Pennsylvania to expand lower-cost passive investment strategy

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Pennsylvania is expanding its passive investment strategy to include the publicly traded fixed- income portfolio, state Treasurer Joe Torsella announced.

According to Torsella, the move will save nearly $9 million per year in Wall Street fees, totaling roughly $300 million when compounded over 20 years.

The move also takes a further step to change the pay-to-play culture within the commonwealth, Torsella added.

“My job is to help build the futures of Pennsylvanians by putting their interests first, not Wall Street’s,” Torsella said.

The transition of fixed income investment holdings to passive strategies, where available, is expected to take place over the next month.

Torsella said he will authorize the transition of more than $2.9 billion in fixed-income investment holdings from active managers to lower-cost passive strategies, resulting in an estimated savings of $3.78 million annually that was paid in fees, and almost $110 million in additional savings when compounded at 3.5% over 20 years.

Torsella in April 2017 announced that he would move $2.4 billion in public equity investments holdings to a passive investment strategy.

Passive investments buy and hold securities proportionately to their weighting in a broad market index, such as the Bloomberg Barclays Aggregate Index or the Bloomberg Barclays US one-to-five year credit index.

With lower fees, investors get better returns than they would from funds with similar holdings but higher management fees and transaction costs, which act as a drag on investment performance, said Torsella.

Passive management generally works best for easily traded, well-known holdings like stocks in large U.S. corporations, said Kent Smetters, a business economics professor at the University of Pennsylvania's Wharton School of Business.

That's because so much is known about those firms that active managers are unlikely to gain any special insight. “You should almost never pay for active management for those things," he said.

In niche markets such as emerging-market and small-company stocks, with assets are less liquid and more under the radar, active manager could spot "diamonds in the rough," said Smetters.

Research by S&P Global Ratings says that in most cases, active managers are unable to pick enough winners to justify their fees. Over the most recent 15-year period, said Torsella, 70% of all actively managed Global Income Funds, for example, underperformed a broad market index.

More than half of Treasury’s active fixed-income managers have failed to beat their benchmarks over the last five years, Torsella said.

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Public pensions Joe Torsella Commonwealth of Pennsylvania Pennsylvania