OLYMPIA, Wash. - The $36.9 billion Washington State Investment Board dumped its six active U.S. equity managers in favor of indexing, after deciding it's too hard to choose good performers.
As a result, $2.2 billion managed by three enhanced equity managers and three active small- to midcapitalization stock managers will be moved to passive portfolios already managed by Barclays Global Investors, San Francisco.
Washington appears to be the first of the largest 200 U.S. pension funds tracked by Pensions & Investments to index all of it domestic equities.
The terminated enhanced indexers and the amount they managed are: Advanced Investment Management L.P., Pittsburgh, $344 million; Independence Investment Associates Inc., Boston, $570 million; and Pacific Investment Management Co., Newport Beach, Calif., $493 million.
Terminated for small- to midcap were: Chancellor LGT Asset Management Inc., New York, $316 million; Denver Investment Advisors L.L.C., Denver, $348 million; and Wilke/Thompson Capital Management, Minneapolis, $88 million.
The move is another hit to active managers, which have taken a pounding in recent years from passive portfolios based on the Standard & Poor's 500 Stock Index.
"The index has been an awfully tough bogey to beat the last two years," said James Parker, executive director of the fund.
Dissatisfaction with active domestic equity management had been growing among board members for several years, Mr. Parker said. During previous reviews of the active manager roster, he said, some trustees had expressed regret that they did not move to an all-indexed approach following a previous review.
This time they did it.
Washington already had about $10 billion in passive domestic equity portfolios managed by Barclays, which were run in funds that seek to approximate returns in the S&P 500 and the Wilshire 4500 Index, effectively creating the returns of the whole market.
The assets from the active managers will be divvied up proportionally between S&P 500 and Wilshire 4500 funds to keep the domestic portfolio in line with the Wilshire 5000.
Alexandra Trower, vice president in corporate communications for Chancellor LGT, said executives there were surprised and disappointed in the loss of the small-cap account.
She said Chancellor executives support Washington's decision, but still believe value can be added in the active small-cap arena.
She noted Chancellor continues as an active Pacific Basin equity manager for Washington, running $460 million.
She declined to comment on performance.
Derek Hepworth, senior vice president and director of marketing for Independence, said firm officials are "obviously disappointed to lose (a) client like Washington State." But, he said active management will win out in the long haul.
"We're very happy with the performance we've provided our clients," Mr. Hepworth said. He declined further comment.
Executives for the other managers declined to comment, were unavailable for comment or didn't return phone calls.
A spokeswoman for Barclays declined comment.
Enhanced indexing returns were not materializing in Washington's $1.4 billion portfolio, even as use of the approach has grown among pension funds. "Results have been disappointing across all these managers," active and enhanced index, said Christopher Ailman, chief investment officer.
AIM's approach for the fund was to shift between stocks in the index and index futures, based on whichever was priced lower. Independence used a quantitative approach to screen out selected stocks in the index, and optimize stocks relative to the index, Mr. Ailman said. PIMCO used its fixed-income expertise to try to outperform short-term rates embedded in stock index futures.
But PIMCO and Washington arranged for a performance-based fee, and PIMCO wasn't earning much on the portfolio, Mr. Parker said.
Washington's overall benchmark for its equity portfolios is the Wilshire 5000, which was reviewed by the board at its May meeting, and retained, he said.
Even that decision was subject to debate, he said, given the S&P 500's relatively strong performance.
The Washington board also shoulders some of the blame for its managers' underperformance, staff members said. "We've had a long history" of not being able to pick good-performing managers on the domestic equity side, Mr. Ailman said.
The probability of being able to pick good managers is much higher in private and international equity, and in real estate, where there are more inefficiencies to exploit, Mr. Parker said.
And, to do it right, a pension fund would almost have to hire managers that have done poorly, and fire those that have done well, in order to take advantage of cycles in performance, Mr. Parker said.
The changes don't affect the $4.5 billion in international equity portfolios or a $352 million global asset allocation portfolio managed by Cursitor Eaton Asset Management Co., Boston, which was reviewed earlier this year.
Currently, half of non-U.S. equities are indexed in portfolios managed by State Street Global Advisors, Boston.
Fixed-income portfolios are managed in-house in an active, duration-controlled fashion, Mr. Ailman said.
Wilshire Associates, Santa Monica, Calif., assisted with some of the research for the decision to drop active management, Mr. Parker said.
Executives for Wilshire could not be reached for comment, but in a previous interview, Stephen L. Nesbitt, senior vice president and principal for Wilshire, noted some enhanced indexers that used PIMCO's approach were falling behind their benchmarks because the market was trading away the inefficiencies they were seeking to exploit.
David Brief, senior associate for Ennis, Knupp Associates, a Chicago-based consulting firm that advocates indexing, but wasn't involved in the Washington situation, said a pure indexing approach still is unusual.
Pension funds in P&I's top 200 with at least 70% of their overall equities indexed include: the California Public Employees' Retirement System, Sacramento; the New York City Retirement Systems, New York; the New York State Teachers' Retirement System, Albany; the Western Conference of Teamsters, Seattle; the International Operating Engineers, Washington; Aluminum Co. of America, Pittsburgh; Monsanto Co., St. Louis; and Texaco Inc., White Plains, N.Y.
Over time, the index will beat about two-thirds of active managers, Mr. Brief said. At certain times, active managers will do better and sometimes they'll do worse, he said. Lately, they've done as bad as they've ever done, he said.