Some pension executives, expecting the fog will lift over traumatized markets, stand ready to grab mispriced securities, particularly in the shrouded subprime mortgage area.
Ive had conversations with managers with solid credit analysis capabilities and Ive told them, If you see an opportunity there, let me know, and Ill raise the money, said David Kushner, deputy director for investments at the $16.7 billion San Francisco City & County Employees Retirement System.
Other pension funds looking to take advantage of undervalued securities include the $29 billion South Carolina Retirement System, Columbia; the €2.5 billion ($3.4 billion) APK Pensionskasse AG, Vienna; and the $39 billion Alaska Permanent Fund Corp., Juneau. Meanwhile, some pension funds, including APK and the $32 billion Retirement Systems of Alabama, Montgomery, previously put in downside protection to hedge their equity allocations.
Several pension funds have been raising cash that they now plan to invest in undervalued subprime mortgages and other credits. The amounts are relatively small anywhere from $25 million to $500 million but the potential for outsized returns is substantial if pension funds can scoop up bargains.
Were trying to position ourselves to have some dry powder to step into these opportunities, said Robert L. Borden, chief investment officer for the South Carolina system.
Meanwhile, money managers are seeking to capitalize on these opportunities as well.
The South Carolina Retirement System has set aside $100 million to invest through a money manager looking for subprime mortgage opportunities. Mr. Borden declined to say what money manager the fund would use.
Following recent state legislation liberalizing investment limits, the South Carolina system is restructuring the majority of its investment portfolio. Fund officials sold off 12% of its S&P 500 assets and reinvested half of that money in cash and half in international equities.
Weve been extraordinarily concerned about how extended and overleveraged the credit market was, he added.
In July, the San Francisco City & County board approved awarding $25 million to Los Angeles-based TCW Group Inc.s special mortgage credit fund because of new investment opportunities across a broad array of mortgage-related instruments. Their analysts are some of the best in the industry at credit analysis, Mr. Kushner said.
In mid-July, the fund withdrew $100 million from the equity markets as part of the funds regularly scheduled rebalancing. We were lucky we took it out before the market started to crash, Mr. Kushner said. Even so, San Francisco still lost about $140 million from the downturn in the market during July.
The Austrian multiemployer pension plan APK has increased its cash reserves from contributions over the last few weeks as a source for tactical positions that might come in the markets, said Gunther Schiendl, head of investments.
It has built up uninvested cash reserves of about 5% of plan assets, and separately has increased short-term cash to 10% of the portfolio by liquidating long-dated government bonds over the last six months.
Anticipating a stock-market correction, APK executives in June bought short positions on index futures against part of the plans equity portfolio. This hedge helped reduce the plans equity risk during Julys volatility by about a third, Mr. Schiendl said.
Pension executives are convinced that the recent market turmoil represents a short-term correction, not a long-term decline in securities prices.
I think its just a correction. Its been a fairly vicious and violent one. Volatility is picking up, but until recently, consumer spending has stayed up, said Bruce Dunn, chief investment officer of the $17 billion fund for the Ohio Bureau of Workers Compensation, Columbus. He also noted that corporate earnings are up and that employment is still extremely strong.
Michael Burns, executive director and chief executive officer of the Alaska Permanent Fund, agrees.
I think the markets have moved up so quickly, its just a natural reaction, he said.
Mr. Burns fund lost about $1 billion during the last week of July because of the market downturn.
In May, anticipating problems in the credit market, Alaska fund officials made a $500 million commitment to Crestline Investors Inc., a Fort Worth, Texas-based manager that invests in distressed debt.
It looked like a historical pattern was repeating itself, Mr. Burns said, noting that spreads were narrow and credit requirements were lax.
Marc Green, the Alabama Retirement Systems CIO, said the downturn was expected.
From a technical basis, the market was a little extended, but where it goes from here, I dont know, he said. The pension plan doesnt own any collaterized debt obligations or residential mortgage-backed securities, Mr. Green said.
Alabama officials use structured notes as downside protection on their indexed equity portfolio. It wasnt playing out too well until the last few weeks, Mr. Green noted.
Pension executives appeared calm despite recent market stresses.
Vera Kupper Staub, chief investment officer of the 14.8 billion Swiss franc ($12.2 billion) City of Zurich Pension Fund, said returns during July were lower as a result of the volatility in credit markets, but this was not giving her sleepless nights.
I am not concerned. That is volatility and investment risk and it is nothing new, she said. Year-to-date performance slipped to 3.3% as of July 27, down from 4.9% at the end of June.
Angela Docherty is senior corporate investment consultant at Unilever Corporate Pensions, which oversees the management of the €19.5 billion global pension assets of Unilever PLC, London. She said she had been in touch with the plans money managers and did not expect a notable negative impact from the funds traditional bond portfolios or its investments in hedge funds of funds.
Fundamentals are strong
Some managers concurred that the markets appear to be overwrought.
The volatility in equity and bond markets was the result of a short-term lack of liquidity combined with panic about the risk of contagion from subprime mortgage-related strategies, said Mark Morris, principal at Payden & Rygel Global Ltd., London.
The fundamentals look relatively good, growth is robust, inflation is well contained and defaults are at low levels. The level of panic seems to be overdone. But it is very difficult to determine if the withdrawal of liquidity will last and if it will impact economic growth and fundamentals, he said.
Ryan Stork, deputy head of institutional business for Europe, Middle East and Africa at BlackRock Inc., London, said that despite meaningful equity falls, recent market volatility stemmed from relatively isolated issues in the credit market, and that U.S. and international growth rates remained strong.