One of the first public pension funds to embrace alternatives is scaling back its exposure, attempting to boost liquidity as the fund matures and its funding ratio declines.
The board of the Pennsylvania State Employees' Retirement System, Harrisburg, on June 13 cut the pension fund's target allocation to alternative investments to 16% over the next 10 years, from 30% as of year-end 2011.
The alternative investment allocation consists of private equity, special situations, venture capital, private energy, non-core real estate and “other real assets with similar structures and terms,” according to the investment plan report.
The cutback, announced in the fund's 2012-2013 strategic investment plan, is the result of a study done last year by staff and general consultant R.V. Kuhns & Associates, alternatives consultant StepStone Group and real estate consultant Townsend Group.
Liquidity becomes an issue at pension funds as their benefit payments begin to outpace their employee contributions, which first occurred at SERS in 2010.
As of Dec. 31, the actuarial value of plan assets was $27.6 billion, while accrued liabilities were $42.3 billion. That computes to a funding ratio of 65%, 10 percentage points lower than a year earlier.
The investment plan report cites the funding ratio as a major driver in the decision to continue to “shift away from its legacy "endowment model,' which had a significant allocation to illiquid investments, and toward a more liquid, total return strategy with market risk that does not exceed that of the board-approved composite benchmark.”
Anthony Clark, chief investment officer, said in a telephone interview that the system's historical endowment-style model worked when its liability requirements weren't that significant to the size of its assets.
Given endowments' fixed payout ratio of 5% prescribed by law, an endowment model for pension funds might cease to be effective when a pension fund's payouts exceed 5% of its assets, according to Mr. Clark.
While many other factors have gone into addressing the funding gap, wrote Mr. Clark, among the ways the new plan will help will be to “increase the net return of the assets by eliminating unintended hedges, reduce fees, concentrate assets with the best managers on better terms, reduce potential losses associated with capital impairment risk, and increase the fund's total exposure to equity-like investments.”