International indexed equity assets rose a solid, market-adjusted 14.5% in the six months ended May 31, as plan sponsors - increasingly comfortable with international investing - continue to pour money overseas.
In comparison, domestic indexed equity assets were relatively flat, slipping a mere 0.5% on a market-adjusted basis, Pensions & Investments' semi-annual update of leading index fund managers shows.
Indexed assets of all fund managers reporting as of May 31 totaled $730.3 billion. However, four new managers are listed in this survey, the largest being the Teachers Insurance and Annuity Association - College Retirement Equities Fund, New York, with $51.041 billion in indexed assets. The assets of these new managers were not counted in the comparisons for this story.
Total indexed assets managed by index fund managers reporting for both periods grew a market-adjusted 3.6%, to $676.522 billion between Dec. 1 and May 31.
In other survey findings:
Indexed assets managed for defined contribution plans are steadily increasing. Since May 31, 1995, assets are up almost 32.9%.
Domestic fixed-income assets grew to $143.238 billion, or 12.4%, adjusted for the Salomon Broad Bond Index, which fell 1.2%.
International indexed bonds took a big hit, falling 39.8% to $1.269 billion when adjusted for the -0.5% return of the J.P. Morgan Non-U.S. Government Bond Index.
Institutional tax-exempt enhanced index assets grew 13%, to $125.05 billion from $110.642 billion on Dec. 1, and more than 26% since May 31, 1995.
After last year's 38.6% gain in the Standard & Poor's 500 Stock Index helped propel institutional tax-exempt indexed assets to more than $600 billion as of Dec. 1, this year is a very different kind of creature. So far, the roller-coaster ride, witnessed through the daily peaks and dips in both the stock and bond markets, and a cycle that shifts between favoring small- and large-capitalization stocks, has domestic indexed equity just about back to where it started at the beginning of the year. While the equity market, as measured by the S&P 500, gained 11.8% in the six months ended May 31, domestic equity indexed assets grew an unadjusted 11%, to $445.034 billion.
Domestic equity index assets make up about 66% of the assets in this survey, with most of that managed in S&P 500 index funds.
International equity indexed assets grew at a strong pace, particularly in the emerging markets area. This despite the fact international markets have underperformed the U.S. stock market for the past several years. The S&P 500 returned 37% for the year ended Dec. 1, while the Morgan Stanley Capital International Europe Australasia Far East Index returned only 7.9%. And in the six months since, the EAFE returned 8.3%, vs. the S&P's 11.8%.
Managers cite several reasons for this continued growth in international indexing, including plan sponsors' growing comfort level with international investing and their long-term outlook on the market. They also speculate some plan sponsors, having benefited from hefty gains in the U.S. market, are fulfilling their previously targeted international allocations.
Three managers - State Street Global Advisors, Boston, BZW Barclays Global Investors, San Francisco, and Bankers Trust Co., New York - manage a combined $70.7 billion, or 82%, of the international indexed equities in this survey. The growth of those assets since the beginning of the year has been substantial.
On a market-adjusted basis, State Street Global's international indexed equity assets grew 24.9%, to $32.062 billion; Bankers Trust's grew 23.2%, to $12.252 billion; and BZW's assets grew 11.7%, to $26.392 billion.
Peter Leahy, managing director international structured products at State Street Global, said both its public and corporate pension clients are increasing their allocations to international indexed equity, especially in emerging markets. For the first six months of 1996, State Street's U.S. and non-U.S. clients added $2 billion to emerging markets, with approximately 75% of those new assets coming from U.S. institutional tax-exempt clients, he said.
Investing in emerging markets seems to be the natural next step for plan sponsors who already have made a commitment to international investments.
Initially, plan sponsors were less then enthusiastic with emerging markets indexes, said Mr. Leahy. But since 1991, when State Street first offered the vehicle, indexes have matured and have an increased level of support.
Mr. Leahy cited growing evidence that it's tough to outperform an index, adding there is nothing to prove that will not be the same for emerging markets. Plan sponsors that believe in indexing a portion of their portfolio for other investments will use them for emerging markets, he said.
While P&I uses the EAFE index to show market growth for this asset class, it would be unusual for a State Street plan sponsor client to choose the index for an international indexed equity portfolio, Mr. Leahy said. The bulk of State Street's defined benefit assets under indexed management is in customized indexes, he said, noting a big part of the job is helping clients sort through the many new international indexes, making country and currency bets and rebalancing weightings, so that plan sponsors can make strategic asset allocation decisions.
Since the beginning of the year, Bankers Trust, New York, has won four large international indexed equity accounts, including two that moved EAFE index funds from other managers, said Rick Vella, managing director and head of the global index fund group. Many clients are increasing overall international allocations.
Growth in international equity indexed assets comes despite the underperformance of international markets. Mr. Vella said some plan sponsors, who have benefited from gains in the domestic market, were increasing their international allocations to previously established targets, while other plan sponsors were increasing their target allocations and including emerging markets.
Emerging markets indexing has been the most active area, Mr. Vella said. Active managers have not been performing well against the Morgan Stanley Capital International Emerging Markets Index. In 1995, the MSCI Emerging Markets Index returned -5.2%, while the median manager returned -6.1%, according to the Pensions & Investments Performance Evaluation Report.
Another significant area of growth for international equity index funds at Bankers Trust is defined contribution plans, said Mr. Vella. The firm created a daily valued index fund for its defined contribution clients and has been boosting educational efforts aimed at plan participants. The result has been a significant flow into international index funds from defined contribution plans.
Although most of Bankers Trust's international index assets for defined benefit plans are in EAFE accounts, there are some customized indexes.
Overall indexed assets managed for defined contribution plans shows a steady increase. Since May 31, 1995, assets are up almost 33% to $71.628 billion from $53.894 billion. Most of those assets are in equity, with 85% in domestic equity and 12% in international equity.
Another area of solid growth for the index assets over the six months ended May 31 is domestic fixed-income. Assets grew an adjusted 12.4% to $143.238 billion. Some of the growth in fixed income can be explained through asset shifting by tactical asset allocation managers.
TAA manager Mellon Capital Management, San Francisco, with $40.244 billion in indexed assets, has changed the weightings of its normal TAA portfolio since the beginning of the year, moving equity assets back into bonds. At the beginning of the year, Mellon Capital had 80% in stocks, 10% in bonds, and 10% in cash. By the end of May, the allocation was 60% stocks, 40% bonds. Mellon uses index funds for its TAA portfolios.
International indexed bonds, however, took a big hit over the six-month period. Assets fell 39.8% to $1.269 billion when adjusted for the -0.5% return of the J.P. Morgan Non-U.S. Government Bond Index.
One explanation of the drop in international indexed fixed income could be the turnaround performance by active managers. For the first two quarters of 1996, the median active international fixed-income manager has outperformed the index by more than 100 basis points, said Mike Savage, assistant vice president of InterSec Research Corp., Stamford, Conn. InterSec has 30 active international fixed-income managers in its database. He said that in 1993, passive international fixed-income benefited from the underperformance of active managers, who where losing returns to currency and duration.
Enhanced indexing managed by the leading index fund managers continued its steady growth in the six months ended May 31. Institutional tax-exempt enhanced index assets grew 13%, to $125.05 billion from $110.642 billion on Dec. 1, and more than 26% since May 31, 1995. Enhanced indexed assets make up 18.5% of the assets in this survey and include both equity and fixed-income portfolios.
There are two important changes to P&I's survey of the leading index fund managers.
In addition to TIAA-CREF, the other new managers included in this survey are: Amalgamated Bank of New York; American Express Institutional Services/IDS Advisory Group, Minneapolis; and Federated Investors, Pittsburgh. The indexed assets of the new managers account for an additional $53.787 billion of which $47.48 billion is domestic indexed equity assets, $3 million in domestic fixed income and $6.304 billion in international equity.
Prudential Insurance Co. of America Inc. is also listed for the first time in this survey. Prudential's assets, however, have been included in previous surveys under the names of the firm's subsidiaries: Prudential Diversified Investment Strategies and Prudential Global Advisors.