Self-imposed hedge fund allocation limits at state pension funds, a protective policy once considered stodgy, have helped many of them weather the market storm this year.
On the other hand, ones that found the lucrative prospect of alternative investing too appealing to pass up include funds in Pennsylvania and New Jersey, both of which have been hit by sobering margin calls after using exotic strategies like portable alpha (see “An Alpha Bet Gone Bad”).
The upshot is a broad, renewed interest in the so-called legal list, a set of limits that certain states place on their public pension funds. Proponents of the list argue that a pension fund must meet its payout obligations even in the worst economic slumps, unlike, say, a college, which can postpone building a new hockey rink until it can rebuild its endowment. Thus, the pension funds that have not made the headlines lately tend to be models of successful conservative investment. Take New York’s $120 billion Common Retirement Fund, which pays out some $600 million a month to beneficiaries. Its legal-list restriction means the fixed-income components of the portfolio are managed so that they will provide the liquidity needed for payouts. Alternative investments by law cannot exceed 25 percent of the overall mix.
Still, restrictions don’t always provide a perfect shield. One of the riskiest recent asset classes is domestic equities, says Thomas DiNapoli, the New York state comptroller who oversees the CRF. DiNapoli says he has developed an asset allocation study for 2009 in which he will look for ways to change the pension fund’s investment mix with an aim toward decreasing volatility.
Not everyone is adopting this view. The board of directors of the nation’s largest public employees pension, the California Public Employees’ Retirement System, reviews the asset allocation strategy at the $182.6 billion portfolio every three years. It last tweaked the mix in 2007, when it was valued at $249.6 billion at the end of June; CalPERS spokesman Clark McKinley says the board has no plans to review the allocations before it is scheduled to do so again, in 2010. The shifts at the end of 2007 included a 2 percent increase in real estate, to 10 percent of the total portfolio, as well as a decrease in fixed income, to 19 percent from 23 percent. Two thirds of the fund remains in public and private equities. “Historically, the stock market is very efficient,” says McKinley. “That is a hard thing to say at the moment, but it’s simply the truth.”
Last year the 77-year-old fund, which has never missed a payout, paid $10.8 billion and took in about the same amount in contributions. “We don’t follow the credit rating agencies and instead favor our own more judicious research,” McKinley says by way of explaining the fund’s stability.
Another reason is the implicit understanding that the goal of a pension fund is to achieve 100 percent “funding of assets to liabilities,” says Teresa Ghilarducci, chairwoman of the Bernard Schwartz Center for Economic Policy Analysis at the New School for Social Research in New York. “Anything more, and there’s a call to increase benefits. Anything less, people assume the politicians are being greedy.”
