How Pension CIOs Are Dealing With the Pandemic Storm
April and March were the cruelest months for pension funds, especially public ones, with asset values shrinking. Re-ordering the allocations of their holdings is a big task nowadays.
Although some stability returned with Washington’s multi-trillion-dollar rescue effort, the advent of summer still brings unease along with the soft breeze. “Things look better now,” said Shivin Kwatra, head of LDI portfolio management at Insight Investment. “But we’re not sure we’re out of the woods.”
Public plans are the worst off. For public pension funds, average funding ratios for defined benefit (DB) plans have tumbled to 60% and below, down from 74% prior to the coronavirus-induced economic crisis, according to Goldman Sachs. Among corporate DB pension programs, says actuarial and consulting firm Milliman, the largest 100 saw the ratio drop to 84% in April from 86.3%.
So pension chieftains have been making moves, in some cases to de-risk their holdings, in others to take advantage of opportunities. Some were already in position to weather the market turbulence. Others are re-ordering their asset line-ups. No one can be sure that another stock market free fall won’t occur this year.
Going forward, CIOs must get a handle on their equities allocation, which often is the best engine of growth, but has a bad tendency to sink amid rough economic waters. Then there’s how to deal with alts, in particular hedge funds and private equity funds, which are meant to be diversifiers.
And the human element is also involved, like dealing with a pension investment board, a powerful entity that may contain important people who aren’t very financially sophisticated. Also, many outside managers come peddling seemingly magical ideas on how to take advantage of a crisis. Can they? Really?
One good thing: Professional asset owners are seldom caught napping. Pension plans set up elaborate systems to oversee and re-do their asset allocations in the event of trouble. At the Pennsylvania Public School Employees’ Retirement System (PSERS), CIO Jim Grossman has made some adjustments to maintain liquidity, such as changing the plan’s cash position.
This didn’t require a lot of moving things around, which is a testament to Grossman’s foresight. “We’ve maintained our asset allocation goals, with relatively minor tinkering, through the market volatility the world has seen since early to mid-March,” he said.
His two committees that oversee asset allocation increased their meeting frequencies. The meetings, which now are done remotely, started occurring weekly. The panels’ charge is to figure out if they need to or how to “rebalance certain portions of the portfolio and to evaluate opportunities in the market.”
Typical for a large pension portfolio, PSERS ($58.8 billion in assets as of Jan. 31) has established allocations that the actual investment values usually operate slightly under or above. Equites are 30% of the total, fixed-income 36%, real assets 24%, etc. In the quest for liquidity, the fund has maintained cash levels near its 6% target. The managers can move expeditiously. Rebalancing is done at the staff level, without the need to clear it with higher authority.
Here are some of the considerations that top public pension fund chieftains, who recently participated in our CIO Roundtable, are weighing as they chart a path forward:
Board Relations
Getting the pension board’s approval to make moves in a time of crisis is very important. And that involves keeping members in the loop as events are unfolding. As Scott Chan, deputy CIO of the California State Teachers’ Retirement System (CalSTRS), put it: “I would just say that it’s a time—even at CalSTRS, where I think we have great board governance—it’s the time to overcommunicate, and our CIO Chris Ailman has done a fantastic job of communicating with them in this time.”
Speaking in general about boards, Ash Williams, CIO of the Florida State Board of Administration (SBA), observes that, for CIOs, part of dealing with them is calming members who are fixed on how values stand right now. Particularly when stocks are cascading toward the basement rapidly, as we saw earlier this spring.
“It’s hard to maintain control when you’ve got people who say, ‘Never mind that I said I was with you on this. I don’t like the way this is going. Get out,’” Williams said. “In many situations, ‘getting out’ is an option available only at a steep loss, if available at all.” For a CIO, he advised, a vital requirement is making sure the board understands long-term objectives and that the relationship with “those you report to is really durable.”
And, in turbulent spells, CIOs must realize, and communicate to others, that the road ahead is uncertain and likely rocky. “One of the things about investing in dislocated markets is that nobody really knows when you will get to the other side,” Williams noted. “Inflection points aren’t marked. You’re probably going to be in rough water for a while.”
Stocks
Equities have long been the key growth driver for portfolios, and the 11-year bull market that ended in February has been a big help. Managing them going forward will be a particular challenge. Given the economy’s swoon, odds are very strong that the stock market, now almost back to its February peak (the S&P 500 closed just 8.5% below the apex on Friday), will look at the staggering economy and take another steep fall.
Indeed, options on the top 100 stocks of the S&P 500 are pricing in almost 40% more downside than upside, wrote Nobel laureate Myron Scholes and Ash Alankar, both now top officials at Janus Henderson Investors, in a Bloomberg News essay last week. That level, they stated, is “similar in magnitude to what was registered during the 2008 bear market rally.”
Bill Coaker, CIO of the San Francisco Employees’ Retirement System (SFERS), showed foresight in being underweight equities, at just 31% of his portfolio. “We never know what the trigger, the timing, the duration, or the depth of a bear market or a systemic shock might be,” he said, “but we were well-positioned for that.”
Similarly, Jonathan Grabel, CIO of the Los Angeles County Employees’ Retirement Association (LACERA), was prepared for a storm. A few years ago, the plan lowered public equity exposure to 35% from 50%. “We consolidated our asset categories to four—growth, credit, real assets and inflation hedges, and risk mitigating strategies—to hopefully perform better across multiple investment environments,” he indicated.
Hedge Funds, Private Equity
These two asset classes are the big kahunas of alternative investments, asset classes chosen because they aren’t correlated to stocks, and the best ones often deliver superior returns, or hope to. Their diversification value alone is a comfort in eras of stress.
During bad times, of course, plan leaders typically can’t expect a big slug of distributions from these funds, the proceeds of selling off holdings. That’s particularly true for private equity (PE): Selling a company during a recession seldom brings much of a premium. In such trying times, hedge and private equity funds usually don’t ask their investors for more money, known as a capital call, but it can happen.
Thus, pension investors need to be ready for that, cautions San Francisco’s Coaker. Amid a downturn, he said, “We have to be prepared that we are going to have a larger net cash outflow to fund uncalled commitments than our base case planned for.” Coaker said his fund has created several scenarios for such calls and enlarged its cash position if that happens. The fund, he said, is “lined up to provide for capital calls in a multi-year worst-case scenario.”
For CalSTRS’s Chan, these times present good opportunities for PE deals, notably for distressed assets. A good way to do that, he said, is via co-investments, where his organization could take a minority position in an acquisition, led by a PE fund. Or it could get involved in secondary PE deals: That’s where a PE fund sells one of its companies to another PE player instead of taking it public.
About Those Outside Managers
Not every outside manager approaching a fund with a razzmatazz strategy, claiming it can mint a fortune thanks to the crisis, is worthwhile, Florida’s Williams cautions: “The fact that there are a bunch of people calling you up saying, ‘We’re forming a fund to do X’ doesn’t mean a thing other than they want your money.”
Give a jeweler’s eye to the background of these folks, Williams said. “You could get calls from 20 firms, and maybe two of them actually are deeply qualified for the opportunity and have done it before.”
For someone of Williams’ stature, who has done it before, there’s no doubt that “hard times are full of both peril … and opportunity.”
Related Stories:
Goldman Sachs Estimates Public Pensions Now Less than 60% Funded on Average
US Corporate Pension Funded Ratio, Risk Transfer Costs Decline in April
CIO Roundtable (Part 1): How Top Asset Allocators are Dealing with Today’s Volatile Market