Pennsylvania Gets on Indexing Bandwagon | Chief Investment Officer

Joining the growing trend towards indexing, Pennsylvania is moving its $2.4 billion in public equity investments into passive investments. Pennsylvania Treasurer Joe Torsella expects the move to save the state about $5 million a year in fees paid to managers who frequently underperform the market, cut down in investment risk, and also provide a better return to the state’s taxpayers.

According to Torsella, “I took an oath to put the public’s interests first, not Wall Street’s. Study after study has shown that a passive investment approach for stocks, by dramatically reducing the costs to taxpayers, has a high likelihood of performing much better than a high-fee active investment approach over the long term.”

The state will gradually transition its public equity holdings, about $1 billion of which is actively managed, to passive investments over the next six months. The passive investing approach is gaining in popularity and has become a “strategy of choice,” according to the University of Pennsylvania’s Wharton School of Business.

While there are some active managers who are adept at beating the market for any defined period, it is difficult to find those who achieve this feat consistently. Another factor that sways Torsella towards passive investing is the difficulty in identifying those managers who will outperform in the future, aslooking at past performance does not help.

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He said he would prefer not to make a casino game of investing public funds in an attempt to beat the market. Rather, his aim is to “capture the underlying market return at the lowest possible cost.” To this end, he sees the “broad strategic allocation of investment funds” as the most important decision for an investment portfolio. “We can’t control investment performance or consistently beat the market, but the one variable we can control is costs – and I have a fiduciary obligation to taxpayers to do so,” Torsella noted.

Supporting Torsella’s move, Standard & Poor’s research finds that in the most recent 10-year period, more than 87% of actively managed US stock funds did not perform better than a broad market index. During this same period, most international stock funds did not beat the market either.

Another advocate for passive investing is Warren Buffett. He has asked investors to take this route, considering that even many institutional investors and wealthy people have paid out billions of dollars in recent years to hedge funds and other money managers that charge high rates for substandard performance.

According to Buffett, “The bottom line: When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Tags: active vs. passive, fees, Pennsylvania

Despite geopolitical uncertainty, market practitioners are increasing allocations to European equities, according to a survey conducted by Bank of America Merrill Global Research. In the Global Fund Manager Survey, allocations to European stocks reached 15-month highs with a net 48% of investors overweight the sector, relative to a net 27% of investors who overweight last month. Roughly, 172 market participants representing nearly $498 billion in assets responded to the survey.

“In spite of the French Presidential election starting in less than a week, investors’ perception of Europe is increasingly bullish,” stated Ronan Carr, European equity strategist, in a press release. “Although we agree on the allure of Europe’s earnings recovery, complacency looks extremely high.”

The rotation into European equities likely stemmed from investors lowering their exposure to US. stocks. A net 83% of investors believed that US equities are overvalued, with allocations dropping to their lowest levels since January 2008.

“Investors are showing love for Europe and scrambling out of US equities, as the majority find US stocks overvalued and perceive a risk of delayed US tax reform,” stated Michael Hartnett, chief investment strategist at the bank.

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Fewer respondents expect tax reforms to pass before summer recess compared to findings in last month’s survey. Delays in US tax reforms also jumped to the second-highest most commonly cited tail risk, with 21% of investors holding this view. European elections raising disintegration risk (23%) was considered the biggest tail risk.

Other key takeaways included:

Being long, the US dollar remained as the top most-crowded trade
Nearly one-third of the respondents believed global equities are overvalued, near 17-year highs
A net 47% of investors felt emerging market equities were undervalued
Respondent were bullish on the banking sector, with allocation rising to new all-time highs at a net 32% overweight
Cash holdings slightly increased month-on-month to 4.9% from 4.8%; the 10-year average has been closer to 4.5%