The $25.1 billion Iowa Public Employees' Retirement System rejected a proposal to move to a risk-parity whole-portfolio approach that would have leveraged government bonds by $15 billion because of fear that rising interest rates would pummel returns in the near future.
The proposal came from investment consultant Wilshire Associates Inc. as one of two ways the pension fund might boost returns to continue meeting its 7.5% return assumption while keeping a lid on risk.
The other proposal would use “moderate volatility absolute-return strategies as replacements for existing fixed-income and equity allocations,” Karl C. Koch, chief investment officer of the Des Monies-based system, said an e-mailed statement.
“Wilshire Associates reviewed different types of risk-mitigating strategies, including risk parity, tail-risk hedging, low-volatility equity, active volatility management and tactical asset allocation,” Mr. Koch said.
IPERS would need to leverage its assets by $15 billion to achieve its 7.5% return objective over the next 10 years without exceeding its risk tolerance, Mr. Koch said.
Such a leveraged strategy would enable the system's fund “to gain more exposure to lower volatility bonds while reducing exposure to higher volatility stocks,” Mr. Koch said. But the leverage would expose the IPERS fund to “significantly more interest rate risk at a time when interest rates are expected to rise.”
The analysis was part of IPERS' annual review of its asset allocation and consideration of new strategies.
Eileen Neill, Santa Monica, Calif.-based managing director at Wilshire, presented modeling “with the objective of determining if some new strategies could help IPERS achieve its 7.5% return objective” over the next decade and stay within the IPERS board's tolerance for risk, Mr. Koch said.
The modeling “indicated that in the low-return environment currently forecasted by Wilshire, it is not possible to achieve the 7.5% return objective without employing a large amount of leverage in the portfolio,” Mr. Koch said.
On the absolute-return strategies, the analysis showed it would “provide a small increase in returns, but did not significantly improve Sharpe ratios,” a measure of risk-adjusted performance, he said.
“Grosvenor Capital Management provided information on hedge fund investing and how the industry is addressing transparency, risk management and fees.”
IPERS has no hedge fund or absolute-return allocation now.
The pension fund has two existing portable alpha strategies, both “global tactical asset allocation mandates with volatility targets of 5% or less,” Mr. Koch said in an e-mailed response to questions. One is managed by Mellon Capital Management Corp. and the other by First Quadrant LP, each with about $390 million.
The Wilshire analysis concluded “a levered bond strategy achieved the 7.5% return, improved the Sharpe ratio, reduced the portfolio's exposure to equity risk, and reduced the portfolio's overall risk,” Mr. Koch said. “However, a levered bond strategy would require approximately $15 billion in leverage through a Treasury futures overlay, and would expose the fund to significantly more interest-rate risk.”
The IPERS board decided against adopting either strategy for now. “Based on the analysis, staff and Wilshire recommended that the current policy asset allocation be maintained, while continuing to periodically review levered bond and absolute-return strategies,” Mr. Koch said.