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California's Big Pension Fund Turns to Passive Management

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A large U.S. pension plan is joining the growing legion of 'mom and pop' investors who are moving away from actively managed stock and bond funds. The $380 billion California Public Employees' Retirement System (CalPERS) has "delivered a nightmare" to some "unlucky fund managers," according to the Financial Times. 

The daily newspaper reported in early January that just before Christmas, the nation's largest defined benefit plan let managers of more than a dozen active equity funds know they were being replaced. As part of its review of investment strategies, CalPERS has decided to "slash" more than 83% of the pension fund's active stock fund assets.1 

Most of that money, the FT noted, was "shovelled" into internally run passive strategies. "This move exemplifies the woes faced by the tribe of stock pickers that has long dominated the investment industry," the article added, "with active U.S. equity funds suffering about $1 trillion of investor withdrawals over the past decade, according to Morgan Stanley."

In a memo obtained by trade publication Chief Investment Officer (CIO) magazine, CalPERS's Chief Executive Officer Marcie Frost explained to the pension plan's board members that a so-called emerging managers program was also slashed. Its allocation was cut from $3.6 billion a year to $500 million, veteran institutional funds reporter Randy Diamond disclosed in CIO.2

The program was set up to provide seed money to up-and-coming active managers at smaller funds and to help support greater diversity within the asset management industry. Reporter Diamond pointed out that CalPERS's Chief Investment Officer had "repeatedly expressed concern" about more than just the pension fund's ability to hit its 7% annual assumed rate of return. 

Since taking over as the system's chief investment officer in early 2019, Ben Meng also voiced concern about issues related to underfunding, Diamond observed. In his article, CalPERS was estimated to be only about 70% funded. Its CEO's memo, he wrote, let the pension plan's board know that "over the last five years, traditional managers have underperformed their benchmarks by 48 bps (basis points, or 0.48%) and emerging managers by 126 bps (or 1.26%)."

Although this was apparently a surprise to CalPERS' board members, it shouldn't be to investors and readers of Over the years, we've been covering comprehensive research studying longer-term trends between active and passively managed funds. An ongoing series that has impressed us for its academic rigor and consistency in methodology is published by Standard & Poor's. 

This semiannual report, which scrubs performance for survivorship bias and style drift (see our latest article reviewing full-year SPIVA data for more details), is aptly referred to as the S&P Indices Versus Active (SPIVA) Scorecard. 

Through mid-2019, for example, the study found that 90.25% of all U.S. small-cap stock funds trailed the S&P SmallCap 600 Index over the past 15 years. In domestic large-cap equity funds, 89.83% lagged the S&P 500 index going back to June 2004. With international developed stock funds, 90.21% of active managers fell to their respective index. Meanwhile, across emerging markets, some 94.34% failed to beat their indexes over such an extended period. 

While CalPERS might be applauded by index investors for taking a more critical look at active management, it's also somewhat ironic that such a purveyor of the so-called 'smart money' in U.S. markets actually fell behind less-sophisticated mom-and-pop (i.e., individual) investors. 

As we've chronicled before, passive fund assets have been gaining in popularity. (See: "Out of the Shadows, Passive Assets Catch Active.") By August 2019, Morningstar found that funds tracking domestic stock indexes hit $4.27 trillion in assets, topping actively managed funds with $4.25 trillion. 

"This milestone has been a long time coming," noted Kevin McDevitt, a senior Morningstar analyst. "Over the past 10 years, active U.S. equity funds have had $1.3 trillion in outflows and their passive counterparts nearly $1.4 trillion in inflows." 


1.) The Financial Times, "Active fund managers pray for turnround as exodus continues," Jan. 2, 2020. 

2.) Chief Investment Officer magazine, "Exclusive: CalPERS Fires Most of Its Equity Managers," Dec. 4, 2019. 

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