Index assets, both passive and enhanced, climbed significantly in the first half of 2000, and for the first time since 1997 substantially outpaced market gain, Pensions & Investments' six-month update of index assets shows.
U.S. institutional tax-exempt index assets rose to $1.68 trillion as of June 30. Domestic index equity makes up 74%, or $1.243 trillion of these assets, and grew a market-adjusted 5.3% for the six months -- despite the twists and turns of the stock market in the first half. The Standard & Poor's 500 stock index dropped 0.49% for the period.
On a market-adjusted basis, that would put overall index assets up 9.1% from those reported as of Dec. 31.
One of the reasons for the big jump is that two new managers -- J.P. Morgan Investment Management Inc. and Merrill Lynch Investment Managers, both of New York -- are included in the survey, adding more than $67 billion in institutional tax-exempt assets to the database. J.P. Morgan's $48.14 billion in enhanced equity index and Merrill Lynch's $19.1 billion in domestic equity and enhanced international equity are now included in the survey.
When comparing just the largest managers who reported in the last survey, institutional tax-exempt assets are still up appreciably, gaining 4.7% on a market-adjusted basis, bettering the gains of the second half of 1997, when the S&P 500 gained 13.56% for the six months while index assets grew 4.4% on top of that. The last half of 1997 had been the strongest six-month growth period since 1991 on a market-adjusted basis. (While the totals given in this story include the Morgan and Merrill figures, the comparisons to previous periods do not.)
J.P. Morgan, well known for its traditional active management, has been managing enhanced index assets since 1989 but hasn't reported in this survey previously. In a story on enhanced index fund managers in 1995, J.P. Morgan had $8 billion in its two enhanced strategies; that has grown to more than $48 billion.
Bernard Kroll, portfolio manager, structured equity group, credits part of that growth to the spectacular returns of the S&P in the past few years.
The key to J.P. Morgan's securities selection strategy is its fundamental stock research -- the same research it uses for its active management, said Mr. Kroll. A computer-based optimization process is overlayed to control risk. "It's like adding your chocolate to my peanut butter." said Mr. Kroll. "We use humans on the front end and a quantitative optimization model on the back end to build the portfolio."
A typical enhanced index fund has a tracking error of less than 2% and is designed to control risk. Of J.P. Morgan's two main strategies, its research enhanced index has a 1% tracking error, and its structured stock selection is more aggressive, with 1.5%.
Although J.P. Morgan has been involved in enhanced indexing for 11 years, Merrill Lynch's Quantitative Advisors group is just over a year old. In July 1999, a five-person indexing investment team left Deutsche Asset Management, New York, to start up the quantitative business unit at Merrill Lynch.
As of June 30, the Merrill Lynch quant group managed $44.6 billion in index assets worldwide, $29.8 billion of that for U.S.-based clients. For U.S. institutional tax-exempt clients, Merrill Lynch manages $19 billion, all of that for defined benefit plans.
Soon after its inception, according to P&I data, Merrill Lynch's quant group was hired by Georgia-Pacific Corp., Atlanta, to manage an international enhanced index portfolio for its defined benefit plan. In the first six months of this year, it has been hired by the four plans in the New York City Retirement System to manage Russell 3000 index portfolios for each, and the Springfield (Mass.) Retirement System for an S&P 500 index portfolio.
Fastest growth rate
Although domestic equity dominates indexing, U.S. institutional tax-exempt index bond assets grew at the fastest rate. For the six months ended June 30, index bonds gained a market-adjusted 6.5% compared with the last six months of 1999, growing to $261 billion. The Salomon Smith Barney Broad bond index returned 3.92% for the same period.
International index equity dropped for the third consecutive six-month period. Assets were $173 billion, down 3.4% when adjusted for the 3.95% drop in the Morgan Stanley Capital International Europe Australasia Far East Index.
International bonds -- the smallest asset class in the survey -- grew to just more than $2 billion from $469 million reported on Dec. 31. Assets in this class have tended to vary dramatically over different time periods, in part because a gain or loss of a client can substantially affect so small an amount of assets.
The top five managers of passive and enhanced index assets make up 69% of the institutional tax-exempt assets reported in this survey. Barclays Global Investors, San Francisco, continues as the largest manager of index assets with $525.6 billion; followed by State Street Global Advisors, Boston, with $337.4 billion. TIAA-CREF, New York, with $110.7 billion; The Vanguard Group, Valley Forge, Pa., with $92.7 billion, moved up from fifth on the list, followed by Deutsche, with $92.3 billion, which fell out of the top three managers for the first time.
Total worldwide index assets grew to more than $2.442 trillion, up 5.8% for the period. Unlike the assets for U.S. institutional clients, worldwide index assets had their strongest gains in years in non-U.S. equity assets, which grew to $460 billion, up a market-adjusted 10% from the previous period, and international bonds, with more than $52 billion in assets, up 22%.
Spotlight on enhanced
Enhanced indexing is gaining attention from U.S. plan sponsors, with assets growing 6.3% to $387 billion in the six-month period. Enhanced domestic equity grew the fastest of all domestic equity categories, up 10.2% to $284.5 billion. Enhanced index assets make up 23% of the assets reported. While passive indexing is generally a core strategy, enhanced indexing strategies often are used to capture incremental returns from segments of the market.
Other findings include:
* Index funds managed through mutual funds grew steadily, though more slowly than in the final months of 1999. For the first half of the year, index mutual fund assets were up 5.9% to $440 billion. Vanguard, with $238.7 billion, continues to lead managers in this category, followed by State Street Global, with $40.4 billion, and Fidelity Investments, Boston, with $38.5 billion.
* Defined benefit assets account for about $1.023 trillion of the total U.S. institutional tax-exempt index assets, up about 8% from a year earlier. Defined contribution plan assets in indexing are up 7.3%, growing to just more than $409 billion in the 12 months. These rates are not market adjusted.
* For the first time, P&I asked managers surveyed for a sampling of the fees charged to institutional tax-exempt clients for passive and enhanced index strategies. The categories address only the account size range and whether the portfolio is a passive or enhanced index fund. Managers were asked for a representative range of fees charged for particular account sizes, those responses were averaged.
In a passive equity account of $10 million to $100 million, fees ranged from 7.6 to 13.8 basis points when all manager responses were averaged. The median fee for the same managers ranged from 7 to 10 basis points. The fee range for the average enhanced index equity account of $10 million to $100 million was 23.8 to 38.9 basis points.