Heading into its asset allocation study next year, staff at the Municipal Employees’ Retirement System of Michigan are cognisant that managing pension fund assets does not necessarily mean building the ultimate asset management portfolio. Chief investment officer of the fund, Jeb Burns, spoke to Amanda White about the fund’s asset allocation including a recent increase to commodities.
The Municipal Employees’ Retirement System of Michigan hasn’t done an asset allocation review for nearly five years. A lot has happened in that time, and the investment presentation at the annual meeting this week will highlight economic conditions back to 2001, to give context and background to the portfolio’s annual returns.
Since 2005 when the last asset allocation study was conducted, a number of portfolio shifts have occurred.
In particular the portfolio has increased its allocation to commodities from 2 to 5 per cent in the last couple of months, with the aim of “getting in front of potential inflation issues”.
Chief investment officer of the fund, Jeb Burns, says he has been personally concerned of inflationary issues for some time.
“With liquidity globally waiting to be released, I don’t know how you can print that amount of money without inflation,” he says.
With this in mind infrastructure was added to the portfolio within the fixed interest bucket a few years ago, and in addition to the commodities allocation acts as an additional inflation protection.
The investment team has also been examining TIPS, although Burns is not sure “that is the answer” and is currently researching currency as a potential hedge.
“We are at the research phase and haven’t got the conviction to pull the trigger on that yet. But it will probably be in the form of an active currency manager,” he says. “We see currency in terms of an inflation tool and for absolute return qualities. If we do it then we want to increase the risk/return of the portfolio.”
MERS has six investment professionals managing about 15 per cent of the fund, including the 1.5 per cent active allocation to cash. Burns predicts that allocation will increase next year as the fund matures and baby boomers retire.
“We have this active allocation in order to manage liquidity to make pension payments. We might look at embracing yield in that area and maybe it’s somewhere where we could allocate to currency.”
The internal team manages the short-term collateral pools. For example, within the commodity allocations it manages the cash, as well as all the underlying managers’ residual cash in a separate portfolio.
“We have been active in the short-term commercial paper market for years, and we also manage futures and derivatives in-house.”
Burns says the amount of passively managed domestic equities managed by the internal team will probably increase, as it has proved to be quite successful.
“In some cases the team has added 40 or 50 basis points over the benchmark,” he says.
The fund currently has a 35 per cent allocation to domestic equities, 25 per cent in fixed income, 15 per cent in international equities, 8 per cent in private equity, and 7 per cent in real estate which includes a 2 per cent allocation to timberland.
The portfolio is set up in a multi manager platform and it is expected a number of changes will be made as part of the asset allocation review.
In the past couple of years there has been a conscious effort to move towards global mandates, including more customised expanded mandates. This has included an increase to beta, managed internally using futures or swaps to access beta, and at the same time an increase in pure active.
The 8 per cent allocation to private equity is reasonably high compared to the fund’s peers, and while Burns believes it is justified based on portfolio comparison research, this is unlikely to increase.
“We see those with higher allocations to private equity as having liquidity issues,” he says.
“We did a pretty extensive analysis in early spring. The portfolio is six years old, some series are pretty mature, we had taken some money from the equity allocation to allocate to private equity, so we wanted to analyse the potential alpha differences. Every series we invested in outperformed the equities market on a long term basis, so strategically it is doing what we wanted.”
Early next year the fund will begin its asset allocation study by flushing out its formal risk model and reviewing the portfolio from a risk perspective.
“It is a good time to do this because of the recent interesting data,” Burns says.
In second or third quarter of next year Burns and his team will prepare an asset allocation document, followed by internal debate with the investment committee, and a final presentation to the board next summer.
“We will try to look at it from a blank slate, pretend we have a new beginning. I have said to the investment staff, imagine someone just gave us $5.5 billion of cash, what is the best way of constructing it,” he says. “The danger in what is happening now is there is a tendency to say what we had didn’t work.”
Burns believes this is a year of reflection for many pension funds, and while there were some returns last year approaching -30 per cent, the question is how many of those losses were actually realised.
“The institutional investor community generally forgot they are not just asset managers, but that we are captive asset managers. Pension funds manage portfolios to make pension payments, endowments produce returns to fund future courses and build buildings. Doing this means you will not necessarily build the optimal portfolio. and business needs will trump asset management,” he says. “Also my philosophy is that sometimes simpler is better. There is complexity risk and if I can’t understand it then we won’t invest in it.”