Still boring after all these years, Idaho makes case for convention

When the Public Employee Retirement System of Idaho examined its asset allocation with an eye toward the next decade, one simple question dominated the exercise.

It was the same basic jumping-off point that the $19.6 billion pension fund has used for a quarter century: "What's our stock/bond split?"

For Chief Investment Officer Bob Maynard, the simple answer harkens to the old-fashioned 70/30 model that has faded from relevance over the years.

Idaho is one of the last public pension funds still using a conventional asset allocation rooted in modern portfolio theory and its core assumptions about risk.

All but 12% of the fund's assets are strategically earmarked to either stocks or bonds. That remaining portion, invested in private assets, is viewed as an important diversifier. But private markets haven't particularly moved the needle.

Long term, PERSI's performance is solid. It's 25-year annualized return is 8.6%, putting it, Mr. Maynard says, in the top quartile.

There are a handful of other so- called conventional allocators, including the $11.4 billion Oklahoma Public Employees Retirement System, Oklahoma City (roughly 70/30).

The $44.6 billion Public Employees' Retirement System of Nevada, Carson City, is 60% stocks in two index funds with another 28% passively pegged to U.S. bonds.

Industry members continuously debate the merits of the old faithful 60/40 mix or a conventional 70/30 approach vs. the so-called endowment model, with its greater reliance on alternatives vs. an array of other more newfangled asset-mix strategies, including risk parity, factor-based investments and global tactical asset allocation. Regardless of the diversification approach taken or the labels that get used, most institutional investors with open funds seem to favor having a preponderance of riskier, return-seeking assets relative to fixed income, once considered a portfolio cornerstone.

As of Sept. 30, the public pensions plans within the largest 200 U.S. plan sponsors had, on average, 21.1% of their total portfolios in domestic fixed income, according to Pensions & Investments' data.

The average U.S. public DB plan fixed-income allocation is up from 20.8% one year prior. These plans had 2.6% of their total portfolios in global/international fixed income, up from 2.1% a year earlier.

Callan's large public fund clients tend to have between 20% and 25% in global fixed income, according to Jay Kloepfer, head of the firm's capital market research team.

"Over the years, we've seen public pension funds tiptoe away from 60/40," Mr. Kloepfer said.

"If anything, it's now 80/20, an even greater reliance on return-seeking assets."

A fair amount of those large fund clients have moved below 20%, with a handful even reaching as low as 10% to the point "where now there are conversations starting to happen as to whether, considering the late stage of the economic cycle and liquidity needs, fixed-income allocations have dropped too low," Mr. Kloepfer said.Callan's database of public funds shows a median 10-year return of 8.25%. Very large ($10 billion or greater) public funds had a median return of 8.8%, reflecting the more aggressive asset allocations seen in larger funds relative to smaller ones. The Idaho plan returned an annualized 8.4% over the 10-year period.

The 37 largest Callan-tracked funds appear to be performing in lockstep: Over the past one-, three- and five-year periods, the range of return outcomes among these funds has been tightly clustered. Over five years, for example, only about 130 basis points separate the returns in the 75th percentile from those in the 5th percentile.

In addition to the pension assets, Mr. Maynard, who has been in his role since October 1992, helps oversee $237 million in defined contribution plan assets and a $612 million sick leave fund that is so simply constructed he dubbed it the state's "pet rock" portfolio. It has three slices, entirely indexed: 55% U.S. equities, 15% international equities and 30% investment-grade bonds.

For the 10 years ending Dec. 31, the sick leave fund, a consistent top-decile performer in Callan's universe, returned 9.7%.

"It's beating most everybody," Mr. Maynard said. "Including us."

While the typical large pension fund has approximately 20% to 25% pegged as fixed-income, Mr. Kloepfer pointed out how those allocations tend to include numerous "spread bets" in emerging markets, high-yield corporate credit and private credit, such that the traditional ballast of safe, low-return investment-grade bonds is in reality actually only a relatively tiny slice of the pie.

Asked at conference events over the past decade why he remains comfortable having 30% in such a low-expectation asset class, Mr. Maynard, the king of deadpan one-liners, has been known to crack, "It's bonds for crying out loud, who cares?"

Bonds are there as a hedge in case "everything else goes to hell," he adds, sometimes calling them "an Armageddon hedge."

"And when bonds are dead money, guess what?" Mr. Maynard said by phone in early February. "Stocks often do remarkably well."

He has come to use "70/30" as shorthand for an approach he considers "conventional." But Idaho is slightly more complicated than that.

The "70" chunk breaks out as 29% U.S. equity; 15% Europe, Australasia, Far East equity; 10% emerging markets equity; 4% real estate investment trusts, 8% private equity and 4% private real estate.

The "30" consists of 15% Bloomberg Barclays U.S. Aggregate Bond index; 10% Treasury inflation-protected securities and 5% Idaho commercial mortgages.

More than half the pension fund is indexed. They have 20 traditional active managers and have done only two broad searches in two decades.

Mr. Maynard emphasized that the fund can afford to be so boring because PERSI, at 94% funded — well above the median public plan that is about 75% — does not have to overreach.

Their targeted real return is 4 percentage points above the consumer price index.

After all of these years, the conventional approach simply fits their comfort zone, bearing in mind resource limitations and board member turnover and high conviction that their mix will suffice for their needs.

"Conventional works for us because we have been in good shape over the years," Mr. Maynard said, noting that the state and other relevant constituencies have all consistently contributed their required shares to the pension fund.

"But if we were in a situation where the pension fund was not as well funded or our return needs were significantly higher, then we would have to consider a more aggressive approach."

Once cash flows and reasonably near-certain cash-availability assumptions are taken into consideration, the next major portfolio objective is, simply, avoiding big mistakes.

"The most difficult part of conventional investing is that it requires extreme patience — an organization must be able to ride through extremely volatile markets without taking major action," Mr. Maynard wrote in a Dec. 31 report summarizing how investment policy is crafted and implemented, written for both the board and also the public at large.

The portfolio is rebalanced, normally an annual exercise, and tactical moves are shunned.

As Mr. Maynard's December report to the board explains: "In order to make a major tactical asset allocation move pay off, three decisions, not just one, have to be correct: one, when to get out of an asset type; two, when to get back in; and three, where to put the money in the meantime. An incorrect decision on any of these three can lead to severe losses."

Mr. Maynard is a member of "The 300" a global industry peer network of self-described innovative thinkers with respect to ways of running institutional assets.

To most of these folks, Mr. Maynard must seem like a sailor at sea with only the sun and stars to guide him. Not one has anything resembling 70/30.

Mr. Maynard isn't necessarily preaching the old ways but relishes the role of new-age iconoclast.

"We all want to think we can do better," Callan's Mr. Kloepfer said generally of how the industry veered off the 60/40 course.

One of the wittiest conference stage utterances from which Mr. Maynard has gotten plenty of mileage over the years involves his conceit that now and again a great idea does strike him.

His punch line: "And when that happens, I lock the door, turn off the lights and lay down until the idea goes away."