As more evidence mounts against active managers, institutions continue to switch back to passive strategies. A survey of US institutions by Market Strategies International showed, while the majority of institutional assets are currently actively managed, 39% of corporate pensions and 11% of tax-exempt institutions plan to decrease their holdings in actively managed US public equities over the next few years. Respondents cited concerns about fees as their main reason for seeking passive investments.
Analysis of the cost savings available by switching to passive look compelling.
Hymans Robertson produced a report for the Department for Communities and Local Government which concluded The Local Government Pension Scheme (LGPS) could save £230m per year through greater use of passive investment, or “trackers”, for listed equities and bonds without damaging investment performance. For the LGPS in aggregate, equity performance for most geographical regions has been no better than the index before fees.
The report states: “This outcome is consistent with wider international evidence which suggests that any additional performance generated by active investment managers ( relative to passively invested benchmark indices) is, on average, insufficient to overcome the additional costs of active management.”
Greater use of passive investment would also reduce turnover costs, according to Hymans Robertson, which calculated the LGPS would have saved around £190m in reduced turnover costs as a result of investing passively in listed equities. Furthermore, the one-off transition cost of moving to passive management (estimated to be around £215m) is no more than the hidden additional turnover costs incurred in active management, and would be saved in a single year.
THE ‘WRONG’ REASONS
However, some experts have raised important questions about the research and, therefore, the validity of its findings.
In its response to the government’s consultation about the Hymans Robertson report, bfinance argued the report lacked vigour and accuracy. In particular, bfinance drew attention to issues regarding benchmarks, fee calculations and the dangers of looking at recent history to determine the best course of action for the future, all of which materially impact the findings of the report.
According to bfinance, if the appropriate benchmarks against which most active mandates are managed were used (e.g. MSCI instead of FTSE outside the UK), the outperformance of active management increases by over 50 basis points (bps) on average across equities over 10 years.
“The benchmarks used in Hymans Robertson’s analysis for active managers were heavily generalised and in some cases not representative of those used by active managers,” says Chris Jones, managing director at bfinance. “In many cases the underperformance switched to outperformance or outperformance increased to the extent the additional costs of active management were covered.”
The 50bps outperformance of active management resulting from the use of appropriate benchmarks is considerable in the context of the 13bps saving Hymans Robertson believes could result from greater use of passive management.
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