Alternate Side Parking
Timing is everything. Upwards of 100 local, city and state government entities added leverage to their pension fund portfolios last year, double the previous record sum, The Wall Street Journal reported yesterday, based on data from Municipal Market Analytics. Industry giants are set to follow suit. The California Public Employees’ Retirement System (Calpers), which boasts $440 billion in assets, will attempt to juice returns through borrowing beginning in July, marking a first in its 90-year history.
Of course, red has been in fashion this year, as both stocks and bonds have absorbed hefty losses following the bull market bacchanal that characterized the prior 18 months. Industrywide median first quarter returns registered at negative 4% according to the Wilshire Trust Universe Comparison Service.
Some observers have earned their distaste towards portfolio leverage the hard way. Former Pasadena city manager Steve Mermell has repeatedly lobbied against the strategy, after witnessing a similar move backfire at the turn of the century following the 9/11-induced swoon in asset prices, burdening Pasadena’s local pension fund with additional debt payments without investment returns to show for its additional debt load. “It’s like going to the ATM in Vegas and then going to the roulette wheel and it comes up red and you go back to the ATM,” he told the Journal.
One heavyweight fiduciary, meanwhile, battens down the hatches. Paula Volent, who joined Rockefeller University as chief investment officer in August after quadrupling Bowdoin College’s endowment over the past 20 years, cautioned that “this is going to be a harder time to generate returns” in a Bloomberg Television interview airing today. “It’s the time to protect capital, not to shoot the lights out to get some great return.”
Instead, the dimmer lights of the private markets offer a tempting proposition for those public stewards. Thus, Calpers reported a positive 1.14% total return for the first quarter according to data from Aon plc., bucking the poor results from its peers. So-called alterative assets such as hedge funds, real estate, private equity and private credit (which, of course, are infrequently traded and are not valued on a mark-to-market basis as public securities are) were primarily responsible for that relatively strong showing, Aon relays.
Rival systems accordingly look to keep up with the Joneses. In a landslide 139 to 10 vote last month, the New York State legislature passed a bill increasing maximum state pension allocations to alternative assets to 35% from 25%. That comes eight years after erstwhile Governor Andrew Cuomo vetoed a similar measure allowing for up to 30% of assets in alternatives, citing “the increased risk and higher fees frequently associated” with those asset classes. Calpers will likewise bump its “real assets” portfolio share to 15% from 13% as of July 1, with private equity allocations rising to 13% from 8% and private credit garnering a newly minted 5% share.
State and local pension funds have allocated some 25% of their $5 trillion in assets into alternatives, according to data from the Center for Retirement Research. Private equity holdings among state and local pension funds stand at $480 billion per Preqin, up 60% from 2018. Yet that breakneck pace has slowed with the bull market in retreat, as such fundraising totaled $64.8 billion during the first quarter, off 26.8% from the same period last year.
Then again, a recent survey from Natixis found that two-thirds of institutional fiduciaries plan to ramp up alternative investments at the expense of conventional fixed income in order to “generate yield,” compared to just over half of respondents in a 2017 poll.
The prospect of a bruising stretch for the pension industry at large colors the migration into the deeper end of the risk swimming pool. An analysis from Moody’s Investors Service last Wednesday projects a systemwide 12.2% loss over the 12 months through June 30, far below the assumed 6.8% return target. That shortfall would leave assets sufficient to cover 6.9 years of retirement benefits, down from 8.3 years in mid-2021 and the lowest figure since at least 2016.
Moreover, the ratings agency noted that “a persistent environment of high inflation would likely drive up wages for active employees and cost-of-living adjustments for retirees, increasing future pension obligations and governments' budget outlays.” State-directed efforts to contain raging price pressures may prove less-than-effective, as California Governor Gavin Newsom announced plans to distribute $1,050 direct stimulus checks to 23 million local residents “who are grappling with global inflation and rising prices of everything from gas to groceries,” his office declared.
Nothing a bit more leverage and alternative assets can’t fix.
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