LANSING, Mich. - The $31.8 billion Michigan Retirement Systems will increase by $300 million its allocation to international swaps during the next 12 months, said Barry Stevens, director-bureau of investments.
The allocation resumes the system's funding of its 5% commitment to international swaps that was put on hold during last year's derivatives witch-hunt.
Michigan's Investment Advisory Committee decided to roll over and increase selectively four swap agreements that will expire this year. The first, a $100 million agreement worth $117 million, will be rolled over and increased to $200 million.
Michigan implemented its international swap portfolio in 1993 as a way to get exposure to international equity markets, said Mr. Stevens. The strategy was chosen over a dedicated portfolio strategy because it was cheapest.
"All we are doing is replicating the major indexes in each of the eight largest (as measured by stock markets) countries," said Mr. Stevens.
Michigan's passive strategy has exposure to two stock market indexes each in Japan and the United Kingdom, and one equity market in Germany, Switzerland, France, Hong Kong, Australia and The Netherlands.
The retirement system likely will increase its exposure to other countries as it fulfills the 5% commitment, said Mr. Stevens. "We are looking hard at Spain and Italy. Malaysia is a third one," he said.
"This is the most efficient and cheapest way to replicate foreign markets."
The international swaps program costs Michigan 25 basis points. The more expensive alternatives include Deutsche Bank's Country Baskets and Morgan Stanley's World Equity Benchmark Shares, both of which are passive strategies but cost at least 85 basis points, said Mr. Stevens.
(The country basket/benchmark programs are passive strategies that replicate specific foreign equity markets. Michigan's international swaps program is also passive and uses futures to replicate foreign markets. Exposure is achieved by swapping a fixed-income return for the return of 10 foreign equity markets.)
Active management would cost between 100 and 125 basis points, he said.
Michigan's international swap agreement also has been profitable; the system's $1 billion book value portfolio is ahead by $200 million.
In spite of its success, the Michigan investment committee was deemed guilty by association when Orange County, Calif., went bankrupt in late 1994, because of excessive leverage as part of a derivative strategy.
Michigan didn't use leverage, but a $40 million paper loss from a decline in some international equity markets last February brought scrutiny from local media and legislators. Michigan officials then decided to take a go-slow approach to fulfilling the commitment.
State Treasurer Douglas Roberts appeared before the Michigan Legislature four times to discuss derivatives. "The 'D' word," Mr. Roberts said at the May IAC meeting, "created a lot of consternation.'
"When Orange County went belly-up everything that had a D was bad," said Mr. Stevens. "As we know, that is not so."
Mr. Stevens said he doesn't expect the resumption of the program will cause a furor.
Mr. Roberts met with legislative committees and retirees to explain Michigan's strategy and how it differs from Orange County, said Mr. Stevens.
"People learned that there was no leverage and that we are dealing with AAA-rated counterparties," Mr. Stevens said.
"We've had no controversy for over a year and we (don't) expect any," he said.