Many plan sponsors have employed passive-core and active-satellite investment portfolios. Under this approach, the passive-core generally is a passive multi-asset (or balanced) portfolio, while the satellite layer includes more concentrated equity mandates and/or some alternatives. The plan sponsor allocates risk to asset classes and strategies that have a better chance of being rewarded, while achieving a portion of its strategic asset mix for a very low cost. Such an approach allows for a more targeted approach to accessing skill. With excessive equity volatility in 2008 and large under performance by many “satellite” type managers, the question of whether this remains a viable approach is being asked by many.
Some plan sponsors are increasing the core portion of the investment portfolio. With market volatility increasing, the amount of risk represented by the satellite layer was more than anticipated by many, and certainly more than was comfortable for them. Reducing the risk in the satellite layer does have overall expected return implications, though on a risk adjusted basis, less so. What goes into the satellite layer is also being reconsidered. For many, it included allocations to hedge funds, private equity and other less liquid assets rather than simply more concentrated or absolute return strategies. Many plan sponsors have discovered that not only was the risk-reward trade-off not to their liking, but that the extra governance required was more than they were willing to provide.
This naturally brings the question of active versus passive management to the fore. Should plan sponsors consider indexing a portion of their pension plan for risk and cost control, or is active management a viable approach? Watson Wyatt believes in active management, but also recognizes that there is a place for indexing.
Index management is most often used when markets are efficient and the probability of success and reward from pursuing active management is low. Additionally, active management has the best probability for success in the less efficiently priced market areas—small/mid cap equities, international/global equities, corporate debt and alternative investments. These are the market segments that represent the best use of a plan’s active management risk budget. Thinking about portfolio construction from this perspective makes sense, but what are plan sponsors actually doing?
In its annual survey, Greenwich Associates asks plan sponsors to provide their overall asset mix, as well as the types of mandates they employ within their investment structure. The results for Canadian plan sponsors are shown in the table below:
| 2003 | 2004 | 2006 | 2007 | 2008 | |
| Canadian equities – total | 27.10% | 23.90% | 22.60% | 21.10% | 18.70% |
| active | 19.80% | 16.40% | 15.70% | 16.60% | 15.70% |
| passive | 7.20% | 7.60% | 6.80% | 4.50% | 3.00% |
| Canadian bonds – total | 30.10% | 32.50% | 31.80% | 30.20% | 30.70% |
| active | 19.70% | 24.50% | 22.10% | 24.20% | 24.70% |
| passive | 10.40% | 8.00% | 9.70% | 6.00% | 6.00% |
| Foreign equities | 25.70% | 25.20% | 28.60% | 29.60% | 27.40% |
| Alternatives | 17.00% | 18.40% | 17.10% | 19.10% | 23.20% |
On average, more than 400 Canadian plan sponsors are surveyed each year, including public and corporate plans, large and small. As you can see from the results, the percentage allocated to passive investing in Canadian bonds and Canadian equities has been declining over the past few years. The survey does not track the proportion of active and passive for foreign equities. For this we turn to the U.S. Greenwich results, which include the asset mixes and mandates of more than 2,200 plan sponsors.
| 2003 | 2004 | 2006 | 2007 | 2008 | |
| US equities – total | 47.00% | 46.70% | 44.80% | 42.40% | 37.60% |
| active | 24.40% | 24.90% | 24.30% | 22.60% | 21.00% |
| passive | 17.80% | 17.40% | 16.70% | 15.90% | 13.90% |
| US bonds – total | 23.70% | 22.80% | 22.40% | 22.70% | 24.20% |
| Foreign equities | 25.70% | 25.20% | 28.60% | 29.60% | 27.40% |
| active | 10.80% | 11.40% | 12.40% | 14.30% | 13.00% |
| passive | 2.40% | 2.50% | 2.90% | 2.90% | 3.00% |
| Alternatives | 16.00% | 16.60% | 17.60% | 17.70% | 22.10% |
You will note that the same trends exist in the U.S.—there does not seem to be a large use of indexing in the EAFE equities allocation, nor does the amount of indexing seem to be increasing. The passive allocation in U.S. Equities has been declining, but remains a significant percentage. This is not surprising since the U.S. equity market is perceived to be one of the most efficient in the world.