By David G. Barry
Timing is everything.
If you don’t think so, just ask James Nolan, chief
investment officer of the Pennsylvania State Employees’ Retirement System
(SERS). He recently saw the $35 billion pension system register an
unexpected gain while rebalancing a portion of its portfolio – a situation that
more institutions are finding themselves in or may face because of the decline
in stocks.
Specifically, after altering its asset allocation mix, SERS
found its largest investment segment – U.S. Large Cap stocks – at 22.8%, or
more than 5% below its 28% target. To get closer to that target, the pension
fund transferred $1.5 billion to a large cap index fund, $1.12 billion of that
amount coming from three of its small-cap index funds and the remaining $375
million from its cash reserves.
What made the transaction noteworthy is that SERS invested
the capital in the index fund in late May on what proved to be a bad day for
stocks. So bad, in fact, that by the time Nolan appeared before the SERS’
investment committee on June 3, the market, he said, had gone up by 7% – giving
the $1.5 billion investment a gain. Just how much was not clarified by Nolan at
the meeting or by a spokesperson contacted by Markets Group.
“It’s nice to have but it’s not something you can plan for,”
said Nolan.
Indeed, generating short-term gains is clearly not the hope
of those rebalancing portfolios. In fact, for many institutional investors,
rebalancing portfolios has become a challenge – thanks to the unfortunate
oddity of both stocks and bonds going down.
Jay Kloepfer,
an executive vice president with Callan and co-head of the firm’s
Capital Markets Research Group, said there’s normally a “flow from one asset
class to the other” but with both stocks and bonds down, the institutional
investment consulting firm is hearing from clients that “we don’t have the
normal flows.” Kloepfer said that in general, most institutions aren’t that far
from their targets so there is no pressure per se to sell off bonds or utilize
cash to get equity levels back to where they should be.
That being said, some institutional investors have plowed ahead or are
taking steps to bring their equity allocations in line with their targets.
The Illinois State Universities Retirement System (SURS),
for example, found the equities portion of its portfolio underweight versus its
policy target. As a result, the system’s cash overlay manager increased its
exposure in the segment by purchasing $480 million in global equity futures in
mid-May.
Another fund, The Public School and Education Employee Retirement Systems of
Missouri (PSRS/PEERS), has during the fiscal 2021-22 year rebalanced its
equities portfolio 17 times. Eleven of those events occurred between August and
November 2021 – when the stock market was surging. The systems removed exposure
totaling approximately $815 million, according to a presentation made by CIO Craig
Husting.
However, as the stock market fell, PSRS/PEERS between the
end of February and the end of May made six moves to add “exposure” totaling
$400 million. This capital came primarily from utilizing U.S. equities and
derivates because of trading costs, Husting said.
In remarks during Alaska Permanent Fund Corp.’s May
meeting, CIO Marcus Frampton said that he and his team are continuing to
rebalance the fund’s portfolio but are doing so “less” and “in different ways.”
At the time of that meeting, APFC was underweight by 4.5% to public stocks
while overweight 4.5% on private equity – a situation that Frampton descripted
as a “neutral equity risk.”
The fact that bonds are also down has investors like APFC
looking at alternatives. Frampton told his board that he is looking to other
areas of its portfolio, especially since more than half the fund’s assets could
be liquidated in a “couple of days.” It, for instance, in May put $300 million
from its Risk Parity managers toward rebalancing. It also took advantage of the
market being up by 2% one day in May to execute trades aimed at rebalancing its
public portfolio.
But the key question, said Frampton, is “rebalance to what?”
He said that instead of rebalancing a target asset class he is focused on
rebalancing the sum of the private and public equities target verse their
aggregate target.
Such moves explain why JPMorgan Chase & Co.
recently projected that pension funds, sovereign wealth and balanced mutual
funds will have shifted some $250 billion from bonds to stocks by the end of
this month to reach their appropriate equities target. Pension plans would
account for $167 billion of that, according to JPMorgan. As a result of this
projected activity, the bank is projecting that stocks could increase 10% by
the end of the month.
In a paper on rebalancing, Meketa Investment Group
said investors can utilize one of three strategies to rebalance: directing
necessary cash flows, using index funds and shifting actively managed assets.
The key, said the investment advisory and consulting firm, is how much
institutions wish to put out in transaction costs.
In looking at investors’ actions between January 1979 and March 2018, Meketa
found that those who were active in rebalancing their portfolios had better
returns than those used a “buy-and-hold” approach. The ones who did the best
were those who did rebalancing on an annual basis rather than on a monthly
basis, the firm said.