By Anastasia Donde
William Estabrook: It’s a big boost to have those kinds of numbers associated with the program |
Many pension funds dumped portable alpha, an alternative investment fad that caught on with these investors in the last decade, after losing big on the strategy in 2008. But the $11 billion Ohio Police & Fire Pension Fund is taking an entirely different tack. It is not only sticking with portable alpha, it’s boosting its allocation to the strategy. “The board and our chief investment officer still have confidence in the strategy, and there has been no discussion to do anything otherwise,” says OP&F executive director William Estabrook. He says the pension was in the early stages of building the portable alpha program back in 2008 and still wants to give the strategy a chance to work. “We’re just trying to stay the course,” he says.
Ohio’s decision may seem surprising, given portable alpha’s dismal performance during the market crisis. The strategy entailed replicating a given market exposure—in OP&F’s case, large cap equity—using swaps or futures, and then using cash that would otherwise be invested in underlying securities to invest in hedge funds or other alternative investments. The idea was to give investors a way to invest in hedge funds, which were expected to produce gains whether the broader markets went up or down, while maintaining their exposure to the broader markets.
But hedge funds can and sometimes do lose money, as portable alpha boosters learned the hard way in 2008. When their index exposures started to lose money at the same time that their hedge fund investments also started to post losses, many portable alpha investors posted losses of 10% to 20% in their portfolios. Some large pensions, including Pennsylvania’s Public School Employees’ Retirement System and the Massachusetts Pension Reserves Investment Management Board, wound up dismantling their portable alpha programs in 2009 and 2010. Nonetheless, the strategy has some defenders, including Ohio’s staff and consultants at Wilshire Associates, who think that portable alpha is still a viable strategy for long-term investors such as pension funds.
OP&F is now looking to allocate some 21% to 30% of its U.S. equity portfolio into portable alpha strategies. The plan’s equity component accounts for about 38%, or $4.3 billion, of its overall assets right now. The equity portfolio consists of several prominent hedge funds and funds of funds and delivered a 26% gain last year, while the overall portfolio returned 15.83%.
“It’s a big boost for us to have those kinds of numbers associated with the program,” says Estabrook.
The pension initially decided to invest 10% of its total portfolio in portable alpha strategies back in 2005 to replace its large- cap domestic equity allocation, as this segment of Ohio’s portfolio had gained less than benchmark equity indices and contributed the most risk and volatility.
“We did an asset/liability study in 2004 and started an education process with the board. Then things started clicking,” says Estabrook. The pension first hired Western Asset Management Company, the Pasadena, California, fixed-income firm better known as WAMCO, in 2005 as the first manager for the strategy. “Then we started steadily acquiring other managers and putting the other pieces in place.”
The Ohio plan hadn’t finalized its portable alpha program before the crisis hit, so it avoided the problems of 2008—namely, poor performance and issues with margin calls—that caused the strategy to fall apart at many other pension plans. Still, its overall portfolio fared badly that year, losing 28.06%. At the time, OP&F had hired some but not all of the hedge funds and funds of funds it had planned to hire for the strategy, so the pension decided to press on, regardless of the problems at other pensions, because it still had faith in portable alpha.
OP&F spent several years trying to implement the strategy because of the lengthy and complicated process that public funds often have to follow when hiring managers. The pension had to issue several requests for proposals for each different segment of the strategy and then go through a time-consuming selection process with the staff and board.
It hired WAMCO to handle $200 million in an enhanced-index U.S. equity strategy and started looking for currency overlay managers toward the end of 2005. FX Concepts and Bank of New York Mellon were hired in 2006 to handle currency, for a total of $200 million.
In the next few years, the pension tapped funds of funds Investcorp and Grosvenor Capital Management for the market-neutral component of the portfolio and hedge funds AQR Capital Management and Bridgewater Associates for global macro. It hired Russell Investments in early 2010 to handle the derivatives overlay portion of the portable alpha portfolio. For now, Russell is only managing the index component for Grosvenor Capital Management, one of the fund-of-funds managers in the portable alpha program, but it will eventually do so for all seven managers in the portfolio.
OP&F is so keen on portable alpha that it’s extending the concept to its global inflation-protected securities portfolio. This allocation, which the pension is using to fight expected inflation, has also been raised to 12.9% of the pension’s total portfolio, up from 6% at the start of 2010. Bridgewater Associates, whose Pure Alpha fund has delivered some of the best performance within the pension fund’s portable alpha portfolio, is now also running the inflation-protection portfolio, using some of its underlying fixed income and Treasury-inflation protected securities strategies.
Bridgewater is using U.S. TIPS and nominal Treasurys, sovereign debt and corporate inflation-linked bonds to create a custom benchmark, while the Pure Alpha fund is the alpha source for the inflation protection portfolio. The Pure Alpha fund gained 44.8% in 2010. Bridgewater ran traditional fixed-income and TIPS strategies until 2005, when the firm decided to manage only hedge funds. These days, the firm will still run traditional strategies for some clients, provided they keep money in one of Bridgewater’s hedge funds.
The pension has big plans for the rest of its fund this year. Having adopted a new asset allocation strategy in early 2010 to better diversify the portfolio, reduce overall risk and cut back the hefty weighting to equities, OP&F is now getting ready to work on implementing these changes.
The pension is planning to institute a new commodities allocation at 3%. Having already raised its target to the inflation protection portfolio and implemented the strategy through Bridgewater, the Ohio plan is also preparing to change its fixed-income allocation. This includes raising its exposure to long-duration fixed income—a strategy often used to better match liabilities—to 23.7%, up from 6%. The high-yield fixed-income component will increase to 15% from 6%.
OP&F also decided to cut its overall allocation to U.S. equities to about 22%. When that happens, most of the remaining money allocated to U.S. equities will be invested in portable alpha strategies, according to Estabrook.
“While we’re reducing our total equity allocation, the idea is to boost portable alpha up,” Estabrook says. “That’s one of the driving forces.”
Despite the general hue and cry about portable alpha, Estabrook says the pension is exactly where it wants to be with respect to the strategy, and it is not planning to make any sudden changes to its portfolio.
“We believe all the approaches that we looked at took us right in the direction that we wanted to be in,” says Estabrook. “We haven’t had any second thoughts.”
