Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. ASSET OWNERS
October 28, 2013 01:00 AM

Iowa PERS nixes risk-parity proposal amid fears of rising interest rates

Barry B. Burr
  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print
    Karl Koch said IPERS will revisit both leveraged bond and absolute-return strategies.

    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.

    A challenge for all

    Jay Love, Atlanta-based partner and senior consultant with Mercer Investment Consulting Inc., who isn't involved with the plan and spoke generally, said reaching such an assumed return will be a challenge for all pension funds over the next 10 years.

    A 7.5% assumed return “is going to be difficult to achieve without using more complex investments and investment structures,” Mr. Love said. “A plain-vanilla approach cannot achieve 7.5% without taking a significant amount of equity risk.”

    “Portable alpha would be a typical way to achieve that objective,” Mr. Love said. “But taking it does entail significant equity market volatility.”

    In terms of other approaches, “illiquidity risk is generally rewarded, if they (pension funds) are willing to take it on,” Mr. Love said, citing private equity and real estate investments as examples. “Public plans do have that long-term horizon to permit that illiquidity,” he said.

    IPERS' current allocation is U.S. equity, 23%; international equity, 15%; core fixed income, 28%; credit opportunities strategies, 5%; U.S. Treasury inflation-protected securities, 5%; private equity, 13%; real estate, 8%; other real assets, 2%; and cash, 1%.

    “Based on current assumptions, IPERS' current asset allocation has a mean expected return of 6.8% with a standard deviation of 10.3% over the next 10 years,” Mr. Koch said.

    But that expectation is not a reality yet.

    In the one- and three-year periods ended June 30, the pension fund portfolio's respective returns were 10.12% and an annualized 11.06%. Both far exceeded the fund's assumed return but underperformed its benchmark returns of 10.64% for the year and an annualized 11.79% for the three years. For the 10 years ended June 30, it returned an annualized 7.78%, surpassing its assumed return but underperforming its 8.07% benchmark return.

    The equity market has been strong in recent years, Mercer's Mr. Love pointed out. “Because the equity market has been so strong, it raises valuations over time” making equities not as attractive as they have been.

    For the next 10 to 20 years, Mercer projects annualized returns of 7.1% for U.S. large-cap equities, 7.2% for U.S. small-cap equities, 3% to 4% for fixed income, close to 8% for international and emerging markets equities, and at least 8% for private equity and opportunistic, or aggressive, real estate, Mr. Love said.

    Mr. Koch, in his response to questions, said: “IPERS' objective is to fund all future benefits when they come due. Those payments stretch out considerably longer than 10 years. Investments play an important role in meeting the objective, and our investment policy states that we will strive to earn a return that will fund the liabilities over the long term, but always within the risk tolerance of the board.”

    “It is important to understand that actuarial discount rates are used to discount liabilities over a much longer time horizon then 10 years,” Mr. Koch continued. “So the fact that the current asset mix is not expected to earn the actuarial investment return assumption of 7.5% over the next 10 years does not mean that IPERS needs to rush out and load up on stocks or hedge funds, or leverage so that the optimizer can spit out a 7.5% expected return.

    “I'm not saying that IPERS will never use those strategies, but I believe ... those possibilities introduce risks that the board and staff are not comfortable taking at this point in time, or they do not improve things enough to justify the change. We live in interesting times.”

    Related Articles
    Market sell-off hurts risk parity, similar strategies
    IPERS' allocation, returns
    Iowa seeks global custodian, securities lending provider
    Iowa PERS to seek OK for investment consultant search
    Iowa PERS scouting for investment consultant
    Iowa PERS starts search for private equity
    Iowa Public Employees scout for active, passive REITs
    Iowa PERS sticks with Wilshire
    Iowa PERS gives Pathway Capital another $100 million for private equity searches
    Recommended for You
    ONLINE_190329864_AR_0_YBKZZQSSKIZH.jpg
    IMCO returns 9.6% in 2021, outperforming its benchmark
    SLIDESHOW2_824009999_PH_7_HOEACWCAWVKF.jpg
    Northern Trust plan universe returns 0.2% in Q3
    Northern Trust: Institutional asset owners post 6% gain in Q2
    Northern Trust: Institutional asset owners post 6% gain in Q2
    Emerging Markets: A Selective Approach
    Sponsored Content: Emerging Markets: A Selective Approach

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit