Four years into an overhaul of its investment management philosophy, the $3.4 billion Pennsylvania Municipal Retirement System has fully embraced a new risk-off approach, Timothy Reese, the Harrisburg-based pension fund’s secretary, told Pensions & Investments.
Reese has officially held the position of the pension fund's top executive official since January. The role had been vacant since the departure of Steve Vaughn in the fall of 2019, and Reese had been leading the pension fund as a consultant since November 2020.
Previously, Reese was founder and CEO of Forge Intellectual Capital, a treasury management and investor services consulting firm, and he had also served as Pennsylvania's treasurer from 2015 to 2017.
Reese was originally brought aboard as consultant in 2020 to help the system through the turbulent COVID-19 pandemic era, and was brought in as state treasurer in 2015 on a similar mission.
The first thing Reese did in 2020 was recognize that much of the post-COVID market gains were due to the federal government’s stimulus efforts and there was no way the “gangbusters” market was going to last.
“I was looking at the investment policy and looking at the way it was tilted,” said Reese, “and it had in my opinion a very ‘risk-on’ policy, and that’s because of the level of active management we had to retain.”
As of June 30, 2020, the pension fund — which had $2.6 billion in assets at the time – had a total of $569 million invested with four active domestic large-cap equity managers, $268 million invested with four active domestic small-cap equity managers and $257 million with two active international equity managers.
At the time, State Street Global Advisors ran four passive equity portfolios for the pension fund: $138 million in small cap, $113 million in large cap, and $155 million in international equities. SSGA was also the pension fund’s sole emerging markets equity manager, running $251 million, and its sole fixed-income manager, running a $410 million passive core portfolio.
Reese thought domestic equities is a pretty efficient market, so he asked, “What are we really paying for?”
After a review of the investment policy, he thought it was best to reduce risk in the portfolio and in May 2021, the board approved a new target allocation in concert with its new investment consultant Marquette Associates.
New targets
Separate targets of 25% and 15%, respectively, to domestic large-cap and small-cap equities were eliminated and a new target of 32.5% was created for domestic equities. Separate targets of 15% and 10%, respectively, to international equities and emerging markets were also eliminated and replaced with a 17.5% target to non-U.S. equities. A 20% target to real assets was replaced with a 10% target to private real estate and a 5% target to timberland and farmland, and new targets of 24% and 5%, respectively, to U.S. fixed income and high yield replaced the 15% target to fixed income.
“Instead of having four active managers in large cap, we made that change where now in a risk-off strategy, we went to two active and two passive,” said Reese. “We decided to take off that ‘growthy’ edge and decide when we want to pay for alpha. So now, we pay for alpha in our international, we’re paying for alpha in some of our fixed, where we can believe we can get a little more performance, and that’s tilted the portfolio tremendously, but we haven’t sacrificed returns in doing it.”
12-month returns
For the year ended June 30, the pension fund returned a net 9.5%, below its policy benchmark return of 10%. The return was just short of the median return of 9.9% among the 78 public pension funds whose returns for the period have been tracked by Pensions & Investments as of June 30. By asset class, domestic equities was the top performer with a net 19.4% (below the benchmark return of 23.1%), followed by non-U.S. equities at a net 11.1% (below the 11.6% benchmark); global equities, 9.4% (9.1%); fixed income, 4.6% (2.6%); and real assets, -2.6% (-3.7%).
The retirement system's fiscal year ends on Dec. 31.
The majority of domestic equity assets are now in passive portfolios, two managed by Northern Trust Asset Management ($425 million in assets in the pension fund as of June 30), and one managed by Xponance ($315 million). Five active managers oversee active portfolios totaling $427 million. Rhumbline Advisers runs $168 million in a passive global low-volatility portfolio, while in non-U.S. equities SSGA runs two passive portfolios totaling $370 million, with active managers Hudson Edge and Hardman Johnston running $117 million and $111 million, respectively.
Within fixed income, SSGA runs $400 million in its passive core portfolio, while Federated Hermes runs $354 million in an active core strategy and Ares Management runs $184 million in an active global multiasset credit strategy.
New initiatives include an ongoing search for an active international value equity manager in order to achieve further diversification, said Reese.
PMRS manages the assets of 1,100 municipal employees' pension funds in Pennsylvania.
