Wednesday, July 21, 2010

California Pension Giants Bounce Back



Earlier this week, Michael B. Marois of Bloomberg Businessweek reported, California Teachers Fund Earns 12% After Record Loss Last Year:
The California State Teachers’ Retirement System, the second-biggest U.S. public pension fund, earned 12.3 percent in the year ended June 30, led by gains in stocks and bonds that offset losses in real estate.

Calstrs, as the Sacramento-based fund is known, ended the fiscal year with $129.8 billion under management, up from $118.8 billion a year earlier. Stock holdings earned 14.5 percent and its bonds rose 12.3 percent, the fund reported today. Investments in private equity funds rose 21.7 percent, while real estate fell 12.4 percent.

“We’re not out of the woods yet,” Calstrs Chief Investment Officer Christopher J. Ailman said in a statement. “The American economy suffered a near-death experience in 2008, and it’s going to take some time to fully recuperate from that.”

The gain comes as the fund that provides benefits for 833,000 public school and community college teachers plans to ask lawmakers in 2011 for an increase of as much as 14 percent to what the state and school districts already pay toward employee retirement benefits.

The fund lost 25 percent in 2009, led by a 43 percent drop in real-estate and a 28 percent decline in private-equity. The pension said in January that its unfunded liability, the difference between assets and anticipated future costs, had almost doubled to $42.6 billion since June 2008.

The fund’s board in June voted to launch a commodities program as part of an inflation-linked asset class. The category can account for as much as 5 percent of holdings.

Commodity prices surged 23 percent last year as the outlook for global economic growth, led by China, the fastest-growing consumer of raw materials, spurred demand for metals, energy and grains. Higher prices have drawn increased interest from hedge- fund managers and pension funds.

The California Public Employees’ Retirement System is the largest public pension fund in the U.S., with $201.5 billion of assets as of June 2.

On Wednesday, ai5000 reports, CalSTRS Thanks Alternatives for Positive Returns:

The $129.8 billion California State Teachers' Retirement System (CalSTRS), the nation’s second-largest public pension fund, posted its first gain in three years, partly attributing its growth to successfully boosting its allocation to alternatives.

“We’ve taken steps to position the portfolio for long-term growth, but we’re not out of the woods yet,” said Chief Investment Officer Christopher Ailman. “The American economy suffered a near-death experience in 2008, and it’s going to take some time to fully recuperate from that. This year’s performance is a solid start along that road to recovery.”

In the year ended June 30, the plan returned 12.3%, boosted by a 21.7% return in its private equity portfolio. After falling by about 25% in its last fiscal year, the CalSTRS Board and investments staff is seeking recovery by:

  • Expanding its target asset ranges to avoid having to sell at a loss.
  • Temporarily shifting 5% of the portfolio from global equities to fixed income, real estate and private equity to take advantage of the distressed market.
  • Permanently shifting 5% of the portfolio from global equities to create a new absolute return asset class for inflation-protection.
  • Adopting a new asset allocation mix to further diversify the portfolio and decrease its stake in the global stock market.
  • Launching the Innovations and Risk unit to explore new investments such as a macro global hedge fund strategy, commodities and microfinance.

As of June 30, 2010, the portfolio holdings consisted of 51.7% in U.S. and non-U.S. stocks, 22% in fixed income, 14.5% in private equity, 10.1% in real estate, 0.9% in absolute return assets and 0.8% in cash. Its five-year strategic asset allocation targets are 47% U.S. and non-U.S. equities; 20% fixed income; 15% real estate; 12% private equity; 5% absolute-return strategy for inflation protection, including hedge funds, infrastructure and commodities; and 1% cash.

Separately, the fund today issued a statement applauding financial regulatory reforms, joining with its partner state pension funds and plan sponsors in applauding meaningful financial regulatory reforms signed into law today by President Obama.

"We now have in place safeguards to help prevent a repeat of the 2008 market collapse which has hurt all investors, large and small," the fund said in a statement.

"We also have tools for investors that will bring appropriate transparency, accountability, and management of risk at the corporate level. Regulators and investors must remain vigilant and alert to restore and maintain the integrity of our capital markets and the accountability of its participants."

I am not so sure we have safeguards in place to prevent a repeat of 2008, but some financial reforms were way overdue. As for CalSTRS's performance in private equity, lots of opportunities presented themselves in distressed markets over the past year and to their credit, they capitalized on them.

The launching of the Innovations and Risk unit to explore new investments such as a macro global hedge fund strategy, commodities and microfinance is interesting. I wonder if they are going to develop strategies internally, or farm them out to investment managers.

CalSTRS was not the only California pension giant reporting their performance. Last week, Calpers posted its best returns in 3 yrs as markets gain:

The California Public Employees' Retirement System, America's biggest public pension fund, said on Thursday its investments earned 11.4 percent for the year ended June 30, marking their best performance since 2007.

The Sacramento, California-based pension fund known as Calpers said in a statement that over the 12 months ended in June its assets increased to $200 billion. In the previous fiscal year, Calpers suffered its biggest-ever annual loss when returns dropped 23.4 percent as markets were hard-hit by the financial crisis.

Helped by recovering financial markets, investments in private equities, global bonds and stocks all delivered double-digit gains, the fund said in a news release.

"With the exception of real estate, all of the asset class had positive returns for the year," said Calpers' chief investment officer, Joseph Dear. "We're definitely in the recovery mode with the opportunity to capture future returns because of our long-term investment horizon," Dear who came to Calpers a year ago to help stabilize investment returns said.

The fund, whose picks are followed closely in the investment community, said its investments in stocks gained 14.4 percent as its bond holdings rose 19.5 percent. Private equity funds performed even better, posting a 30.9 percent gain.

Its bets on real estate, however, soured, falling 37.1 percent.

Calpers also said it is working on a new plan for how to allocate capital in public stocks, private companies, bonds and other fixed income, real estate and inflation-linked assets like commodities, infrastructure and forestland.

Some of those real estate deals are coming back to haunt CalPERS. Global Pensions reports it's now being sued by a nonprofit charity over the release of records concerning its US$100m investment in a controversial residential property firm.

But despite the terrible performance in real estate, CalPERS and CaSTRS bounced back, much owing to public stocks, but also owing to their private equity portfolios which capitalized on opportunities in distressed markets.

The question now is how will these giants perform in the next five years? Bouncing back from 2008 lows was the easy part, but they are still heavily underfunded and need to address their skyrocketing pension deficits. That's more complicated and will require tough political decisions ahead.

I think these giants need to think carefully about a course of action to continue making money and more importantly, controlling downside risk. Farm out some funds to top hedge funds, but keep and eye out for smaller talented managers where you can get more "bang for your buck". Use your size not to muscle managers on fees, but to leverage off their expertise, building your own internal absolute return teams. Most of all, make sure you're paying for alpha, not leveraged beta.

CalSTRS is right about developing their global macro hedge fund portfolio (hopefully, some of that will be internal). I still think in a low interest rate environment with lots of uncertainty, there is a premium for liquid strategies where risk can be controlled more easily.

On Wednesday, Federal Reserve Chairman Ben Bernanke told Congress the U.S. economic outlook remains “unusually uncertain.” This simply means that rates will stay low for a protracted period until the Fed feels the risks of deflation have been completely thwarted. But as John Makin of the American Enterprise Institute reminds us, the rising threat of deflation is real, and these pension giants better tread carefully or risk suffering steep losses in their investment portfolios again. Let's hope that post-2008, they're better prepared for what lies ahead.

***Links to Annual Reports***

Please note annual reports for FY2010 are not available yet. When they are, you will be able to read CalSTRS's annual report by clicking here, and CalPERS's annual report by clicking here.

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