Institutional investors are fleeing to the relative safety of stock index funds, shunning active managers, according to managers and consultants. But whether the shift to passive will last is questionable.
According to passive managers, increasing institutional investment in index funds, which started roughly two years ago, spiked in the second half of this year especially after the bankruptcy of Lehman Brothers Holdings Inc., New York, in mid-September.
We saw very, very large flows into traditional indexing said Carter Lyons, principal and strategic account manager at San Francisco-based Barclays Global Investors, whose most popular index strategy this year has been the Russell 1000 index fund.
Paul Trickett, European head of investment consulting at Watson Wyatt Worldwide, Reigate, England, said in a news release that 2009 will see more pension funds matching their investment strategies with their governance capabilities, by either simplifying their strategy or raising their game. This will result in an acceleration of certain funds moving toward lower cost, passive solutions.
Gerard Mullane, principal of Vanguard Group Inc.'s institutional investor group, Malvern, Pa., added that pension funds are boosting allocations to equity index portfolios as a way to rebalance.
Pension funds recently shifting assets to index strategies from active ones include:
• Illinois State Board of Investments, Chicago, which terminated Amalgamated Bank from a $333 million enhanced Standard & Poor's 500 index fund and moved the assets to an existing S&P 500 index fund managed by RhumbLine Advisers Corp., Boston. William R. Atwood, executive director of the $11.2 billion system, said the shift was permanent, and was generated by a general lack of confidence in the value proposition of enhanced indexing;
• The $15.8 billion San Francisco City & County Employees' Retirement System, which increased its internal S&P 500 index fund to 32% of its $4.2 billion domestic equity allocation. David Kushner, deputy director, said the shift was a tactical move to reduce the fund's overweighted small-cap exposure and didn't reflect a bias toward passive management. He said he doesn't know whether this shift would be temporary or permanent; and
• The $9.9 billion Hawaii Employees' Retirement System, Honolulu, which terminated four active domestic equity managers, moving a combined $684 million in assets to two Russell 1000 index funds managed by Mellon Capital Management, San Francisco.
Arlene Rockefeller, executive vice president and global equities chief investment officer at State Street Global Advisors, Boston, agreed the net inflow into plain-vanilla index funds is significant.
Clients find index funds more attractive now because they want to lower their investment risks while still having the market exposure.
Ms. Rockefeller said 60% of the new investments came from new clients. She added that existing clients also are looking to lower their risk exposure and to shift away from riskier active strategies.
Money managers and consultants said poor investment returns are hurting active managers. They said billions of dollars will continue to flow into index funds early next year, much of which will be domestic and international equities but also might include other asset classes.
People are liquidating their actively managed funds now, said Mark A. Keleher, global head and chief executive officer of Mellon Transition Group, a division of Bank of New York Mellon Corp., New York. He said investors are moving into pure stock index funds because of their transparency, lower cost and broad diversification. They are very good ways to get exposures, he added.
The shift to passive portfolios might be a short-term reaction to weak active management performance, consultants said.
Michael A. Rosen, principal and chief investment officer of Angeles Investment Advisors LLC., Santa Monica, Calif., said it has been a challenging year for active managers and investors naturally place their investments in index funds as they are reallocating across asset classes and managers on temporary basis.
Theodore L. Disabato, principal at investment consultant Disabato Advisers, Chicago, said the shift to passive could be the result of the fear of the straw that broke the camel's back.
The last thing (investors) needed was another money manager to screw up their portfolios, he explained. Mr. Disabato said when investors believe they cannot be protected from the risk, they at least want to control the tracking error risk. Ultimately, when the market settles down, the investors will go back to the old ways.
However, the bear market is aiding index funds, where their performance typically outshines those of active managers.
Added Vanguard's Mr. Mullane: People are more willing to pay active managers in a bull market.