It's hot outside. The stock market is even hotter. But pension fund executives and tactical asset allocation managers kept cool last week as the market hit an all-time high.
Things cooled a bit at the end of the week, but the market still hovered in the thin air just below's Wednesday peak.
Indeed, by Pensions & Investments' calculations, domestic equity returns alone swelled the assets of the nation's 200 largest pension funds an average of 37% between Sept. 30, 1996, and July 16. The top 200 funds now have about $1.358 trillion in U.S. equities in their defined benefit plans, up from $991.2 billion Sept. 30.
Still, the Dow Jones industrial average surpassing 8000 wasn't enough of an event to alter the asset allocations of pension funds and tactical asset allocation managers. Any rebalancing that occurred was done following models that dictate the investor's asset allocations, not the market events of last week.
"There are really two key issues at play here," said Steven Nesbitt, senior vice-president of Wilshire Associates Inc., Santa Monica, Calif. "There's a tactical as well as a strategic question.
"We strongly discourage our clients from tactical thinking, and believe that if we have set targets, it's best to keep focused on those goals," said Mr. Nesbitt. "We do not believe in short-term directing of funds."
Mr. Nesbitt added, however, that when it comes to asset targets, it's important for clients not to allow their portfolios to diverge too far from their goals.
"We do think that it's important that clients make sure to rebalance their assets so that they are in keeping with their long-term targets," he said. "Since the late 1980s, this has become a more pronounced issue.
"If clients find that increases in stocks are overweighting them in certain areas, we advise them to do what is necessary to return to their long-term goals."
It is a position with which Jim Biundo concurs.
Mr. Biundo, president of U S WEST Investment Management Co., Englewood, Colo., which oversees investment of the $17.5 billion U S WEST pension fund, said he remains confident in the fund's 63% allocation to domestic equities. That allocation is "slightly overweighted .*.*. and was playing against the experts," he said.
"We don't get involved in immediate market rebalancing, and we learned our lesson during the Gulf War," Mr. Biundo said. "During that war, we tried to out-move the market and it hurt us badly.
"There are 200 trading days per year, and over the last 10 years if you've missed even 10 days of high earnings per year, it really cost you," he said.
U S WEST has a well-diversified portfolio and can withstand the volatility of the market, said Mr. Biundo.
"We believe that, given the current inflationary and economic statistics out there, an 8000 Dow is justifiable," he said. "Rather than concentrate on what number the market is at, we instead plan to watch earnings and earnings growth.
"We feel that's a better way to go to help decide if valuations are justifiable."
Alabama buying stocks
David Bronner, chief investment officer of the $16 billion Retirement Systems of Alabama, Montgomery, said his internally managed fund is buying stocks. Alabama legislators, a few years ago, gave the pension fund permission to invest more than 20% of total assets in equities, and the state fund, now with 40% in domestic equities, is trying to get to 50%, said Mr. Bronner.
"We doubled it but we are below the average pension fund," said Mr. Bronner. "For many public pension funds, there are not many alternatives to domestic equities."
An 8000 Dow doesn't figure in the Wisconsin Investment Board's decision to rebalance, said Michael McCowin, chief investment officer of the $39 billion pension fund. Besides, stocks haven't risen high enough yet to trigger a rebalancing.
The fund has an equity target of 55%, and Mr. McCowin said the actual allocation probably is closer to 60% now.
"I can't give you a number for the Dow" that would result in a rebalancing, he said. "I guess it would have to go another 10% to get us to the edge of doing that."
Southern California Edison, Rosemead, Calif., also has no immediate plans to alter the current asset allocation in the wake of the surging Dow, said David Ertel, manager of investments with the $4.7 billion fund.
"We currently have about 22% of our assets in the bond market, and that's a level that we feel comfortable at for the time being," Mr. Ertel said. "We have a variety of domestic equity accounts, including small cap, and we believe our diversification and allocation is about where it should be."
Southern California Edison's equity allocation already "leans more heavily than most on the international equity side of things," said Mr. Ertel.
The pension fund has about 70% of its assets in combined domestic and international equities, which breaks down to 45% domestically and 25% internationally, said Mr. Ertel.
"We have remained fairly constant for the last several years, and our last substantial shift in equities hasn't occurred since about 1993."
TAA managers unfazed
Even the tactical asset allocators, whose livelihood depends on correct forecasting of market turns, are not placing too much stock in the Dow hitting 8000 as a signal.
Robert Harrell, chief executive officer of the Dallas-based firm that bears his name, said the key to asset allocation shifts is the level of inflation. Right now, inflation is low and the stock market is thriving.
"When inflation and interest rates move up, the (stock) market goes down," said Mr. Harrell. "We know that you can't anticipate changes in inflation and no one has been able to predict interest rates."
Mr. Harrell has been holding his accounts at 50% equities since March, when the Federal Reserve last increased short-term interest rates.
Should short-term rates turn down noticeably, he said he would not be surprised to see his TAA model move more toward equities.
"You can't have much of an ego in a situation like this," he said. "Ours is a totally mechanical approach and has nothing to do with my intuition or clairvoyance . . .
"In a period like this we can't capture all of the market upside, but when it collapses our clients will have downside protection, which is the entire purpose of TAA management," Mr. Harrell said.
He said it might not be popular in light of the stock market buoyancy, but his model does not suggest any immediate changes.
Christopher Luck, a spokesman for TAA manager First Quadrant L.P., Pasadena, Calif., said his firm also relies more on its model and less on the peaks and troughs of the market.
"We're neutral on bonds," said Mr. Luck. "We were bullish on bonds earlier in the year, when short-term rates were rising, but now we're fairly neutral."
"The model used to favor bonds as an alternative to overvalued stocks, but it is now moving us into larger cash positions, Mr. Luck said. "But the Dow reaching 8000 is not in itself causing us to make any changes."
Against a 60% stocks, 40% bonds, moderately aggressive benchmark, First Quadrant's model portfolio is around 30% equities, 40% and 30% cash. This contrasts with the beginning of the year, when the model was closer to 40% stocks, 60% bonds.
"If stocks were overvalued at the beginning of the year, they're more so now," said Mr. Luck. "We've only moderately reduced our equity exposure, but as you can see, we have significantly changed our bond position in favor of cash."