The events of 11 September did not shock the pension funds of New York City’s firefighters, police officers and other municipal workers as deeply as the Enron bankruptcy is now affecting them. Not only have the five NYC pension funds lost $109m (e124m) in Enron investments, but this loss – added to $25m in Kmart stocks – is making their managers rethink the whole investment strategy.
That is what new City Comptroller William Thompson, who took office on 1 January and is responsible for the funds, recently declared. In fact the $77bn city pension system was heavily committed in Enron and Kmart stocks only because these two companies were included in the index funds in which it invests.
Index funds that track the whole stock market or segments of it grew more and more popular in the 1990s among US pension funds. The NYC funds have followed the trend: in recent years they have invested more money in this passive way, rather than with active managers, who are more expensive and historically find it very hard to beat the market.
But, after two years of market downturn and the collapse of huge companies like Enron and Kmart, active management is likely to regain appeal. “Index funds charge smaller fees than actively managed funds and many have done well over time,“ says Thompson, “but they lack aggressive or active managers, who will say ‘Oops, look at this’ and bail out of a situation if it deteriorates”.
The city comptroller serves as investment adviser and custodian to all five NYC funds. He announced he would speak to the trustees of all five about the possibility of relying less on indices and on looking for long-term active investments. In the meantime, the city system is joining forces with other big American public retirement funds, burned by losses on Enron, to play a lead role in the shareholder lawsuits against the company.
Together, public pension funds are believed to have lost anywhere from $5bn to $10bn when Enron’s stock collapsed, suffering an estimated 10% of the total losses. Among the biggest losers were the Florida state retirement system, which lost an estimated $306m and the state pension funds of Ohio, Washington State, Georgia, which saw $250m disappear in Enron’s stock plunge, according to the Ohio Attorney General’s office. All these pension systems owned Enron stocks through index funds, but so far their managers have not announced any change of investment strategy.
On the contrary two of Canada’s biggest public sector pension funds have already announced a move away from their passive investment strategies, saying that index funds are a lot riskier than originally thought. The Ontario Teachers Pension Plan Board and the Canada Pension Plan (CPP) Investment Board are questioning long-held assumptions about index funds, especially after they lost a lot with the decline of Nortel.
The $473bn teachers’ fund, which is Canada’s second-largest pension fund, has about three-quarters of its Canadian equity portfolio invested in index funds tied directly to the Toronto Stock Exchange. The latter is dominated by a small number of companies which account for a huge proportion of overall market capitalisation. Up until July 2000 almost one third of the whole market was made up of just of one stock, Nortel Networks Corp, a telecom company whose shares were then listed at $123 and are now down to about $12. The teachers’ fund owned $37.8m in Nortel shares, its biggest single equity investment.
“The lesson we’ve drawn from that is if you think you are controlling risk by saying, ‘Well, we are just passive investors in a market index’, you’re dreaming,’’ says Leo de Bever, Ontario Teachers’ senior vice-president of research and economics. Keith Ambachtsheer, president of Toronto pension consulting firm KPA Advisory Services, stresses the same point: “We kind of lulled ourselves into a state of mind that you could put a large part of the system on automatic pilot. That was a good model through most of the 1990s. It’s now become dysfunctional.”
The CPP Investment Board has recently started actively managing its $12bn equity portfolio. It hired Goldman Sachs investment banker Donald Raymond last September to help develop its thinking on active investing.
The new trend is encouraged by consultants like Irshaad Ahmad, head of William M Mercer’s Toronto investment consulting division, who at the 10th annual “Fearless Forecast” conference in Toronto this year said that over the next 10–20 years equities are expected to produce single-digit annual returns and possibly “low single-digit returns”. In this new environment, Ahmad said pension plan sponsors that had used lower-cost passive or index-based investment strategies would shift back to either enhanced index or fully active approaches.

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