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Pennsylvania changes investment approach

After weathering this year’s market turmoil the $26 billion Pennsylvania State Employees’ Retirement System (SERS) has a new chief investment officer and a new investment approach after changing consultants that have advised the fund for almost 20 years.

This year has seen a raft of changes at SERS, one of the oldest pension funds in the US, which provides statewide pension plans for 227,000 public employees.

Since arriving in February, SERS chief investment officer Anthony S. Clark has overseen a re-examination of the fund’s investment approach.

In September, this resulted in the fund replacing its general consultant Rocaton Investment Advisors and alternative investment consultant Cambridge Associates after nearly two decades of service.

“SERS chairman Nicholas Maiale explained the decision saying: “the markets, our demographics and the maturity of the fund are all changing, and it’s time for a fresh look”.

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The fund decided to appoint RV Kuhns & Associates, Inc. as its asset consultant and StepStone Group LLC as the fund’s alternatives consultant.

In December, the fund also decided that it would look to change the way it invests in alternative assets, with the board moving to create a “diversifying assets” program.

SERS says the program will target equity-like returns through “fund-of-one limited partnerships”, saying this vehicle offers better returns as well as greater liquidity and transparency than co-mingled structures.

The fund began the program with an allocation of $250 million each to Tiger Management Advisors LLC and Entrust Capital.

The investments will be funded over time from cash and redemptions from existing managers in the absolute returns portfolio.

It has set target asset allocations for 2011 that see it reducing its cash holdings from just over 5 per cent of the overall portfolio to zero.

It is also targeting an extra 5 per cent allocation to absolute return assets, lifting this allocation to from 10.9 per cent to 15.5 per cent of the portfolio.

Alternatives are targeted to tick slightly lower to just under a quarter of the portfolio, while an extra 2 per cent will be added to fixed income, taking this allocation to around 17.5 per cent of the overall portfolio.

As a mature plan, SERS says it must focus on ensuring short-term liquidity.

In 2010 it received $622 million in contributions but paid out $2.4 billion in benefits.

As of the end of 2010, SERS had 111, 713 annuitants and beneficiaries and 109,255 active members.

SERS reports that difference will grow and it is projected that annual benefit payments will reach $3 billion by 2015, an increase of 54 per cent from 2005 levels.

Despite these funding challenges, Clark says the fund has managed to avoid some of the investment losses other public pension funds have suffered in a tumultuous third quarter of the year.

The fund achieved a 1.9 per cent return (all returns net of fees) for the year to September and lost 4.4 per cent in the third quarter.

“We weathered the harsh quarter better than most,” Clark said when announcing the result earlier this month.

“SERS return was –4.4 per cent for the quarter but most large pension funds were down twice that.”

In comparison, the Wilshire large fund universe median return for the third quarter was -8.3 per cent while the TUCS public fund median return was -8.9 per cent.

The country’s largest public pension fund, CalPERS, recorded a 7 per cent loss over the same time period.

In its last annual report SERS reports that its actuarial funded ratio was 75.2 per cent.

The fund has an 8 per cent return target.

In the third quarter of 2011 SERS reports its quarterly returns for fixed income was 1.9 per cent; absolute return (fund of hedge funds), -3.4 per cent; inflation protection (including commodities), -13.1 per cent; global stocks, -16.0 per cent; U.S. stocks, -16.1 per cent; and non-U.S. stocks, -20.0 per cent.

In its other asset classes its performance information lags a quarter. Private equity in the second quarter of the year returned 5.2 per cent, venture capital 4.8 per cent and real estate 3.1 per cent.

Also affecting SERS’ funding status was several losses experienced over the past decade, in particular a 28.7 per cent loss for 2008.

This further compounded losses of 7.9 per cent (2001) and 10.9 per cent (2002) during the dot com crash.

Under legislative rules governing the fund, losses must be smoothed over a five year period.

In its latest annual report the fund says that to date 60 per cent of the loss incurred over the global financial crisis has been recognized with the remainder to be accounted for in the next two years.

On the market value of assets, the funded ratio of the fund at the end of 2010 was 66.1 per cent down from 68.9 per cent the previous year.

The fund achieved an 11.9 per cent return in 2010 and a 9.1 per cent return in 2009. SERS reports it has exceeded its 8 per cent target return in 12 of the last 16 years.

The estimated compound rate of return for the 20 years ended in December 31, 2010 is 9.1 per cent and the 30-year return is 10.1 per cent.

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