2014-09-20

A Few Billion More Votes for Index Funds

CalPERS, the California Public Employees' Retirement System, manages a cool $300 billion for the state's 1.6 million eligible employees. This is the second largest public pension fund next to the federal government's CSRS, the Civil Service Retirement System. In the ~$13 trillion US mutual fund industry, this positions CalPERS as a heavyweight institutional investor.

This serious amount of money adds weight to the announcement that CalPERS is pulling out of its $4 billion investment in hedge funds and replacing the actively managed mutual funds in its$2 billion defined contribution plans with index funds.  This will decrease the annual expenses associated with holding these funds by 89% (0.06%, from 0.52%).

This is in line with the announcement in October 2013 that the CalPERS board had adopted the following as one of its ten "investment beliefs":
Calpers will take risk only where we have a strong belief we will be rewarded for it.  Sub-beliefs:
• An expectation of a return premium is required to take risk; Calpers aims to maximize return for the risk taken
• Markets aren’t perfectly efficient, but inefficiencies are difficult to exploit after costs
• Calpers will use index tracking strategies where we lack conviction or demonstrable evidence that we can add value through active management
• Calpers should measure its investment performance relative to a reference portfolio of public, passively managed assets to ensure that active risk is being compensated at the Total Fund level over the long-term

Eight out of every $10 invested in mutual funds and exchange traded funds (ETFs) has gone into low-cost passively managed funds, according to the Morningstar Fund Flows reports. This makes sense, because active funds charge higher fees and don't consistently beat passive funds even before fees—over the past five years, 73% of actively-managed domestic large-cap mutual funds failed to match the S&P500. If CalPERS and they Harvard MBA's they pay to manage their active funds can't do it, what chance do you think you have at beating the markets? The evidence is clear: spending your own time or paying someone else money to pick stocks for you is a losing game. Lining your nest with index funds is your best (and simplest, and cheapest) bet. In The News Time: The Triumph of Index Funds Chicago Tribune: CalPERS dumps hedge funds citing cost, to pull$4 billion stake
NY Times: With Pension Fund Giant CalPERS Quitting Hedge Funds, Other Investors Reflect
Marketwatch: Pensioners: CalPERS embraces indexing
Investment News: CalPERS switches to all-passive DC plans
Forbes: Why CalPERS Tired of Vampire Hedge Funds
Forbes: Nation's Largest Pension Considers More Indexing (2013)