AUSTIN, Texas The Teacher Retirement System of Texas, guided by new CIO T. Britton Harris IV, could have the largest percentage allocation to alternative investments of any public pension plan in the U.S. if a proposal to overhaul the $106 billion systems investment program is approved.
In mid-April, Mr. Harris unveiled a proposal at a board of trustees meeting to move about $38 billion into alternative investments over the next several years.
This 35% allocation to alternative investments would be the largest, by percentage, made by any major U.S. public plan, according to data from Pensions & Investments 2006 annual survey of the 200 largest retirement systems. It would surpass the Washington State Investment Board, Olympia, which had 27.4% of its $52.4 billion in defined benefits assets in alternatives as of Sept. 30, according to data submitted to P&I last year. It would also be a huge increase from the Texas systems current alternatives allocation 2.4% in private equity, 1.7% in absolute return and 0.4% in core real estate.
At the same time, the Texas system would more than halve its domestic equity target allocation and would reduce its bond allocation by more than 40%.
The Austin-based plans move is bold, industry observers said, with the system and Mr. Harris, the one-time president of Verizon Investment Management Corp., positioning themselves to be vanguards in public pension plan investing.
If anyone can make it work, some observers said, Mr. Harris can. He is definitely an appropriate candidate, said David Morris, a Houston-based partner at executive search firm Heidrick & Struggles Inc. And he should be commended for taking the stance he has and saying that things need to change.
Mr. Harris has had extensive experience with alternative investing, Mr. Morris noted, most recently as the chief executive officer at Bridgewater Associates Inc., a Westport, Conn.-based alternative specialist with $165 billion in assets under management that he left in June 2006. Before Bridgewater, Mr. Harris was president of Verizon Investment, where he oversaw roughly $60 billion in pension assets for Verizon Communications Inc.
At Verizon, Mr. Harris helped lead the pension plan into more alternative and absolute return strategies, said Kevin Lynch, managing director and co-head of the non-traditional investments at consulting firm CRA RogersCasey LLC, Darien, Conn.
Mr. Lynch, formerly director of strategic relations and absolute return strategies at Verizon under Mr. Harris, said the company began moving assets into hedge funds and absolute return vehicles in 2003. This was, Mr. Lynch said, essentially the beginning of a 10-year plan to move Verizon into more alternative investment strategies.
One of the few
Britt is one of the few people who could pull of a something of this magnitude, said Mr. Lynch, of Texas Teachers move into alternatives. Hes a thought leader, and hes always ahead of the curve.
Before Mr. Harris left at the end of 2004, Verizon had roughly 17% of assets in alternative investment strategies, according to P&Is 2004 annual survey of the 200 largest retirement systems.
We all thought that this could get interesting when he was first hired, said Mr. Morris. Hes a very talented individual running a large pool of capital larger than anything hes run before and its at a public institution. So everybody will be watching.
Mr. Harris was not available for an interview for this story.
The trend (toward high alternatives allocations) has been in place, but now it is only accelerating, said Richard Charlton, chairman and chief executive officer of New England Pension Consultants Inc., Cambridge, Mass. Its a logical step for all investment programs; the benefits costs and funding concerns are increasing for many.
To fund the new allocation, Mr. Harris proposed that the system significantly reduce its 52.8% domestic equity and 25.7% fixed-income exposures, according to information distributed at a board meeting on April 12. The system also has 15.1% in non-U.S. equities and roughly 2% cash.
Under the recommendation, Texas Teachers would have only 25% of its assets in domestic equities and 15% in bonds, a combined 38.5 percentage points less than before. Much of this would be dedicated to alternative investments with allocations of 10% of total assets to private equity, 10% absolute return, 5% core real estate, 5% opportunistic real estate and 5% other real assets, including timber and infrastructure investments. Also, 15% of total assets would go to unhedged Europe Australia Far East equities, and 10% would be allocated to emerging markets.
The new investment policy would produce expected returns of 8.72%, roughly 100 basis points more than its current expected return of 7.73%. This would ultimately add $1.1 billion in total additional returns to the retirement system.
At the same time, the assets would be invested with a similar or lower level of risk; the new investment policys standard deviation of 9.64% would be 84 basis points lower that its current level, and its downside risk would be decreased by 366 basis points to 6.89%.
Diversification and downside protection are two of the primary motivators behind the proposed shift to alternatives, said Dory Wiley, the member of the retirement systems board of trustees responsible for overseeing its alternative asset committee. Mr. Wiley is also the president of SAMCO Capital Markets Inc., a Dallas-based broker-dealer.
Texas Teachers was hit hard in 2001 and 2002 when the domestic equity markets experienced major declines. Because of its asset allocation at the time, which Mr. Wiley said was roughly 70% equities and 30% fixed income, the retirement systems market value declined by $30 billion.
Stop the swings
We had to find a way to stop the volatility swings, said Mr. Wiley. Some people may look at the new policy and say its far from conservative. But the truth is, its actually more conservative than a 70/30 asset mix.
Kevin Quirk, founding partner of strategic consultant Casey, Quirk & Associates LLC in Darien, Conn., called Texas Teachers proposal a radical step toward building a portfolio that is more typical of how the capital markets are structured and function.
Theyre loosening their constraints and building a more diversified portfolio, one that resembles what many endowments and foundations have being relying on for years. Mr. Quirk said.
Indeed, the new investment policy would put Texas Teachers in line with most large university endowment funds alternative investment allocations. Last year, the average university endowment with more than $1 billion in assets had roughly 36% of its assets allocated to alternatives, according to the latest report from the National Association of College and University Business Officers, Washington.
The average public pension plan, meanwhile, had roughly 9% of assets invested in alternatives at the end of September 2006, according to P&I data.
Ideally, Mr. Quirk and NEPCs Mr. Charlton said, other public pension funds will soon follow in the footsteps of Texas Teachers, though some might be wary of taking of taking such radical steps. The biggest risk in the public sector is headline risk, said Mr. Charlton. No one wants to be seen as the fall guy.
Mr. Quirk added that the risks associated with not being diversified, however, are far greater than the blow-up risk, or the potential for something to go wrong in a seemingly more complicated investment program.