The trend towards passive management is unstoppable, judging by the results of this month’s Off the Record survey. The overwhelming majority of respondents are taking the indexation route and seem more than satisfied with the results. Many have found active managers failed to live up to expectations. But the dissenters are just as forceful in their views
To be passive or not to be passive is the question we posed for this month’s Off the Record.
And the overwhelming answer from pension fund managers surveyed is a resounding ‘yes’, with high levels of satisfaction expressed by most in the passive market.
However, such zeal for indexation is matched by ardent views against amongst the minority of responding funds that have no passive exposure whatsoever and appear unlikely ever to go the way of the index.
Almost three quarters of Off The Record respondents are already indexing portfolios, some since the early 1980s, but most having gone the passive route from the early to mid 1990s onwards.
Faith in the passive cause, though, has its dabblers as well as its devotees. Some funds are allocating more frugal portions of between 3 and 10% of their portfolio. Others are indexing with a no-holds-barred approach and hurdling the 90% barrier.
One fund says it indexes 93% of its assets, although the average allocation of respondents with passive funds comes out at just under a third of the fund.
Unsurprisingly, the majority of pension funds’ passive portions are in the domestic market, with some schemes still dedicating their entire portfolio to the home country and the rest keeping for the most part 10–50% in their own backyards.
Non-domestic European equities do not appear to have many passive takers, with most funds having little or no indexed exposure, despite a couple of schemes committing more than 50% to this asset class.
The story is similar for US equities, although other equity regions. such as the Pacific, or asset classes. such as property and cash. are being addressed through passive chunks of 5–30%.
In terms of fixed income the message seems to be either do it extensively – with a small number of funds registering levels of above half of their passive portion – or don’t do it all, with the remainder negating or holding minimal fixed-income positions.
Cost is the main factor turning funds on to passive, according to respondents, followed closely by the adoption of indexed portfolios as part of a core/satellite investment approach. One manager described passive management as an easy way to implement its strategic asset allocation plan.
Significantly, though, there appears to be explicit evidence of a trend amongst funds to merely match the index in their returns. Just under half of the passive users said they were ‘happy’ to do so.
Furthermore, pension fund managers say they are also making such decisions off their own backs without the need for trustee involvement or consultant recommendation.
And while around a third of managers felt it would be useful to have consultant help in setting up a passive portfolio, the figure dropped back to under 5% who felt a consultant would be necessary to actually run the passive portfolios.
Just as fundamental though in the switch to passive is the lack of belief in the claims of active managers. Over half of the managers tracking indices say they do not feel active houses can deliver above-index returns over a reasonable time frame. As one manager firmly puts it: “We could not find an active manager who could consistently beat the index.”
Another comments that the fund’s passive manager is the ballast for its more errant active mandates: “One of our three domestic equities managers got an index mandate and the other two remained active. We accept a higher tracking error for the two others.”
One thing is certain, though, the passive tide is swelling. Three quarters of respondents report that the investment trend is definitely towards indexation in their domestic markets around Europe. And not many managers are looking to jump ship at present, at least while the ride continues to run smoothly onwards and upwards.
Over 60% of the funds say that since beginning indexing they have upped their allocation levels – a convincing endorsement for passive managers. A solitary manager in the survey has moved from a pure passive to a tilt structure.
Almost all these passive mandates are being outsourced, bar a single fund that manages its own portfolios and a minority of others that share the job with their investment manager.
The highest number of index managers appointed to a single fund is five, with an average of two per fund. Barclays Global Investors, State Street Global Advisors and Invesco appear to be the managers setting the pace among the funds surveyed, picking up several index briefs apiece.
Tellingly for these managers the reassuring message is that once a passive manager is selected it is exceptional for them to be dropped in favour of another.
Around 75% of the pension fund managers say they have stuck with the same manager ever since adopting the passive approach.
However, the warning signs are there that should a manager slip in its competitive ability then funds will change their set-up. The quarter of respondents that have switched mandates clearly focus on “pricing reasons” and management fees becoming “too high against the competitors”.
As one manager points out though, it is not always the client who changes the asset manager: “They changed us. Bankers Trust sold their passive business to Invesco, but we stayed with the new manager.”
The real worry for active managers has to be the overwhelming response of all the responding funds currently operating a passive strategy that they are satisfied with the service they are receiving.
Not a dissenter was to be heard and almost all parties noted that tracking error and costs were exactly as expected.
Appropriately, the praise for passive managers is glowing: “They do what we want with no surprises,” “Performance is good,” “There are a range of countries in which they can manage money for us,” are just a selection of many comments.
All the passive users who responded to the question also felt that in the event of a bear market their fund trustees would not desert the index approach.
However, the quarter of surveyed pension funds not using indexation are certainly not passive in explaining their reasons why.
As one manager assertively explains: “We do not want to follow the herd and consider active management too risky. For example, in the US the performance of the S&P 500 index is made by 10 large growth cyclicals which gained 34% and 490 cyclicals which gained 0.5%. I also believe that when we move to a bear market active management will perform even better.”
And one comment notes: “I do not see the added value. We manage 11 active mandates today and the aggregate risk is lower than the composite benchmark while the performance, net of fees, is even a little better than the benchmark.”
Some funds are considering adding a passive tranche, though, citing strategic asset allocation recommendations: “A combination of balanced active, specialist and passive managers is seen as likely to provide an optimum combination of risk and return.”
Another manager adds that the fund is still “mildly” in favour of active management but that “times and markets aren’t changing” so passive was possible for a part of the portfolio.
One manager, however, emphasising his faith in active management with an exclamation mark when confirming the fund would never switch to passive, sums up the debate succinctly: “Active or passive is a question of belief.”
“All the scientific time series which show the outperformance of one or the other style are well selected time windows used as sales arguments.”