The $83 billion Teacher Retirement System of Texas is a little more than halfway toward its goal of increasing alternative investments to 29% of plan assets in the second year of the fund's portfolio makeover.
Staff of the Austin-based fund is in the midst of implementing a sweeping portfolio revamp, approved in the summer of 2007. The fund's former 65% equities/35% fixed-income mix was scrapped in favor of a portfolio that lowers market exposure and significantly increases exposure to non-correlated, alpha-generating asset classes, said Lee Partridge, deputy chief investment officer.
To meet these objectives, investments in the Texas Teachers' portfolio were regrouped into what Mr. Partridge called three major building blocks:
•Global equity, comprising 60% of the overall portfolio, of which public equities is targeted to be 50% of the total fund and private equity, 10%;
•Stable value, making up 20% of the overall portfolio, with a target allocation of 4% to hedge funds, 15% to fixed income and 1% to cash;
•Real return, accounting for 20% of total portfolio assets, with target allocations of 15% to real assets and 5% to global inflation-linked bonds.
As part of the revamp, the total allocation to alternative investments was raised to 29% of assets from 8.5% as of June 30, 2006.
Public equities, fixed income and an opportunistic allocation were reduced by a total of 20.5% in order to increase alternative targets.
Private equity was raised to 5% of the total fund from 4%; hedge funds to 4% from 1.5%; and real estate to 4% from 3%. New allocations were earmarked for global inflation-linked bonds, 10%; commodities, 3%; real estate investment trusts, 2%; and other real assets, 1%.
Mr. Partridge said active money managers are being added gradually to run all of the alternative investment allocations, with funding coming from the reduction of internally managed passive portfolios. The investment team is using overlays to provide synthetic exposure up to the target allocations in each of the alternative asset classes until all the active external managers have been hired.
As of June 30, the alternative investment allocation totaled 17% of total assets, or about $14 billion, leaving about $10 billion more to be invested.
In an interview, Mr. Partridge provided a few more specifics about the remake of the fund's $3.4 billion hedge fund portfolio or the new portions of the total fund.
He said staff began to analyze the components of the hedge fund portfolio last April, deciding it was fine if “it was supposed to be two-thirds a substitute for equities and one-third a substitute for bonds.”
But fund officials didn't want to pay typical hedge-fund costs of 2% management fees and 20% performance fees for equity exposure, he said. “I have no problem paying hedge fund managers a lot of money, but I want to pay for true, idiosyncratic skill.”
The portfolio had fairly heavy weightings to long/short equity, distressed, merger arbitrage and credit managers, he said, with too much market exposure when it was supposed to provide a “neutral alpha stream.” In order to reduce the beta exposure, Mr. Partridge said allocations to these strategies were reduced and uncorrelated strategies such as equity market neutral, relative value, global macro and managed futures were added.
The new hedge fund policy weight allocation is equity market neutral, 20%; equity long/short, 15%; global macro, 15%; convertible arbitrage, 15%; multistrategy event driven, 10%; distressed, 10%; fixed-income credit, 5%; managed futures/commodity trading advisers, 5%; and fixed income relative value, 5%.
Texas Teachers officials are reducing some strategies. The most severe cut is in long/short equity, which made up 32.4% of the hedge fund portfolio as of Aug. 31, 2008, the most recent data Mr. Partridge said he could provide.
About 90% of the hedge fund reconstruction should be done by the end of 2009 with the remainder finished by the end of 2010, Mr. Partridge said. He declined to identify any new managers hired or searches under way.
One manager hire that was not part of the hedge fund portfolio: a $400 million allocation to dislocated credit to be managed by Marathon Asset Management LP.
Mr. Partridge said staffers are optimistic about the prospects for both public and private dislocated securities, noting “the plumbing got all out of whack” after last year's credit crunch set in.
While final details remain to be determined, Mr. Partridge said Marathon will be given fairly broad investment discretion, including possibly adding a side pocket to hold investments from the U.S. Treasury Department's Public-Private Investment Program. Marathon is among the managers selected by Treasury to participate in the PPIP, which will help banks sell their distressed commercial and residential mortgage-backed securities.