The appeal of indexing continues to widen beyond the world of U.S. institutional tax-exempt investors.
Indeed, U.S. institutional tax-exempt indexed assets dipped in the last half of 1999. But the leading index fund managers in Pensions & Investments' biannual survey saw a sharp pickup in worldwide index assets and mutual fund indexed assets. Those assets grew a market-adjusted 11.2% and 13.1%, respectively, during the six months ended Dec. 31. And although reported pension plan searches and hirings in P&I's database for both passive and enhanced index fund managers in the second half of 1999 exceeded those in the first half, U.S. institutional tax-exempt index assets declined a market-adjusted 1.6%.
Worldwide index assets managed by the leading index fund managers reached $2.222 trillion by the end of the year. Nearly 70% of those assets, $1.544 trillion, were U.S. institutional tax-exempt.
The top five leading index fund managers account for more than 80% of the U.S. institutional tax-exempt assets reported in this survey. Barclays Global Investors, San Francisco, continues as the largest manager of index assets with $468.9 billion in U.S. institutional tax-exempt index assets; followed by State Street Global Advisors, Boston, with $314.2 billion; Deutsche Asset Management, New York, with $131.8 billion; TIAA-CREF with $103.8 billion; and the Vanguard Group Inc., Valley Forge, Pa., with $75.5 billion.
"Indexing is still a good core strategy for plan sponsors," said John Russon, senior consultant for Asset Consulting Group, St. Louis. Noting the drop in assets listed by the managers, he explained, "There's a great deal of interest in bringing investment management inhouse, and it's not because of fees." Plan sponsors have developed the capabilities to manage securities internally and they want to do it, he said. The people joining pension investment staffs come with the ability and hope that they might run some of the assets internally.
In P&I's survey of the largest pension funds, internally managed index assets of the nation's largest 200 pension funds jumped 46%, to $387.6 billion, in the year ended Sept. 30 (P&I, Jan. 24).
"We don't see a lot of movement toward or away from indexing," said Jeff Nipp, head of investment research at Watson Wyatt Worldwide in Atlanta. Mr. Nipp said he could not comment on index assets being moved to internal management because the plan sponsors with which Watson Wyatt works don't do a lot of internal management.
"Most large plan sponsors have some money in indexing," he said. "It's a cheap way to get exposure to the broad market, I don't see that changing."
A bellwether of indexing popularity, domestic equity assets make up almost two-thirds -- $1.122 trillion -- of the assets managed by the leading index fund managers for U.S. institutional tax-exempt investors. Domestic equity indexed assets grew 5% in the six months ended Dec. 31, but when adjusted for the Standard & Poor's 500 Stock index return of 7.7%, assets dropped 2.4%. The S&P 500 is the benchmark for just more than 58% of the domestic equity index assets reported.
Because most index assets are large-cap U.S. equities and they've done so well, it might be that plan sponsors are taking some of those assets off the table, using them to pay benefits or to fund other investments, Mr. Nipp said, speculating on the drop.
While neither consultant saw a change in the basic use of indexing, they noted there could be changes in implementation.
Some plan sponsors are reactionary, and they are reacting to the technology-heavy weighting of the index itself, said Mr. Russon. "They want the index to be more sector neutral and are overtly reducing the technology weighting. They are trying to fabricate something more normal."
On the style side, although Mr. Nipp has not yet seen it happen yet, "there is talk and thought by plan sponsors of moving their value equity allocations into index funds," he said. Plans sponsors have been frustrated with underperformance of value as an asset class. Compounding the poor performance of the class are active managers who have been underperforming even the poorest performing value index, said Mr. Nipp. That could mean a move to a Russell 1000 Value index fund.
Domestic bonds up
Domestic indexed bonds, the only category to gain assets over market growth for this period, grew a market-adjusted 4.6%. "We see a lot more plan sponsors looking for passive fixed income," said Mr. Russon. The Salomon Smith Barney Broad Market bond index returned 0.6%.
In the second half of 1999, the Morgan Stanley Capital International Europe Australasia Far East index neatly outperformed the S&P 500, returning 22.3% over the six months. But, for only the second time in the past five years, international index equity dropped. Assets fell a market-adjusted 4% during the six months ended Dec. 31.
As far as international and small-cap investing goes, sponsors prefer active management -- it's more efficient, said Mr. Nipp.
A very small asset class, with just $469 million, international indexed bonds dropped even further out of favor, slipping more than 50% since June 30.
Enhancing the process
Some passively managed assets are being moved increasingly to enhanced indexes.
A lot of managers are calling themselves different things, said Mr. Russon. Many active managers are offering a synthesized version of their active strategies in the form of enhanced index funds. The expectation for outperforming the index in those enhanced funds vs. active management is lower, said Mr. Russon.
Enhanced index assets grew to $317.886 billion from $308.172 billion as of June 30. As of Dec. 31, enhanced domestic index equity assets were $213.8 billion; enhanced international equity index assets were $24.7 billion and enhanced index bond assets were $79.3 billion. A market-adjusted comparison was not possible because of changes in reporting procedures.
There are many enhanced index strategies with varying risk and return levels, but for this survey P&I has asked managers to report only those controlled-risk strategies benchmarked to a specific index that were expected to return up to 150 basis points over the underlying benchmark. There are products called enhanced index products that might not fit this definition and therefore would not be included in this survey and managers who are primarily active managers offering enhanced products who are not included in a survey of index fund managers.
Mutual funds growing
Individual mutual fund investors are following the institutional line and adding money to index funds. Index mutual fund assets reported by the leading fund managers are growing at a faster pace than institutional index assets. The leading index fund managers reported just more than $404.2 billion in index mutual funds at the end of 1999.
With 87% of the assets, domestic index equity mutual funds stood at $351.4 billion as of Dec. 31, up a market-adjusted 14.3% from June 30. Domestic index bonds also fared well, with $32.4 billion, gaining 13.2%. On the other hand, international index equity mutual fund assets fell 4.5% and international bonds dropped 23.3%.
The Vanguard Group continues to dominate other index fund managers in this category. Vanguard reported $228.935 billion in index mutual funds followed by Fidelity Investment, Boston, with $38.5 billion, and State Street Global Advisors at $29.619 billion.
In P&I's survey, the leading index managers also are asked how much they manage in index funds for non-U.S. pension funds and how much of those assets are invested in U.S. indexes. Both categories saw strong growth in calendar 1999. Index assets managed for non-U.S. pension funds rose 61.6%, to $289.477 billion, from Dec. 31, 1998. Of that total, $67.01 billion was managed in U.S. index funds, up 77.8% from the year-earlier report.
During the past five years, index assets managed for non-U.S. pension funds have grown more than 300% from the $71 billion reported at the end of 1995.