Optimal Selection of Passive Portfolios

Abstract

In the last few years, the use of as one part of a total investment strategy has gained acceptance among investors, particularly among corporate pension sponsors. Use has been spurred partly by the passage in 1974 of the Employee Retirement Income Security Act (ERISA), which caused many pension sponsors to re-evaluate the management of their pension portfolios.* Index funds are appealing both on economic and fiduciary grounds, because typically they have lower management fees and higher diversification than managed portfolios. This has led to considerable growth in indexed pension assets, as is demonstrated by the figures in Exhibit 1. The majority of these assets are managed by external money managers, but there is a distinct trend for corporations to manage a proportion of their pension assets in an in-house index fund. This trend is also true for public funds, as evidenced by the recent formation of a $500 million index fund run by the New York State Common Retirement Fund [5]. An index fund is a passive (as opposed to active) portfolio that is designed to track closely a visi-

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