Pension funds should be prepared for long-term weakness, even if in the short term they take very defensive positions in portfolios and focus on protection of capital, instead of returns.
“What pension funds should be concerned with is we are in a different (and) a weak market and economic regime that could last many years,” said Andrea Malagoli, director at Buck Consultants. “The downgrading is one manifestation of the unraveling of excesses … way too much leverage in the system in both the private and public sector. All the monetary and fiscal policies have mainly shifted the problems, not eliminated them.
“Pension funds need … to have courage to abandon some commonly established investment policies and look at policies that are far more discretionary and dynamic and more responsive to current market events,” Mr. Malagoli said. “In this market, dynamic asset allocation is key. …They need to make allocation decisions a lot faster.”
For now, however, the steep decline in the stock markets hasn't shaken the resolve of public pension executives. Those contacted by P&I Daily said they're holding firm with their investment strategies despite the downgrading of the United States' credit rating and the drubbing the markets took as a result.
The $11.4 billion Illinois State Board of Investment, Chicago, is making no changes. But William R. Atwood, executive director, said: “The downgrading contributes to the volatility in the markets.. The volatility is having us look at rebalancing more frequently.”
Mr. Atwood said the reaction to the downgrade is “more emotion than anything else.”
“S&P has just said what everyone knows,” Mr. Atwood said. “Treasuries are a worse credit today than five or six years ago.”
But he added that the Treasury rate “is still the risk-free rate. It is still the best credit in the world as far as ISBI is concerned. It is just as not as good as in the past.”
Tom Rick, chief investment officer of the $4.3 billion Milwaukee City Employes' Retirement System, said: “We're long-term investors … We have a strategic allocation and that's what we are sticking to. There are no changes being discussed because of the downgrade.”
The Milwaukee system had 2.6% of total assets in U.S. Treasuries and an additional 2.34% combined invested in Freddie Mac and Fannie Mae, all as of July 31.
“We don't have a heavy weighting in Treasuries We don't have a dedicated Treasury portfolio. We are broadly diversified in fixed income and not heavily weighted in anything,” Mr. Rick said.
The $23 billion Iowa Public Employees’ Retirement System, Des Moines, “is not currently directing its money managers to sell IPERS’ positions in U.S. Treasury obligations — or holdings in any other asset class,” according to Judy Akre, IPERS director of communications.
"Contract guidelines with those managers are currently flexible enough that the downgrade will not force them to sell,” Ms. Akre write in an e-mail. “However, the firms do have discretion to reallocate their assets between the different sectors of their respective markets, and may adjust their portfolios in the future based on their perceptions of market risk. We have not seen any of our money managers selling Treasury securities as a result of the downgrade.
Although Ms. Akre wrote that market movements probably will trigger rebalancing to meet the ranges set in the investment policy, “IPERS staff is not recommending any changes in our current investment policies or strategies at this point, but we continue to closely monitor and assess the evolving economic and investment risks that this event highlights.”
The downgrade appears to have contributed to “the downdraft in the stock market, but it is not the only factor. Combined with some weak economic reports, it certainly has helped sour investors’ mood,” Bob Jacksha, chief investment officer at the $9.2 billion New Mexico Educational Retirement Board, Santa Fe, wrote in an e-mailed response to inquiries.
Board officials are uncertain of the impact on the fund’s bond portfolio, Mr. Jacksha said. “We don’t generally price it intraday,” he said. “We try not to engage in ‘knee-jerk’ trading in any case.”
The fund’s REIT portfolio is down along with the rest of the stock market, he noted. However, it is too early to say how the sovereign downgrade as well as Monday’s downgrade of Fannie Mae and Freddie Mac, which have been lenders on commercial multifamily projects, will have on the board’s equity real estate portfolio. “It will depend on how it plays into investor sentiment,” Mr. Jacksha stated.
“Today’s news is of concern,” New York State Comptroller Thomas DiNapoli, sole trustee of the $146.5 billion New York State Common Retirement Fund, Albany, wrote in an e-mailed response to questions. “However, we are a long-term global investor and have long term confidence in the global marketplace.”
“The market’s reaction today to perceived weaknesses should not cause us to lose sight of areas of financial strength and good investment opportunities worldwide,” Mr. DiNapoli wrote. “Moreover, I believe that many of the most attractive opportunities are in the United States.”
Staff at the $158.8 billion Florida State Board of Administration, Tallahassee, is evaluating each asset class with external managers and consultants for possible impacts of the downgrade, John Kuczwanski, communications manager, wrote in an e-mailed response to questions. “We will continue to monitor and expect it to be a topic of conversation” at the Sept. 19 investment advisory council meeting, he wrote.
The $74.9 billion North Carolina Retirement Systems, Raleigh, made no changes to its investment strategy as a result of the downgrade, said Julia A. Vail, spokeswoman for state Treasurer Janet Cowell, the system's sole trustee.
“While any portfolio will suffer in such market downturns, the pension fund is positioned appropriately,” Ms. Vail wrote in an e-mailed response to questions. “The portfolio has a high allocation to investment-grade fixed income (such as Treasuries) and relatively lower allocation to risk assets (such as equities). Also, our equity holdings are diversified globally to help reduce the impact of steep declines in any one country or region.”
No changes are expected at the $37.1 billion Maryland State Retirement and Pension System, Baltimore. “The S&P downgrade does not trigger sells, nor would an additional similar downgrade by another credit agency,” interim CIO Melissa Moye said in e-mailed response to questions.
“While market conditions will fluctuate, the New York City pension funds are long-term investors and are better positioned to withstand these swings due to the further diversification of our assets,” according to an e-mailed response from Michael Loughran, spokesman for city Comptroller John Liu. Mr. Liu is trustee for the five pension funds in the $119 billion New York City Retirement Systems.
For corporate plans, uncertainty over the downgrade isn't likely to trigger allocation changes, said Ethan Kra, senior partner and chief actuary with Mercer. “Most companies don't sell on a panic,” Mr. Kra said in an interview. “They tend to take a deliberate, committee analytics approach and try to follow a logical process.”
Mr. Kra said the bigger issue will come up in 2012, which is the end of the seven years afforded under the Pension Protection Act for reaching 100% funding.
“Most corporations will take a look before then as they do their financial planning overall,” he said.
Lynn Dudley, senior vice president of the American Benefits Council, said the true impact of market conditions will come in 2012, as plans reach their “wall of contributions” required by PPA, but that most plans are in good shape.
“People have been putting in tons of money since 2006 (passage of PPA),” Ms. Dudley said in an interview.