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Seeking Alternatives in Hunt for Yield?
Submitted by Leo kolivakis, publisher of Pension Pulse.
Walden Siew of Reuters reports that pension funds seek alternatives in hunt for yield (hat tip Mike):
Large public pension funds in New York, California and Ohio are looking increasingly to alternative investments in hedge funds, private equity and emerging markets in a global hunt for yield, senior managers and trustees said.
The global credit crisis has put a squeeze on money managers who must try to boost returns by looking at nontraditional investments that are a growing allocation in some portfolios, in some cases making up more than a quarter or more of fund holdings.
"We're going to act prudently and be hesitant to rapidly increase our assets to alternatives, but we're pretty much of the opinion that that's where you have to be," said Joe Alejandro, treasurer of the New York City Patrolmen Benevolent Association, during an Alternative Investment conference on Sunday.
Recession has hit states including Ohio hard but alternative investments in areas such as real estate and casinos may present opportunities, added J.P. Allen, investment committee chairman of the Ohio State Highway Patrol retirement system.
"When things are bleak, now is the time to buy, when there's blood on the street," said Allen, who said its fund benefited from real estate and timber investments in 2008. It has since pared back on some of those investments, he said.
The California Public Employees' Retirement System, or Calpers, the world's biggest public pension fund with over $200 billion in assets, spearheaded the move by public pensions into alternative investments.
Calpers invested in private equity, high-end vineyards and hedge funds in the late 1990s and early 2000s. But not all of those investments fared well. A $500 million equity investment in Manhattan's Peter Cooper Village and Stuyvesant Town, a sprawling apartment complex, has drawn criticism.
The venture's partners are now close to defaulting on $3 billion of debt and the equity has been wiped out.
New York's Alejandro said his current allocation is about 70 percent equity and about 25
percent in alternative investments, which he would like to increase to between 30 and 35 percent. He said he has made a push for greater investments in hedge funds of funds, private equity and real estate to the new comptroller, who starts in January.
About 350 hedge fund managers, trustees and treasurers attended an Alternative Investment conference that began on Sunday held at the Ritz-Carlton in Dana Point, California, sponsored by the Opal Financial Group.
That's down from about 400 participants last year, organizers said, and a sign of how the market for complex investments has shrunk.
More than 1,000 participants attended the group's annual Collateralized Debt Obligation conference before the credit crisis hit two years ago. The group has since canceled its annual CDO and CLO conference and focused on alternative investments.
Keith Rodenhuis, trustee of the $7 billion Orange County Retirement System, said he holds about a 10 percent allocation in real estate, 7 percent in "absolute return," which includes hedge fund positions, and 5 percent in private equity.
Rodenhuis said his fund boosted "real return assets" to 13 percent from 10 percent, involving investments in commodities and timber. The fund cut back investments in international fixed income to boost those real return assets, he said.
The fund is looking to allocate from zero to 5 percent in opportunistic investments such as distressed mortgage funds.
"We're hoping that slowly climbs back," said Rodenhuis, who also sees opportunities in energy, green technology and local medical technology, as "Orange County is a hotbed for medical technology," he said.
Ohio's Allen said many retirees took hits in the wake of the global credit crisis, but alternative investments in timber and real estate in 2008 helped offset losses, although he has since sold some of those assets to book profits.
So some pension funds are preparing for a down market by investing more into alternatives. I hope they know what they're doing because it could backfire on them. Another reason why pension funds invest so much into alternatives? Leverage. They can allocate to outside funds and use the power of leverage to juice their returns. Again, this could backfire on them.
Finally, not all pension funds are so bent on alternative investments. Last week, the WSJ reported that UK pensions funds pull out of private equity:
The UK's pension schemes halved their allocations to private equity and real estate, according to the most comprehensive annual survey of the sector, pulling out some of their capital in the wake of falls in value.
A survey of 300 schemes with a total of GBP410 billion (EUR450 billion) of assets, just published by the National Association of Pension Funds, showed the average allocation to private equity fell from 2.5% to 1%, as at the end of June each year.
The decrease was due to pension schemes reducing their exposure to the asset class. Some schemes pulled out altogether, with the proportion of schemes with some exposure to private equity falling from 24% last year to 21%.
Only 3.9% of UK pension schemes' assets are allocated to property this year, compared with 7% last year and 7.5% in 2007. The proportion of schemes invested in property fell from 64% last year to 61%.
Schemes had been unpleasantly surprised by the severe falls in the property market, according to the authors of the NAPF survey, who said: "Previously low-risk investment options such as property have seen large fluctuations in value over the past two years."
Pension schemes have continued to increase their allocation to hedge funds, however.
The proportion of schemes invested in hedge funds have risen from 17% in 2007 to 24% last year and 26% this year. The average allocation of those that have invested in hedge funds rose from 6.7% in 2007 to 7.8% last year, and was maintained at 7.8% this year.
The overall allocation across all pension schemes, a function of more schemes investing and steady rates of exposure, has gone up from 1.2% in 2007 to 1.9% last year and 2% this year.
Pension schemes moved the capital they took out of private equity and property into global equities. The overall allocation to this asset class went up from 6.6% last year to 12.8% this year. This confirms the reports of investment consultants including Watson Wyatt, which have performed more searches for global equities managers than any other, on behalf of their clients.
The allocation to UK equities fell from 21.1% last year to 19.5%. This confirms a long-term trend of UK pension schemes diversifying away from exposure to UK financial markets.
Publication of the reductions in property and private equity has come just as a trio of Dutch academics publish a report that concludes investors are wasting their capital if they invest in private equity and hedge funds.
It looks like the lustre of private asset classes isn't as strong over in the UK. I don't blame them. It could be years before we see another sustained uptrend in private markets, but don't tell this to North American pension funds. They're busy investing in the next big buyout fund hoping that the golden age of private markets will come roaring back again. They will be sorely disappointed.
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***UPDATE***
Tom Croft, author of Up From Wall Street: The Responsible Investment Alternative, was kind enough to send me his comments on dark pools:
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Tom Croft, an international expert on innovative capital strategies and Director of Pennsylvania’s Steel Valley Authority, is the author of Up From Wall Street: The Responsible Pension Alternative (Cosimo Books, 2009).
People need to figure out that they can invest in real estate with their pension funds and Self Directed IRAs. Yeah, I know that you're probably thinking real estate is an awful idea, but you should look into multi-family houses, not single families. Apartments are appraised based off of their NOI (Net Operating Income), so they aren't affected by the single family market. (In fact, most of the time they INCREASE in value, because your renters go UP because everyone has lost their house and has to move into your building!)
People need to figure out that they can invest in real estate with their pension funds and Self Directed IRAs. Yeah, I know that you're probably thinking real estate is an awful idea, but you should look into multi-family houses, not single families. Apartments are appraised based off of their NOI (Net Operating Income), so they aren't affected by the single family market. (In fact, most of the time they INCREASE in value, because your renters go UP because everyone has lost their house and has to move into your building!)
I used to wonder how this is possible - Who loses in every trade so that JPM and GS and their ilk shows a profit and has the money to pay it out as fat bonus ? One of the main sources is it right here. Pension Funds -The pension managers facilitate the transfer of this money - the pledged funds and the unfunded liabilities as well as the salary deductions of the employee(that I guess is the only real money in the equation) - they get paid far more in bribes from the investment bankers.
Late when the pensioner comes begging for what was promised - we will just kick on them their shins and say " We are taking away your entitlements - you pigs !"
Look up 12-B1 fees.
Leo,
The "ride" you mention must be a roller coaster named "Ponzi Scheme". I refuse to get on the ride because I do not trust "Wall Street". George Washington's post was a nice summation of my thoughts on the current predicament. I hope all of these gangsters are wrong with the understanding that most if not all of the middle class, myself included, will be decimated by the decisions of these fools.
They can always fall-back on Chinese solar stocks, I guess.
In the markets we are heading in, sector calls will be increasingly important. Problem is that pension funds (and other funds) have bad track records on strategic and tactical asset allocation. If they were smart, they would be hiring teams of sector specialists in both private and public markets and get the information flowing both ways (without jeopardizing any sensitive info on the private side).
re: Chinese solar stocks
*Ouch*
But you know, it's all in getting out at the right time...
Leo,
Would all these pension funds be chasing returns if the Fed were not using QE to such a large extent?
The answer is YES! Pension funds are bound by actuarial rates of return that are based on rosy forecasts. How can they deliver 8% nominal returns when bond yields are so low? Only way is by taking on more risk in public markets and in alternative asset classes.
By the way, as pension funds go back to their old ways, shovelling billions into private equity and hedge funds, you'll see an acceleration of some of those bubble trends I've been monitoring.
Hang on for the ride of your life, Uncle Ben, pension funds, sovereign wealth funds, insurance funds, endowment funds, hedge funds and private equity funds are all hoping this bubble will restore the health of bank, household and pension balance sheets. If they're wrong, it's game over for a generation.
Leo, this was one of your best posts yet. I don't think a lot of people understand that all this bubble behavior is fueld in part by yield chasing. Wall Street can make up all the junk they want, if there are no buyers, it won't matter.
One important way to avoid future bubbles would be to force pension funds to own up to their underfunding by prohibiting them from using ridiculous return assumptions. It is a joke that the actuaries sign off on these assumptions. Talk about lack of professional standards.
David Goldman pointed this out back in 2006, here is a link to a recent update.
http://blog.atimes.net/?p=1190
From Jan 2006: "Investors are not piling into levered synthetic BBB structures because they are complacent about credit risk. On the contrary, all the investors I know are scared to death. But as long as the average U.S. pension fund requires returns of 8.75% to meet its long-term obligations, and the aggregate corporate bond index yields just over 5%, institutional investors will continue to pick up nickels on the slope of the volcano."
Hear! Hear!
Many of these domestic pension fund outlays cannot survive multiple years of tepid returns. Their bubble chasing orientation is rock solid. So they will have to chase the outsized returns.
It's like watching a slow moving train wreck about to happen.
I would think an intrepid fund manager could make a living by observing what Calpers does, then taking the opposite position.
I live in CA, and participate as a taxpayer, not a customer of CalPERS, and I HEARTILY second the above comment.
Alas.....Now one knows where the next "bubbles" lurk....