Northern Trust: In Contrast to Popular Belief, Active Managers, Equity Overweighting Spur Strong Returns

(April 26, 2011) — US pension plans, endowments and foundations in the Northern Trust universe — which comprises 300 institutional investment plans with combined assets of about $706 billion — had a median 3.6% investment gain in the first quarter.

The main drivers of the gain: strong equity performance coupled with the success of active managers.

“What we’ve seen in our universe is that a lot of our plan sponsors have been overweight in small to mid-cap stocks, which have done particularly well,” William Frieske, senior performance consultant at Northern Trust Investment Risk & Analytical Services, told aiCIO. “The strong performance of active managers has helped that gain,” he added.

According to Frieske, the superior performance of active over passive managers contrasts with assertions by prominent figures in the investment industry, such as Vanguard. “We’ve proven period over period that active managers are a good idea, as our universe has demonstrated that the median manager — the guy in the middle of the pack — is better than the index,” he said.

The firm found that while public funds had a median return of 3.9% in the quarter, foundations and endowments returned a median 3.7% and corporations a median 3.6%. Meanwhile, US equity investments among plans in the universe returned a median 6.6% for the period; private equity, 4.7%; hedge funds, 4%; international equity, 2.7%; and fixed income, 1%.

A surprising finding, Frieske noted, is the fact that private equity and hedge funds have underperformed relative to public equity, running counter to the manner in which those assets are being sold. “Hedge and private equity have been glamor guys, at least for the last three quarters,” Frieske said, “but our findings show a different result.”

In terms of asset allocation changes for large institutions, the composite allocation to US equities across all plans dropped from 50% at the end of 2000 to 35% in the first quarter of 2011. On the other hand, fixed-income saw an increase in allocation from 27% to 30% over the same period, while allocation to hedge funds increased from just above zero to 4.3%. The results showed that large institutions increased their allocations to private equity from 3.5% to 6% across all plans during the 10-year period.

Northern Trust’s Frieske continued that the firm has witnessed a movement toward liability-driven investing (LDI) strategies, particularly among defined-benefit public pension plans. “While this movement has been more mature in Europe, funds in the US are changing the way they manage themselves. They are looking more closely at their liability streams and trying to match the duration of the assets with more accuracy.”