Texas Teachers records the highest quarterly return in its 85-year history – 333 basis points of alpha – with US and Indian equities fuelling the excess return. Known for its active management the fund has made a number of recent changes to the portfolio including removing China and reducing allocations to private equity.
The Teacher Retirement System of Texas (TRS) the $203.7 billion Austin-based pension fund posted the highest alpha in its 85-year history in the second quarter of 2024, ending the quarter with a 1-year return of 9 per cent and +333 basis points of excess returns.
“Morale is quite high,” said chief investment officer Jase Auby, speaking during the fund’s mid-September investment committee meeting.
The strong one-year market returns at the pension fund have been supported by US equities, the largest asset class in the fund and accounting for 21.2 per cent of the return. Returns in Indian equities have also driven performance.
“India continues to outperform and is the top performing major equity market for the past year and all the 2020s,” said Auby.
He added that in contrast to India, China has performed badly in recent years.
TRS only has a half weighting to China in its emerging market benchmark and the fund’s new asset allocation removes China in totality. Although the public equity benchmark allocation is zero, TRS’s active strategies are able to make out-of-benchmark allocations to China although these exposures are small.
Auby said it is still unclear whether the US will enter a recession. One indicator that suggests it could is unemployment levels. The Sahm Rule, highly predictive of recession, was triggered last month by nonfarm payrolls. However, he countered that one of the reasons recession has been forestalled so far is the strength of the US consumer, indicative in strong retail sales.
“The US consumer continues to spend with surplus funds got through covid to power the economy,” he said.
New strategic asset allocation
The TRS board recently approved a new strategic asset allocation at the fund that aims to increase resilience to potential financial market shifts. Headline changes in the new SAA, conducted every five years, include lowering the target to private equity to 12 per cent from 14 per cent.
TRS will also shift some allocations in the global equity and stable value portfolios within its diversification framework, as well as reduce the allocation to the risk parity portfolio.
Elsewhere the fund has created a new 6 per cent allocation to inflation-linked bonds within the government bonds sleeve to both reduce duration and sensitivity to inflation. The asset allocation to nominal government bonds will be cut from 16 per cent to 10 per cent.
An eye on corporate earnings
Auby explained how corporate earnings – a company’s net income after tax – and often referred to as the bottom line, offer one of the most important indications of stock market growth or decline ahead.
The reason that the US stock market continues to outperform all other regions is strong corporate earnings. Although earnings declined during the pandemic the market is now predicting double digit earnings for US corporates at this time. He said that European indices have underperformed because corporate earnings are lower compared to other regions.
US outperformance is due to America’s booming tech sector, and the fact the US has the highest concentration of tech companies reporting strong earnings compared to any other region.
“Nvidia contributed 2.1 per cent of the total 10 per cent earnings growth over the last year for the S&P 500,” he said, referencing the star performer whose earnings analysts now view with as much importance as economic data.
TRS incorporates earnings into its equity strategy in a number of different ways.
In depth fundamental research finds companies set to beat earnings growth to tap excess alpha. Other strategies include quality analysis that brackets companies according to the quality of their earnings in different buckets.
“If you invest in the quality factor you are investing in the best and it gives you the highest return,” said Auby. “Quality is a statistical measure of earnings stability, strength of balance sheet and those higher profit margins; three things shown over time to outperform market.”
