Asset Allocation

Penn PSERS trims leverage, adds fixed income and hones in on fees

From this October $71.9 billion Pennsylvania Public School Employees’ Retirement System, PSERS, will reduce net leverage, add fixed income allocations, and continue to shave costs off its external investment management fees.

The fund is targeting an annual $130 million reduction in fees by “prudently” lowering the private markets target allocation to 30 per cent (it is currently 36 per cent) and taking the absolute return target allocation down to zero from current levels of 4 per cent of assets.

The trimming and shifting of the portfolio comes after the fund decided to adjust its strategic asset allocation in response to significant ongoing market changes.

Typically the board reassesses the SAA every three years (it last adjusted its SAA in 2021) but may consider adjustments during the interim should material changes occur to the underlying economic and capital market assumptions. In a recent board meeting, members heard how the latest decision reflects the fund’s strength and flexibility to adjust to an ever-evolving market environment.

“PSERS has successfully applied a modest amount of leverage over the years to improve diversification and enhance long-term return expectations,” CIO Ben Cotton said in the meeting. “However material changes to underlying return expectations make it practical to reassess our present targets.”

Rising interest rates have made the cost of leverage higher and by extension, the benefits of such leverage less certain, explained Cotton who oversees 65 internal investment professionals and staff.

“Reducing net leverage and making the planned reductions to private markets and absolute return allocations also allows us to simplify the overall asset allocation and reduce risk,” he said. “At the same time, we can preserve the fund’s diversification and liquidity while still maintaining sufficient long-term return expectations to hopefully meet or surpass our 7 per cent annual assumed rate of return.”

The absolute return allocation has targeted returns with a low correlation to public financial markets and strategies have included event driven, relative value, tactical trading and long short equity.

Cutting management fees

PSERS commitment to cut fees follows a concerted strategy to reduce management fees in recent years. According to its annual report, investment expenses decreased by $92.7 million from $618.1 million in FY 2021 to $525.4 million in FY 2022. As a percentage of total benefits and expenses, investment expenses have decreased from a high of 8.2 per cent in FY 2013 to 6.2 per cent in FY 2022.

PSERS is renowned among public pension fund peers for its fee transparency. It requests management fee information from each of its limited partnerships and collective trust fund investments, even if it is not specifically disclosed in the fund’s standard reports or identified in capital call requests.

This information includes base and performance fees obtained from either the fund’s administrator statement, capital account statement, or financial statements and is then used to report all relevant management fees in PSERS’ financial statements.

PSERS – one of America’s oldest pension funds, founded in 1917 although it only had assets under management of $6 billion in the early 80s –  has a 40 per cent long term target asset allocation of equity that includes a 12 per cent allocation to private equity. Public equity consists of small, mid large cap US equity (12 per cent) non US equity (16 per cent). PSERS invests around 33 per cent of the portfolio in fixed income, divided between investment grade, public and private credit and US inflation protection

Real assets comprise 29 per cent of the portfolio and includes public and private real estate and infrastructure, commodities and gold.

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