Global pension funds are sticking with passive investment styles despite rising concerns about concentration risk, a new survey has found.
About 90 per cent of respondents in the study by UK research firm Create had exposure to index-based share strategies while one in two invested in passive bond funds.
Most respondents have favoured market capitalisation-based indexes for their passive allocations but the tide could be turning as “concentration risks” build in the underlying benchmarks.
The Create report – backed by DWS, the asset management arm of Deutsche Bank – says that in 2020 the five biggest technology firms – Apple, Amazon, Facebook, Microsoft and Alphabet (the Google parent) – together made up about 25 per cent of the US S&P 500 index.
“Some of these tech companies are attracting increasing regulatory scrutiny, as they have turned into veritable monopolies by acquiring fledgling competitors,” the study says. “As a result, our respondents are rebalancing their passive portfolios… by reducing the share of cap-weighted indices.”
Smart beta (factor-based) and thematic index strategies – increasingly via exchange-traded funds (ETFs) – stand to benefit as pension schemes ease away from cap-weighted approaches, the study says.
And active management could also be staging a comeback among some pension funds at least, especially in the wake of a resurgent value-investing sector at the back end of 2020.
“At this early stage, our respondents appear to continue using a pastiche of passives and actives,” the report says. “The increase in their new allocations to value style is seeing more a rotation from poor to good performers within the active space, than a diversion of new money from the passive space.”
The survey also found global pension funds were continuing to implement environmental, social and governance (ESG) policies through passive funds.
But in the wake of the COVID-19 pandemic, the ‘S’ factor was becoming increasingly important for institutional investors, the Create report says.
“As the pandemic entered its second year, the ESG conversation has moved from risks and returns to a more fundamental question: what role do companies have in creating a fairer and more sustainable society, as today’s capitalism faces its worst challenge in living memory?”
Approximately two-thirds of respondents planned to increase allocations to index funds targeting social factors, the study says, with equities the favourite asset class. At the same time, however, 70 per cent still require S-weighted passive funds to keep tracking error below 1 per cent, creating a conundrum for product manufacturers.
“… our survey respondents recognise that their capital markets alone cannot cure the ills of our societies,” the report says. “Governments need to play a lead role, rather than abdicate responsibility to central banks, as happened after the 2008 crisis… Even so, business leaders today face a choice: they can reform capitalism, or let capitalism be reformed for them by an angry public.”
The study, fourth in an annual series, tapped the views of 142 pension schemes across 17 jurisdictions and managing a collective €2.1 trillion.
Create, headed by Amin Rajan, carries out a range of “high level advisory assignments for governments, global banks, fund managers, multinational companies and international bodies”, according to its website.