Author: Ted Ballantine

CalPERS’ allocation changes in the final months of 2016 have caused the pension fund to miss out on $900 million in potential investment return, according to remarks made by the CIO at a board meeting on Monday.

The pension fund moved away from stocks and private equity in September, opting for a less volatile asset allocation that is project to return around 6 percent annually.

However, CIO Ted Eliopoulos cautioned board members to keep the long-view.

From Reuters:

CalPERS Chief Investment Officer Ted Eliopoulos said during a board meeting on Monday that he wanted to “allay some of the anxiety and fears” by reminding the board that “our practice require us to take much longer periods of time into account.”

CalPERS decided in September to reduce some volatile stocks and private equity from its portfolio. Over the four months following until Dec. 31, the fund made more than $12 billion in net equity sales, according to fund documents. During that time, it experienced a lower return of approximately $900 million.

[…]

CalPERS expects a 5.8 percent annual investment return under its new portfolio asset allocation, significantly lower than the fund’s assumed rate of return of 7 percent by 2020.

The fund plans to make up for lower returns expected in the coming decade over the next 30 years or more.

One board member wondered if CalPERS could devise a method to retain its less volatile allocation while still capturing rallies. From the Sacramento Bee:

Board member Theresa Taylor questioned whether CalPERS could devise a different policy that might allow it act faster if trends change.

“I just want to make sure you are exploring all options so we are not leaving money on the table,” she said. “I know we are risk adverse and I get that but I also think that we leave ourselves open to not being able to do what we could be doing.”

 

The CIO of Danika, the $200 billion wealth management arm of Danske Bank A/S, doesn’t see hedge funds as part of his portfolio in the near future.

The reason? Hedge funds have forgotten how to hedge.

But he’s still open to investing in the right funds.

More comments from Anders Svennesen, via Bloomberg:

“If you look back over time, there are a lot of hedge funds that were really exposed to the market,” Anders Svennesen, the chief investment officer of Danske’s pension arm, Danica, who was recently made CIO at the bank’s wealth unit, said in an interview at his office outside Copenhagen.

“A real hedge fund ought to be market neutral, but an awful lot of them have been riding the wave of falling rates and rising stock prices,” Svennesen said. He doesn’t see outsourcing to hedge funds as a model that suits his goals here and now.

[…]

Svennesen says the trick is to identify hedge funds that actually live up to their mandate of being market neutral, so that they don’t start bleeding money when a sudden shock upends a price trend. He rejects speculation that today’s low-rate environment has undermined the logic of hedge funds, which traditionally charge high fees for their services.

“Those that really manage to be market neutral, and go in and operate in the right way, deliver a positive return, and there’s absolutely still a need for that,” he said. “Especially in the current environment.”

CalPERS expects to see an annual return of 5.8 percent under its new, more cautious allocation strategy, according to documents posted online by the pension fund this week.

The pension fund implemented the new allocation in September in anticipation of slower market growth over the next few years.

Notably, the expected return figure falls short of both CalPERS’ discount rate, which currently sits at 7.5 percent but will be lowered to 7 percent by 2020.

More from Reuters:

CalPERS’ caution mirrors outlooks from public pension funds across the United States as they try to grapple with investment forecasts of slow market growth over the next decade.

The new CalPERS allocation reduces the portfolio’s more volatile stock and private equity sectors and increases allocations of more stable investments such as real estate and infrastructure. The board expects to review the allocation again in 2018.

In December, CalPERS staff said the fund’s 10-year expected return was 6.2 percent. They expected annual returns to jump to 7.83 percent in the decades to follow. As a result, the fund’s long-term average would more closely align with CalPERS’s new discount rate, which the board voted in December to lower from 7.5 percent to 7 percent by 2020.

CalPERS spokeswoman Megan White told Reuters in an email on Tuesday that the 6.2 percent expectation is “more reflective of the desired allocation, and what we expect will emerge from the [asset liability management] meetings over the coming year.”

 

The Pennsylvania State Employees’ Retirement System will soon stop investing in international REITs, and will shift that money toward domestic strategies, according to IPE Real Estate.

The pension fund is also changing the benchmark index by which its measures its $2.4 billion real estate portfolio.

More from IPE:

Pennsylvania State Employees’ Retirement System is planning to stop investing internationally in real estate investment trusts (REITs).

The $26.3bn (€24.6bn) pension fund said it would move to a dometsic strategy to “continue to strive for the highest performing investments with the lowest volatility and best value for our members”.

The $369m REIT portfolio will be rebalanced using the pension fund’s existing REIT managers, CenterSquare Investment Management and CBRE Clarion Securities.

The pension fund is also changing its benchmark, swapping the S&P Developed Market Property Index for the FTSE NAREIT US Real Estate Index.

California lawmakers are pushing CalPERS to divest from the controversial Dakota Access Pipeline, but pension fund staff have balked at that recommendation, arguing that the country’s largest pension fund can more effectively engage with companies if it remains a shareholder.

This is the latest instance of the ongoing debate over divestment at public pension funds. On one side, observers say that large institutions should divest from energy companies that contribute to climate change.

But pension professionals argue they can more effectively push for corporate change if the pension fund has a “seat at the table” — in other words, that institutions can affect change more effectively when they remain shareholders.

More on the CalPERS situation, from Reuters:

California Public Employees’ Retirement System should maintain its investments in the controversial Dakota Access oil pipeline project in order to exert influence over the companies involved, staff for the largest U.S. public pension fund said on Monday.

Legislation proposed in California would require CalPERS, a $300 billion fund, to divest from companies involved in the building and financing of the 1,168-mile-long underground pipeline project, which would affect an estimated $4 billion in CalPERS holdings, according to staff.

CalPERS staff said that while divesting stocks of companies involved in the project may reduce stakeholder perception that the fund’s investments contribute to climate change, the move would limit CalPERS ability to change corporate behavior through engagement.

“There is considerable evidence that divesting is an ineffective strategy for achieving social or political goals, since the consequence is generally a mere transfer of ownership of divested assets from one investor to another,” staff said in its recommendation, which was published on its website.

The CalPERS investment committee will discuss the bill at its meeting next week.

 

CalSTRS, which previously assumed a 7.5 percent rate of return on investments, on Wednesday voted to lower its discount rate in two stages: first to 7.25 percent, then to 7 percent by 2018.

From the LA Times:

Board members, faced with a widening gap between investment returns and expectations, said they took action to lessen the likelihood that existing retirement promises made to teachers won’t be kept.

“I fear that waiting may put us, the fund, in a more precarious situation,” board member Joy Higa said during a public meeting in San Diego.

CalSTRS had previously assumed a 7.5% rate of return on its $196-billion portfolio. That rate will now be cut in two stages — first to 7.25%, then to a more conservative 7% assumption in 2018.

The average discount rate among the country’s pension systems is 7.62 percent, according to a NASRA brief.

Meanwhile, the 10-year annualized investment return of the average pension fund is 5.8 percent.

The New York Common Retirement Fund in December fired a second employee — Philip Hanna — in connection with the pay-to-play scandal in which the fund’s fixed income director took bribes in exchange for commitments to two brokers, according to a new report from the Wall Street Journal.

Hannah — who hasn’t been accused of any wrongdoing — may have helped Navnoor Kang hide evidence related to his grift by harboring Mr. Kang’s laptop in his house.

More from the Wall Street Journal:

The day after federal prosecutors accused former New York state pension executive Navnoor Kang of taking bribes , the giant retirement system fired another employee in connection with the case, said people familiar with the matter.

The New York Common Retirement Fund escorted Philip Hanna from the pension’s Albany offices on Dec. 22 without giving him a reason for his termination, these people said. Mr. Hanna reported to Mr. Kang, and the two were close friends, they said. The men were college classmates at the University of Texas’ Arlington campus and later started their own spirits company called Secrets Vodka LLC, according to these people and state filings.

U.S. prosecutors allege that Mr. Kang hid laptops containing evidence of his crimes at the home of a colleague. That colleague—identified in the indictment as “co-conspirator 1”—was Mr. Hanna, according to the people familiar with the case. Last month, the federal judge presiding over Mr. Kang’s case wrote in a court filing that prosecutors planned to reveal information found on computers “recovered from the residence of the individual identified as `CC-1,’ which were obtained pursuant to search warrants.”

For the first time under the Multiemployer Pension Reform Act, pension fund members have voted to cut their own pension benefits in order to maintain the solvency of the fund.

The Iron Workers Local 17 pension fund was the first to have its benefit cut proposal approved by the Treasury back in December; other pension funds have submitted proposals for benefit cuts, but they had been rejected by the Treasury.

Under the MPRA, plans are eligible to propose cuts if their funding is “critical and declining”. There are 70 such plans in the United States.

More from Bloomberg BNA:

Members of Iron Workers Local 17 in Cleveland have approved cuts to their pension benefits in an effort to keep their pension plan from going insolvent, and it’s the fund’s retirees who are going to take the hardest hit.

Of the nearly 2,000 plan participants, fewer than half submitted a vote. That’s significant because under the MPRA, not casting a vote is the same as voting to approve the pension cuts. Of the 936 members who did vote, two-thirds voted in favor of the cuts.

[…]

Benefit cuts, under the MPRA, are allowed only if the plan trustees determine that all reasonable measures to avoid insolvency have been and continue to be taken and that the suspension would allow the plan to avoid insolvency, assuming the suspension of benefits continues until it expires by its own terms or, if no such expiration is set, indefinitely. Cuts can be made to no more than 110 percent of the Pension Benefit Guaranty Corporation’s limits for multiemployer plans.

The Harvard Management Co. announced this week that it’ll be sending half its employees home for good and outsourcing most of its money management.

It’s a big change for an endowment that for many years was the best money manager in the business; but since 2005, the fund’s fortunes have changed.

HMC lost money in FY2016, returning -2% even as its benchmark portfolio returned 1% and broader markets grew even more.

Are there any lessons to learn from HMC? Barry Ritholtz think so. He writes at Bloomberg:

No. 1. When a money manager is outperforming the benchmarks, leave them alone: Under Meyer, HMC had captured lightning in a bottle. Messing with that rare and delicate thing is simply foolish. Harvard had to learn that the hard way.

No. 2. Simpler and cheaper beats complicated and expensive: Investing luminaries such as Charles Ellis, Jack Bogle and Burton Malkiel have long argued that the simpler and cheaper a portfolio is, the better its long-term performance. This is true even for a $37 billion endowment like Harvard’s.

No. 3. Opining about things you know nothing about is an expensive self-indulgence: The second-guessing of outsiders who thought they knew better is a perfect example of this. The Harvard professors and alums who deemed themselves more insightful about the mysteries of investing than the professionals is just the sort of hubris that the trading gods love to punish. This 2004 New York Times article about how much higher Jack Meyer’s pay was than that of Yale Chief Investment Officer David Swensen sums up the critics’ complaints — and naivete. What the critics accomplished was saving millions of dollars in management compensation while forsaking billions of dollars in returns. That was a dumb trade.

No. 4. Costly, underperforming alternative investments are on notice: This is part of a broader trend that was first thrust into view in 2014, when the giant California Public Employees Retirement System (CalPERS) pension fund said it was dumping its hedge fund investments, and reducing other so-called alternative investments. But pension funds and endowments move slowly; Harvard has had six different endowment managers before reaching the same conclusion as CalPERS. Other pension funds and endowments are likely to find religion as well. (Are you listening, New York?) It’s inevitable that pensions and endowments will also cool on venture capital and private equity.

Read the rest of the lessons at the link.