Christopher Ailman sees a 'subtle trend' among pension funds to add leverage.

Risk from liquidity to regulation a concern for investment execs

Investment professionals talk about their concerns

Money managers and asset owners are wrestling with how to help employees manage their investments to provide adequate retirement income in a defined-contribution-dominated world, said speakers at Pensions & Investments' Investment Innovation & the Global Future of Retirement conference, held in New York June 22-24.

As workers live longer and defined contribution plans overtake defined benefit plan growth, industry experts are implementing new asset allocation approaches that cut across traditional and alternative investment classes in DB plans and pondering investment options such as a greater array of index funds in DC plans.

Another hot topic is risk. After suffering through the financial crisis and its aftermath, investors are trying to mitigate myriad risks — from return risk to liquidity risk — lurking in their portfolios.

“Most people think that I spend my time thinking about return risk,” said Charles Van Vleet, assistant treasurer and chief investment officer, who oversees $10 billion in defined benefit and defined contribution plan assets at Textron Inc., Providence, R.I.

Instead, Mr. Van Vleet said he is concerned about governance, regulatory and liquidity risks.

He spoke on a panel about mitigating risk, along with David Iverson, head of asset allocation at the NZ$$25.5 billion ($22.1 billion) New Zealand Superannuation Fund, Auckland, and William Kinlaw, senior managing director and head of portfolio and risk management research at State Street Associates, Boston.

Too much liquidity is just as bad as too little liquidity, Mr. Van Vleet said, noting he likes investments that are either perfectly liquid, such as stocks, or illiquid, such as private equity.

“I don't like investments that are in between,” Mr. Van Vleet. An example is open-end real estate funds that promise liquidity but in market downturns have forced investors to wait in line to get their money, he said. Some 80% of Textron's $600 million in real estate is in direct investments.

By contrast, investors have a way — albeit an expensive one — to exit private equity funds through the secondary market. Open-end real estate funds have no secondary market “when those things turn to cement,” he said.

Main task

Mr. Iverson said his plan's main task is to offer “maximum return without undue risk.”

How you make that trade-off can be “very complicated,” he said. “That's where I lose the board,” whose trustees often struggle to understand the interplay between risk and return in specific deals.

The credit crisis raised the specter of “regret risk” that could affect the board's investment behavior, he said. At times, these feelings could lead executives to stray from their asset allocation, which could result in “worse outcomes at the end of the day,” Mr. Iverson said.

In order to get boards to focus both on asset allocation and risk, “you need to speak in two languages,” Mr. Kinlaw said, noting risk operates around factors, not necessarily around asset classes.

Still, plan executives also are focused on boosting returns.

Indeed, there is a “subtle trend” of pension funds willing to add leverage, Christopher Ailman, CIO of the $184.8 billion California State Teachers' Retirement System, West Sacramento, said during another conference discussion.

“It's all about squeezing more return,” said Roger Urwin, global head of investment content at consulting firm Towers Watson & Co., who moderated that session. Mr. Urwin said he knows of several pension funds that are leveraged as much as 150% to 200%.

Mr. Ailman added that leverage isn't bad, it just amplifies the risks. “I have a problem with leveraging up bonds,” he said. Pension funds are adding leverage because it is difficult to get 7% or 8% returns in the current economic environment, Mr. Ailman said.

Asset owners are looking less at bonds and more at such alternative asset classes as farmland for income in their DB plans, Mr. Ailman said.

Large investors around the world — from Canada and the Netherlands to Japan — are diversifying through alternative assets and developing more sophisticated investment programs for both their DC and DB plans, Mr. Urwin said.

On the defined contribution plan side, John C. “Jack” Bogle, founder of Vanguard Group Inc., noted during a luncheon keynote chat with Barbara G. Novick, vice chairman and chair of government relations steering committee at BlackRock (BLK) Inc. (BLK) that he has been in a defined contribution plan since 1951.

“It's like magic,” he said. Some 15% of his compensation, at no cost to him, was invested in a Wellington balanced fund, and, he said, “it keeps growing tax deferred.”

Keith Ambachtsheer, director emeritus of the International Centre for Pension Management at the Rotman School of Management, University of Toronto, said in the second day luncheon keynote address that the industry needs to “rethink what we are doing with portfolio investments.”

“Talk about betas, whether exotic or dumb ... give me a break. The goal is creating wealth,” Mr. Ambachtsheer said.

“It's an exciting time,” he added. “We are redefining what investing should be about” that focuses on risk sharing without risk transfer, he said. n

This article originally appeared in the July 7, 2014 print issue as, "Risk a concern from liquidity to regulation".