The New Mexico State Investment Council’s 2020 annual investment plan calls for protective measures implemented into the state sovereign wealth fund’s $25 billion portfolio, in anticipation of what the council is calling a shallow recession. The annual plan is used to illustrate the council’s outlook of the market over the next seven- to 10-year period.
“Based upon long history, we can expect a recession over the next 7-10 years, and likely toward the first half of that period,” the council said in prepared remarks. “The International Monetary Fund estimates may account for a mild recession in their estimates, but there appears to be little to no room in the numbers for a deep or protracted recession or serious crisis.”
Chief Investment Officer Vince Smith explained to CIO several broad strategies that the state’s investment council has implemented to position the portfolio against the anticipated downturn. One is to lower its total exposure to publicly listed equities, which it began in 2014, subsequently accelerating in 2017, and now consummates approximately 40% of its total holdings—“a fairly conservative allocation” in relation to other institutional investors, Smith said.
The free room was spread across “alternative assets [including] real estate, private equity, real assets—particularly infrastructure,” he added. “We’re finding higher rates of return outside of publicly listed equities.”
“The environment the council expects for the forward investment horizon [next seven to 10 years] is not an easy one,” the council said in the 2020 plan. “We are expecting a recession…perhaps as early as next year. The characteristics of that recession could be different than the typical recession of the past couple of decades. The coming recession could be more shallow, as readily-identified excesses have not built up in the system as they have in prior cycles, but be extended relative to history as both monetary and fiscal policy may be more limited in scope than in prior recessions.”
The council maintains a long-term view of generating investment returns and employs little in the way of shorting or hedging. A 10% allocation to hedge funds present when Smith arrived as CIO in 2010 has been eliminated.
Instead, the council has been carrying out three key strategies to better position itself against any market downturns, Smith explained. First is to reduce its publicly traded equity exposure, which is just about done at this point now that it is at its 40% target. The second strategy is to raise and structure liquidity within the portfolio, and implement a measured degree of flexibility across its holdings.
This was covered in 2017, when the council divided its fixed income portfolio into core and non-core divisions, whereas the core portfolio was developed with reduced duration, higher credit quality, and higher liquidity. The idea is to increase the overall portfolio’s ability to respond to adverse scenarios and provide ample liquidity in the event of a serious market downturn, to subsequently rebalance and gain additional exposure to risk assets.
Thirdly, Smith and his team have been shifting their asset allocation with more weight towards assets that produce higher rates of income, on average—namely real estate, real assets, and credit. “These asset types produce the preponderance of their expected return with income, insulating the portfolio to a degree from returns generated by capital gains, which can be volatile,” Smith said.
Not all is doom and gloom however, says Smith. “While we are still on the downslope globally in terms of demographics, labor force participation rates have also been very low this cycle, and that seems to be improving.” Smith also cites that “productivity has been stagnant this cycle, but technological advance is finally pushing productivity forward.” If these trends were to hold in the seven- to 10-year investment horizon, “the combination has the potential to soften or shorten our base case recession, and put economic growth rates toward the top end of our range.”
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