Originally posted at Index Universe.
By Olivier Ludwig.
CalPERS, the huge California state pension plan, is keeping the door open to increasing the percentage of its passive investments, casting its long shadow in ways investors everywhere should pay close attention to.
The signal, detailed in broad brushstrokes in an “Investment Beliefs” document it released last month, reaffirms that the $265 billion public pension plan will look seriously at increasing passive exposure should it be clear that active management isn’t likely to deliver alpha.
The salient language in the broad and philosophical position paper is as follows:
“CalPERS will use index tracking strategies where we lack conviction or demonstrable evidence that we can add value through active management.”
Not exactly barn-burning verbiage that suggests CalPERS is setting the stage for a wholesale abandonment of active management.
But it’s worth putting out there, if for no other reason than a fair amount of ink has been spilled in recent months in the blogosphere on CalPERS’ passive intentions in the run-up to the Sept. 16 publication of that Investment Beliefs paper.
As I wrote about in a blog around the time of all that misleading tweeting, about a third of CalPERS’ portfolio is passively invested.
That number is derived from the fact that the only part of its massive portfolio that can currently be invested passively is public equities. The target public-equities allocation of the overall CalPERS portfolio is slightly more than 50 percent.
That means two-thirds of that 50 percent target is passively invested. In other words, two-thirds of one-half of the fund’s total assets of $265 billion—a third of the total portfolio, or nearly $90 billion—is currently indexed, as the huge fund’s latest monthly performance report shows.
Contrary to a lot of giddy accounts on the Internet over the past few months, the “Investment Beliefs” document didn’t immediately lead to a bump up in the passive allocation. Nor was it ever meant to.
The reality is more plodding and slow moving, maybe a bit like the movement of a glacier.
The nuts-and-bolts decisions that could lead to increases to the passively allocated portion of the public equities portfolio will be made at meetings in the next two months, and any actual changes are likely to be implemented over time after those decisions are taken.
There’s also a possibility that the passive allocation won’t be changed at all at those meetings.
But since CalPERS already allocates a third of its huge portfolio to passive strategies and—to the extent that it’s open to indexing and is mindful of the importance of keeping the investment costs down—it would be unwise to bet that it won’t raise its passive allocation over time.
As the latest SPIVA report reaffirmed yet again about the nature of the passive versus active debate, in any given period, only about a third of active managers outperform their index.
More damning is that there’s almost no evidence that the active managers who do outperform their indexes are able to do so consistently over time.
As I said last time, CalPERS’ 33 percent passive allocation is very much in the ballpark of the overall percentage of institutional assets that are indexes.
Forty years ago, that number was zero, which means change has come, but it has come rather slowly.
Still, it’s useful to understand that CalPERS, hailing from what has historically been a bellwether state, has a growing fondness for indexing. That itself is something of a bellwether in the institutional investment space.