After years of sprucing up their portfolios with exotic allocations like portable alpha and infrastructure, institutional investors are making room for a more mundane addition: cash.
Such moves reflect the pickle many investors find themselves in now after the flood of liquidity in recent years has evaporated, leaving them working overtime to rebalance their portfolios or cover benefit payouts.
Some pension fund executives say they are considering adding cash allocations in the low single digits, but at least one expert predicts that 5% to 20% of total assets in cash will prove a more realistic allocation, with alternative-heavy endowments and foundations likely to come in closer to the top of that range.
In a volatile market like this, liquidity remains our No. 1 priority, said Alan Van Noord, chief investment officer of the $54.7 billion Pennsylvania Public School Employees Retirement System, Harrisburg. You never know how much you need until you can't get it, he said.
To reflect the new market realities, PSERS is looking to add a permanent cash allocation of up to 2% of its portfolio, Mr. Van Noord said.
Others, citing longer-term factors in addition to the imperatives of short-term volatility, are mulling setting aside even more. The $20 billion South Carolina Retirement Systems, Columbia, has established a 3% to 5% liquidity position as a tactical move, and is considering making that a strategic allocation, said CIO Robert L. Borden. When pension plans such as South Carolina's mature demographically to the point where they're seeing net outflows, there's a strong argument in favor of a permanent allocation to cash, he said.
At a trustee meeting of the $39.6 billion Massachusetts Pension Reserves Investment Management Board on Dec. 2, CIO Stanley Mavromates suggested the board also discuss whether PRIM should add a cash component to its asset allocation.
After the meeting, Michael Travaglini, PRIM's executive director, expressed some reluctance to do so, noting that the more money the fund parks in cash, the more difficult it would be to meet or exceed its 8.25% annual target for asset growth.
Some analysts predict a growing number of institutional investors are likely to overcome that reluctance. Liquidity is the new best practice, and the size of permanent allocations being added will depend on how much a pension plan or endowment has in illiquid asset classes, said Cynthia Steer, managing director and chief research strategist with Darien, Conn.-based investment consultant Rogerscasey Inc.
Ms. Steer said endowments and foundations, which have led the way in investing in illiquid asset classes, could end up with permanent cash allocations nearer the high end of a range she figures could be between 5% and 20%. An executive with a multibillion-dollar U.S. corporate defined benefit plan said he's also considering adding a substantial allocation to cash, to balance what he predicted will be a move by institutional investors toward more private equity-style multiyear lockups in areas such as hedge funds.
The executive, who declined to be named, said the real problem this year hasn't been too little liquidity. Rather, it's a matter of too much institutional money remaining in supposedly liquid asset classes, such as commingled credit funds or hedge funds or even equities, where values were dragged down when other investors ran for the door.
He predicted his pension plan might gravitate to a liquidity barbell approach, with more money flowing to private equity or hedge fund investments with multiyear lockups, and at the other end a big chunk of money in very liquid instruments, such as U.S. Treasuries.
Ms. Steer said it is unclear whether the institutional investor rush to add cash components to their asset allocations will prove a long-term trend spanning decades or a shorter-term phenomenon of five or 10 years.
PSERS' Mr. Van Noord likewise expressed uncertainty, noting that should liquidity prove abundant again in a few years, the permanent allocation might prove to be not so permanent.