Brief description of case background
On August 11, 1998, United States Amoco Corporation (Amoco) and The British Petroleum Company p.l.c. (BPC) announced the BPC merger with Amoco. With a combined number of participants of 40,000 and $7 billion investment assets under management, the merged pension and savings plan of the new company is viewed by both management and employees as a bellwether of the success of the merger. Therefore, the new investment team must be able to “harmonize” the very different two original plans. Comparison of the pre-merger plan offerings of BP America and Amoco The Defined Contribution Plans offered at Amoco has an index-oriented, passive management nature.
The plans, known as Core investment options, feature funds closely matched to S&P 500 and the Lehman Brothers Aggregate Bond Index. The advantage that Core investment option has is low management fees, which is 10% and even lower than that of publicly traded index mutual funds. Another feature of the Amoco DC plan is heavy investment in the company stock. In December 1998, more than half of the plan assets (55.5%) are invested in the Amoco stock. Again, the brokerage fees for the stock investment are reduced by trading on net positions in the open market.
The Defined Contribution Plan at BP America provides a mixture of investments in the BP ADR, an internally managed stable income fund and seven public mutual funds. Unlike the Amoco plan, most of the funds that BP America invests in are actively managed. 51% of the BP America plan assets are invested in the stable income fund1. The rest of the plan assets are invested in company stocks (16%), equity funds (14.6%) and balanced funds (10.6%). Unlike that of Amoco, the BP America plans do not have a significant investment in the company stock. Recommendation of investment alternatives for BP Amoco’s post-merger plan 1. Actively managed mutual funds
In order to smooth the transition, the project team will go through a selection process for mutual funds that are already available for former BP America employees. To keep the characteristics of the funds in line with the Amoco Core investment approach, the following dimensions are considered: Best fit index of fund: S&P 500 (the index of the pre-merger Amoco equity investment) Best fit Beta of fund: close to 1 (±10%)
Annualized 5-year rate of return: benchmark: 24.1%2, no less than 90% of benchmark After applying the above criteria to the mutual funds listed in Exhibit 4 of the case document, the following funds are selected as recommendations: Columbia Growth, Fidelity, Fidelity Growth Company, Founders Growth, Invesco Blue Chip Growth, MSDW Instl Equity Growth A. 2. Index investment options
The index investment options for the new plan need to be in conformity with the Amoco core investment principle. Therefore, we have the following index investment recommendations for the Harmonized Savings Plan: Balanced Index Fund-Moderate of State Street Global Advisors, with the same asset allocation as the Balanced Fund of the Amoco pre-merger plan. International Equity Index Fund of State Street Global Advisors, with the same market index as that of the Amoco pre-merger plan.
Mid-Cap Equity Index Fund of State Street Global Advisors, with the same market index as that of the Amoco pre-merger plan. Small-Cap Equity Index Fund of Deutsche Bank, with the same market index as that of the Amoco pre-merger plan. Bond Index Fund of Deutsche Bank, with the same market index as that of the Amoco pre-merger plan.
3. Single BP-Amoco stock investment
When deciding whether to take a single-stock fund in the BP Amoco ADR, the team should consider whether the stock of the new company has hedging function for down-side risk of the equity funds in the Core investment option. Considering past performance, as is shown in Exhibit 1 and 2 of the case document, neither Amoco Stock Fund nor BP ADRs beat the Equity Index Fund (S&P 500) in terms of Annualized Rate-of-Return.
Therefore, hedging effect of the stock investment is perhaps the only reason for including it in the investment option. Moreover, if BP-Amoco ADRs is added in the investment, instead of more than fifty percent, asset deployment of this single stock fund (in terms of percentage) should be kept at a reasonable level in the new Core investment options. Recommendation of default allocation for BP Amoco’s retirement plan For plan participants who fail to make an individual investment selection, the default asset allocation for them should follow the Core investment options and allocation expanded from the pre-merger Amoco plan.
The following default allocation suggestion is based on the asset deployment shown in Exhibit 1 of the case document, assuming 1) single stock fund is not added in the plan; 2) deployment of Money Market Fund is kept at the original level as the need for liquidity is not changed, and 3) deployment of Equity Index Fund and actively managed mutual fund is combined for the lack of further information for optimization. Investment Option
Bond Index Fund
Equity Index Fund/Active Mutual Fund
International Equity Index Fund
Mid-Cap Equity Index Fund
Money Market Fund
Small-Cap Equity Index Fund
U.S. Savings Bonds