Holding tight on allocations ensures investment success

Chief investment officers' secret for investment success in 2020 was simple: stick to the plan.

None of the CIOs Pensions & Investments contacted said it was easy to manage multibillion-dollar defined benefit plans during the early phase of market turmoil that flared up in response to the COVID-19 outbreak.

But they stressed that by maintaining their asset allocations through rigorous portfolio rebalancing and by taking advantage of distressed investment opportunities created by pandemic conditions, their portfolios came out of the panic phase in 2020 in good shape and went on to produce strong performance in the year ended Dec. 31.

"The pandemic illustrated perfectly that good investment policy fulfills exactly the role that's needed to keep your portfolio on track. The power of this process can't be understated," said Ashbel C. Williams Jr., executive director and CIO of the Florida State Board of Administration, Tallahassee, in an interview.

The SBA managed a total of $168 billion in defined benefit plan assets and $12.2 billion in defined contribution plan assets as of Sept. 30, according to data from P&I's survey of the largest retirement plans.

Despite their resolve to stay the course and adhere to their asset allocations, many plan sponsors needed reassurance during the intense six-week "market free fall" beginning in February last year, said Jeffrey MacLean, CEO of investment consultant Verus Advisory Inc., El Segundo, Calif., in an interview.

"I did a lot of hand-holding, a lot of explaining, a lot of calming people down about the unusually high level of market volatility and a lot of reminding institutional investors to maintain their long-term asset allocations over the past year," Mr. MacLean said.

Asset owners like Florida SBA said they found that internal management of a significant portion of their defined benefit portfolios was a distinct advantage during tumultuous markets early last year.

Alison Romano, the SBA's deputy CIO, said in an interview that "we had the right tools to operate when COVID hit last year: the right asset allocation, the right crew and the right technology to navigate the situation."

Adhering to the pension plan's asset allocation was the investment team's first priority, to ensure the board could maintain sufficient liquidity to pay benefits, Ms. Romano said.

The board's internal asset-class investment teams helped in decision-making for rebalancing the portfolio, she said, noting "tough markets brought out the best in the way the teams collaborated across asset classes."

As of Sept. 30, $77.4 billion of the DB plan was managed internally.

The SBA team actively rebalanced assets between equities, liquidity portfolios and fixed income through the early stages of the pandemic to meet benefit payments and to harvest returns as equity markets began to improve in April.

Ms. Romano said the investment team also invested in opportunities created by the market dislocation including in private real estate and real estate investment trusts, private credit and private equity.

"We have long-term relationships and partnerships with alternative money managers and were able to get into the funds we wanted to" when other plans could not, Ms. Romano said.

The internal investment management team at the State of Wisconsin Investment Board, Madison, also was instrumental in managing the Wisconsin Retirement System through the 2020 pandemic as well as in producing a preliminary net return of 15.2% for the defined benefit plan's core fund, said Edwin Denson, managing director, asset and risk allocation, in an email response to questions.

The defined benefit plan totaled $118 billion as of Sept. 30 of which $58.8 billion was managed internally.

"SWIB ended the year in a strong positive position," Mr. Denson said, adding that the core-fund return was 106 basis points above the plan's benchmark.

"This 2020 outperformance was due to our internal investment management staff and external partners sticking to their investment strategies in a disciplined fashion and taking advantage of the significant market dislocations that occurred in the first quarter, positioning the fund for success over the balance of the year," Mr. Denson said.

As a long-term investor, Mr. Denson added that "at a time when many investors were facing too much uncertainty to commit additional capital to external managers, SWIB's investment discretion, expert staff and long-term focus allowed us to move quickly, putting more than $1.1 billion with high-conviction, capacity-constrained managers."

Like other large asset owners, SWIB's investment team diligently rebalanced the portfolio to policy targets monthly, Mr. Denson said, but added that "at the same time, staff used discretion to initiate overweight positions in higher return/higher risk asset classes, like equities and high-yield bonds, during the first quarter, to the ultimate benefit of the plan."

SWIB also managed $6.5 billion in the state's defined contribution plan of as Sept. 30.

At the start of the pandemic, officials of the $60.4 billion Los Angeles County Employees Retirement Association, Pasadena, Calif., made quick changes to procedures and policies to cope with market turmoil.

"In March, we started a rolling 90-day cash forecast to look at inflows and outflows on a daily basis to make sure we had three months of cash at all times," said CIO Jonathan Grabel in an interview.

"We used our cash overlay to stay true to our strategic targets without having to be a forced seller of any securities at an inopportune time," he said.

In areas where LACERA was underweight, Mr. Grabel said plan officials continued to make new investments, some of them with new managers.

For example, in May, LACERA's board invested $400 million in Magnetar Financial, an illiquid credit hedge fund strategy managed by Magnetar Capital LLC, Evanston, Ill., and $300 million in Hudson Bay Fund, a relative value multistrategy hedge fund managed by Hudson Bay Capital Management LP, New York.

Both are new relationships for the pension plan.

Magnetar manages $12.3 billion in hedge fund and other alternative strategies. Hudson Bay manages $8 billion in multistrategy hedge funds.

LACERA officials have stayed away from making short-term investment decisions during the COVID-19 crisis, Mr. Grabel said, noting "it is difficult to be tactically correct in the face of tremendous uncertainty. We adhere to our investment beliefs and attribute good outcomes to strategy and process."

State Universities Retirement System of Illinois, Champaign, encountered some difficulty in the second year of implementing a new asset allocation due to impacts of the COVID-19 outbreak.

The board approved the new allocation for the defined benefit plan, which totaled $20.5 billion as of Sept. 30, in 2018 after an asset-liability study.

The new model "organizes SURS' assets within a functional framework rather than the traditional descriptive-oriented asset-based framework. In this approach, assets are grouped by similar risk profiles, rather than asset-class name," said CIO Douglas C. Wesley in an email.

The new allocation classifies assets as growth-oriented or diversifying strategies and separates core and non-core real assets and core and credit fixed income into separate portfolios, Mr. Wesley said. He added that a new allocation to crisis-risk offset strategies "as expected, delivered positive returns during the peak of the COVID market correction, offsetting the negative returns of most risk assets."

SURS' new long-term asset allocation is 26% stabilized growth — hedge funds of funds, option strategies, credit fixed income and core real assets; 25% traditional growth — U.S. equity, non-U.S. equity, global equity and real estate investment trusts; 20% crisis-risk offset — long-duration bonds, systematic trend following and alternative risk premia; 15% non-traditional growth — non-core real assets and private equity; 8% principal protection — core fixed income; and 6% inflation-sensitive — Treasury inflation-protected securities and commodities.

SURS' previous long-term asset allocation was 23% U.S. equity, 19% each non-U.S. equity and fixed income, 8% global equity, 6% each private equity and direct real estate, 5% hedged strategies, 4% each TIPS and REITS, 3% emerging market debt, 2% commodities and 1% opportunity fund.

Mr. Wesley said SURS' investment team "did experience challenges restructuring the portfolio in 2020. Market volatility, arising from the pandemic, caused us to delay the (restructuring of the) traditional growth portfolio, originally planned for March 2020, to early July."

What did work well for the SURS investment team was use of a cash overlay for portfolio rebalancing and a futures-based program that provided the mechanism "to maintain the appropriate equity and U.S. Treasury (bond) exposure," Mr. Wesley said.

SURS also manages a defined contribution plan, which totaled $3 billion as of Sept. 30.

The investment staff of the Public School and Education Employee Retirement Systems of Missouri, Jefferson City, had what CIO Craig Husting described as a "really good year because we stuck to our asset allocation process" for managing the defined benefit plan.

The plan returned a net 13% for the year ended Dec. 31. The pension plan had $47.5 billion in assets as of Sept. 30.

Mr. Husting stressed the importance of "good governance and good leadership" from the fund's board and staff, adding "having these two elements gives you such an advantage as an investor and contributed to the plan's very good return."

PSRS/PEERS investment staff had no difficulty meeting benefit payments because the system's asset allocation includes a 20% liquidity sleeve in cash and U.S. Treasury bonds, Mr. Husting said.

Staff also used their investment discretion to employ direct leverage on the total portfolio to assist in rebalancing asset allocations to their targets, including to increase the fund's equity allocation as markets began to rebound.

Because the market's recovery from its swift, steep decline in February was so rapid, Mr. Husting said "investment opportunities from the market dislocation dried up very fast" and the investment team wasn't able to invest in some of the new private market funds they wanted to.

The investment team was able to meet a capital call from a private credit fund it had committed to pre-pandemic in the first half of the year and set up some direct lending deals with private companies beginning in March and throughout the summer, Mr. Husting said.

Arleen Jacobius contributed to this story.