Dow jump an opportunity for funds
Some institutions rebalance, others buy a little as market hits new highs
By Rick Baert and Rob Kozlowski | March 18, 2013
Institutional investors are taking advantage of the U.S. stock market's lofty heights this month to rebalance their portfolios and move assets into new or increased allocations.
The Dow Jones industrial average hit 14,253.77 on March 5, breaking the previous high set on Oct. 9, 2007, and setting off a stretch of eight consecutive record-setting sessions before dipping slightly on Friday to close at 14,514.11. The S&P 500 also flirted with the record of 1,565.15 set on Oct. 9, 2007, closing at 1,560.70 on Friday.
The $36.3 billion Tennessee Consolidated Retirement System, Nashville, “is staying neutral to our targets, which means we sell as equity markets move higher,” said Michael Brakebill, chief investment officer. “Most institutions are probably behaving in a similar manner.”
The record U.S. stock run serves as “a good reminder” to rebalance, said Monte Tarbox, Washington-based CIO of the $14.7 billion National Electrical Benefit Fund. “It's a great time to rebalance, to the extent that the equity portion of an investor's portfolio has gotten ahead of itself. It's not a tactical call. It's doing something pension funds ought to be doing anyway.” He would not say what allocation changes, if any, the NEBF is making.
“The current equity market valuation relative to our other asset classes is still within our policy ranges, so we are comfortable with our very modest overweight of 2%,” said David Holmgren, CIO at Hartford HealthCare, Hartford, Conn. “Risk-management-wise, within our equity exposures we greatly favor managers which focus on the corporate fundamentals ... so the market directionality noise you are concerned about is partially mitigated by our cultural conservative preferences.
“Interestingly, as other endowments play catch-up to now holding traditional long equity, they're pulling from their illiquid bucket, leaving us now in the selective spot to cherry pick as we move against the herd. For us, this is a classic win-win scenario.”
Hartford HealthCare has $1.8 billion combined in its pension plan and endowment fund, with a 55% growth allocation that includes U.S. and international equities and private equity. The private equity allocation of 6% was approved in February, to be funded from rebalancing the U.S. equities to 26% and international equity to 23%.
Increases and tilts
“We are increasing exposure to stocks that we consider dividend growers and tilting the international exposure toward emerging markets,” said Fadi BouSamra, CIO of the $2 billion Metropolitan Government of Nashville (Tenn.) and Davidson County Employee Benefit Trust Fund. “We are constantly monitoring valuations in all asset classes but as of now we are not selling stocks and moving into fixed income. We are tactically over our target allocation in U.S. equities.” He would not say what allocation changes the fund plans to make.
Selling stocks at this point “depends on your time horizon and your starting point,” said William Stromberg, vice president and head of equity at T. Rowe Price Group Inc., Baltimore, with $576 billion in equity assets.
“For long-term investors, if you started when stocks were inexpensive and you're now overweight, now's the time to rebalance,” he said. “If you're underweight, it's dangerous to pull out now. I wouldn't be a seller of stocks right now ... If you do sell, where are you going to go? Could go into bonds, but you might get hammered. And the alternatives are not all that attractive.”
He said short-term investors might make tactical changes given that a correction is “a distinct possibility,” but those with longer time horizons would be wise to stay the course on equities.
“They're reasonably priced relative to other” investments.
“Implementing a tactical decision now is hard,” agreed Tennessee's Mr. Brakebill. “Stock valuations look reasonable, but prices have moved a lot. Bonds may be safe, but prices are pretty rich.”
Mr. Stromberg said the fair value of stocks is tied to corporate earnings, which have had a “substantial recovery.” He said there was a similar recovery in the S&P 500 in March 2000 and again in October 2007, but “the difference this time is the earnings.”
Price-to-earning ratios were 29 in 2000 and 17 in 2007, but are now 15. “U.S. stocks are now more reasonably valued,” he said.
Christopher Ailman, CIO of the $161.4 billion California State Teachers' Retirement System, West Sacramento, said the pension fund is at “policy weight within the U.S. equity market. We overweighted midcaps and megacaps. We thought the megacaps were going to be an important area in our portfolio. We were underweight and low-weighted in fixed income. That hurt a couple of years ago. Last year it helped.”
“We would rather be over(weighted) in the U.S. than anywhere else in the world,” Mr. Ailman said.
Bill Riegel, senior managing director and head of equity investments at TIAA-CREF, New York, said, “Equities aren't cheap, but they're not expensive. They're fair relative to interest rates.” And how long that will last is uncertain. The Fed minutes of its Jan. 29-30 meeting issued last month created an “Oh, my God!” moment for the market, Mr. Riegel said, because it sparked speculation that the Fed would reduce or eliminate bond purchases this year.
“There is a clear worry investors must entertain — be careful what you wish for,” he said.
“The economy could grow faster than the 2% to 2½% growth rate. The broad market is going to say, "I hear what you said, Fed, but I remember 1994,'” when the Fed surprised markets by tightening monetary policy and Treasuries plunged. “Stocks are cheap relative to a 2% bond rate,” he said. “At 3% to 3½%, stocks have a problem with that. When fear is in the bond market, it's a tougher environment for stocks.”
TIAA-CREF had $198 billion in equity assets as of Dec. 31.
Mr. Riegel said the return expectation for this year is similar to the 13.4% return of the S&P 500 in 2012, but so far the index is up 9½%, “so we're three-quarters of the way there already.”
Growth and profits
“Corporate profit margins are close to multidecade highs, but we think that profitability is sustainable and expect modest earnings growth again this year. With the housing market now firmly in recovery, employment rising and many more cyclical indicators of recovery still depressed, the outlook for domestic profits looks good,” said Paul Quinsee, New York-based CIO of core and value equities at J.P. Morgan Asset Management (JPM), which had $135.2 billion in equity assets under management as of Dec. 31.
He said continued earnings growth and profits “will be the drivers” going forward and are likely to overcome the effects of higher interest rates. “Interest rates at super low levels are not a sign of a healthy economy.”
Just when a correction will occur and how deep it will be remain uncertain.
“I think (the correction) will come on June 17,” joked Peter Gilbert, CIO of the $1 billion Lehigh University endowment, Allentown, Pa. “I have no idea when a correction will come, you know, but I think there's concern about it. We're what, in the fourth year of this rising market, fretfully but rising nonetheless, but you see something happen five or six years down the road.”
“How much will that correction be? Sometimes you see a correction of 10%, but it depends what else is going on. If you have geopolitical issues it could be a whole lot worse.” Mr. Gilbert said. “We're looking to put some more money into equities (through external managers). Emerging markets still look attractive or at least better than other markets.”
T. Rowe Price's Mr. Stromberg said, “In all likelihood, there'll be a modest correction, from 4% to 8%, but conditions don't seem right for a bear market right now.” He said what could spark increased market volatility are fiscal issues, terrorist activity and energy prices.
Meanwhile, Mr. Riegel of TIAA-CREF said a correction occurred globally last month. “I think you had a correction globally in February,” he said. “The ACWI markets went down 5% to 10%.” In the U.S., he said, “the last two weeks in February, the market rotated to large-cap stocks following the release of the Fed minutes.”
This article originally appeared in the March 18, 2013 print issue as, "Dow jump an opportunity for funds".