When Pennsylvania’s Treasury Department announced last week that it was taking about $1 billion out of the hands of active money managers, it joined a growing flood of investors embracing passive investment strategies.
Treasurer Joe Torsella directed the department to transfer all of its $2.4 billion in public equity investment holdings to passive strategies over the next six months. That means placing the stocks – about $1 billion of which are managed by professionals who try to “beat the markets” – in funds that replicate a market index like Standard & Poor’s 500 or the Russell 3000.
Torsella believes the change will save Pennsylvania an estimated $5 million per year in fees – a drop in the bucket for the state’s projected $3 billion deficit, but a drop that Treasury estimates will compound to about $195 million in savings over the next 20 years.
“I think the evidence is fairly convincing that, when it comes to stocks, thinking you can beat the market is a recipe for paying too much,” Torsella said.
The move makes Pennsylvania one of a growing number of investors, big and small, ditching active management strategies in favor of ones that mirror the markets. Since 2006, the number of actively managed funds in the U.S. has decreased almost 15 percent.
The rationale among these investors is that passive strategies mean paying fewer fees to expensive money managers who actively pick stocks to invest in. A growing body of research, including an analysis by S&P, shows that actively managed funds rarely outperform passively managed ones anyway, especially after fees are factored in.
Not everyone agrees. When Montgomery County booted 15 outside money managers from its employee retirement fund in 2013, one manager warned a passively managed fund risked losing money in a downturn.
“You’ll come crawling back,” another manager reportedly predicted.
Many firms take a less hard-line approach, saying an active strategy is not right for everyone, but can be appropriate for certain kinds of investments. Others argue the fees are not as steep as passive-investing proponents have led people to believe in recent years.
The most passionate embracers of a passive strategy brush off the more ominous prognoses from money managers as fear-mongering by people afraid of losing their jobs. Tim Decker falls in that camp.
Decker, president of ISI Financial Group in Lancaster, has for years extolled what he sees as the values of passive investment strategies.
Active managers try to outperform market returns by either identifying mispriced securities – i.e. saying they know something about a company’s stock that isn’t already reflected in its price – or “timing the market” by predicting the financial effects of things happening in politics or the economy.
Both strategies, he said, rely on the assumption that the manager knows something the rest of the world doesn’t. To Decker, that logic doesn’t add up.
“It’s a very obvious conclusion when you look at the evidence,” he said.
Torsella believes much the same – although his philosophy behind the switch to passive investment extends beyond the potential for savings. Even if a manager could reliably make the right predictions, he believes the government has no right to take risks with taxpayer money, especially when the Treasury has such a long history of political scandal.
The Treasury, he added, “is not in the business of gambling.”
Torsella and Gov. Tom Wolf hope the state’s pension funds will follow suit.
Friday, both officials endorsed a letter to the Pennsylvania State Employee Retirement System and State Employee Retirement System urging them to adopt annual fee caps, consolidate certain operations and expand the state’s deferred compensation plan to certain county and municipal employees.
The letter says SERS could save $46 million annually just by adopting fee caps. Research, they say, shows Pennsylvania needs to make that move: SERS and PSERS collectively rank fourth-highest in the U.S. in terms of fees paid as a percentage of assets under management.
A passive investment strategy could play a part in the funds’ fee reduction. The proposal not new – similar ones have floated around the state for years – but Torsella noted such a move is no longer without precedent.
States like Nevada and California have cut ties with many money managers in recent years, he said, and one of Pennsylvania’s pension funds already indexes a portion of its stock holdings.