SACRAMENTO, Calif. -- Investing in non-U.S. government fixed-income assets would add only modestly to the risk/return performance of the California State Teachers' Retirement System, preliminary findings of a study indicate.
The study, by Pension Consulting Alliance, Studio City, Calif., sought to define the long-term impact of investment in non-U.S., government debt on the $82 billion CalSTRS portfolio.
Using various mixes of U.S. and non-dollar government fixed-income assets in a simulated portfolio, the study found the expected returns hardly varied, ranging from 9.77% to 9.74%.
Adding non-dollar fixed income to a series of test portfolios modeled on CalSTRS' asset allocation "had virtually no impact on the return" the study found.
On the issue of risk, the PCA report stated: "These findings show that, at the margin, including unhedged non-dollar fixed income in the overall fixed-income asset class, may provide a modest improvement to the risk/return profile of the portfolio over a long investment horizon."
To get that modest reduction in risk "would require a significant strategic allocation to unhedged non-dollar fixed income," the report stated.
The risk reduction was less in a fully hedged portfolio.
The preliminary findings appear to be somewhat unfavorable news for supporters of international fixed-income investment. Although asset allocations for pension funds vary, the study's preliminary findings also would appear to raise questions about the worth of international fixed-income investing for large U.S. funds with substantial exposure to the U.S. fixed-income market like CalSTRS.
However, PCA and CalSTRS staff members want to study the issue further.
INCREASING POPULARITY
Part of the reason for the CalSTRS study is that non-dollar fixed income has become increasingly popular in recent years, although not nearly as common as international equity investing. The PCA study found the 14 largest public pension funds in the United States had exposure to the global or international fixed-income markets.
Numbers from the Institute for Fiduciary Education, Sacramento, Calif., for the nine-month period from June 1996 to March 1997 were used for the comparison. The $28.8 billion Virginia Retirement System had the largest exposure at $6.2 billion, according to the study. Some other funds with large international fixed-income holdings were the $128 billion California Public Employees' Retirement System, with $4.4 billion exposure, and the $50 billion State of Wisconsin Investment Board, with $3 billion exposure.
CalSTRS has a $400 million exposure.
One reason some investment professionals are giving support to investing in non-dollar fixed-income investments is that the market is large, $12.6 trillion. The U.S. fixed-income market is estimated around $10.4 trillion.
Another reason is that the opportunity for superior returns might exist in the non-dollar market relative to the U.S. market.
A third reason is the probability of a low covariance with the U.S. market and the resulting risk reduction by diversifying investments.
In studying these potential benefits, the PCA study only focused on non-dollar government debt. Some consultants say non-dollar government debt is the safest form of international fixed-income investment.
6 DIFFERENT MIXES
In its analysis, PCA looked at six portfolios or mixes of assets. The investment in non-dollar fixed assets ranged from 0 to 26% of assets.
As the percentage in hedged or unhedged non-dollar assets was increased in the portfolios, the percentage of assets in the domestic fixed-income portfolio was decreased. The percentage in the other asset classes remained the same.
The purpose of the tested portfolios was to find the potential contribution non-dollar fixed income could provide to the overall portfolio.
Following its research, the PCA report concluded: "The research conducted to this point has been broad in scope and has demonstrated that non-dollar fixed income on a strategic basis is not expected to add significant value to the (CalSTRS) fund."
The idea that the larger non-dollar international fixed-income market might offer higher returns wasn't supported in the PCA study. Adding unhedged non-dollar fixed income to CalSTRS' fixed-income portfolio had virtually no impact on the investment return over the long term.
The study also didn't find that CalSTRS would get a significant reduction in risk if it invested in the non-dollar fixed market.
MODEST IMPACT
The study found investment in non-dollar fixed income would provide only a modest positive impact in reducing risk for CalSTRS. To get that modest positive impact would require investment of substantial amounts of money in the non-dollar market.
A fully hedged fixed-income portfolio would provide less risk reduction for CalSTRS than an unhedged one, the study found.
For an unhedged portfolio, the study found the highest expected return of 9.77% was with no non-dollar fixed income. The lowest expected return, 9.74%, was with a 26% allocation in non-dollar fixed income. The expected returns were identical for the hedged portfolio.
The expected risk, measured by standard deviation, for the unhedged portfolio ranged from 3.94% in the portfolio with no non-dollar assets to a lower 3.83% for the portfolio with 26% of assets in non-dollar fixed assets.
For the hedged portfolio, the expected risk numbers ranged from 3.94%, with no non-dollar assets, to 3.86%, with a 26% allocation.
MORE STUDY WANTED
PCA and the CalSTRS staff are likely to do additional studies on non-dollar fixed-income investment.
PCA and CalSTRS want to assess the impact of passive vs. active investment on non-dollar fixed assets. They also want to:
* Review non-dollar government benchmarks used in measuring performance;
* Analyze the implications of internal vs. external management; and
* Consider the impact of the formation of the European Monetary Union and its use of a single currency.
