Institutional investors are coping with converging
alternative investment strategies by creating new - and bigger - allocation
buckets. Rather than keeping each asset in its own silo, investors increasingly
are crossing asset allocation lines, bundling diverse types of investments into
a single portfolio for a stated goal or theme. Lower-return market conditions
are driving investors to take a hard look at their allocations and discard the
old approach, which had failed to consistently provide the returns.
The Teachers' Retirement System of the State of
Illinois, Denmark's PKA and M.J. Murdock Charitable Trust are among the
investors that have ditched the traditional bucket system for a more
wide-ranging asset allocation. A number of other investors — including Los
Angeles County Employees Retirement System and New Mexico Public Employees
Retirement System — have added asset-class-crossing portfolios such as
opportunistic fixed income or real assets.
Trustees of the Illinois Teachers' Retirement System,
Springfield, will consider adoption of a much simpler asset allocation model
that acknowledges the many convergences among the strategies in its alternative
investment portfolios. For a public pension plan, Illinois TRS has an unusually
large allocation to alternative investments: 39%, or $17 billion of the $43.6
billion fund. TRS has maintained a traditional asset allocation in reporting to
trustees regardless of formal asset class labels.
Currently, there are eight asset classifications with the
following target allocations: domestic equity, 23%; international equity, 20%;
global fixed income, 16%; real return, 10%; real estate, 13%; hedge funds, 6%;
private equity, 11%; cash, 1%. The proposed allocation will have four
categories with the following target allocation ranges and components:
- global equity, 50% to 60%, domestic public
equity, international public equity, private equity, opportunistic real estate;
- global fixed income, 15% to 30%, core/core plus,
short duration, floating rate, non-dollar emerging market debt, special
situations, convexity strategies;
- diversifying assets, 10% to 15%, hedge funds,
global macro/global tactical asset allocation, risk parity; and
- real assets, 10% to 20%, core/value-added real
estate, Treasury inflation-protected securities, farmland.
As of March 31, the pension fund's real estate assets
totaled $5.4 billion; private equity/venture capital, $4.6 billion; real
return, $4 billion; hedge funds, $2.4 billion; and special situations/credit,
Oversight of credit strategies likely will come from a
combination of traditional fixed-income investment officers, as well as private
equity and hedge fund specialists, because credit funds often use a hedge fund
approach and/or have a longer lockup, similar to private equity funds.
Investors' concern with the risk lurking in their portfolios
has caused them to organize their asset allocations around risk factors rather
than traditional asset classes. Investors are looking for a customized
combination of multiple strategies and learning that any product is a package
of risk factors and labeling them in artificial containers may not be the best
way to choose the options out there.
The $800 million Murdock Trust, New York, divides the world
into three “risk buckets” — low, medium and high — and considers all types of
investments, across asset classes, for any of these risk buckets. Last year,
for example, the 194.8 billion Danish kroner ($35.55 billion) Pensionskassernes
Administration A/S, Hellerup, Denmark, hired Acadian Asset Management to
run a $450 million managed volatility strategy. The pension administrator,
which is owned by five occupational pension funds, restructured its equity
portfolio in 2012, adopting an investment process that allocates to 17
different risk premiums within the equity portfolio rather than using
traditional strategic allocations to regions.
One theme the Teacher Retirement System of Texas,
Austin, is focusing on is energy and natural resources. The pension fund
established an initial 3% allocation last year. The allocation is likely to
increase to 5%. The portfolio aims to include oil, gas, water, agricultural
real estate, timber, mining and other related sectors in order to capture
promising returns over the next 10 years and to diversify the overall
Some investors are investing around themes such as water and
food scarcity. Other institutional investors are investing around outcomes,
such as inflation protection or interest rate increases. Another theme for the
endowment is emerging markets. Seven
years ago, the pension plan started down the path of making its overall
portfolio more like an endowment. The pension plan is in the midst of an asset
allocation study that could add leverage to its $126 billion portfolio.
Investors such as the $46.5 billion Los Angeles County
Employees' Retirement Association, Pasadena, CA and the $36.6 billion Tennessee
Consolidated Retirement System, Nashville, have created opportunistic
fixed-income or credit allocations that include both publicly traded and
In May, the New Mexico Public Employees Retirement
Association, Santa Fe, adopted an asset allocation that included several
blending features. It added a 5% allocation for a new portfolio that includes
public and private investments pension plan officials call “fixed income-plus.”
Pension fund officials also increased alternative investments to 23% from 20%.
This included increasing its “inflation hedging portfolio” — which includes
real assets and real estate — to 12% from 8% and decreasing the absolute-return
portfolio to 4% from 7%.
The idea is that fund officials will sprinkle
absolute-return strategies across the entire portfolio, rather than keeping the
investments within the alternative investment allocation.
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