While the data continue to show that active management may not be worth the extra fees, the strategy remains popular with institutional investors — most likely because they need it if they want to achieve their return targets, according to the University of Florida’s investment chief.
As institutions like the $4.6 billion Seattle City Employees’ Retirement System or the $2 billion University of Nebraska Foundation question active’s efficacy and rely on passive investing to achieve their return objectives, UFICO’s CEO and CIO Mark Baumgartner is a firm believer in pursuing active.
In a phone interview with Institutional Investor, Baumgartner argued that most allocators want (if not need) to achieve CPI+5 percent — and to get there, they’ll need to use active.
“Most institutional investors need inflation plus five,” Baumgartner said, noting that the most bullish forecasts expect no more than CPI+4. “The markets just aren’t going to get you there if you’re investing passively. You’re going need to make it up with alpha.”
Despite discussion of alpha disappearing, Baumgartner argues that alpha has to exist because institutional investors seek significantly better than average returns. “Alpha is created simply by people wanting to outperform,” he said. “A lot of people are willing to take the other side of your bet.” That’s where active managers come in, whether they have a high chance of success or not.
Under Baumgartner’s leadership, UFICO is going all in with active management. Since joining the Gainesville, Fla.-based university in January, he has removed the 12 percent of the $3.5 billion long-term pool that was passively managed, making the fund now 100 percent actively managed.
Skepticism Remains
Both the S&P Dow Jones Indices and Morningstar have reported this year that most active equity funds have underperformed for the past few years. Steve Edmundson, CIO for the $64.5 billion Public Employees’ Retirement System of Nevada, said in an email that “indexing is the most efficient way to access the market exposures we want in the allocation.” NV PERS’ publicly traded stock and bond exposure remains fully indexed.
Nevada’s not the only organization that’s skeptical of active management. Seattle City’s CIO Jason Malinowski sees no proof that volatility creates alpha, while the University of Nebraska’s investment chief Brian Neale believes most allocators overestimate their manager selection skills. (Seattle’s equity portfolio is 75 percent passive; Nebraska’s entire book of U.S. public equities is indexed.)
Although Baumgartner agreed with some of the arguments against active management, he believes that allocators who rely solely on index funds do so at their own peril. “Do I agree that on average, active will underperform an index after fees? Yes, the market is the market. There’ll be winners and losers. But it doesn’t mean that you shouldn’t do it if you think you can pick the winners.”
As more money flows into passive, the risks for active go up — but so do the rewards. And for the University of Florida, it all comes down to: What is the institution trying to do, and what’s the best way to do that?
“We’re in a different world for sure, but the basics for supply and demand for assets have not changed,” Baumgartner said. “Do you really think a 70-30 passive [portfolio] is going to give you a CPI+5? I think if you do, you’re dooming yourself to failure.”
