New Jersey leads flight from equities

The New Jersey Division of Investment, which manages the $67.3 billion in state pension funds and was the best-performing US fund last year, has made some dramatic changes to its asset allocation in line with its objective of relying less on public equities for returns.

The New Jersey Division of Investment has made some dramatic changes to its asset allocation for the remainder of 2010 and into 2011, based on new return assumptions for each of the asset classes, reflecting the significant changes in market conditions since late 2008 when the 2009 investment plan was made.

The assumed returns on public equities were reduced by about 50 basis points and assumed volatility was modestly increased. With this in mind the fund will reduce its allocation to large-cap US and developed international equities, but increase its allocation to emerging markets. In addition it will transition from using separate MSCI EAFE and emerging market benchmarks to the MSCI All Country World ex-US benchmark.

In a memorandum to the State Investment Council, acting director Ray Joseph, said the change to the benchmark would result in a doubling of the allocation to emerging market equities as a percentage of total non-US equities from about 10 to 20 per cent, reflecting where the fund sees an investment opportunity.

“As a result, even thought the non-US equity allocation is being reduced, the allocation to emerging market equities will increase. We expect that the long-term growth in emerging market will surpass that of the developed world.”

The fund will continue to use its four external advisers for emerging markets, but has suggested it may need to expand this to other service providers and vehicles, with ETFs on the agenda, due to capacity limits.

ETFs were also mentioned as a way to get US small-cap exposure in addition to the division staff’s investments, and as a way to get commodities-related exposure.

Commodities form part of the 4 per cent allocation to inflation-sensitive assets. About 2-3 per cent of the exposure is allocated to commodities, with 1-2 per cent set aside to infrastructure and other real return investments. The fund has used ETFs and commodity-linked notes in the past to gain exposure to commodities.

The division is developing an infrastructure investment policy and has conducted a request for information for identifying investment opportunities in the area. A $300 million portfolio of public infrastructure related equities has been funded to gain some exposure to this space while this process is being worked through.

One of the key long-term objectives of the fund is to continue to allocate a greater percentage of the portfolio to alternative investments, in line with its plan to reduce reliance on traditional public equities to drive returns, and has requested regulatory change to increase the 28 per cent limit on alternatives.

“We believe the markets will present compelling investment opportunities in many sectors of the alternative investment environment and would like greater flexibility to pursue these opportunities over the long term,” Joseph, who took up the acting position when William Clark left in February, said.

“This greater allocation to alternatives will be balanced in a dynamic fashion between liquidity to meet benefits obligations and existing private investment commitments, and returns from committing to new alternative investments. We expect the beneficial impact of alternative investments to continue to improve the fund’s risk-adjusted returns.

“It is our opinion that the fund would benefit from greater investment flexibility by regulatory changes that would increase the 28 per cent top end of this range, positioning the division to take advantage of attractive near-term investment opportunities and maximise the fund’s long-term risk-adjusted returns.”

Total planned commitments for private equity are up to $700 million for the next 15 months, versus $1.2 billion planned for the 2009 fiscal year and $3.1 billion the year before. Unfunded private equity commitments total $4.6 billion at the end of September last year and the fund is projecting that $1.7 billion of that will be called between now and the end of financial year 2011.

The new investment plan incorporates no change to the current private equity target of 5.5 per cent, but recommends an increase in the hedge fund target from 6 to 6.75 per cent it is currently at an allocation of 4.3 per cent, and a corresponding reduction in the real estate midpoint from 4 to 3 per cent to accommodate these changes.

New hedge fund commitments are expected to be concentrated within newly funded market neutral and global macro strategies and an increase in the allocation to event-driven strategies, and a reallocation towards new managers within equity long/short.

Within the bond portfolio, the fund will continue to increase the allocation to investment grade fixed income for the next financial year, but will continue to be underweight financials.

The fixed income portfolio’s duration is about 10.5 years compared to 12.2 for the benchmark and there is a focus on increasing this duration to better align with long-term liabilities.

It cited Build America Bonds, taxable municipal bonds with imbedded tax subsidies issued as part of the American Recovery and Reinvestment Act, as an attractive segment of the fixed income market.

It is not recommending an allocation to international fixed income, but expects to increase its exposure to high yield.

Over the past year, the expected TIPs returns have dropped from 5.2 to 4.1 per cent but the fund will maintain its 5 per cent allocation to the sector.

The New Jersey Division of Investment made claims to be one of the best-performing US pension plans last year, for the fiscal year to the end of January, the fund returned 13.23 per cent versus the benchmark of 12.49 per cent.