Enhanced indexed assets shot up by more than 30% among the nation's largest pension plans during the 12 months ended Sept. 30, while passively managed indexed assets continued to increase but by a more leisurely 9% during the same period.
While total assets dedicated to enhanced index investments is much lower than in traditional passively managed index funds, the percentage gain for enhanced strategies in 2000 was impressive. (Enhanced strategies offer investors several basis points over selected equity and bond benchmarks, generally through the use of derivatives or stock selection strategies.)
Total defined benefit indexed assets reported by the top 200 pension plans in P&I's survey grew to $878 billion during the 12 months ended Sept. 30, up from $805 billion the previous year. Indexed equities grew 9% to $743 billion, and indexed bonds, 10% to $135 billion.
But enhanced index investments in defined benefit plans surged 30% to $131 billion during the 12 months, from $100 billion the previous year. (The survey asked only for total assets, total equity and total fixed income in each strategy; it did not break out assets between international and domestic investments.)
The shift to enhanced index strategies is even more pronounced in the 10 plans reporting the most in enhanced indexed assets.
The top 10 funds alone saw enhanced index investments grow 38%, to $73 billion during the 12 months ended Sept. 30, up from about $53 billion the year before. Nine of the funds that were in the top 10 last year are also on this year's list. The Virginia Retirement System, in 10th place this year, moved up one spot from last year.
Enhanced bond indexed investment was up by 65% to nearly $34 billion from $20 billion a year earlier, a relatively small amount when compared with total indexed assets. Enhanced equity investment increased 21% to approximately $97 billion during the 12 months.
Indexed investments among the top 200 funds with defined contribution plans grew 14%, to $157 billion for the 12 months ended Sept. 30. Equity indexing among defined contribution plans increased 16% to $148 billion, while bond index investments declined to $9 billion, a drop of 9% from $10 billion the prior year.
The move toward enhanced indexing might be a further sign that plan sponsors are growing impatient with active managers that fail to beat their benchmarks over the long term, while seeking a few basis points of additional return over the benchmark.
"For the last five years (active) asset management has had a tough time beating the S&P 500," said Louis Finney, investment consultant with William M. Mercer Inc., Chicago. "A lot of plan sponsors are throwing in the towel and trying something less risky relative to their benchmark," he said. "A lot of it could be due to frustration during that period."
Another factor that might be prompting interest in enhanced indexed investments is "a greater sense of risk control by plan sponsors looking at tracking error more closely," he said. "But they still want to give asset management a shot."
Mr. Finney said he has seen increased interest in enhanced index investments, especially among large plans. But not everyone agrees.
"I don't make a lot out of it," said Howard Pohl, consultant at Becker, Burke Associates Inc., Chicago. "It gets down to a very fine line sometimes when discussing enhanced indexing and how it differs from traditional (passive) indexing. You might find some plans moving to enhanced indexing because their existing index managers are saying that 'we can do this too.'"
The $65 billion State of Wisconsin Investment Board, Madison, shifted almost $7 billion to an enhanced equity portfolio with existing index manager Barclays Global Investors, San Francisco, during the year to improve returns, said Brian Heimsoth, quantitative risk analyst at the Wisconsin fund. It had nearly $6.8 billion in enhanced equity index strategies as of Sept. 30, up from $474 million the year before.
"We moved a large amount from a passive S&P fund to an enhanced equity fund, an enhanced alpha tilt in our domestic equity allocation," he said. "This is a slightly enhanced approach, which we believe will add value from an active management standpoint."
The $106 billion State Board of Administration of Florida, Tallahassee, moved $2.6 billion into an enhanced fixed-income strategy from its internally managed active core fixed-income portfolio. Barbara Jarriel, chief of fixed income, said the move was made to further diversify the fund and was part of a program to apply a risk budgeting approach to several asset classes.
She said the assets were shifted to two existing managers in a risk-controlled mortgage pass-through approach using the Lehman Brothers Mortgage index as the benchmark.
"It was a question of where do you get the biggest bang for the buck in a risk-controlled portfolio," she said.
Shift of $5 billion
The $13.4 billion Kentucky Retirement Systems, Frankfort, shifted nearly $5 billion to enhanced indexed strategies from traditional passively managed indexed assets during the 12 months ended Sept. 30. The fund reported $7.4 billion in total enhanced indexed strategies as of Sept. 30, up from the $1.2 billion reported a year earlier. Enhanced equity strategies as reported by the fund rose to nearly $6.3 billion from $1.2 billion and enhanced bond strategies, at close to $1.2 billion, apparently are new. Officials from the fund could not be reached for comment.
Not for everyone
Not everyone was moving into enhanced indexed investments. The $32 billion Public Employees Retirement Association of Colorado, Denver, eliminated most of its enhanced equity index investments and shifted nearly $2.4 billion into passively managed index equity investments in the 12 months ended Sept. 30. A fund spokesman said the plan shifted assets from an options investment portfolio into indexed equities.
Several funds also made major commitments to traditional passively managed indexed investments during the year.
The $4.8 billion Orange County Employees' Retirement System, Santa Ana, Calif., more than doubled its total indexed assets to $1.2 billion during the 12 months ended Sept. 30 from $593 million the year before. Farouki Majeed, chief investment officer, said the fund now has about 20% of its assets indexed.
"We think that (indexed) exposure was a reasonable portfolio for the return characteristics and compared favorably with active (management)," he said.