Indexing still on growth track
According to the 2000 Greenwich Associates’ report on investment management in continental Europe, 12% of pension fund assets are passively managed and this is set to rise to 16% within three years. The report also concludes that, for institutional assets exceeding E125m in total, the percentage of funds passively managed will rise across the board over the same period. This trend seems reiterated by those responding to the survey and, of the 19 offering passive management, 15 felt it was a growth area.
State Street is one of the largest indexers in Europe with E38.5bn assets under management, 78% of which are passively managed. The company scored a coup when a couple of months ago it won the mandate to run Sweden’s 7th AP fund. The size of the mandate is unclear at present since it is unknown what percentage will opt for the default fund but the total is expected to top Skr20bn (E2.3bn). Richard Grottheim, executive vice president at the 7th fund, says the portfolio will be completely passively managed from the outset but that they will eventually appoint some active managers.
Passive management also simplified the 7th Fund’s launch by minimising the number of transactions. Grottheim says the logistics of hiring a passive manager are easier than for an active manager as there are fewer around. “There are only about ten or fifteen that can supply this kind of product. When it comes to active mandates the process of choosing an active manager is longer,” he says. In Sweden only 9% of institutional assets are passively managed and according to Greenwich, this is likely to stay the same over the next three years.
Diversification, often listed as one passive management’s attributes also played a part in the decision. “In order to get exposure to the all the markets that we should have, it was better to go with a passive mandate,” he says. The decision to run all the assets passively was not due to the belief that passive is better then active management. Consultant Mercers helped the 7th fund ran an extensive analysis of the suitability of markets for passive management by looking at past performance, liquidity and market structure.
Some of the markets analysed were more suited to passive management than others. Many of the survey’s respondents not providing passive management gave market inefficiency as the reason and it appears some markets are more efficient than others. For example the 7th fund concluded the US market was better served by a passive manager, a significant decision given 36% of the overall portfolio will be in American equities. Grottheim says the performance of managers even in the upper quartile during the last 10–15 years haven’t performed as well as you would have expected to add value. “The US market is well-informed, it a free market with a lot of players, good liquidity etc (talking large caps). It’s hard to add value in that market for an active manager.”
In Sweden there has been a pick up in hiring passive managers. Although the supply of passive managers in the market is limited, Swedish investors investing abroad tend to hire passive managers. Grottheim says the reasons are simple – it’s cost effective and in some markets it’s difficult to beat the index.
Switzerland is one of Europe’s leaders in passive management, with 26% of institutional assets passively managed and this set to rise to 34% within three years according to Greenwich . Daniel Gloor, head of asset management at the Kanton of Zurich pension fund, has indexed for years and says 72% of the funds’ Swiss equities are passively managed, as are 71% of foreign equities.
At the beginning of the 1990s, the passive active split for Swiss equities was 50-50. The proportion passively managed is pretty consistent and has been for the past five years. Gloor says returns in the Swiss market have been very good for passive managers. “In Switzerland returns were better over the past 10 years on an indexed basis. There were very few managers who beat the market … in the long run, and I always think in terms of five to 10 years it’s very difficult for an active manager to beat the market on a cost basis and on a risk-adjusted basis,” he says.
The UK’s attitude to indexation is similar to Switzerland and according to research by Phillips & Drew, 20% of the UK’s pension fund market is now passively managed. Its pension fund Indicators 2000 report says that over extended periods active managers have, on average, failed to outperform market indices. Figures published by the UK’s National Association of Pension Funds show over £72bn (E123bn) in private pensions and £17.1bn in public funds are passively managed in 1999. Corresponding figures for 1997 were £42.5bn and £15bn.
Citigroup pension fund, with total assets of £550m (E937m), changed earlier this year when it transferred a £240m active mandate from Mercury and split it 50/50 between Deutsche Asset Management and Barclays Global Investors. Deutsche will continue to run the assets actively but the £120m BGI mandate is passive. The decision to go passive was made by the trustees on the advice of consultants Bacon & Woodrow after disappointing performance by Mercury.
Gloor at the Kanton of Zurich also says economies of scale affect the decision to go passive. Smaller funds don’t have the resources to employ numerous specialist managers and when active managers are failing to outperform across the board, passive management is an attractive alternative. Greenwich Associates’ report estimates the percentage of funds between E125m and E250m that are passively managed will increase from 22% to 46% in the next three years. The large passive managers like State Street, BGI and Legal & General will be relishing the next few years.