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  2. MARKETS
April 14, 2014 01:00 AM

Pension funds ride stock market roller coaster

Executives enjoying gains but won't lose sight of long-term horizon

Rick Baert
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    Christopher Ailman said CalSTRS will be taking profits from the runup as needed for cash flow.

    Gains in the U.S. stock market since February have allowed three pension fund executives to take advantage of the returns in a long-running bull market, although recent declines in the technology sector and concerns over early first-quarter earnings reports suggest the market could continue to lose some steam.

    Since Feb. 3, the Standard & Poor's 500 index rose 8.6% to 1,890.90 on April 2, but since declined 4% to close on April 11 at 1,815.69. Meanwhile, the Nasdaq composite jumped 9% from Feb. 3 to a high of 4,357.97 on March 5 but has plunged 8.2% since then, ending April 11's session at 3,999.73.

    On April 8, Alcoa Inc. kicked off the spring earnings season by reporting $5.5 billion in first-quarter revenue, a 2% decline over the prior quarter and a 6% decline from the first quarter of 2013, but still outperforming analyst forecasts of $5.4 billion in revenue.


    See related story: Institutional money continues pouring into equity markets

    Still, the recent declines and earnings worries don't mean a bear market is around the corner, said Christopher Ailman, chief investment officer of the $180.8 billion California State Teachers' Retirement System, West Sacramento.

    “The bottom line is, yeah, this bull market is getting long in the tooth, but the market is driven by corporate earnings per share and investor sentiment as in the price-to-earnings ratio,” Mr. Ailman said. “While investors may be weary (and) the earnings momentum may slow, it does not automatically mean a bear market. If you look for one, it won't happen. It doesn't mean I'd buy a bunch of stocks here; the market can trade sideways and things are still OK.”

    Mr. Ailman said corporate earnings will be key to what the market does in the short term. At CalSTRS, “we have decided to stay the course and we will take profits off U.S. equity as we need cash flow,” he said.

    Funding benefit payments

    The rising stock market in February and March provided an opportunity for the Phoenix City Employees' Retirement System to use the excess return from being overweight U.S. equities to pay benefits, said Greg Fitchet, investment officer at the $2.1 billion plan.

    The pension fund, which has a 23% domestic equity target, had been overweight by about four percentage points; it's currently about 1.1% overweight.

    “We were able to shoot the lights out and take advantage of the returns as a kind of mini-rebalance to fund our pension payrolls,” Mr. Fitchet said. “But being overweight at the right time is not the issue. We operate in an artificial world” because of central bank actions, “and we need to sustain the returns long term.” He added that the pension fund's 2010 quarterly rebalancing policy remains in effect.

    At the Ohio Police & Fire Pension Fund, Columbus, the equity gain “was welcomed, but did not change our pacing in rebalancing our portfolio,” said John Gallagher, executive director. The $14.1 billion pension fund has used a risk-parity approach in its investments for several years, he said.

    “U.S. equities may need a breather-correction, as it's been a great string of years,” said Mr. Gallagher, but “we continue to have significant equity exposure across the globe.” OP&F had 26.7% in domestic equity and 25.4% in international equity as of Dec. 31, both above the targets of 18.5% each.

    Mr. Gallagher said any effect of the declines, specifically in technology stocks, would be less at OP&F than at other pension funds “because of our risk-diversification approach and the alternative strategies being used in our portfolio to dampen volatility. We wouldn't pretend to be market prognosticators, but as for rebalancing ... we are gradually making allocation changes and hope to take advantage of whatever opportunities the markets present to sell into strength or buy into weakness.”

    In foreign markets, declines specifically in Asia and Europe would have “ripple effects” in the U.S., Mr. Gallagher said, “but we expect corrections to occur and for markets to resume a positive trend in the continued recovery of equity markets worldwide.”

    Global ecomony

    The interrelation of economies can mean U.S. markets are affected when there's volatility in equity markets elsewhere, Mr. Ailman said. “Trader emotions move the market for a day, but not for weeks at a time. The EU is far from resolving its difficulties; Greece, Spain and Italy haven't resolved a thing. Corporate earnings matter, and the U.S. is in far better condition than the EU.”

    The equity rise earlier this year did not specifically spur thoughts of rebalancing at CalSTRS, Mr. Ailman said. “We are always thinking of rebalancing,” he said. “Always. Every week of every month, within equities and across the plan.”

    Regarding fixed income, Mr. Ailman said asset owners are anticipating continued return declines as the Federal Reserve Bank tapers its bond buyback program “Change is ahead,” Mr. Ailman said. “Maybe not for a year, but the taper ends in October and the Fed will raise rates after a "considerable time.'

    “Institutional investors are looking at all types of alternatives to traditional fixed income,” he added. “Look at how the average allocation to traditional fixed income has declined since 2009. For us, it's only 17% of the portfolio, compared to 45% three decades ago.

    Ohio Police & Fire has increased its allocations to alternatives, opportunistic and alternative fixed income and master limited partnership strategies while trimming its allocations to equities and equity risk since the beginning of 2013. On March 27, the pension fund committed up to $100 million to MC Credit I, managed by MC Credit Partners, OP&F's first investment in a middle-market direct-lending fund.

    “We have already shifted a core fixed-income mandate to a multistrategy, alternative fixed-income structure and with our consultant, Wilshire Associates, we are looking at other alternative fixed income approaches,” Mr. Gallagher said. “We have added timber and MLPs to the portfolio over the past few years and are considering whether to increase our MLP target allocation. We have been increasing our private equity and real estate exposures.” n


    See related story: Institutional money continues pouring into equity markets
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