Study Examines Herd Mentality in Pension Investing

glasses

Pension funds exhibit a herd mentality when formulating investment strategies, according to a new paper that studied the investment decisions of UK pension funds over the last 25 years.

The paper, authored by David P. Blake, Lucio Sarno and Gabriele Zinna, claims that pension funds “display strong herding behavior” when making asset allocation decisions.

More on the paper’s conclusions, from ai-cio.com:

According to the study, there was overwhelming evidence of “reputational herding” behavior from pension funds—more so than individual investors.

Pension funds are often evaluated and compared to each other in performance, the paper said, creating a “fear of relative underperformance” that lead to asset owners picking the same asset mix, managers, and even stocks.

Data showed herding was most evident at the asset class level, with pension funds following others out of equities and into bonds at the same time. They were also likely to herd around the average fund manager producing the median return—or a “closet index matcher.”

The paper can be found here.

 

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San Francisco Pension Investment Staff Recommends Foray Into Hedge Funds

Golden Gate Bridge

The investment staff of the San Francisco Employees’ Retirement System (SFERS) has recommended to the board that the system allocate up to 10 percent of its assets in hedge funds.

SFERS has been waffling for a year over whether or not to put money into hedge funds, and what the allocation should be.

From Bloomberg, via FinAlternatives:

The San Francisco Employees’ Retirement System staff is recommending its board consider investing 10 percent of assets in hedge funds.

[…]

The staff said it also could support a 5 percent hedge-fund allocation for the $20 billion city pension, according to a memo sent to the board from William Coaker, the chief investment officer. The board is scheduled to consider the recommendation at a Feb. 11 meeting in San Francisco.

“Many of the objections we have heard about hedge funds are at best an incomplete picture,” Coaker’s memo said. “Hedge funds have less than half the volatility of the equity market. Transparency is improving in the hedge-fund industry as a whole.”

The San Francisco pension board in December postponed a decision on adding hedge funds to its investment mix and asked staff for a more detailed analysis ahead of this month’s meeting. The fund isn’t currently invested in hedge funds, which are loosely regulated investment pools that are generally open only to high-net-worth and institutional investors.

The San Francisco Employees’ Retirement System manages $20 billion in assets.

 

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Preqin Tells Private Equity to Heed the “Power of the Limited Partner” After CalPERS’ Cuts

Calpers

Research firm Preqin has released a note reacting to CalPERS’ cutting of private equity managers.

The firm notes that limited partners are beginning to wield more negotiating power, and cautions private equity firms to consider CalPERS’ actions an “effective statement” on the power of limited partners.

More from Chief Investment Officer:

Private equity fund managers should take heed of the California Public Employees’ Retirement System’s (CalPERS) overhaul of its allocation to the asset class and focus on justifying the terms they present to clients, according to Preqin.

The research firm was responding to last week’s announcement by CalPERS that it wanted to drastically reduce the number of private equity managers it uses in order to cut costs.

“The decision by CalPERS may not immediately result in a drop in overall commitments to private equity funds,” Preqin said in a research note, “but serves as an effective statement to fund managers on the importance of justifying fund terms, as well as the power of the limited partner.”

The research firm said CalPERS’ decision reflected a wider concern among investors that fees were the biggest challenge to their investment in private equity. Roughly 58% of respondents to Preqin’s survey of US public pensions said fees were their chief concern.

It’s important to note that CalPERS is not cutting its allocation to private equity, only the number of PE managers it employs.

Preqin’s research note can be found here.

 

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CalPERS Is Cutting Its Private Equity Managers, But That Doesn’t Mean It’s Breaking Up With PE

Calpers

CalPERS announced this week that it was cutting down the number of private equity managers it employs – possibly by as much as two-thirds.

The change comes in the name of cutting costs. A similar rationale was used when the pension fund decided to exit its entire hedge fund portfolio last year.

But unlike hedge funds, private equity will remain a significant part of CalPERS’ investment strategy going forward.

From the New York Times:

Calpers is not planning to significantly reduce its allocation to private equity, though it may redistribute it, Joe DeAnda, a Calpers spokesman, said in an email. He said the pension fund may increase its allocation to individual private equity managers as it culls the number of managers.

As of October, Calpers had $31.2 billion invested in private equity, or about 10.5 percent of its overall portfolio, according to the most recent disclosure. It aims to have 10 percent of its portfolio allocated to the strategy.

[…]

When it comes to private equity, Calpers is also trying to reduce costs. But its approach is more subtle.

Réal Desrochers, the pension’s head of private equity since 2011, announced in late 2013 that Calpers aimed to reduce the number of managers to as few as 100. (DealBook reported on it here.)

In a presentation to the Calpers investment committee in December that year, Mr. Desrochers discussed his review of the pension fund’s private equity portfolio. It included 389 managers at the time.

“I think this portfolio should have — given the size where we are — it should be probably around 100, 120, something like that,” Mr. Desrochers said. (See the 29:15-minute mark in this video.)

In other words, this move has been in the making for a long time.

CalPERS allocates about 10 percent of its assets towards private equity.

 

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Report: Japan Pension Set to Benefit From Reforms

Japan

Japan’s Government Pension Investment Fund (GPIF) – the largest pension fund in the world – implemented numerous changes in 2014, including an asset allocation shake-up and the hiring of its first chief investment officer.

A new report says the reforms will benefit the fund going forward. From Chief Investment Officer magazine:

A report jointly published by Cerulli Associates and the Nomura Research Institute (NRI) stated that the reforms to the ¥130.9 trillion ($1.1 trillion) pension, announced by its management team earlier this year, would help it become “more dynamic.”

“In terms of hiring, the GPIF will not be shackled by low salaries and will be better positioned to recruit top-notch talent,” said Yoon Ng, Asia research director at Cerulli Associates. “This will add more quality to its external manager selection processes.”

[…]

“With public pension fund reforms in place, the GPIF… may show a stronger tendency to hire managers with highly distinctive investment strategies that are differentiated from and relatively uncorrelated with other companies’ strategies,” the report offered.

Atsuo Urakabe, a senior researcher at NRI, said the new asset allocation would push the GPIF to hire managers with “highly distinctive investment strategies” that can offer uncorrelated performance, as it seeks to achieve a higher annual return.

Cerulli’s report said Japanese pension funds had been “bogged down by ultra-conservative investment policy requirements” but pointed to the GPIF’s reforms as an indication that other pensions in the country could revise their asset allocations, diversify, upgrade risk management, and reform governance.

As well as identifying external managers, Cerulli’s research paper predicted that Japanese public pension funds outside of GPIF may seek to build up their in-house expertise.

“In the long run, this will help to bring their costs down and lead to some insourcing of assets that had previously been farmed out to be managed,” the report said.

The GPIF manages $1.1 trillion in assets.

 

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Cuomo Rejects Bill To Increase Alternative Investments By Pensions

Manhattan

New York Governor Andrew Cuomo on Thursday vetoed a bill that aimed to raise the percentage of assets New York City and state pension funds could allocate towards hedge funds and private equity.

From Bloomberg:

Governor Andrew Cuomo vetoed a bill that would have allowed New York state, city and teachers pension funds to allocate a larger percentage of their investments to hedge funds, private equity and international bonds.

The measure approved by lawmakers in June would have increased the cap on such investments to 30 percent from 25 percent for New York City’s five retirement plans, the fund for state and local workers outside the city, and the teachers pension. The funds have combined assets valued at $445 billion.

“The existing statutory limits on the investment of public pension funds are carefully designed to achieve the appropriate balance between promoting growth and limiting risk,” Cuomo said in a message attached to the veto. “This bill would undermine that balance by potentially exposing hard-earned pension savings to the increased risk and higher fees frequently associated with the class of investment assets permissible under this bill.”

[…]

A memo attached to the New York bill said raising the allotment for hedge funds and other investments is necessary for flexibility to meet targeted annual returns. A swing in the value of the funds’ publicly traded stocks can push the pensions “dangerously close” to the investment cap, the memo said. The change would also better enable the funds’ advisers and trustees to “tactically manage the investments to take advantage of market trends, react to market shocks and potentially costly rebalances or unwinds at inopportune times,” it said.

New York City Comptroller Scott Stringer supported the bill.

 

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Video: CalSTRS CIO Talks 2015 Market Expectations, Asset Allocation Changes

CalSTRS chief investment officer Christopher Ailman sat down with Bloomberg TV on Monday morning to talk about the odds of the market returning 8 to 10 percent in 2015, and how CalSTRS might change its asset allocation next year.

 

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Japan Pension Considers Change In Stock Classifications

Japan

Japan’s Government Pension Investment Fund (GPIF) last month decided to double the amount of assets allocated to domestic and foreign stocks.

Now, the President of the GPIF is considering further changes that would remove the distinction between domestic and foreign stock holdings.

From Bloomberg:

Japan’s Government Pension Investment Fund is considering whether to overhaul its $389 billion of stock investments by loosening rules that restrict managers to domestic or international equities.

A month after the $1.1 trillion pool unveiled plans to more than double local and foreign share targets so that each makes up 25 percent of assets, Takahiro Mitani, its president, said separating the world into Japan and everywhere else may not be the best approach. GPIF should consider letting some of its managers invest both at home and abroad, he said.

“More funds are investing without discriminating between domestic and foreign, and I think that’s worth considering,” Mitani, 65, said in an interview in Tokyo on Dec. 3. “If choosing between Toyota and Volkswagen, instead of being limited to just Toyota and Nissan, raises investment performance and efficiency, it’s an option we mustn’t rule out.”

The California Public Employees’ Retirement System, the biggest U.S. public pension, makes no distinction between local and foreign holdings. Calpers, which oversees about $295 billion, has a 51 percent target for public equities, according to its website. GPIF’s stock investments were parceled out to managers in 45 different pieces as of March 31, according to the fund’s annual report.

[…]

GPIF would have to revise its systems to allow one manager to invest across Japanese and non-domestic shares, Mitani said. Alternatively, it could create a new global stock class on top of the existing ones, he said. The fund is due to review foreign equity managers in about 18 months, according to Mitani, who said he plans to retire when his five-year term finishes at the end of March.

Regardless of how it deploys managers, the Japanese fund is looking to put more money in foreign assets at a time when its home currency is slumping. The yen weakened past 120 per dollar for the first time in seven years yesterday.

Here’s what the fund’s asset allocation targets look like after last month’s overhaul:

GPIF’s new portfolio is split into four asset classes: the 25 percent targets for Japanese and foreign stocks, up from 12 percent each; the 35 percent allocation to domestic bonds and 15 percent for foreign debt, an increase from 11 percent. The fund had 18 percent of its holdings invested in Japanese stocks at the end of September.

Government Pension Investment Fund is the largest pension fund in the world. It manages $1.1 trillion in assets.
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San Francisco Pension To Consider Smaller Foray Into Hedge Funds

Golden Gate Bridge

The San Francisco Employees’ Retirement System has spent the better part of 6 months weighing whether to dive into hedge funds for the first time.

The fund was originally considering a plan to invest up to 15 percent of assets – or $3 billion – in hedge funds. But the figure was too high for many board members, and the vote was tabled numerous times.

Now, the board is considering a proposal that would allow the fund to invest up to 3 percent of assets in hedge funds – a much smaller allocation that may be more palatable to board members.

From Bloomberg:

The president of the San Francisco Employees’ Retirement System board has asked advisers to look at a hedge fund investment of zero or 3 percent, less than the 15 percent proposed by the pension’s staff.

The board will meet today in San Francisco to consider the proposals, which are part of a broader effort to recalibrate the fund’s asset allocation. The updated figures were in a letter from Angeles Investment Advisors.

“The VM mixes have higher volatility,” Leslie Kautz and Allen Yeh wrote in a Nov. 25 memo to Victor Makras providing modeling on several mixes that they said he specified.

[…]

The hedge fund proposal stems from a June meeting when the San Francisco staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options.

The staff recommended a 15 percent hedge-fund allocation, citing good returns, low volatility and very good risk-adjusted returns, according to a memo today to the board from William Coaker, the fund’s chief investment officer.

“Hedge funds provide good protection when stocks decline,” Coaker said. “Since 1990, they have lost only one-fourth the amount stocks have lost in market downturns.”

The San Francisco Employees’ Retirement System manages $20 billion in assets, none of which are allocated to hedge funds.

 

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New Chicago Treasurer Makes Pension Funding His Priority

chicago

Chicago Treasurer Stephanie Neely is stepping down at the end of November.

Her replacement, Kurt Summers, said his priority will be fixing the city’s pension systems. From the Chicago Sun-Times:

The full City Council is expected to ratify the appointment of Kurt Summers at Wednesday’s meeting, but the incoming treasurer is not waiting for the vote before rolling up his sleeves and getting to work.

He’s already meeting with actuaries and pouring over the books of the four city employee pension funds.

They include the Municipal Employees and Laborers funds that have already been reformed and police and fire pension funds still waiting for similar action.

In 2016, the city is required by law to make a $550 million contribution to shore up police and fire pension funds with assets to cover just 29.6 and 24 percent of their respective liabilities.

Much of that money will have to come from Chicago taxpayers.

That’s because, unlike Municipal Employees and Laborers, police officers and firefighters do not get compounded cost of living increases.

The process of making the city’s pension funds healthy, he said, includes decreasing investment fees and increasing investment returns. In other words, “investing more efficiently and less expensively.” From the Sun-Times:

As a member of the board overseeing all four city employee pension funds, Summers said he can “make a dent” in the taxpayer burden by reducing investment fees and bolstering returns.

Summers noted that the firefighters and laborers pension funds are paying dramatically higher fees to their investment managers than the Municipal Employees and police pension funds.

“One fund is paying 80 percent more in fees. Another is paying 50 percent more. Yet, there’s one client: The city of Chicago. That’s real money. For fire, the value of that is about $2.5 million-a-year on $1 billion in assets,” he said.

“These kinds of things aren’t going to solve the kinds of holes we have. But any benefit we can find to invest more efficiently and less expensively is a benefit to taxpayers and retirees.”

Summers noted that the bill that saved the Municipal and Laborers Pension funds — by increasing employee contributions by 29 percent and reducing employee benefits — assumes an “actuarial rate of return” on investments of 7.5 percent-a-year.

That makes it imperative that the funds invest in the “right type of assets,” he said.

“If there’s market shock during that time that looks anything like what happened in 2008 — or even what we saw in July — then you end that period of fixed, graduated contributions with less funding than was modeled out in the legislation and there’ll have to be greater catch-up to get to 90 percent funding,” Summers said.

“We’ll have to have portfolio and asset allocation changes to protect our rate of return because ultimately, the taxpayers and retirees are relying on us to hit that number and, if we don’t, they have a bigger bill on the other side of the graduated payments structure.”

That doesn’t necessarily mean being conservative, he said.

“It’s a common misconception to say, `If I invest in the markets or fixed-income [instruments], we’re gonna be protected, but real estate, private equity or hedge funds are risky.’ That’s plain wrong,” Summers said.

“The reality is, you have just as much, if not more exposure to risk and volatility in the market with investments in basic public securities than you do with alternative products meant to mitigate risk and limit volatility. That’s the business I was in — trying to do that for clients around the world.”

As Treasurer, Summers would be a trustee of the city’s pension funds.