Passive investing has been a dominant trend in recent years, but some large U.S. pension funds are seeing more opportunities ramping up in active management.

In some ways, the trend is surprising. Low-fee index funds — particularly those focused on the efficient large-cap segment of the U.S. stock market — have historically outperformed their actively managed counterparts over the mid to long term. The track record and cost efficiency of passive products have made them a great success: In 2023, passive fund net assets eclipsed those in active funds for the first time ever, according to data from Morningstar.

But, despite the continued growth of passive management, there has been a growing number of fund managers claiming that, in the “new normal” of higher interest rates and increased market volatility — as well as the outsized influence of the Magnificent Seven on large-cap U.S. equity products — the pendulum is slowly swinging back to favor active investment. Many active managers also argue that the rise of passive investing puts the economy on autopilot, allowing big companies to get even bigger unchecked, without necessarily staying inventive, good or even profitable.

For pension funds, however, the decision to increase their exposure to active U.S. equities is less about conviction in the merits of active investment and more about an opportunity to find alpha.

For the latest Pensions & Investments survey of the largest U.S. retirement plans, active U.S. equity assets for the top 200 defined benefit plans jumped 18.6% to $252.7 billion as of Sept. 30, topping a 10.9% rise in passive U.S. equity assets to $714.8 billion — following a decade or more where the growth of passively managed assets has dwarfed that of active. Over the past five years ended Sept. 30, active U.S. equity is down 37.6% while passive is up 18.1%, according to P&I data.

In 2023, the $181.7 billion Texas Teacher Retirement System, Austin, increased its active U.S. equities by 20% to $25.7 billion, and decreased its passively managed U.S. equities by nearly 37% to $3.2 billion. The $30.6 billion pension plan of the Alaska Retirement Management Board, Juneau, committed $2.85 billion to active equity in 2023 — up from zero the previous year — and decreased its passive exposure in the same category by 34% to $5 billion. The $21.5 billion pension plan of the Idaho Public Employees Retirement System upped its active U.S. equities exposure by 26% to $3.25 billion and decreased its passive U.S. equities exposure by a modest 6% to $1.8 billion.

Even the $450.3 billion California Public Employees’ Retirement System, Sacramento — which still heavily leans passive, with $102.4 billion in passively managed U.S. equities last year — upped its exposure to active U.S. equity by 131% to $8.65 billion. Passive U.S. equity was down 2.6%.

Jase Auby, CIO of Texas Teachers — whose public equity portfolio is approximately 6% passive and 94% active — said the fund’s exposure to active investment products is a conscious choice.

“However, it’s on an opportunity-by-opportunity basis. We would not hesitate to go passive if we didn’t see opportunities. You know, we’ll shut down a portfolio and just put it in a passive (product) without even thinking about what we’ll replace it with. And likewise, if we find a good alpha source we will invest in it without thinking about how much passive there is,” Auby said. “So passive is a byproduct of our investment process rather than an allocated amount.”

Over the past year, Auby said his portfolio delivered record alpha.

“We’ve seen a real return to fundamental investing, things folks invested in that haven’t worked for so long because interest-rates were going down and down,” Auby said. “Fundamentals are starting to be rewarded now that the Fed has begun to tighten.”

That opportunity to find alpha in actively managed products is driving pension funds like CalPERS and the $95.2 billion Massachusetts Pension Reserves Investment Management Board to add more to their active strategies in 2024.

“One of our key objectives is implementing active strategies with the potential for adding value relative to the (strategic asset allocation) benchmark and doing so without materially increasing total portfolio risk,” a CalPERS spokesperson said. “We intend to expand our active programs as we build out new capabilities, with the focus on increasing our value add.”

Earlier this year, historically passive-leaning MassPRIM tapped RhumbLine Advisers to manage $500 million in active U.S. equities.

Michael McElroy, director of public markets at MassPRIM, said during a Jan. 30 investment committee meeting that the $500 million commitment was a “small initial allocation” while the fund observes its performance compared to passive products. McElroy also said the RhumbLine fund excluded Magnificent Seven stocks — Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.

Like the other pension funds turning to active investments for alpha, that toe-dip could turn into a plunge if the returns are good enough.

“Hard to say how large we would potentially want to get this, but we’re asking for $500 million and then we would come back to the committee at a later point if we thought it was warranted,” McElroy said.

John Delaney, a Philadelphia-based portfolio manager with Willis Tower Watson’s OCIO business, noted there is a “certain level of concentration risk” from the Magnificent Seven that is driving broader index returns as they become such a large portion of major developed market indexes.

“We’ve seen asset owners look to more actively manage strategies, to reduce the potential concentration risk of those seven stocks in their portfolios,” said Delaney, adding that there have been more discussions around equity in the past year “than we’ve probably had in the past five years combined.”