New Hampshire Retirement System mulls cutting bonds

The New Hampshire Retirement System board will study whether a sharp cut in the $5.9 billion pension fund's core bond allocation makes sense as a 30-year bull market in bonds draws to a close.

The pension fund's board had its investment consultant, Cambridge, Mass.-based NEPC, draw up two 80% equity/20% fixed-income asset allocation mixes for consideration. The current target is 70% equities — broadly defined to include publicly traded securities, real estate, private equity and hedge funds — and 30% fixed income.

One of the proposed allocations reduces the 5% hedge fund target to 0.5%, boosts the target for publicly traded equities by 14.5 percentage points to 64.5%, and cuts the core bond allocation by 10 points to 13%. The other mix retains the 5% hedge fund allocation, with a 10-point boost to publicly traded equities offsetting a 10-point cut to core bonds.

With current allocations to global bonds, high-yield bonds and emerging markets debt of 5%, 1.5% and 0.5% respectively, total fixed-income allocations for both proposed asset mixes would fall to 20% from 30%.

These scenarios can serve as a “discussion point,” and framework for considering how to reallocate the 10% of system assets freed up, noted board member Hershel Sosnoff at a meeting of the system's investment committee on May 18.

The review of the system's asset mix comes as the yield on 10-year U.S. Treasuries fell to a multidecade low of 1.7% on May 17 — a level at which the potential benefits of holding fixed income as a hedge against deflation become ever more limited, while the prospects of losses, should bond prices fall as rates rise, increase.

“While interest rates may continue at these levels for some time, the investment committee wants to consider the appropriate target for fixed income when interest rates start to increase,” noted Lawrence A. Johansen, director of investments for the Concord-based pension fund.

Citing the preliminary nature of New Hampshire's discussions, Mr. Johansen declined further comment.

Investment consultants and other pension executives say concerns about the role that fixed income will play within institutional portfolios in the coming years are growing.

“There is a very active debate over fixed income right now,” as pension overseers weigh the tug of war between the enormous amount of monetary and fiscal stimulus that has been pumped into the economy and signs that economic sluggishness could persist for years, said Monte Tarbox, chief investment officer of the $8 billion IAM National Pension Fund, Washington.

While it has been a topic of active discussion for some time, the subject is now being put on to the agendas of a number of public pension boards, noted Neil Rue, managing director of investment consultant Pension Consulting Alliance, Portland, Ore.

Terry Dennison, a Los Angeles-based global partner and head of U.S. consulting with Mercer's investment consulting business, said concerns about fixed income now could serve to widen the dichotomy between corporate pension plans using fixed income to reduce risk by hedging their liabilities and public plans with absolute-return objectives that are taking on more risk.

“Everyone in my shoes is wondering about the role of fixed income” amid concerns that allocations long seen as a pension fund's “safety net” have become overvalued, said a public fund CIO who requested anonymity. But the CIO said it's an open question whether increasing equity exposure will provide a better way of coping with an inflationary period.

Market players say that until now, inflation-wary institutional investors were more inclined to seek a better mix of betas in their bond portfolios than to cut back on their fixed-income allocations.

Moves by investors to steer away from broad, core bond exposure in favor of various flavors of non-U.S. bonds, emerging market debt and other higher-income issues are picking up this year, with mandate sizes increasing along the way, said Steven Puodziunas, head of client service and marketing support at Western Asset Management Co., Pasadena, Calif.

Another public fund CIO said New Hampshire could do what his fund did when the fixed-income exposure was cut: Rather than boosting the portfolio's holdings of publicly traded equities, the fund added allocations to absolute return and real return strategies with bond-like characteristics, said the CIO, who declined to be named.

Some market veterans predict concerns about portfolio losses in a rising rate environment will prove overblown.

Anything is possible, but with the deleveraging process the economy is going through likely to persist for years, a sharp rebound in interest rates isn't the likeliest scenario and a gradual rise in rates shouldn't prove problematic, said Michael A. Rosen, principal and CIO with Angeles Investment Advisors, Santa Monica, Calif.

Asked if fears of losses on bond allocations could prompt the Vermont Pension Investment Committee, Montpelier, which oversees a combined $3.3 billion for three public pension funds in the state, to cut its exposure, Steven Rauh, the committee's chairman, said focusing on a specific risk could threaten the “balanced portfolio framework” that should “serve us well for the intermediate to longer term.”

“Even though you may be correct about interest rates, you may be wrong about total portfolio risk exposure, since you had to reinvest the funds previously allocated to bonds somewhere else in the portfolio, thereby assuming more of those risks,” said Mr. Rauh.

Some market veterans speculate that the impetus for public funds to lift equity exposure now might simply reflect the funding pressure that cash-strapped public funds are facing in a harsh political environment where taxpayer-funded contributions will be increasingly tough to come by.

At some level of underfunding, public fund executives will get to a point where they figure they'll simply have to “swing for the fences,” noted one veteran investment consultant, who declined to be named.