More than $2 trillion in assets worldwide are invested in index funds.
It's a big pool of assets growing steadily, and in the case of index mutual funds, energetically, according to Pensions & Investments semi-annual survey of the leading index fund managers.
Worldwide index assets grew a market-adjusted 2.2% over the six months ended June 30, while index mutual funds jumped 10.5% over the same period.
For the first time in almost five years, international index equity for U.S. institutional investors fell.
Worldwide index assets grew to $2.03 trillion. Indexed U.S. equities grew 0.9% to $1.37 trillion, when adjusted for the S&P 500, which gained 12.22% year to date as of June 30; while U.S. bonds grew a market-adjusted 10.1% to $262.7 billion.
"International index searches have picked up over the last six to 12 months, particularly for large, sophisticated global investors," said Craig Russell, managing director and head of technical sales at Deutsche Asset Management, New York. "Large non-U.S. institutional investors are looking at global mandates and are decidedly interested in indexing in the U.S."
Bankers to Deutsche
Bankers Trust, now part of Deutsche Asset Management, has been an index fund manager for a long time. In 1977 the bank was the fourth firm in the U.S. to offer index funds, and it has been one of the largest three firms with index funds under management since.
In P&I's current survey of the leading index fund managers, assets listed previously under Bankers Trust are represented by Deutsche Asset Management's Global Indexing Group.
As of June 30 Deutsche Asset Management reported worldwide index assets of $213.9 billion, of which $204 billion is for U.S.-based clients; including $175.4 billion for U.S. institutional tax-exempt clients.
"Bankers Trusts' quantitative business was very appealing to Deutsche Bank," said Mr. Russell, referring to the purchase of Bankers Trust by Deutsche Bank.
Deutsche Bank has been getting a lot of interest in its passive/quantitative business from around the world, much of which is from investors considering indexing for the first time.
For many non-U.S. institutional clients coming in clean to the global market -- those with no active international managers -- there is no debate over active vs. passive management, Mr. Russell said. They're looking at indexing as an entrance into the global market.
The majority of the worldwide indexed assets reported still belong to U.S.-based investors, about $1.71 trillion. This includes both taxable and tax-exempt assets.
Just under 20% of those assets is managed through mutual funds, which grew to $331.6 billion from $271.2 billion reported for year-end 1998. Domestic equity assets in indexed mutual funds, at $285.4 billion, were up a market-adjusted 8.6%; domestic bonds grew 19.9% to $28.440 billion; and international equity grew a market-adjusted 26.8% to just over $17 billion. International bonds grew to $693 million, from $11 million reported previously.
For index mutual funds the Vanguard Group Inc., Valley Forge, Pa., continues to be, by far, the largest manager. Assets reported by Vanguard were up 13.9% from Dec. 31, growing to $191.9 billion from $152.1 billion. The vast majority of those assets -- just over $170 billion -- are in U.S. equities.
But while non-U.S. and other U.S.-based investors are starting to take to indexing, the biggest part of the pool still belongs to U.S. institutional tax-exempt investors. As of June 30, the leading index fund managers report $1.5 trillion in index assets, up from $1.3 trillion at year-end 1998.
Market gains factor
Market gains may account for some of the increase in assets reported. Domestic equity, which makes up 74% of the assets, topped the $1 trillion mark for the first time at $1.1 trillion, growing slightly faster than the market. When adjusted for the return of the S&P 500, assets were up 0.3%, but when compared with the Russell 3000, with 11.36% for the period, domestic equity index assets grew 1.1%.
Although index funds pegged to the S&P 500 dominate, over the past several years plan sponsors have been spreading their index choices across several large-cap, midcap, small-cap and broad-market indexes. As a result, the Russell 3000, a broad-market index, may be more representative of the equity component.
On the other hand, the Wilshire 5000 would be a fairer benchmark since it's an aggregate of the whole equity market, said Lawrence Tint, vice chairman of Barclays Global Investors, San Francisco. BGI, the largest indexer in this survey, has $428.4 billion in U.S. institutional tax-exempt index assets under management, $303.2 billion of that in domestic equity as of May 31.
Using the 11.87% 6-month Wilshire 5000 return would put the growth for the period at 0.6%.
Others aren't broadening
But other investors are not broadening the indexes they use. Deutsche Asset Management has developed a strong subadvisory business over the past few years particularly for variable annuity, 401(k) and retail managers. Those investors are moving to the S&P 500 in part because of brand recognition, Mr. Russell said. Unlike institutional investors, they are not diversifying to broader indexes, he noted. Last year the bank reported a pretty even split between assets in the S&P 500 and Russell 3000, but this year the S&P 500 portion has risen to 65%.
"On the retail side, the Russell indexes haven't taken hold." Mr. Russell said.
Overall, U.S. institutional tax-exempt index assets, including U.S. and non-U.S. equity and bonds, grew a market-adjusted 1.8% (using the Russell 3000 return for domestic index equity).
Domestic index bonds, at $223.8 billion, gained 9.5% for the period, when adjusted for the -1.39% return of the Salomon Smith Barney Broad Market Bond index in the first six months of the year.
International index bonds grew a market-adjusted 2.3% to $920 million. The benchmark for international bonds in this survey, the J.P. Morgan Non-U.S. Government Bond index, returned -9.33% for the period.
Bringing up the rear for the first time in almost five years, international index equity assets dropped when adjusted for market growth. For the first half of 1999 international index equity assets fell 3.5%. That hasn't happened since 1994, when international index equity assets dropped 3.2% in the last half of the year. Market-adjusted growth is based on the six-month return for the 4.1% Morgan Stanley Capital International Europe Australasia Far East index return in the first half of the year.
State Street dominates
The largest international index fund manager is State Street Global Adivsors, Boston, with $61.7 billion, followed by BGI with $42.5 billion and Deutsche Asset Management with $22.7 billion. The three manage 82% of the international indexed equities reported under management for U.S. institutional tax-exempt investors.
Over the past several years plan sponsors have been funding their international mandates, which has helped international index equity assets grow. Although plan sponsors are not moving out of the international arena, new international investments have slowed in the first half of 1999 (P&I, July 26).
The money that has been going in has been on the active side. BGI's Mr. Tint said that new domestic equity assets have been moving to indexing, while new international equity assets have been moving to active strategies. It's not so much a matter of active vs. passive management as an issue of performance vs. the benchmark influencing the choice, he said.
Tough to beat
In the domestic market, an active manager who invests in large-cap stocks and a few small-cap stocks can't beat the index, in this case the S&P 500. In the case of the MSCI EAFE, the performance and weighting of Japan, which makes up a good part of the index, affects how well active managers can perform against the index. When they underweight Japan, they can outperform the index.
Index fund managers offer enhanced index management as well as passive index management. Mr. Tint helped create the first enhanced fund in 1979. That yield-tilt market index promised to outperform the index by 40 basis points and for the past two decades it has, he said.
How much a plan sponsor has invested in active strategies depends on its risk budget. In order to diversify risk, a sponsor should have index, enhanced index and active management, Mr. Tint said.
Enhanced indexing does not try to be a better forecaster than the rest of the world, but has a systematic advantage, he said. In the case of yield-tilt market funds, high-yield stocks were in less demand by most investors because of the tax issue.
Assets moving into enhanced indexes are coming from both the passive and active sides, Mr. Tint said.
$308 billion slice
Enhanced index assets, with $308.2 billion, make up 22% of the institutional tax-exempt assets reported in this survey. Enhanced equity assets, which include both domestic and international assets, rose just 1.2% to $229.6 billion; while enhanced index bond assets jumped almost 20% over the period to $78.7 billion. Because enhanced index assets, particularly equity, include both domestic and international investments it is not possible to market adjust the growth for the period.
Once a year, P&I asks index fund managers to report how much of their indexed assets are invested for defined benefit and defined contribution plans. The plans make up approximately 86% of U.S. institutional tax-exempt assets reported in this indexing survey. Assets grew to $1.3 trillion, up from $1 trillion reported as of May 31, 1998.
Defined benefit index assets, which at $879 billion make up the bulk of pension assets reported, grew 20% from the previous reporting. Growing a bit faster were defined contribution index assets, up 25% over the period to $372 billion.
Move to indexing
Defined contribution investors, frustrated with the high fees and performance of active mutual funds, are moving to indexing, Mr. Tint said. "It has taken a while for investors, but they are getting the message," he said.
The largest defined contribution index fund manager continues to be TIAA-CREF, New York, with $102.4 billion, all in domestic and international indexed equities.
For defined benefit index assets the leaders are BGI, with $274.9 billion, and State Street Global, with $203.215 billion.