Why LACERS Uses Passive, Active Investing


Michael Wilkinson, LACERS/Legal Representative

By Michael R. Wilkinson, LACERS Commissioner
Email: MikeWilkinson4LACERS@gmail.com


ACERS diversifies its investments so that we don’t “put all our eggs in one basket,” as the proverb says. How do we do that? LACERS uses careful asset allocation by buying different types of investments with the aim to not be fully invested in investments that move up and down in lockstep. If this diversification is successful, when some investments go down, others gain. However, there are times when all assets move together.

One other type of diversification is between passive and active investments. Why is this important? Active investing is the kind everyone knows about. A money manager buys and sells investments with the objective of making profits and performing better than a goal called a benchmark. What is a benchmark? It is a group of like investments that can be used to measure the performance of an active manager. What is a passive investment manager? A passive investment manager is one who uses an index, such as the S&P 500 Stock Index, to buy and hold all the stocks in that index and does not pick individual investments.

Why not always have an active manager if the active manager can always outperform the passive index? Wouldn’t that be the best? In certain asset classes, like big U.S. companies, active managers have a difficult time beating the passive manager, using an index, on a long-term basis. 

So what advantage does the passive manager have if they must hold all the stocks, the good the bad and the ugly (sorry I couldn’t resist), while the active manager can pick what they think are the best investments? Well one answer is fees, and the other is performance. What matters to LACERS is the return to the pension plan after paying the fees. The active manager charges much higher fees since the manager must pay for people and infrastructure to make the decisions on what to buy and sell. The passive manager can pass on much lower fees to provide a higher return after fees if the performance is comparable. Also, the active manager may have years when they lose money compared to the index.

How does LACERS use passive investing? For some asset classes, active managers have been able to show consistently higher performance to justify their higher fees. In those asset classes, LACERS uses active managers. In private equity, for instance, there is no accepted index, and LACERS uses active managers. In other classes, passive managers excel and LACERS gets the performance of the index at a much lower price.

Here’s the breakdown: 

  • LACERS U.S. Equity (companies) is 79 percent passive; 
  • Non-U.S. Equity 42 percent passive; 
  • Core fixed income 22 percent passive; and 
  • the overall passive investment for the total fund is 29 percent.