Illinois SURS Gears Up for Unique Crisis-Prevention Allocation

Report reviews primary risks and potential gains with lofty 20% allotment.

The State Universities’ Retirement System of Illinois is allocating 20% of its portfolio to an asset class called the Crisis Risk Offset Class (CRO), a new segment dedicated to insulating the pension’s assets to major market swings.

Specifically, it’s supposed to diversify away from growth risk, one of the largest risks for institutional investors, by providing a negative conditional correlation to equities and delivering positive returns when equities decline substantially. It’s a good move for the pension, which was 43% funded last year, with $19.4 billion in assets and $25.9 billion in unfunded actuarially accrued liability.

The new allocation for the educator-funded pension was approved late last year and is expected to sit alongside respective broad growth (66%), inflation sensitive (6%), and principal protection (8%) classes. To make room for CRO in its portfolio, the system trimmed allocations to hedge strategies, emerging markets debt traditional growth, and commodities. Overall, SURS believes it’ll reduce the potential returns of the portfolio in the most favorable market conditions and insulate it from substantial negative drawdowns in the event of a recession or other market turmoil.

The portfolio is essentially expected to consummate investments in 20-30 year US Treasury bonds, to be implemented via passive strategy providers. Another segment is to be comprised of trend-following strategies—essentially buying investments spanning equities, fixed income, currencies, and commodities that are increasing in value and divesting from those with sharp reductions. SURS is expected to use derivatives-based leverage to set strategy volatilities here. Additionally the portfolio is expected to invest in assets that generate alternative risk premia.

Staff at the pension believe that the portfolio has just a few major risks, one of them being its unpredictable behavior during shorter drawdowns. It’s “reasonably probable” that CRO will produce negative returns in equity markets during shorter equity drawdowns. Also, SURS staff believes that a material allocation to CRO could potentially result in the portfolio lagging behind its peers during bull markets.

SURS also found that the new policy will “smooth” projected funding scenarios, bringing expected funded ratios closer to their target, and significantly reducing anomalies in funding ratio scenario simulations.

SURS and its consultant, Pension Consulting Alliance, will develop draft policies for the allocation’s investment policy statements and begin the manager search process for different components of the portfolio, with the expectation of concluding by the end of the year. The pension has its sights set on fulfilling the new allocation by 2021.

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