Execs taking cue from corporate brethren
Public pension plan chief investment officers and investment committees are trying to catch up with their corporate counterparts when it comes to managing their funds more actively in response to market and economic conditions.
Corporate defined benefit plan CIOs have been in the forefront on implementing portfolio-wide, dynamic asset allocation programs in an effort to control volatility and maintain plan funding levels.
Among the corporations us-ing an active tactical asset allocation approach in their liability-driven investment programs are Exelon Corp., Chicago, with $11 billion in defined benefit plan assets; Verizon Communications Inc., Basking Ridge, N.J., for its $23.7 billion plan; and Boeing Co., Chicago, for its $49.3 billion plan.
Only a few public plans such as the $101.1 billion Texas Teacher Retirement System, Austin, and the $6 billion San Bernardino County (Calif.) Employees Retirement Association have given their investment departments latitude to run TAA programs, and good results over the past few years are a powerful testament to the benefits of dynamic allocation.
Investment officers of California Public Employees' Retirement System, Sacramento, now have freedom to tactically manage asset classes of the $223.1 billion pension fund within set ranges, but the system is reviewing a holistic, top-down asset allocation approach that will help portfolio managers there manage assets even more dynamically in response to market conditions and changes in asset valuations.
Meanwhile, the $7.2 billion Rhode Island Employees' Retirement System, Providence, is close to adopting its first dynamic asset allocation investment strategy.
In response to extreme market conditions in 2008 and 2009, many corporate plan sponsors granted CIOs and investment committees more latitude in tactically managing their portfolios, Joseph Nankof, partner at investment consultant Rocaton Investment Advisors LLC, Norwalk, Conn., said in an interview.
The more active investment approach helped corporations dampen asset swings that wreaked havoc on pension funding levels and helped avoid having to make contributions to the plan under the requirements of the Pension Protection Act of 2006, sources said.
Exelon, for example, reaped the benefits in 2011 of a change in investment governance that allowed investment staff there to manage pension assets dynamically within an LDI structure.
By taking an active approach to asset allocation beginning in mid-2010, the company's investment staff, led by Douglas J. Brown, senior vice president and CIO, were able to steer the pension fund toward a 5.3% return year-to-date Sept. 30, compared to the 9% drawdown of the Standard & Poor's 500 index for the same period, while raising the funded status of the plan.
A short list
The list of public pension plan investment departments that are managing portfolio assets “as if they are a global balanced manager” is much shorter than the corporate plan list, Erik L. Knutzen, CIO of investment consultant NEPC LLC, Cambridge, Mass., said in an interview.
“Most investors still are on a journey” toward making wider use of more dynamic asset allocation approaches, with many relying more at this point on investing in flexible global multiasset-class mandates that use tactical asset allocation or risk-parity managers and slightly loosening rebalancing rules, than trying to do it themselves, Mr. Knutzen said.
Daniel Celeghin, partner at money manager consultant Casey, Quirk & Associates LLC, Darien, Conn., said the past decade proved conclusively that “if you were true to your asset allocation discipline, you would have lost money.” He noted there no longer is “confidence that investment returns in the next decade will be better. Liabilities are getting closer and everyone is running out of runway, so everyone is spending far more time on asset allocation.”
And it's been successful for Texas Teachers and San Bernardino County. On a three-year basis, returns of each fund's TAA program are strong and have met expectations.
The Texas Teacher plan's TAA overlay program has an annual alpha target of 25 basis points — equivalent to $250 million a year — over the plan's policy benchmark, according to a report to the fund's December investment committee about the fund's portfolio execution and strategy.
In the three years ended Aug. 31, the fund's fiscal year end, Texas Teachers' TAA approach outperformed the fund's benchmark by an annualized 59 basis points, or $590 million — well above the annual alpha target.
Texas Teachers had about $28 billion in TAA strategies as of Aug. 31. Sources said the fund's big focus on the subject likely is because CIO T. Britton Harris IV cut his teeth on tactical investing while he was CIO and president of GTE Investment Management Corp., now Verizon Investment Management Corp., which manages Verizon Communications' pension fund.
Mr. Harris and other Texas Teacher investment officers declined to be interviewed about the fund's TAA portfolio.
In San Bernardino County, the externally managed TAA overlay strategy, called “informed rebalancing” by staff, came after a feasibility study in 2004 on portfolio rebalancing. That study rejected buy-and-hold, calendar-based and volatility-based processes in favor of the tactical overlay that uses derivatives to adjust exposures to various beta sources, Donald Pierce, CIO, said in an interview.
Russell Investments has managed San Bernardino's overlay using 1% of assets since July 1, 2006. From inception through Nov. 30, the strategy has produced 47 basis points of outperformance over the fund's policy benchmark, equivalent to a net $100 million, Mr. Pierce said.
By way of a rough comparison with Texas Teachers' TAA, performance, San Bernardino's TAA overlay produced 158 basis points of alpha, equivalent to $231 million over the three-year period ended Nov. 30, Mr. Pierce said.
Mr. Pierce coauthored a case study of San Bernardino's informed rebalancing approach that was published late last year by the Investment Management Consultants Association. The case study is on IMCA's website.
CalPERS is in the middle of moving from its “long-term, static asset allocation framework” to “a more dynamic framework, responsive to market conditions,” according to a December progress report from CIO Joe Dear about restructuring the fund's investment office.
The importance that CalPERS' investment office and trustees are placing on asset allocation is evidenced by the division late last year of Farouki Majeed's role as senior investment officer, asset allocation and risk management, into two positions. Ben Meng, formerly a CalPERS senior portfolio manager, fixed income/international research, was promoted head of asset allocation for fund, while Mr. Majeed now focuses exclusively on risk management.
Mr. Meng said in an interview that CalPERS sets a strategic asset allocation every three years and revises capital market expectations annually. Investment officers have latitude throughout the year to tactically shift assets within a range to reflect views on the most attractive investment opportunities on expected return volatility, correlations and valuations.
Like Texas Teachers, CalPERS seeks to tap the knowledge and expertise of experienced TAA managers and is searching now for two or three strategic partners to manage about $2 billion as part of a pilot project.
The RFP is explicit about managers' willingness to strike a true partnership with CalPERS for knowledge transfer which will help investment staff get an intimate view of tactical asset allocation management with the goal applying those lessons to management of the whole pension portfolio.
In Rhode Island, the state pension system is “very much in exploration mode,” CIO Kenneth Goodreau said in an interview, noting that the system's investment staff and board have been researching asset allocation options since 2007.
The system issued an RFI for providers of portfolio rebalancing and risk management services, including rebalancing money managers, who will be expected to oversee tactical asset allocation rebalancing; managers who offer portfolio overlay strategies to manage the portfolio's equity risk; and global tactical asset allocators that will be tasked with derisking the portfolio during volatile market periods.
Mr. Goodreau said because “we are right in the middle of something now,” he could not discuss specifics about what the fund's board is considering for asset allocation and risk overlay activities.
While a firm timeline for acting on the outcome of the RFI process has not been set, Mr. Goodreau said he is “anxious to get it done” and hopes to complete the research this year.