Many US public pension funds have posted double-digit returns this year, after experiencing several years in the doldrums, mostly thanks to buoyant equity markets. America’s largest pension fund, the $330.2 billion California Public Employees’ Retirement System (CalPERS) returned 11.2 per cent, boosted by a 19.7 per cent return in its $150 billion public equity portfolio; public equity was also behind the second-biggest fund in the US, California State Teachers’ Retirement System’s (CalSTRS) 13.4 per cent return.
Another one of the best performers was the $12 billion Louisiana State Employees’ Retirement System (LASERS), which had one of its best years ever in 2016-17, returning 15.8 per cent.
LASERS has a chunky, 57 per cent allocation to diversified public equity that returned 20.9 per cent, with international and emerging stocks doing best. Chief investment officer Robert Beale, who has served at the fund since 1997, has overseen a strategy that balances risk and defensive assets, and passive and active strategies, while keeping a lid on fees and trying to ensure diversification in the event of equities plunging.
These endeavours are set against the challenge of navigating a continued equity bias for growth while LASERS’ deficit remains stubbornly high. LASERS is only 63 per cent funded and investment income is the main source of revenue for paying benefits to members and beneficiaries.
“Our funded status doesn’t really affect the investment strategy,” Beale insists in an interview from the fund’s Baton Rouge, Louisiana, headquarters. “We still have to earn a reasonable return of around 7.75 to 8 per cent over a very long time period, which will require an asset allocation similar to what we have now. Our funded status would have to be much higher, at over 80 per cent, before you could look at allocation changes or contribution changes.”
To cut costs, Beale has introduced index strategies in domestic equity (S&P 500, S&P 400, and S&P 600) and international equity (MSCI World Ex-USA and Terror-Free). This means LASERS staff now manage nearly one-third of total assets within these five allocations; however, while passive strategies helped cut costs by more than $9 million through 2015-16, the fund still has an active bias, with 68 per cent in active strategies versus 32 per cent passive.
Apart from the equity allocation, LASERS’ assets are divided between fixed income, private equity, absolute return and risk parity.
Big changes in alternatives
Beale is also midway through a shake-up in alternatives, where the hedge fund portfolio, in particular, has struggled. Alternatives account for just under a quarter of assets under management, divided between a 13 per cent allocation to private equity and an 8 per cent allocation to absolute return strategies; the fund ditched commodities a couple of years ago.
“Absolute return has had a tough time, return-wise, the last two to three years,” Beale says, although he is still committed to hedge funds, for their lack of correlation to the rest of the portfolio, and for their diversification and potential long-term returns. LASERS favours fund-of-funds and multi-strategy investments to allow access to top-tier funds and reduce individual fund and manager risk.
There is room for improvement. LASERS is halfway through a transition to a more concentrated, or best ideas, portfolio, in a restructuring that entails full redemption requests with some managers as portfolios are liquidated.
“We have been changing the way we structure our overall program to [be] more opportunistic; we are still moving in that direction,” Beale says.
The new strategy is multipronged. LASERS invests via a customised fund-of-funds portfolio managed by Prisma Capital Partners, while Bridgewater Associates handles macro strategies and EnTrust Capital has shaped a customised co-investment portfolio.
“The EnTrust portfolio focuses on unique investments that may require longer liquidity or flexibility on providing capital. Most of the deals are combinations of debt and equity structures and private and public securities,” Beale explains.
He is also rejigging managers in the global asset allocation – the risk parity portfolio, accounting for 7.4 per cent of total assets. Here, an optimal strategic allocation mix avoids bias to any one market environment, aiming for a balanced return stream. Now, AQR will manage part of the strategy, with funding coming from a reduction to the existing risk parity manager, Bridgewater, in a bid to diversify the manager base.
“It is a different way to allocate assets, so provides some diversification,” Beale says.
Pondering the future, given the low returns forecast from equity markets, he concludes: “The investment landscape is constantly changing…I think technological advances will make it easier to analyse all aspects of pension plans more accurately and efficiently going forward. Patience is always the key; in the end, our goal in managing the pension plan is to allocate assets in the most advantageous risk/return investments we can discover.”
