El lenguaje de estructuración hipermedia basado en tiempo (HyTime )

Background

The vast majority of large public funds use both active and passive management. Compelling research indicates that active management is difficult. Active management is most successful where market efficiency is relatively low and investment skill of the managers is extra-ordinarily high. The odds of successfully implementing an active management strategy are increased when there is low turnover among the decision-making group, a sound process for selecting (and firing) active managers, investment managers with exceptional skill are hired, and a long-term perspective is maintained.

Within an equity portfolio, a substantial allocation to index funds serves to anchor the portfolio to the asset class benchmark. The case for passive management is strengthened by the highly efficient nature of the U.S. and non-U.S. stock markets. Information on publicly-traded companies flows freely and it is difficult for one investor to have a material advantage over another. Also, broadly

representative and investable market indices are available. Finally, the cost differential between active and passive managers is significant, and since active managers have not consistently beaten the market averages after considering all costs, a diversified, low-cost investment approach is a compelling.

Within the fixed income markets, institutional investors use a predominately active approach. The benefit of active management over passive management in the fixed markets had historically been that available fixed income indices were not sufficiently broad, nor did they accurately track the overall bond market. Instead, they tended to only capture a segment of the bond market. As a result, active managers could improve the efficiency of their portfolios by opportunistically allocating to non- U.S. bonds, high yield bonds, emerging market bonds, convertible bonds, and floating rate bonds, among others.

More and better passive index funds have become available in the fixed income markets that allow access to these same bond market betas, therefore reducing the need to pay active management fees for submarket exposures. While the fee differential between active and passive fixed income managers is much smaller than in equity markets, this evolution has made passive fixed income a more appropriate consideration today than several years ago.

Findings and Analysis

Across all asset classes, approximately 12% or $6.8 billion of the NCRS Total Fund is invested passively. This amount is lower than average. One industry statistic states that on-average, public pension funds with over $20 billion have approximately 22% invested passively.7 _{Another industry} survey cites similar statistics, indicating 26% of public pension fund assets are invested passively.8 All of the NCRS’ index fund exposure is in public equities.

The NCRS has been investing passively for over ten years. Since that time, the IMD and staff periodically revaluate the allocation and use of passive management by asset class. The table on the following page lists the index fund managers used by NCRS, as well as the type of mandates employed.

7 _{RV Kuhns Public Fund Universe Analysis, December 31, 2008.}

Table 4.3 – Index Fund Managers and Mandates Used by NCRS

Manager Mandate

Evergreen S&P 500

Mid Cap (S&P 400)

Bank of America S&P 500

Mid Cap (S&P 400)

First Citizens S&P 500

State Street Global Advisors Small Cap (S&P 600) Barclays Global Investors EAFE Index

Emerging Markets Frontier Markets

It is somewhat unusual to invest in three different index funds to gain passive exposure to the S&P 500 Index. While such an approach may limit organizational risk exposure to an individual manager, it also dilutes economies of scale. Typically, larger mandates in an index fund achieve more

competitive pricing. We acknowledge the fees for each of these three funds are low (2 to 3 basis points). However, investing all the S&P 500 assets in the lowest cost provider would serve to lower the overall fee. Additionally, the larger mandate size may qualify the NCRS for an even more competitive fee schedule. Some large public funds are able to negotiate fees below 2 basis points for index funds.

NCRS has also divided its index fund exposure by capitalization (large, medium, and small cap). This approach allows the NCRS to offset any style-allocations that result in the portfolio due to the specific active managers hired. It also introduces some level of complexity. An alternative approach would be to invest passively in a broad market index fund, such as a Russell 3000 Index Fund or a DJ U.S. Total Stock Market Index Fund. This approach could potentially represent a cost savings to NCRS, and allow for simplified access to broad, diversified exposure to the full opportunity set of the U.S. stock market.

Conclusion

NCRS uses passive management to a lesser degree than do peer funds. An index allocation can serve to “anchor” the portfolio to a benchmark. Furthermore, research and evidence supports a material allocation to index funds.

The structure of the NCRS index fund portfolio is complex and redundant. A more streamlined approach to indexing may benefit NCRS and serve to eliminate misfit risk between the equity portfolio and the asset class benchmark.

Recommendations:

1. Evaluate whether an increased allocation to index funds would benefit the portfolio.

3. Consider the pros and cons of investing in a broad market index fund as opposed to different capitalization segments of the market.

4. Ensure that the allocation to passive management in each asset class is reviewed and adjusted, if deemed appropriate, on a periodic basis.