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Leland O'Brien's Image Marred in 'Meltdown' : Pioneer Portfolio Insurers on the Defensive as Role in Market Skid Is Questioned

November 02, 1987|DOUGLAS FRANTZ | Times Staff Writer

In the ancient history before Oct. 19, 1987, John W. O'Brien's biggest problem was persuading the investment world to pay attention to the esoteric concept of portfolio insurance pioneered by the Los Angeles firm he and two UC Berkeley finance professors founded in 1981.

All that changed when the stock market collapsed, thrusting the investment management firm of Leland O'Brien Rubinstein Associates--the biggest player in a field of finance it virtually invented--into the vortex of a swirling controversy over what led to the worst crash in American history.

"We didn't really have a public image before," O'Brien said in an interview in his office in the First Interstate Bank building downtown. "Our image begins as a tarnished one. We can go from there."

Features of portfolio insurance--used by institutional investors to protect against a falling stock market by trading in U.S. Treasury notes and futures contracts--are being blamed for what New York Stock Exchange Chairman John J. Phelan called a "financial meltdown."

The Securities and Exchange Commission and the Commodity Futures Trading Commission announced reviews to determine the causes of the market volatility, with a special eye on the impact of portfolio insurers and the automatic computerized program trading that is a central feature.

Its role as the nation's premier portfolio insurance firm has put Leland O'Brien Rubinstein, known as LOR, at the heart of that controversy.

As if being blamed for helping grease the skids in the crash were not enough, the firm also faces a barrage from customers who contend that its system failed to protect them.

"We've had some dismayed customers," O'Brien conceded. "Several have said they want to put our protection plan on suspension while we figure out what went wrong."

Such long-term customers as Manville Corp. and the Auto Club of Southern California said they are re-evaluating the effectiveness of portfolio insurance. Others said they won't use it again.

"The system didn't provide us the protection we thought we were getting," said Margot Kyd, treasurer of San Diego Gas & Electric. The utility lost 17% to 20% of the value of its $350-million pension portfolio despite the use of an LOR program designed to guard against a loss of more than 5%.

Other clients, such as the investment subsidiary of Wells Fargo & Co., which had $9 billion of managed money subject to LOR's portfolio insurance strategy, simply refused to comment on how they fared.

Some, however, have come to the defense of LOR, praising the company's system for allowing them to avoid the brunt of the collapse by selling stocks and switching to cash or by selling futures tied to a stock index.

"I was responding to the LOR insurance strategy when I went fully liquid and converted to money markets on Friday, Oct. 16, and I stayed whole," said Jonathan C. Jankus, portfolio manager for a $65-million mutual fund sold by the securities firm of Kidder, Peabody & Co.

A similarly protected fund at Merrill Lynch also reported that the technique had helped stem losses and left its $230 million in equity intact.

But the complaints of dissatisfied customers, coupled with concern over the role of portfolio insurance in the collapse, are forcing O'Brien and co-founders Hayne E. Leland and Mark E. Rubinstein to grapple with what can be described most kindly as an enormous image problem.

Leland acknowledged that the firm's performance was mixed. But he added: "To say that we caused the collapse, that is preposterous."

Nonetheless, LOR is clearly skittish about its current notoriety. Last week, the partners refused to allow their photographs to be taken, with a spokeswoman explaining, "Our counsel felt it was dangerous to allow their pictures in the paper in such volatile times."

'Rocket Scientists'

It's all a far cry from the day in October of 1979 when John O'Brien first heard the phrase "portfolio insurance."

O'Brien was developing new financial products for the A. G. Becker brokerage firm. He was attending a symposium sponsored by the business school at the University of California, Berkeley, when he heard two young finance professors explain their concept for protecting investments in the stock market.

The two Berkeley professors, Leland and Rubinstein, clearly fell into the category of "rocket scientists," a Wall Street term for the theoreticians who devise exotic investment devices. Leland has a doctorate in economics from Harvard, and Rubinstein has an MBA from Stanford and a doctorate from UCLA.

Their theory was a means of doing something quite startling--making money in stocks while minimizing the risk. They called it portfolio insurance.

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