Diversity of the US market
The US market was not a monolithic market where everything was priced fully to reflect the information available, according to John Norris, chief investment officer of the National Benefit & Pension Funds for health and life science workers, in New York. “The market continuously over and under-reacts to events.”
He was one of three pension fund managers that spelt out their different approaches to indexing portfolios at the recent World Cup of Indexing, held in Switzerland, by Information Management Network.
Pointing to his $5bn (E4.5bn) fund’s experience, he said that the equity portfolio had been constructed as an ‘en-hanced equity portfolio’, mixing active and passive in different degrees, to re-flect the different market inefficiencies.
“The results we have achieved so far is that the small cap market is very inefficiently priced and we have generated positive alpha in excess of 500 basis points at this end of the market. In the mid cap segment it is 350bps of positive alpha over and above the mid cap benchmark.” Even on the indexed and indexed plus sections a small return of over 50bps had been obtained over benchmark.
He concluded that “active management has positive pay out in selected areas”, with the small and mid-cap portfolios producing returns well in excess of the costs of producing these results. “Certainly the large cap segment of the US market is very efficiently priced, so we will be increasing our allocation on either a passive or structured basis.”
Norris said that this was possible for funds up to $10bn in his view, over that the portions indexed would be higher. “It is an awesome amount of work to come up with asset managers who outperform, track them to see they are not getting too much in assets under management and so reducing their alphas.”
On the fixed income side, he did not regard the full market so efficiently priced that the fund should be passively managed here.
William MacDougall, who is director of Lucas Varity Fund Management, the in-house manager of Lucas Pension Fund, a UK-based scheme with E5bn, explained the fund’s distinctive approach, in managing its portfolio two thirds passively on a mainly in-house basis. “But we go active where we think it is appropriate to do so and in the UK, we do that for one third of the domestic equities, where we think there is local knowledge we can exploit. Our track record is very good here.”
The overseas developed market are done on a passive basis in-house, since the fund does not have any useful knowledge here. Around E2bn of UK equities and E1bn of overseas equities are managed internally on an indexed basis. “We do it in-house where we think we can do it cost effectively, but part of the reason for that is that we have around E1bn of active UK equities.” Recently, the fund decided to go external for emerging markets, as even on an indexed basis too much local knowledge and trading ability was required.
“Our conclusion is that indexation can be done internally, but whether or not you want to do so, will depend on how large your funds are and the level of skills internally. Be active where there are inefficiencies to be exploited,” said MacDougall.
The issue of the costs involved in active management were emphasised by Christoph Schenk, president of ABB Vorsorge, which is providing pension services to funds in Switzerland. He said the issue was frequently that of obtaining less than passive returns for active fees. “We believe in passive management, but that does not mean that it is right in all circumstances.” Rejecting the notion that there was something “cowardly”, about taking the passive route, he noted: “The decision to go passive is an active decision.” As was the need to make asset allocation decisions, and area where active managers had also destroyed value.
On the question of internal versus external management, he said that it was often a matter of costs. “In our foundation we do not manage portfolios on our own, as it was largely a matter of costs. When we go external we have five or six basis points of costs. That is where we feel really can get the value is in the cost levels.”