Shrinking funding levels have put some US pension funds under pressure. The country’s largest retirement schemes are now looking at boosting investment earnings to fund their growing liabilities.
Over the last few years the $38.9bn Massachusetts Pension Reserves Investment Trust (PRIT), has undergone significant changes in its investment strategy with the objective of generating healthier long-term returns.
“I guess the best way to sum up the changes would be to say we have been moving away from publicly traded securities into more alternative investments,” says Michael Travaglini, executive director at the fund’s investment management board (PRIM).
In 2003 PRIM carried out a major review of the fund’s portfolio aiming to increase its forecasted return and decrease risk by reducing volatility through greater investment diversification.
The new asset allocation strategy included changes in exposure to existing asset classes and the addition of two new asset classes: absolute return funds – mainly hedge funds – and emerging market debt. By doing this, what was a quite traditional portfolio only a couple of years ago looks now more like the investment portfolio of some of the country’s endowment foundations, with its exposure to a wide range of alternative asset classes and a greater international diversification.
Created in 1983, PRIT invests the assets of the Massachusetts State’ Teachers and Employees Retirement Systems as well as those of other local retirement systems. It consists of two separate funds – a ‘capital fund’ and a ‘cash fund’ – which are separately managed.
The capital fund serves as the long-term investment portfolio of PRIT and around 75 per cent of its total assets, or $29.2bn, is invested in public markets securities including domestic and international equities, emerging markets, fixed income and high yield. An additional $2.3bn is invested in alternative investments, $4bn in real estate, $1.3bn in timber and around $2bn in absolute return strategies.
Mr Travaglini explains that the board has been very supportive of all the changes in asset allocation implemented so far. “Otherwise we wouldn’t have been able to make these decisions because they literally have the right to accept or reject any of the investment recommendations. One thing they understand is that the traditional asset allocations of the last 20 years are not going to get you to where you want to be.”
Identifying returns
He adds: “Our job is not as easy as saying ‘70 equity/30 fixed [income] and you get 8 per cent returns’ any more. We are forced because of the market to try and identify where we can get our returns over the next 10 or 20 years.”
Currently the Massachusetts commonwealth’s funding level sits at 72.3 per cent, up to 39 per cent registered at the beginning of the 1990s. Since the fund was created performance has been quite good. The PRIT core annualised return since January 1985 through to the end of September this year represents a healthy 11.11 per cent, which represents 268 basis points in excess performance over the 8.25 per cent target of the fund, as required by the state of Massachusetts. For Mr Travaglini this shows that the underfunding problems faced by many US pension funds “are not portfolio management problems, and we shouldn’t treat them as such”.
“Historically, in Massachusetts the regulator was able to grant new pension benefits without doing cost studies related to those benefits. We have been lobbying to make sure no additional benefits are granted without an actuarial analysis of what that adds to the liabilities of the pension fund,” he explains.
However, better portfolio diversification can no doubt help bridge the gap between assets and liabilities, and that is the main objective of those in charge of the fund’s portfolio. As many other pension funds in the country, PRIT has traditionally had a very strong bias towards domestic equities. Back in 2002 its asset allocation target for US stocks represented 38 per cent of the total portfolio. This has been gradually reduced to the current 29 per cent, although the current target is to bring it down further to 26 per cent, that will result in assets being moved into other type of investments.
“For example, until 2004 we didn’t have any hedge fund investment and we now have 5 per cent of assets invested in absolute return strategies and that money came mainly from domestic equities,” he explains. These absolute return strategies consist of investments in five different funds of hedge funds. “We introduced this fund of funds approach – that I don’t particularly like because you are simply paying a double layer of fees – because we have only one analyst in charge of our absolute return portfolio.” He adds: “That one person couldn’t possibly put $1.5bn to work that it’s what we put to work over the course of three months in 2004.”
High yield exposure
On the other hand, the fixed income portfolio of the fund has also been reduced and the current target stands at 10 per cent, compared to 16 per cent in 2002. “But we have increased our exposure to what we call our high yield fixed income bucket that includes traditional high yield bonds, or ‘junk’ bonds, and emerging market and distressed debt.”
In the alternative investment area, the fund organises its portfolio by calling each asset class by its name. This way real estate and absolute return products have their own separate buckets, whereas what the fund calls alternative investments are mainly private equity funds.
“Alternatives for PRIM are private equity investments. I know some people treat this differently. We treat real estate and timber separately, and our 10 per cent target to alternatives goes mainly to leveraged buy-outs and venture capital,” he says.
Apart from four external consultants, the fund has an investment advisory committee in which Jack Meyer, the superstar investment manager and former chief of the Harvard Management Company, participated for a number of years. It was Mr Meyer who recommended PRIM to consider timber as part of PRIT’s investment portfolio, an asset class in which Harvard’s endowment trust has been investing for years. “Jack got the board to consider diversifying more into real assets. We already had investments in real estate and it was one of his ideas to look at timber.” Mr Travaglini notes.
The next step could be the introduction of commodities in the portfolio, although no final decision has been made as yet. However, the asset allocation review that PRIM undertakes every three years is taking place this month and commodities will be one of the issues on the table.
“Until we go through the review I can’t predict what changes will be made. However, because we are a mature plan that has been around for 20 years, I don’t expect significant changes other than 1 or 2 per cent plus or minus changes.”
He says that there is some concern in the investment world regarding inflation and the fund’s consultants want to look at the potential of increasing allocations to real assets. “This includes things like real estate and timber, that we already have, and commodities. This is certainly one of the areas of analysis we are going to go through in the next asset allocation exercise.”
Diversifying investments and controlling risk will be the key for PRIT’s health over the years to come. “When you are 72 per cent funded it is a little bit difficult to match your assets to your liabilities, but one of our biggest advantages as a public plan sponsor is our investment horizon. What I stress to our staff and our trustees is not to give that advantage back by trying to pull a lot of leverage and make a lot of shorter term asset allocation decisions,” he says.
Room for manoeuvre
Mr Travaglini knows that trying to generate returns of around 8 per cent in what many describe as a ‘6 per cent environment’ is not an easy task, but he is also aware that the good performance of the fund over the last 20 years gives them some room for manoeuvre. “If I try to get 8 per cent in what is truly a 6 per cent environment, and take on risk without proper analysis and end up with 4 per cent instead, everyone at PRIM will be looking for the next employment opportunities,” he comments.
The discussions taking place in December will result in the fund’s investment strategy for the next few years. Although it’s unlikely that the board will decide to make any radical changes to the current target asset allocation, the portfolio of the fund by the end of this decade will look very different to they things were at the end of the 1990s. Greater earnings will no doubt contribute to fund liabilities but changes on the way benefits will be paid in the future are also crucial to achieve long-term sustainability.
FIGURE ONE: PRIT MANAGER LINE-UP (30.09.05)
US Stocks:
State Street Global Advisors, Legg Mason Capital Management,
Fidelity Management Trust Company, Axa Rosenberg Investment Management
Numeric Investors, Wellington Management Company,
Lazard Asset Management , Ariel Capital Management Earnest Partners,
Mazama Capital Management
Putnam Advisory Company
Fixed Income:
Barclays Global Investors, PIMCO, Blackrock Financial Management
Loomis, Sayles & Co
High yield debt :
Fidelity Management Trust Company, Seix Investment Advisors
Shenkman Capital Management, Loomis, Sayles & Co,
Ashmore Investment Management, Grantham, Mayo, Van Otterloo (GMO),
Pacific Investment Management Company, Oaktree Capital Management
International equities:
Marathon Asset Manager, State Street Global Advisors,
Baillie Gifford, The Boston Company
Emerging markets:
Emerging Markets Management, Grantham, Mayo, Van Otterloo (GMO),
State Street Global Advisors
Alternative Investments:
PRIT has a list of over 70 venture capital and special equity partnerships
Real Estate:
Invesco, JP Morgan, LaSalle, RREEF, TA Associates
Timber:
The Campbell Group, Forest Investment Associates
Absolute Return:
Arden Asset Management, Ivy, K2 Advisors
Pacific Alternative Asset Management Company, The Rock Creek Group
Source: PRIT
FIGURE TWO: PRIT ASSET ALLOCATION
Source:PRIT
|
