Pension funds are sticking to their guns when it comes to indexing despite a drop in the S&P 500's performance relative to active domestic equity managers in the past six months.
Although many believe this is active managers' time to shine, pension funds are not looking to dump their indexed holdings.
Jim Bayne, manager of benefits, finance and investments at Irving, Texas-based Exxon Mobil Corp., plans to maintain his fund's 31% allocation to passive management.
"We had outstanding first half results with both stocks and bonds that we have indexed," Mr. Bayne said of the company's $8 billion defined benefit plan.
According to INDATA reports, for the first half of 2000, the S&P 500 index returned -0.5%. For the year ended June 30, it gained only 7.3%, while the median return of equity managers in the INDATA universe was 19.3%. The S&P 500 index ranked in the 68th percentile for the year to date and in the 71st percentile for the 52-week period ended June 30.
Exxon Mobil's pension fund has one of the oldest internally managed S&P 500 index funds in the country -- started in 1977 -- with $2.5 billion in assets as of June 30.
"When large cap is doing good, the S&P 500 will look good," Mr. Bayne said.
Until the first half of 2000, the index looked good indeed, returning more than 20% a year for the last five years.
But according to Pensions & Investments' research, index managers lost $5.5 billion of the $1.1 trillion in indexed domestic equity assets in the first six months of this year. It's uncertain how much the S&P may make up for its doldrums in the first half of the year; the index is up 8% for the 12 months ended July 27, but is still down 1.3% for the year to date.
So, index managers, consultants and their clients remain optimistic that time is on their side.
John Grady, principal and head of client services and sales at SSGA, has not noticed any of his clients changing their passive strategies.
He believes it would be a matter of years of underperformance of the S&P 500 index before plan sponsors would switch from indexing to active management.
"It's a cycle and that's how we are viewing it," said Craig Husting, chief investment officer of the $22.2 billion Public School Retirement System of Missouri, Jefferson City.
Officials believe the pension fund needs to be invested passively for the long term, Mr. Husting said. Right now, $2.4 billion -- or about 30% of the fund's U.S. equity portfolio -- is in an S&P 500 index fund.
At the $47 billion Washington State Investment Board, where the entire domestic equity allocation is invested passively, no changes are planned, said Nancy Calkins, senior investment officer.
The Olympia-based fund has $18 billion in a Wilshire 5000 index fund. That index returned 9.6% for the year ended June 30 and -0.84% for the first six months of the year.
Consulting firms haven't changed their advice, either, when it comes to indexing.
"It's really an uphill battle for an active manager to add value over time," said Jim Callahan, senior vice president and consultant in the San Francisco office of Callan Associates.
Although he has seen the interest in indexing wane as of late there is still activity in the area. He noted that on average, Callan's pension consulting clients generally have 50% to 60% of their domestic large-cap equities indexed.
Over the last five to seven years, it's been a tough proposition to advocate hiring more active managers because there have been lots of active large-cap equity structures that haven't worked, he said.
According to Mr. Callahan's research, about 50% of active managers were able to outperform the S&P 500 index last year. Most were large-cap growth managers.
For Ennis, Knupp & Associates clients, a 50% allocation to passive in a client's overall domestic equity portfolio is "a neutral starting point," said Steve Cummings, president and principal of the Chicago-based consulting firm.
More active managers will underperform over long periods of time, according to the firm's research.
"We like to see active managers performing well, but we don't expect the average active manager to beat the index over a long period of time," Mr. Cummings said.
Consultants like Messrs. Cummings and Callahan have seen increased interest in enhanced indexing, perhaps as some sort of middle ground between active and passive investment management.
Missouri's Mr. Husting in fact made the move to enhanced indexing about a year ago, funding the new $1 billion mandate from the fund's S&P 500 index fund.
John Krimmel, chief investment officer of the $12 billion State Universities Retirement System of Illinois, Springfield, is looking to increase the pension fund's allocation to an enhanced indexing program that invests in S&P 500 futures.
He expects enhanced could grow to half of the fund's $4 billion allocation to a Wilshire 5000 index fund. Right now the enhanced portfolio totals $900 million.
SURS trustees recently decided to index their entire domestic large-cap portfolio after terminating Fayez Sarofim & Co. as a large-cap growth manager and SSB Citi Asset Management Group as a large-cap value manager. The combined $595 million the firms managed was allocated to the passive portfolio managed by Northern Trust Quantitative Advisors.
"They (the active managers) did OK. They broke even gross of fees. One manager was a top-quartile manager. We just found that part of the market was pretty efficient," Mr. Krimmel said.
As enhanced indexing is gaining popularity with consultants and plan sponsors, it is increasingly promoted by a number of large firms that in the past were pure indexers.
Barclays Global Investors, San Francisco, is an example. BGI officials cite the increased interest in enhanced indexing to the increasing use of risk budgeting.
"In understanding the risk budgeting process, some of the active managers should be enhanced index managers," said Larry Tint, vice chairman at BGI.
Risk budgeting is essentially allocating assets by assessing which portfolios hold more risk over time.
Index funds generally are used in asset classes where alphas (the amount of return above the benchmark of the asset class) won't be as high among the managers, said Mr. Tint.
Tony Ryan, principal and head of U.S. sales at State Street Global Advisors, Boston, agrees that plan sponsors are looking to spend their risk in areas other than large-cap stocks.
"The probability of success in large-cap active management has been modest," said Mr. Ryan.
Some of the recent performance of the S&P 500 index has been more of a reversion to the mean. Mr. Ryan said typically, the S&P 500 would be in the 40% percentile in the INDATA report.
And while the index has been in the top quartile in recent years it is generally near median relative to the performance of active equity managers overall.
SURS' Mr. Krimmel is still keeping a watch on the active managers his fund's board terminated. "I know they both had a good second quarter," he said.
He added he will continue to watch their performance. Overall, he will be interested in what happens to the indexing trend in the next two or three years.
