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.