Despite the market turmoil that caused many asset classes to shrink, enhanced indexed assets managed healthy growth in the year ended Sept. 30, according to the annual Pensions & Investments survey of the largest employee benefit plans.
Enhanced indexed assets in defined benefit plans among the top 200 increased 28%, to $133 billion as of Sept. 30, from $104 billion a year earlier. Enhanced indexed equity assets increased 23% during that time, to $91 billion, while enhanced bond assets grew 41%, to $42 billion.
An unprecedented three years of negative returns in the stock market, the muddled outlook for capital markets in general and increased attention to risk budgeting in the face of market uncertainty sharpened interest in enhanced strategies, according to industry experts.
Plan sponsors boosting or initiating allocations to enhanced indexed assets include Sprint Corp., Overland Park, Kan.; Virginia Retirement System, Richmond; World Bank, Washington; New Mexico Educational Retirement Board, Santa Fe; New York State Teachers' Retirement System, Albany; BellSouth Corp., Atlanta; and the Public Employees Retirement System of Ohio, Columbus.
The increased allocation to enhanced indexing was not huge in dollar terms when compared with the $2.5 trillion in defined benefit assets reported by the top 200 sponsors. But the marked increase in enhanced strategies indicates that plan sponsors are searching for controlled risk in attaining benchmark returns, according to some industry sources.
A matter of classification
The increase in enhanced index strategies at some plans wasn't entirely due to additional assets flowing into the strategy, but to how plan sponsors now classify some of their managers.
This was partly the case at IBM Retirement Funds, Stamford, Conn., which indicated a 133% increase in enhanced indexed bonds on the P&I survey, to $3.3 billion. However, R.L. "Jay" Vivian Jr., assistant treasurer and managing director at IBM, said the increase was not that dramatic. "There is sometimes a question in how you define 'enhanced,'" he said. Nevertheless, Mr. Vivian said enhanced strategies play a significant role in the IBM portfolio: "We like it, we think it is a good way to spend your risk."
Sprint Corp.'s $2.3 billion defined benefit plan reported an increase of more than 100% in enhanced equity assets, to $363 million, which came after a restructuring of its domestic equity portfolio in the fourth quarter of 2001, said William N. Searcy Jr., pension and savings trust officer.
He said the portfolio, managed by Pacific Investment Management Co., Newport Beach, Calif., performed well initially but was hurt by the market downturn in 2002. "The pop came at the end of 2001, but net/net, it was still negative." The increase in enhanced equity assets at the end of 2001 "was an opportunity for us to increase our risk controlled domestic equity portfolio relative to actively managed," he said.
The $66.4 billion New York State Teachers' Retirement System boosted its exposure to enhanced index strategies to $2.5 billion in 2002, according to the P&I survey, from $870 million the previous year, said plan spokesman Dave Daly, by shifting assets from passive indexed assets to enhanced. "The board made the decision in January to increase the allocation to enhanced indexed equities ... to increase the potential returns on our passive portfolio," he said.
Ava Williams, principal and member of the product engineering team for enhanced products at State Street Global Advisors, Boston, said there has been a substantial increase in interest by plan sponsors in tighter risk controlled investment strategies such as enhanced indexing. She said SSgA added between $10 billion and $15 billion in new enhanced business in 2002.
Kathy Taylor, managing director at Barclays Global Investors, San Francisco, which has more than $50 billion in enhanced indexed assets under management, agreed sponsors "are starting to focus more on the risk characteristics of their portfolios. In a bull market, even if you underperformed the benchmark slightly, you were still in positive territory. When the markets turn negative, risk matters a whole lot."
Concerns about meeting actuarial earnings rate assumptions also have sponsors looking more closely at enhanced indexed strategies, said Russ Kamp, product manager at INVESCO Senior Secured Management Inc., a division of the London-based AMVESCAP structured products group, New York. "A 1% enhancement over a passive portfolio can make the difference in meeting or beating your actuarial assumptions," he said.