By
David G. Barry
Steve Willer is coming to understand what the phrase “baptism by fire”
means.
Recently elevated to chief investment officer of the Kentucky Public
Pensions Authority (KPPA), Willer is now tasked with bringing the 10 funds
that KPPA oversees into compliance with their asset allocation targets. It is a
process, Willer tells Markets Group, that provides both a challenge and an
opportunity not usually afforded to new CIOs – or, for that matter, CIOs in
general.
“There’s a lot of work to be done in terms of structuring the portfolio,” says Willer,
who initially joined KPPA in April 2020 as fixed income division director and served
as deputy CIO and interim CIO prior to his new role. KPPA’s prior CIO, Steven
Herbert, left in May after less than 18 months on the job.
Willer, who has not been a CIO previously, said changing direction for a public
pension fund can at times be akin to switching direction of an “ocean liner”
and that dealing with the different asset allocation targets of the plans adds
“complexity.” It does, however, come as
valuations have declined in 2022 from where they were in 2021.
KPPA manages five pension funds: The County Employees Retirement System (CERS)
Hazardous Fund; The CERS Nonhazardous Fund; the Kentucky Employees Retirement
System (KERS) Hazardous Fund; the KERS Nonhazardous funds; and the State Police
Retirement System (SPRS). KPPA also manages the health insurance plans that are
tied to each of those five pension plans. Together, the 10 funds had $21.6 billion
of assets at the end of its fiscal year, June 30.
To varying degrees, the 10 funds are currently overweight in cash and under
allocated to such areas as real estate, private equity and real return – which
Willer describes as “broadly traditional inflation sensitive” segments such as
commodities, infrastructure and Treasury Inflation Protected Securities, or
TIPS.
The funds need rebalancing because of a series of moves over the past year,
said Willer. These include a special allocation by the state, payments received
due to employer cessation, changes to the allocation targets and what Willer
says was a “conservative” investing approach.
The fact that these plans were not at their asset allocation targets was a “detractor
from performance,”
for the 2022 fiscal year, he said. Being heavy in cash rather than in some of
the sectors that performed well – or at least better than equities – such as
private equity and real estate – “was not net beneficial” to results.
Collectively, the five pension funds returned -5.7% net of fees and expenses for
the 2022 fiscal year, which beat their benchmark of -5.8%. The five insurance
funds returned -5.3% net of fees and expenses. In contrast, in fiscal 2021, the
funds collectively generated 25% as assets rose from $18.4 billion to $22.9
billion.
According to data presented at the August investment committee meeting of the Kentucky
Retirement Systems – the investment committee for the KERS and SPRS funds – asset
allocation was responsible for reducing returns across the KERS and SPRS funds
by 0.6% and 3.3% for the fiscal year ending June 30.
Given the funding status of the Kentucky pension funds, anything that can move
the needle is crucial.
Pension funds are generally considered in “critical status,” if they fall below
the 65% funded level. According to data released earlier this year by KPPA, the
pension funds were all in the “critical” category. KERS Hazardous was the best
with a funded ratio of 60.4%, while KERS Nonhazardous was the worst at 16.8% as
of the end of the 2021 fiscal year.
SPRS Pension had the largest percentage of cash among the funds. As of June 30,
24% of its assets – $131.8 million – was waiting to be deployed. This was in
large part due to the Kentucky legislature earlier this year approving an
allocation to the fund equal to 60% of the fund’s assets – a total of $215
million. SPRS, as of earlier this year, had a 30.7% funded ratio.
Willer said KPPA has to date reallocated 50% of the capital.
According to the asset allocation targets for the plan, KPPA will look to bring
SPRS’ cash percentage down to 5% and reallocate $105 million, largely to the
real return and real estate sectors. Both roughly account for 3% of the plan’s
assets and are targeted for 10%. To bring those sectors up, $41.8 million would
go to real return strategies and $34.4 million to real estate.
SPRS is the most extreme example, but the other pension funds that KPPA
oversees also must be rebalanced.
The KERS Nonhazardous Pension Fund, for instance, has $402 million, or 13.4% of
its asset allocation in cash and a target of 5%. Meanwhile, its real return
allocation is currently at 3%, well below its 10% target and real estate is at
5% – half of its 10% target.
Willer said a key reason for the high cash levels is that KPPA was “concerned
with the valuations across a number of markets and what the risk and reward
opportunity would be going forward.”
Things are definitely different and Willer said KPPA will seek to take
advantage of its dry powder.
“It’s an opportune time,” he said. “We see a lot of values in asset classes.”
Specialty credit, for example, is an area that KPPA is taking a hard look at,
Willer said.
He said that staff is now getting “pretty methodical” about sizing up
investment opportunities and that his goal is to reduce the cash figure to 3%,
if not less.
“It’s an ongoing process to get the right mandates and right structures in
place and the allocations to where we are shy of targets,” he said.