Steve Edmundson, the chief investment officer of the Nevada Public Employees' Retirement System, is not one to make big, abrupt moves, but in March he did just that.
The self-effacing CIO recommended that the pension fund's board dial down the portfolio’s allocation to equities a whopping 12 percentage points — to 48% from 60% — and steer the money to short-term Treasuries instead.
The board approved the recommendation, setting in motion the beginning of what Edmundson describes as Nevada PERS’ most conservative risk posture in the past two decades.
“It makes me feel good because we get to our ultimate end objective, which is to reach our return goals with the least amount of risk possible,” he said in an interview.
The move was not so much about high equity valuations and the possibility of a market downturn, but rather the high-interest-rate environment that Edmundson believes has normalized.
Why, Edmundson reasoned, take on more equity risk than necessary at a time when higher interest rates on U.S. Treasuries can bolster the portfolio’s return?
“We want to create a portfolio that gets us to our return targets while incurring the least possible risk,” Edmundson said. “That’s ultimately our job here at Nevada PERS.”
Nevada PERS blew past its return target of 7.25% — its long-term assumed rate of return — earning a net return of 11.9% for the current fiscal year end June 30. The pension fund has a 76.2% funding ratio.
The $64.1 billion pension fund topped the one-year return of some of the largest funds in the country, including the $519.9 billion California Public Employees’ Retirement System and the $338 billion California State Teachers Retirement System, which earned 9.3% and 8.4%, respectively, according to Pensions & Investments'' tracking of public pension funds. Nevada had the eighth-highest return out of 60 plans with more than $1 billion in assets as of Sept. 11. Of that same universe, it also ranked in the top 10 for three-, five- and 10-year returns.
High valuations
While Nevada PERS’ investment performance was driven primarily by a robust stock market, Edmundson is nonetheless jittery about stocks, saying that with valuations at near historic highs, “a period of modest or even challenged returns would not be surprising.
“It wouldn’t be surprising to expect modest returns out of equities or maybe even underwhelming returns out of equities over the near term,” he said, referring to the next three to five years.
To Edmundson’s way of thinking, U.S. government bonds help offset the equity risk. U.S. Treasuries, unlike corporate bonds, don’t have any default risk and they’re the least correlated asset relative to owning stock.
“They end up being the best diversifier,” he said.
In addition to the 12% allocation to short-duration U.S. Treasuries, Nevada PERS also has 28% in longer-term U.S. Treasury bonds, bringing the total allocation to U.S. Treasury securities to 40%. It has about 12% alloacted to private markets.
The conservative asset allocation — the most risk-averse in 20 years — was put in place for the long term.
“Ideally this will be a longer-term shift to a lower-risk portfolio,” Edmundson said.
Edmundson acknowledged the caveat that interest rates could potentially nix his hoped-for plan.
“The interest-rate environment will ultimately determine how much risk we have to have in the portfolio, and that remains unknown,” he said.
Still, Edmundson is betting that the abnormally — and once seemingly unending — low interest-rate environment prior to the pandemic will not return. While he expects the short-duration or federal funds rate to come down, he sees 10-year Treasuries “settling out” in the range of 3.5% to 5%.
“I think that's a rational place for 10-year Treasuries to be,” Edmundson said. “If the Fed achieves its long-term inflation target of say 2% to 2.5%, then 10-year Treasuries ranging between 3.5% and 4.5% or 5% would be a rational outcome, and that's where we're operating as a long-term expectation.”
Indexing saves $250 million
Edmundson likes looking out and planning over long-term horizons, saying the approach has been a key factor in the growth and investment performance of the pension fund, which had $27.2 billion in assets when he became CIO in 2012.
He also likes to keep fees low and investment structures simple.
Nevada PERS uses only passive investments across all publicly traded asset classes, a practice that Edmundson estimates saves the pension fund roughly $250 million in total fund fees annually.
Edmundson has nothing against active management but sees passive management as the most effective tool for Nevada PERS to use.
“We spend all of our time focused on asset allocation, and indexing is simply the best tool,” he said. “It’s the most efficient tool for us to implement the market exposures that we want to have in the portfolio. I don’t believe it’s the only way.”
