The State of Wisconsin Investment Board is considering leveraging its $67.8 billion core fund to achieve an asset allocation equivalent to 120% of total assets over the next three years.
The groundbreaking move — believed to the first effort to adopt an approach that a number of pension funds are weighing — would enable the board to reduce its equity exposure and increase allocations to lower-returning and lower-risk assets that offer greater diversification benefits while seeking to meet the board's expected actuarial return.
SWIB officials discovered that, like many pension funds, Wisconsin's exposure to equity risk comprised 90% of the fund's volatility. The pioneering change also would position the fund to endure a period of high inflation and low economic growth, a scenario of growing concern for many investors.
A first-time allocation to hedge funds is also possible, according to recommendations in an asset allocation study presented to the Madison-based board, which oversees a total of $78 billion.
SWIB, which is working with Strategic Investment Solutions Inc., San Francisco, its asset allocation consultant, is among a number of pension funds to consider boosting their effective allocation by leverage beyond 100%. At one point, the Wisconsin board even kicked around the idea of leveraging the fund to achieve an allocation of 200%, according to a staff report about the asset allocation study.
Vicki Hearing, public information officer, said board officials declined to discuss the recommendations or how SWIB would implement the leverage because they don't know what action the trustees might take. The board plans to consider the asset allocation recommendations Jan. 26, she added.
“Over the next five or 10 years, we think this is the direction institutions will go,” said Steven J. Foresti, managing director and head of the investment research group of Wilshire Associates Inc., Santa Monica, Calif.
Mr. Foresti wasn't familiar with Wisconsin's proposal but has been working with a number of other pension plan clients considering leverage for their total funds.
“With some clients, we are deep into conversation for similar strategies (as Wisconsin's) to build more diversity into the fund. The goal is to use leverage to manage risk rather than magnify return,” he said. “I think it is a healthy direction in which to go.”
Mr. Foresti said risks to the program include complexity and poor implementation, as well as overlooking liquidity and cash flow concerns. For example, volatility of asset values could force a pension fund to raise cash to pay higher derivative margins through forced sales of assets. Also, “there will be periods of times leveraged portfolios will underperform a traditional portfolio,” such as in a booming equity market, and test the perseverance of pension fund officials to stay with the strategy, he said.