PROVIDENCE, R.I. -- Textron Inc. is looking at alternative investments to boost returns while keeping its risk exposure at or close to current levels.
That objective might not be far-fetched: With correlations among public securities on the rise -- the correlation between U.S. stocks and international developed-market stocks has gone to 55% from 41% over the past five years, according to Watson Wyatt Worldwide -- the lower correlations available from alternatives might act to reduce the overall volatility of the pension fund, said Assistant Treasurer Deborah Imondi, who oversees Textron's $4.7 billion defined benefit fund.
Measurement difficulties
"Measuring risk in our portfolio is one of our greatest challenges," she said. The problem is that standard measures of risk are based on historical data, while relationships among asset classes are changing rapidly.
That's why Textron pension executives are revisiting historic correlations. If the double-digit returns provided by U.S. stocks during the past five years won't continue, Textron execs will have to seek better returns from other asset classes.
Ms. Imondi's bias is to favor alternatives, such as real estate and private equity, although she emphasized the decision is up to the trustees of the Providence-based fund.
The key will be to ensure the pension fund does not balloon its exposure to risk.
Textron officials also are examining other aspects of pension fund risk:
* A recent asset-liability study -- the first time Textron has been able to conduct a single study for its entire fund -- endorses the fund's current asset mix but might result in some "tweaking."
* A study expected this week from Morgan Stanley Dean Witter, New York, might call for matching the duration of the fund's bond portfolio with pension liabilities or switching the portfolio's benchmark. However, fund officials might opt for an intentional mismatch.
* Pension assets of recently acquired overseas Textron subsidiaries, totaling some $650 million, now affect the company's bottom line, and require scrutiny.
When Ms. Imondi assumed oversight of the fund in 1993, it was invested solely in domestic stocks and bonds. Since then, the fund has diversified into small- and large-cap stocks, value and growth styles, international equities and alternative investments.
But it still has been hard to match assets to liabilities for Textron's 62 pension plans -- each with its own distinct liability profile. "Would you manage to the overfunded plan? The underfunded plan? The biggest plan? The smallest plan?" Ms. Imondi asked.
Thus, Textron officials have employed an accounting technique to consolidate the number of plans in its master trust to 28, with four of them accounting for 90% of assets.
Conservative estimates
Now, Watson Wyatt's Southfield, Mich., office has conducted the first overall asset-liability study for Textron. With more than 100,000 participants, of which 40% are active employees and the remainder are retirees or deferred vested, Textron plans are well funded -- 126% funded as of year-end 1998 and better since then (although data were not available at press time).
"In doing our asset allocation strategy, we always utilize a conservative estimate of what the market should return," Ms. Imondi said. "We're big believers in reversion to the mean around here."
Fortunately for Textron officials, the study reaffirmed the asset mix they had been using. "It told us what we intuitively knew," and provided an asset mix very similar to the current allocation, she said.
Ms. Imondi declined to reveal the actual results of the study. The fund's asset mix as of Sept. 30 was 49.8% domestic equities, 25.7% domestic bonds, 11.9% international stocks, 2.7% cash, 3.2% private equity and 6.7% real estate.
Now, the issues are whether the trustees will become a bit more aggressive, given Textron's solid funding level, and whether it's worth absorbing the transaction costs involved in earning "the small amount of basis points" in incremental returns suggested by the study, she said.
The key is not to jeopardize the trust's overfunded status, which "will disappear quickly if we have a bad market for a year or two," Ms. Imondi said.
International equities are expected to remain steady, despite weaker returns in recent years. Even with higher correlations to U.S. markets, she believes Textron will be rewarded for its risk in investing abroad.
Alternative investments hold the greatest potential reward.
The problem for Textron is getting its investments in real estate and private equity up to 2-year-old target levels of 7.5% each. In real estate, the fund has an 80/20 strategy: 80% is invested directly in core real estate through The RREEF Funds, San Francisco, while the remaining 20% is invested in opportunistic real estate pools.
Assisted by Hamilton, Lane Advisors Inc., Philadelphia, the fund invests in five specialized funds that do such things as employ leverage, invest in hotels or do development deals. The fund is looking for more real estate opportunities through both RREEF and Hamilton Lane, she said.
Private equity tough
As for many pension funds, private equity has been a tougher nut to crack.
When Textron owned Paul Revere Insurance Co., Worcester, Mass., the fund co-invested in mezzanine debt deals with the insurer. But the March 1997 sale of the insurer caused the fund to set a new strategy. Hamilton Lane advised it to invest in an array of strategies, ranging from distressed securities to leveraged buyouts to venture capital to international funds.
Invested in 31 funds, Textron still has only 3.2% invested in private equities -- less than half of its target. Ms. Imondi said Textron will stick with its 7.5% target but will continue to pursue opportunities.
But the fund won't invest willy-nilly: "The last thing we want to do is go chasing deals that shouldn't be in the portfolio just to get to the target," she said.
Risk to the company's bottom line also led to greater monitoring of Textron's overseas pension funds -- picked up in recent years through foreign acquisitions.
With six plans in Great Britain totaling some $600 million in assets, Ms. Imondi is trying to persuade U.K. trustees of the merits of establishing a common investment fund. That way, each asset class would be unitized, and funds would benefit from a common set of specialist money managers, shedding the current balanced managers that each fund employs.
The desired result: better performance and lower management and administrative fees.
But U.K. trustees are wary of handing over responsibility for picking managers. With the help of Towers Perrin's London office, Ms. Imondi, who sits on most of the U.K. boards, is trying to show that trustees would not be delegating that task. So far, trustees have responded favorably, she said.
In addition, Textron officials are pondering whether to consolidate U.K. pension assets with a single global custodian, enabling the fund to profit from securities lending and commission recapture and other cost savings.
