After a one-year interlude where internally managed domestic equity assets eclipsed fixed income among defined benefit plans, internally managed bond portfolios again surpassed the asset numbers of internal equity portfolios.
Pension plan sponsors kept larger amounts of bond assets in-house in 1996, while the internal equity portfolios dropped slightly from 1995's levels, once adjusted for the market's sharp rise during 1996. Internally managed domestic equities among the top 200 pension funds grew 14.7%, to $327.31 billion from $285.2 billion in 1995, but that translates to a drop of 4.6% when adjusted for the 20.3% performance of the Standard & Poor's 500 index.
"It doesn't surprise me that the market-adjusted value of internal management has gone down . . . with general downsizing and the feeling that you can purchase (investment) services at lower costs externally rather than internally," said Stephen Nesbitt, senior vice president and principal of Wilshire Associates Inc., Santa Monica, Calif.
Besides ongoing staff downsizing, another important factor has been sponsors' trouble retaining good staffers, who are lured away by higher salaries, said Mr. Nesbitt. "Many good people who manage money internally end up at money management firms because of compensation reasons," he said. He noted there are very few exceptions, such as Harvard Management Co., the Yale University endowment and General Motors Investment Management Co.
Internally managed international equity jumped 41.1% to $36.141 billion from $25.62 billion in 1995, still a healthy 29.5% when adjusted for the 8.94% 12-month performance of the Morgan Stanley Capital International Europe, Australasia and Far East Index. The international fixed-income assets managed internally dropped 14.7% to $10.757 billion from $12.617 billion, or 18.05% when adjusted for the 4.04% performance in the Solomon Brothers Non-U.S. World Government Bond Index.
"There is more money going into international, and greater comfort with passive international investing. To the extent that more internal management is passively oriented, (numbers) will show a large increase in internal passive international assets," said Mr. Nesbitt.
Two factors have affected internal management in recent years, said Donald Callaghan, principal of Hirtle Callaghan & Co., a Wayne, Pa., firm that functions as chief investment officer for small pension funds. On one hand, many of the largest plan sponsors increasingly are indexing core equity assignments to reap cost advantages over active management fees. But at the same time, many large funds have grown so large they begin to weigh whether they can actively manage assets effectively. As an example, he noted the E.I. Du Pont de Nemours pension fund, which he said has done a great job over the years managing assets internally, has been using more outside managers as it has grown.
"When you get past a certain point you begin to think, as a fiduciary, that you need to outsource your management," said Mr. Callaghan.
Domestic fixed-income assets rose 28.7% - far ahead of the 4.21% performance of the Salomon Brothers Broad Bond index for the same period. Total domestic fixed-income assets rose to $339.57 billion from $263.67 billion, a 23.58% increase on a market-adjusted basis.
The sharp increase in fixed income was driven by public funds, particularly the largest funds, which have seen a dramatic increase in the sophistication and ability to manage fixed-income internally, said Mr. Callaghan. He singled out behemoths such as the New York and Pennsylvania state funds as examples.
But overall, most internally managed allocations were smaller than last year on an absolute basis or were smaller when adjusted for market returns, with a few exceptions:
The Virginia Retirement Systems, Richmond, nearly doubled its internally managed assets, to $3 billion from $1.61 billion - all indexed equity - in 1995. The majority of the assets are indexed equities, but Virginia dropped its internally managed indexed equity to $1 billion, and introduced a $1.1 billion indexed domestic fixed-income allocation to its internal assets.
The total internal assets of U S WEST, Englewood, Colo., rose 46% to $3.805 billion from $2.606 billion. U S WEST nearly doubled its indexed equities - which made up all its internally managed domestic equities in 1995 -to $3.165 billion from $1.806 billion, and added internally managed active equities to bring the equity total to $3.254 billion in 1996. Fixed-income assets - all actively managed - dropped to $550 million from $800 million.
Pacific Telesis Group, San Francisco, increased its internally managed assets by 66.7% to $2.385 billion from $1.43 billion in 1995. Most of the increase came from a new $544 million international equity allocation and an increase in internally managed fixed income to $809 million from $455 million.
The Florida State Board of Administration, Tallahassee, increased its total internal assets by 29.8%, to $23.026 billion from $17.738 billion in 1995. Internal equities rose to $12.448 billion from $4.626 billion.
Many large fund sponsors are comfortable with active fixed-income management and have had consistent success by taking higher credit risk in their portfolios, said Mr. Nesbitt.
The trend away from domestic equities was marked among the indexed assets. While the internal indexed equities among the top 200 funds rose 21.35% to $163.07 billion from $134.38 billion - an insignificant 0.85% increase when adjusted for the S&P's performance - internally indexed bonds rose a whopping 285.8% to $38.62 billion from only $10.01 billion in 1995.
DuPont reduced internal indexed equity to $2.259 billion from $3.154 billion and increased fixed income to $1.943 billion from $1.797 billion. Its total internally managed assets rose only slightly, to $15.157 billion from $14.32 billion in 1995.
Deere & Co., Moline, Ill., reversed the relationship between internal indexed equity and fixed income, reducing equity to $801 million from $956 million and increasing fixed income to $936 million from $859 million.
Prudential Insurance Co. of America, Newark, N.J., kept its internal indexed assets approximately the same, increasing to $1.357 billion from $1.305 billion in 1995, but it shifted indexed assets from equity to start an internal fixed-income index fund. Indexed equities dropped to $1.07 billion to make way for the $287 million fixed-income allocation.
Some funds reduced equity only slightly or increased while adding new indexed bond allocations to their internal assets. Exxon Corp. reduced its equity allocation to $711 million from $788 million and added a $34 million indexed bond allocation; Aetna Life & Casualty Co. doubled its equity allocation to $315 million from $160 million and added a $212 million indexed bond allocation; and Bank of America held internal indexed equities close to $350 million while adding $214 million in indexed bonds.
Overall, internally managed indexed assets rose 39.7% to $201.69 billion from $144.39 in 1995. Some sponsors increased their indexed internal mandates far more than their total internally managed assets:
The Wisconsin Investment Board, Madison, increased internally managed assets by only 1% to $31.38 billion from $31.1 billion in 1995. At the same time, however, the fund shifted its internal assets among classes and among active and passive strategies by reducing its internally managed equity to $11.97 billion from $17.2 billion while domestic fixed-income assets held stable, rising only 0.8% on a market-adjusted basis.
At the same time, the fund increased internally managed international equity to $4.53 billion from $1.8 billion and international fixed income to $2.28 billion from $693 million in 1995. The fund also introduced an indexed equity component to its internally managed assets, placing $3.45 billion of its internal assets in indexed funds, all equities.
General Electric Co., Stamford, Conn., quadrupled its indexed equities, to $1.424 billion from $384 million, while their 13.15% total increase, to $25.38 billion from $22.43 billion, was more modest.
The fact that the S&P 500 has outperformed average managers for the past two years has caused sponsors to consider equity indexing, and the larger the amounts to be indexed, the more internal management makes sense, said Mr. Callaghan. For a fund with $10 billion, setting up in-house indexing can be cheaper than even the single-digit fees charged by index managers for such large accounts, he said. Even if the indexer were to charge a rock-bottom fee of two basis points, that would mean $2 million in fees per $10 billion indexed, while Mr. Callaghan noted a fund could set up an in-house indexing staff for $300,000 to $500,000.
In-house indexing makes sense also when compared to the results for active management seen recently, said Mr. Callaghan. He noted the median large-capitalization equity manager in Evaluation Associates' performance database returned 3.4% gross of fees during the third quarter, compared with 3.1% for the S&P during the same period.
Several funds also managed significant amounts of defined contribution assets internally; internal defined contribution assets added up to $81.8 billion among the top 200 plans. The Federal Retirement Thrift Investment Board, Washington, led the ranking with $23.017 billion, followed by GE with $13.024 billion and Exxon with $6.359 billion.
Following the trend seen over the last few years in outsourcing defined contribution assets to bundled providers, total internally managed defined contribution assets dropped from $90.565 billion in 1995. (Because of a reclassification, the Teachers Insurance and Annuity Association - College Retirement Equities Fund and the ICMA Retirement Corp. are not counted as pension funds this year; the $90.6 billion figure reflects '95 data excluding their assets.) On the other hand, new internal assets flowed in from states that voted to start defined contribution plans for state employees, including California, Montana and Michigan - although not enough to make up for the drop.
The largest plan to move to outside providers was Procter & Gamble Corp., Cincinnati. P&G, with $9.127 billion in-house in 1995, shifted all of its assets to investment options provided by Barclays Global Investors and J.P. Morgan Investment Management. Abbott Laboratories, Abbott Park, Ill., which managed all of its $2.8 billion in defined contribution assets internally during 1995, outsourced its plan to Putnam Investments. Tenneco Inc., Houston, which had also managed its entire $794 million defined contribution plan in-house in 1995, switched to options from Barclays, Putnam, Fidelity Investments, Templeton Investment Counsel and INVESCO.
