SACRAMENTO, Calif. -- The California State Teachers' Retirement System is moving half of its $30 billion domestic indexed equity portfolio in-house.
Barclays Global Investors, San Francisco, which had managed the entire portfolio, will retain the remaining half.
Patrick Mitchell, CalSTRS' chief investment officer, said there were three main reasons for bringing the money in-house:
* "Ancillary benefits. We direct cash flow of about $500 million every month. By managing money internally we stay much closer to the markets and have the benefit of knowing how we should invest the money."
* Safety. Mr. Mitchell said he is happy with Barclays, but added, "If problems arose that would cause us to lose confidence in our indexer, we would have the ability to manage the money in-house. There's safety in having multiple managers."
* Opportunity. Managing money internally will give staffers the opportunity to develop investment expertise and, thus, should allow the fund to attract "a higher level of investment professional."
CalSTRS plans to bring the money inside in $5 billion chunks. The first $5 billion was transferred in May; the move should be finished by year end.
Officials at Barclays are not upset over the move. "This has been part of Patrick Mitchell's plan since he took over the fund. It was not a surprise," said Lawrence Tint, vice chairman.
Barclays still has a sizable amount of CalSTRS money under management. Aside from the remaining $15 billion of the passive equity portfolio, it manages $700 million in an enhanced equity portfolio and $14 billion in an international equities portfolio.
The $101 billion, Sacramento-based pension fund had been managing a $1 billion domestic equity index fund in-house since April 1998.
A report made to CalSTRS' investment committee in May said, "The internal program produced results that met or exceeded expectations."
The internally managed portfolio's 18.49% return for the year was six basis points lower than the return of its benchmark, the Standard & Poor's 500 index, well within the acceptable range for the fund, according to the report.
In making the case for increasing the amount of money managed internally, the report said "a larger fund will make management easier by allowing the purchase of larger baskets and more securities with cash flows that will actually help control tracking error. By increasing the size, the performance of the portfolio will be enhanced in such a manner as to minimize deviation between the performance of the portfolio and the index."
The report includes results of a study by a major brokerage firm showing tracking error to the S&P 500 index drops to 0.1% when investing in increments of $10 million, from 2.15% when investing in increments of $500,000.
"The larger the reinvested basket, the smaller the tracking error when the reinvested basket is combined with the original portfolio," the report said.
There will be "no real cost savings" from the internal management of the index fund, said Sherry Reser, spokeswoman for CalSTRS. However, the fund expects to save some money in its trading costs by using electronic communications networks. For the trial period, the fund used POSIT and Instinet. It plans to expand the program, possibly to include OptiMark and Lattice.
However, Brad Pacheco, spokesman for the nearly $160 billion California Public Employees' Retirement System, said in-house investing does save on costs. CalPERS runs a $65 billion passive domestic equity portfolio in-house and has been passively managing equities internally since the late 1980s.
"It saves on transaction costs and management fees," he said.
Managing the indexed equities internally, "will allow CalSTRS to take advantage of liquidity in the marketplace, while further reducing market impact," the report said.
Fund officials also plan to explore using index options to increase the return of the indexed equity portfolio. According to Ms. Reser, a report is scheduled to be made to the board in April 2000 about the advantages and disadvantages of using index options.
Risks and returns
The brokerage firm's report on internal management said, "the use of (index) options can create risk and return profiles that are either unobtainable with the underlying stocks or too expensive to duplicate with the underlying stocks."
There are more benefits to internal management, according to the report.
The resources used to manage the portfolio also are helpful in planning manager transitions, funding and terminations.
"In each of these instances, the tools developed to manage the internal portfolio support the staff's planning activities and preparation of implementation plans," the report says.
The methods also help the staff to better keep tabs on external equity managers and "to evaluate externally managed portfolio return, risk and trading costs, providing a clearer perspective on portfolio attributes," according to the report.
Moreover, "they also help staff assess portfolio risk and ensure the external manager is adhering to the investment policy."