State of Wisconsin Investment Board, Madison, is considering leveraging up to 20% its $62.5 billion core fund to achieve an asset allocation of 120% over the next three years, according to recommendations presented to the board.
An asset allocation study proposes core fund targets for 2010 at 28% for U.S. equity; 26% fixed income; 25% international equity; 7% TIPS; 6% each for private equity, real estate and multiasset strategies. The study points out the targets total 104% with the introduction of the leverage.
The recommendations call for potentially raising the leverage to achieve a 112% allocation in 2011 and 120% allocation in 2012 when the allocation targets would be 43% combined U.S. and international equity, 35% fixed income, 20% TIPS, 7% real estate, 7% other alternatives, 4% multiasset strategies, 4% active risk strategies.
The core fund's current allocation is 29% U.S. equity; 26% each in international equity and fixed income, 6% each for private equity and real estate; 4% multiasset strategies and 3% TIPS.
The potential introduction of leverage would amplify the performance contribution of lower-volatility assets and better position the overall asset mix for varying economic scenarios — namely, high inflation similar to that of the late 1970s and early 1980s, deflation, low market returns for an extended period, and recession similar to the 1970s market returns, while achieving its expected 8% return assumption, according to a report about the study.
“‘Downside protection' improves with increased leverage in absolute terms, i.e., lower worst-case costs minus higher expected costs,” the report states.
“The cost of leverage is modeled at the expected cash return, or 3%. If SWIB were to ‘borrow' at current (LIBOR rate) on 20% of the total portfolio, expected returns of the alternatives would exceed those of the current policy.”
Vicki Hearing, public information officer, said SWIB officials declined to discuss the recommendations or how SWIB would implement the leverage because they don't know what action the board might take when it considers the asset allocation recommendations on Jan. 27.
Strategic Investment Solutions, SWIB's asset allocation consultant, assisted in the study. Aside from SIS, Ennis Knupp & Associates, the board's investment manager monitoring consultant, and other investment-related firms were included in discussions on the asset allocation proposal.
The study recommends keeping SWIB's $4.5 billion all-equity variable fund allocation at 69% U.S. equity, 30% international equity and a 1% multiasset strategy for liquidity purposes.
The board oversees a total of $70 billion.