Institutional investors advised to take market volatility in stride

Institutional investors' asset allocations, which have grown more risky in the 10 years following the financial crisis of 2008-2009, are prompting some to worry about the recent plunge in equity markets and rise in bond yields.

But industry sources said it's not time to jump into lifeboats just yet.

"If you're an institutional investor, then some if not most of your investments are for distant goals/liabilities," said Michael S. Falk, partner at money manager consultant Focus Consulting Group LLC, Long Grove, Ill. "Let's reprise Mr. Eastwood's 'Dirty Harry' once again: 'Now you've got to ask yourself one question. Did I asset allocate right? Well, did you?'"

What has many pension fund investment executives concerned is that most have riskier investments than during the last recession, said Jay V. Kloepfer, executive vice president, director of capital markets research at Callan LLC, San Francisco.

"That 60%/40% portfolio back then is now 80%/20%," Mr. Kloepfer said. "Since then, investors have diversified into growth assets, not fixed income. They've whittled down their flight to quality, so it could be more painful if we hit a recession. That has people concerned. But again, they've planned for that" with their current asset allocations, "so they can withstand that."

Mr. Kloepfer added: "There's nothing a $50 billion pension fund should do based on two days of data … It's tempting to think that way, that you have to sell, but they've set up their asset allocation to handle the volatility. If they can't, they shouldn't buy stocks. You set it up and you ride the market."

The recent concerns developed after yields in 10-year Treasuries rose from 3.09% on Sept. 24 to as much as 3.23% on Oct. 5 and was followed by two-day declines Oct. 10-11 of 5.28% in the Standard & Poor's 500 stock index and 5.21% in the Dow Jones industrial average. Both stock indexes recovered slightly on Oct. 12, with the S&P 500 closing up 1.42% at 2,767.13 and the Dow up 1.15% to close at 25,339.99.

Mansco Perry III, executive director and chief investment officer at the $96.2 billion Minnesota State Board of Investment, St. Paul, said he was looking at the market plunge "and trying to view it with some perspective. … It's not comparable to the 1987 crash other than they happened about the same time in October. If you look at where the market closed on (Oct. 10), it is still above the close of three months ago."

Mr. Perry said that the board is only doing "normal rebalancing" of its asset allocation, "but not precipitated by (Oct. 10), but planned earlier. We'll review what's going on to see if adjustments are warranted. In other words, review what's happening, but don't let it dictate your strategy."

The market events this month aligned with Willis Towers Watson PLC's forecast of "above-trend (gross domestic product) growth and inflation across the next 18 months with further monetary tightening expected in the longer term," said Jon Pliner, New York-based senior director, investments, and head of delegated portfolio management, U.S. "It also provides an instructive preview of the increased level of volatility and potential downside risks that we envisage being part of normal market conditions over the next few years."

Mr. Pliner said for a traditional 60% equity/40% bond client portfolio of a corporate plan with a primary focus on funded status volatility, the recent yield increase and subsequent equity fall will have somewhat offsetting impacts. The decline in total asset value, he noted, is occurring alongside a decrease in plan liabilities, leaving the overall impact on funded status muted.

"However, in periods of market turmoil, we are often reminded of the benefits of diversification," he said.

Callan's Mr. Kloepfer agreed: "Risk mitigation is just more diversification. That's what most have done."

The volatility encountered in the equity markets Oct. 10-11 differed from the previous 2018 volatility surge in early February, said Chris Scibelli, managing director, ACR Alpine Capital Research LLC, St. Louis, which manages a defensive equity strategy. "In February, the low-volatility funds were short volatility," Mr. Scibelli said. "When the price of volatility suddenly spiked, those funds suffered surprising losses."

Meanwhile, said Mr. Kloepfer, last week's volatility was due more to concerns that an extended equity market expansion was running out of steam. "Why the attention now?" Mr. Kloepfer asked. "The expansion has been a long one, and it's more inevitable now that the expansion will end. But time is not an economic variable."

Mr. Perry of MSBI said he thinks markets will continue to be volatile.

"There is a high expectation of a 'market correction,' which should not be news," Mr. Perry said. Commentators believe that the recent equity performance was caused by fear of the Federal Reserve raising interest rates, he said.

"Again, that is not out of the realm of expectation. None of us know where the market is going. Organizations like mine are constantly reviewing where we are, but usually through the view of a long-term lens. When markets move, we prudently rebalance. While (Oct. 10) may be an inflection point, we will not know it's true meaning for a while."