stock selection. The rest is derived from asset, industry, and style allocations. So he built a system that would emphasize portfolios, not individual stocks. But since he still needed stocks to feed into the systems, he got the idea of using what was already in the public record. ''Those holdings represent the work of Wall Street's analysts and portfolio managers,'' says Francis. ''I'm just leveraging off of that.'' Beal Investment Co., as Francis' unit was then known, signed its first client, Prudential Insurance Co., in 1991. Francis bought the unit from Beal in 1995 and renamed it Paradigm. Boston-based Affiliated Managers Group Inc. joined the buyout, taking a minority stake. ''It's a unique firm, with a great staff, and the investment results are excellent,'' says William J. Nutt, AMG's president. ''We're very happy.'' As long as Francis can deliver those modest but pleasing returns, more big funds will be making a Paradigm shift. By Jeffrey M. Laderman in New York RELATED ITEMS CHART: Moving up Fast Return to top of story

Updated June 15, 1997 by bwwebmaster
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