| Vanguard makes the case for passive benchmarking |
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| 30/09/2007 | |
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Should a pension fund with a deficit pursue active or passive management? The debate has raged for decades. The Ernst & Young pension scheme has in recent years tilted its portfolio in favour of active management (see related story). In the passive camp is Vanguard and one of its portfolio managers, Gregory Davis, was recently in France to woo European pension schemes to invest in its treasury and swap funds. Davis, who oversees $12bn in assets, is a firm believer in the merits of benchmarking. To make the case, he points out that during the recent sub-prime credit crisis, the 6 month standard deviation of performance relative to the benchmark of Vanguard's Bond Index credit and government funds remained within two basis points. "If you are a pension scheme running a deficit, how likely is it that you will invest in 4% of the active managers who outperform the market compared to the 96% which under-perform," says Davis. "Your deficit is likely to worsen if you pursue active investing." The findings are based on the returns (net of fees) of 382 European investment-grade bond funds from January 1999 to August 2007. The fund's performance was measured against the Lehman Brothers Euro Aggregate Index. More than 100 of the funds lagged the index by - 0.5 to -1% and nearly as many by – 1 to -1.5%. Bench this For equity funds, the case for passive indexing is not as strong as it is for fixed-income. It nevertheless remains compelling. During a ten-year period ending in December 2006, the Vanguard Group considered the returns (net of fees) of 188 European diversified equity funds versus the MSCI Europe Index. Nearly 85% (160) funds underperformed the index with more than 60 funds lagging by -2 to -3%, according to data from Lipper Analytics and MSCI. Why do active equity managers perform better than their fixed-income counterparts? The magnitude of dispersion in equity returns is much greater than fixed-income securities. The narrower distribution for bonds is determined by interest rate fluctuations, movements of the yield curve and changes in credit quality, as well as an active manager's positioning of a fund relative to its peers and benchmarks. This is in contrast to the equity markets, where return dispersion is much wider and risk-factor differentials such as style and under or over-weights to benchmarks amplify return dispersion." The longer the time period for the comparisons the stronger the case for passive benchmarking. For example, the percentage of US equity funds outperformed by their S&P 500 index increases from 84% over a three-year period to 87% over a decade, according to Standard & Poor's and the Vanguard Group. Davis insists that European pension funds have been receptive to the passive message and account for most of Vanguard's clients. In the US, estimates of index fund assets, including ETFs, are around $865bn or 15.6% of the $5.5tr US stock and bond mutual fund industry, according to the Investment Company Institute. Historically, indexing has performed favourably in relation to actively managed strategies due in part due to the former's low cost structure. But how has indexing fared during market downturns during which active managers are known to time market declines and upturns? The sceptics argue that relatively efficient markets make it difficult to consistently time market movements with accuracy. According to a Lipper study of active managers' performance during bear markets (defined as a drop of 10% or more in the equity markets), these funds underperformed the S&P 500 Index in the six market corrections between August 1978 and October 1990. The average loss for the S&P was 15.1% compared to 17% for large-cap growth funds. VB |
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Articles of the same Topic : Pension funds US |
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