Brave new world of investing leaves tradition far behind

Institutional investors are coping with converging alternative investment strategies by creating new - and bigger - allocation buckets.

Rather than keeping each asset in its own silo, investors increasingly are crossing asset allocation lines, bundling diverse types of investments into a single portfolio for a stated goal or theme.

Lower-return market conditions are driving investors to take a hard look at their allocations and discard the old approach, which had failed to consistently provide the returns.

The Teachers' Retirement System of the State of Illinois, Denmark's PKA and M.J. Murdock Charitable Trust are among the investors that have ditched the traditional bucket system for a more wide-ranging asset allocation.

A number of other investors — including Los Angeles County Employees Retirement System and New Mexico Public Employees Retirement System — have added asset-class-crossing portfolios such as opportunistic fixed income or real assets.

This month, trustees of the Illinois Teachers' Retirement System, Springfield, will consider adoption of a much simpler asset allocation model that acknowledges the many convergences among the strategies in its alternative investment portfolios.

For a public pension plan, Illinois TRS has an unusually large allocation to alternative investments: 39%, or $17 billion of the $43.6 billion fund.

TRS has maintained a traditional asset allocation in reporting to trustees, even as the investment team moved years ago to grouping strategies with similar characteristics and returns, regardless of formal asset class labels.

“This is how we (investment staff) have been looking at asset classes for a long time,” said R. Stanley Rupnik, chief investment officer.

Currently, there are eight asset classifications with the following target allocations: domestic equity, 23%; international equity, 20%; global fixed income, 16%; real return, 10%; real estate, 13%; hedge funds, 6%; private equity, 11%; cash, 1%.

The proposed allocation will have four categories with the following target allocation ranges and components:

• global equity, 50% to 60%, domestic public equity, international public equity, private equity, opportunistic real estate;


• global fixed income, 15% to 30%, core/core plus, short duration, floating rate, non-dollar emerging market debt, special situations, convexity strategies;


• diversifying assets, 10% to 15%, hedge funds, global macro/global tactical asset allocation, risk parity; and


• real assets, 10% to 20%, core/value-added real estate, Treasury inflation-protected securities, farmland.

As of March 31, the pension fund's real estate assets totaled $5.4 billion; private equity/venture capital, $4.6 billion; real return, $4 billion; hedge funds, $2.4 billion; and special situations/credit, $573 million.

“Looking at the components in this more simplistic way will help with managing the portfolio,” Rebecca A. Gratsinger, CEO of investment consultant R.V. Kuhns & Associates Inc. and TRS' lead senior consultant, told trustees during a May 29 investment committee meeting.

She added the new model will improve diversification, better balance public and private equity, and improve the pension fund's risk/return profile.

“Grouping like exposures is a common-sense way of linking strategies,” Ms. Gratsinger added.

“Mapping our assets into the new structure will not be that complicated. Reporting is the least of our issues,” Mr. Rupnik explained to trustees, stressing that making sure that “oversight, getting the right people into the room, rather than the old fixed-income and equity teams, is critical.”

Oversight of credit strategies, for example, likely will come from a combination of traditional fixed-income investment officers, as well as private equity and hedge fund specialists, because credit funds often use a hedge fund approach and/or have a longer lockup, similar to private equity funds.

“Oversight of TRS' investments will have to change to focus on the new structure,” Ms. Gratsinger said.

Should trustees approve the new asset allocation model at their June 26 meeting, both old and new reporting systems will be provided for board members for at least a year, Richard W. Ingram, TRS executive director, reassured trustees during the investment committee meeting.

Investors' concern with the risk lurking in their portfolios has caused them to organize their asset allocations around risk factors rather than traditional asset classes.

The $800 million Murdock Trust, New York, divides the world into three “risk buckets” — low, medium and high — and considers all types of investments, across asset classes, for any of these risk buckets, according to sources who declined to be identified and information on the foundation's website.

“We hold no preconceived ideas or built-in biases that prevent consideration of all possibilities,” according to a statement on the trust's website.

“What we see is that investors, more than asset managers, are looking at their choices less in terms of siloed definitions such as hedge funds, private equity funds, real estate funds or fixed income, but more as a customized combination of multiple strategies,” said Jacques P. Chappuis, managing director and head of solutions at The Carlyle Group, New York. “Investors are developing the understanding that any product is a package of risk factors and labeling them in artificial containers may not be the best way to choose the options out there.”

Last year, for example, the 194.8 billion Danish kroner ($35.55 billion) Pensionskassernes Administration A/S, Hellerup, Denmark, hired Acadian Asset Management to run a $450 million managed volatility strategy. The pension administrator, which is owned by five occupational pension funds, restructured its equity portfolio in 2012, adopting an investment process that allocates to 17 different risk premiums within the equity portfolio rather than using traditional strategic allocations to regions.

Some investors are investing around themes such as water and food scarcity. Other institutional investors are investing around outcomes, such as inflation protection or interest rate increases.

Harvard University's $32.7 billion endowment is making investments related to food and agriculture, noted Jane Mendillo, president and CEO of Boston-based Harvard Management Co. Inc. at a recent Milken Global Conference.

Another theme for the endowment is emerging markets, she said. “Emerging markets is trading at a 40% discount to developed markets,” Ms. Mendillo said.

The C$200 billion (US$180.1 billion) Caisse de Depot et Placement du Quebec, Montreal, also is investing around the theme of food scarcity in light of global demand for the diminishing resource, said Michael Sabia, CEO, also speaking at the Milken Conference.

The Caisse's strategy is taking a broad “farmland to Nestle's” focus, not limiting the investments to a single asset class, he said.

“We are investing from beginning to end,” Mr. Sabia said.

One theme the Teacher Retirement System of Texas, Austin, is focusing on is energy and natural resources, said Jerry Albright, deputy chief investment officer. The pension fund established an initial 3% allocation last year.

The allocation is likely to increase to 5%. The portfolio aims to include oil, gas, water, agricultural real estate, timber, mining and other related sectors in order to capture promising returns over the next 10 years and to diversify the overall portfolio.

Seven years ago, the pension plan started down the path of making its overall portfolio more like an endowment, Mr. Albright said. The pension plan is in the midst of an asset allocation study that could add leverage to its $126 billion portfolio, he said.

“Even five years ago, energy used to only be in private equity. Now it is with real assets,” said Peter Martenson, head of global distribution and partner in the La Jolla, Calif., office of placement agency Eaton Partners LLC.

Investors such as the $46.5 billion Los Angeles County Employees' Retirement Association, Pasadena, Calif.; $11.6 billion Orange County Employees Retirement System, Santa Ana, Calif.; and the $36.6 billion Tennessee Consolidated Retirement System, Nashville, have created opportunistic fixed-income or credit allocations that include both publicly traded and private investments.

In May, the New Mexico Public Employees Retirement Association, Santa Fe, adopted an asset allocation that included several blending features. It added a 5% allocation for a new portfolio that includes public and private investments pension plan officials call “fixed income-plus,” said Jonathan Grabel, chief investment officer for the $14.25 billion pension fund.

Pension fund officials also increased alternative investments to 23% from 20%. This included increasing its “inflation hedging portfolio” — which includes real assets and real estate — to 12% from 8% and decreasing the absolute-return portfolio to 4% from 7%.

The idea is that fund officials will sprinkle absolute-return strategies across the entire portfolio, rather than keeping the investments within the alternative investment allocation.

“Absolute return is not necessarily an asset category,” Mr. Grabel said. “Hedge funds span the investible universe of asset categories.”

Said Mark Attanasio, Los Angeles-based co-founder and managing partner of Crescent Capital Group LP: “Increasingly, clients do not want to conduct multiple RFPs. Instead, consultants are visiting firms like ours every day to find managers that know how to take advantage of both strategic and tactical opportunities on a real-time basis. By the time consultants and clients go through the RFP process, it can easily take nine months minimum and by that time opportunities come and go.”

J. Christopher Kojima, managing director and head of the alternative investments and manager selection group in the investment management division at Goldman Sachs Asset Management in New York agreed.

“Traditional labels are increasingly unhelpful to investors,” Mr. Kojima said. “Labels worked in the past. Investors today are so much more focused on broader themes and other factors. Themes and factors wash over portfolios that defy labels.”