U.S. tax-exempt investors' use of index funds has stopped growing, but non-U.S. investors' appetite for passive strategies is getting bigger, Pensions & Investments' latest survey of leading index fund managers shows.
"I'm used to focusing on U.S. institutional clients, but in the last year or so I've been working more and more with overseas clients," said Peter Leahy, managing director-global structured products at State Street Global Advisors, Boston. Between $30 billion and $35 billion of the Boston-based firm's $258 billion in indexed assets are managed for non-U.S. clients, most of them central banks and governmental agencies.
"The U.S. is a leading indicator for many financial trends over the last 15 years or so; indexing is one of them," said Jim Creighton, chief investment officer-global indexing at Barclays Global Advisors, San Francisco.
As of May 31, the managers surveyed managed $1.656 trillion in indexed assets worldwide, with U.S. institutional tax-exempt assets making up the lion's share. In 1992, the first time P&I asked for worldwide indexed assets, the managers reported a total of $353 billion.
For the six months ended May 31, U.S. institutional tax-exempt indexed assets grew to $1.238 trillion.
The overall growth rate reported by the managers in the survey was a modest market-adjusted 1%, adding just more than $156 billion in new money in the six-month period.
The culprit? Domestic equity indexed assets, which make up two-thirds of the money in this survey. Investors were continuing to rebalance their portfolios, moving some of their domestic market gains into international investments.
While U.S. equity index assets lost just less than 1% in the period after adjusting for the Standard & Poor's 500 stock index's 15.06% return, domestic indexed bonds grew a market-adjusted 4.3%.
As of May 31, assets in U.S. equity index accounts totaled $880.67 billion. When adjusted for the broader market index, the Russell 3000's 13.57% return, the domestic equities were flat. About 42% of the equity assets in this survey are pegged to indexes other than the S&P 500.
U.S. indexed bond assets, the second-largest indexed asset class, with $202.489 billion as of May 31, grew 4% when adjusted for the 4.17% return of the Salomon Broad Bond index.
THE HOT SPOT
International index equity portfolios took the lead in growth among the tracked asset classes for U.S. tax-exempt institutional investors, growing a market-adjusted 9%. Assets grew to $153.661 billion from $121.36 billion on Dec. 1, 1997. The Morgan Stanley Capital International Europe Australasia Far East index rose 16.22% in the period.
State Street Global Advisors continues to be the largest manager of international indexed equity assets for U.S. institutional tax-exempt clients, with almost $52.63 billion, followed by Barclays Global with $47.59 billion.
The category of international indexed bonds continued its decline, with just $680 million reported for May 31. The peak for international bonds was $2.22 billion, reported for the six months ended Dec. 1 1995.
In 1992, U.S. institutional tax-exempt indexed assets made up 90% of worldwide index assets in the survey. That proportion has dropped to 75% for 1998.
But U.S.-based clients -- tax-exempt and taxable -- account for about 86% of worldwide indexed assets. Indexed assets from U.S.-based clients totaled $1.426 trillion May 31, almost three-quarters of that is benchmarked to U.S. equity indexes.
The conversion of non-U.S. investors to indexing is more rapid than it was for U.S. investors, who have had the strategy available in some form for almost 25 years.
The learning curve on indexing is compressed for non-U.S. investors because the information flow is so rapid, and non-U.S. investors are aware of the growth of indexing in the United States and the United Kingdom, said BGI's Mr. Creighton.
As was the case in the United States, large pension funds looking for core equity strategies are among the leading investors overseas in index strategies. Government agencies and central banks also are adopting the strategy.
The hot markets for indexing are Japan, Australia, France, Hong Kong and Canada, said Mr. Leahy. South Africa is another country that is showing a lot of interest in indexing.
The United Kingdom already is a very developed market for indexing, said Mr. Leahy, coming in just behind the United States.
State Street Global, which manages both active and index assets overseas, opened local offices in Tokyo, Sydney, London, Paris, Hong Kong and Montreal that manage about $21 billion dollars in index assets for non-U.S. clients.
The rest of the company's commingled and separate account assets are managed in Boston. The growth of non-U.S. assets necessitated a move into the local market to help develop tax-advantaged commingled structured products that were tailored to the market, said Mr. Leahy.
CANADA MARKET GROWS
Mr. Creighton said Canada is one of BGI's fastest growing markets; assets managed for Canadian clients have grown to $12 billion in the past five years.
State Street Global also manages $7.2 billion in Canada for Canadian clients and $4.2 billion in Australia.
In Japan, where pension funds are looking beyond the fixed interest rate returns, there is a strong move toward core index equity, again favoring domestic equity, Mr. Creighton said.
State Street Global manages about $3.2 billion in indexed assets in Japan, Mr. Leahy noted, primarily in separate accounts, which Japanese prefer.
Non-U.S. investors also are looking deeper into their local markets, which are not yet as sliced and diced as the U.S. market. There is a lot of interest in small-capitalization equity and style indexes.
One of the trends Mr. Creighton sees is indexing that doesn't draw a line between emerging and developed countries.
The coming of the European union also could lead to sector industry index funds that cross national barriers, said Mr. Leahy.
Broadening P&I's focus on indexing, managers were asked, for the first time, how much of their total indexed assets were managed through mutual funds. The answer: just more than $220 billion.
Vanguard's big share
Not surprisingly, more than half of that $220 billion is managed by The Vanguard Group, Malvern, Pa. Vanguard manages $124.46 billion in indexed mutual funds. Vanguard's indexed mutual fund assets are up 63% from $76.396 billion in May 1997.
Following Vanguard are Fidelity Investments, Boston, with $21.675 billion; State Street Global, with $17.008 billion; Dimensional Fund Advisors, Santa Monica, Calif., $8.388 billion; and Barclays, $7.798 billion.
When broken out by the type of retirement plan for which the assets are invested, defined benefit plans still account for most of the institutional index assets.
But indexed assets from defined contribution plans -- up 41% to almost $298 billion from May 31, 1997 -- are growing at a faster pace.
The largest manager of indexed assets for defined contribution plans continues to be Teachers Insurance and Annuity Association -- College Retirement Equities Fund, New York, whose assets grew 42% to $92.402 billion. TIAA-CREF is followed by Barclays Global, up 32% to $65.759 billion; Vanguard, up 56% to $36.151 billion; Bankers Trust, up 65% to $33.015 billion; and Fidelity, up 30 to $23.287 billion.
TIAA-CREF is also the largest manager of enhanced indexed assets. As of June 30, TIAA-CREF reported managing $87.783 billion of its $92.402 billion of its domestic and international assets in enhanced equity index strategies. TIAA-CREF did not report enhanced index assets in the previous survey.
Total enhanced index assets stood at $269.105 billion, of which $211.389 billion was in equity and $57.716 billion in bonds.
On a market-adjusted basis, overall enhanced indexed assets were down more than 7% in the six-month period. Again, bonds took the biggest hit, with enhanced indexed bonds dropping a market-adjusted 20%
There are several new names on the current roster of index fund managers -- some are new participants, while others are name changes resulting from restructurings.
New to the survey are: American General Investment Management LP, Houston, with $5.164 billion; Allied Investment Advisors Inc., Baltimore, with $3.779 billion; and First Madison Advisors, Madison, Wis., with $125 million.
As the result of mergers and restructurings: UBS Asset Management (New York) Inc. is now listed under UBS Brinson; Miller, Anderson & Sherrerd LLP is now reported under Morgan Stanley Asset Management/Miller, Anderson & Sherrerd LLP; Chancellor LGT Asset Management, part of AMVESCAP, is called INVESCO (New York); and Old Kent Bank's indexed assets are being reported under its investment subsidiary, Lyon Street Asset Management.
All assets reported for this survey are managed internally by the reporting investment firm.