Navigating trends in pension plan management

In a recent interview with one of the largest public pension funds in the U.S., we delved into the current trends and strategies shaping the world of pension plan management. In this article, we explore the highlights of this interview, providing insights into the multifaceted landscape public pension plans are navigating today.

The current landscape: asset allocation and leverage

At this institution, the asset management process revolves around overseeing multiple funds, with a primary emphasis on the Consolidated Trust Fund, which boasts assets of approximately USD 130 billion. Notably, this institution has explicit allocations to leverage in its policy portfolio, akin to allocations in public equity and private equity, with a significant 15 percent allocation. Additionally, their fixed income portfolio includes an inflation bucket primarily consisting of (Treasury Inflation-Protected Securities (TIPS), representing about 90 percent of this allocation. This allocation serves the dual purpose of providing inflation sensitivity and acting as a key source of leverage through repo operations. This institution also has allocations to public fixed income, which encompass corporate credit and emerging market debt. In the private markets, they maintain a substantial allocation of around 29 percent, with investments in real estate and private equity.

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How much of the portfolio should be managed in-house vs external fund managers?

This pension fund, like many large funds, has a strategic approach to this decision. They prioritize internal management for strategies that can be effectively scaled and provide a compelling risk-adjusted return. This approach considers factors like scalability, tracking error, information ratio, and the separation of alpha and beta components in a strategy. The aim is to maximize the value-add while minimizing costs. However, this institution also recognizes the value of external managers, especially when seeking specialized strategies that are costly to replicate in-house.

What is the level of integration within the organization and what can be achieved through a more unified front?

Effective communication and collaboration are at the heart of this institution's asset management approach. The organization places great importance on collaboration among its various asset class teams. This collaboration ensures that portfolio rebalancing, leverage sourcing, and liquidity management are seamless and well-coordinated activities. The collaborative efforts extend to managing the cost of funding and addressing the needs of both internal and external active managers. Regular interaction with asset class teams helps in making informed decisions about internal vs. external management, active vs. passive strategies, and the optimal allocation of resources.

How to respond to rapidly changing market conditions?

The rapidly changing interest rate environment has raised questions about the optimal allocation of assets. At this institution, the view on asset allocation has not dramatically shifted due to interest rate fluctuations. Instead, the focus remains on assessing each asset class's suitability for active or passive management, both internally and externally. Factors such as skill, cost, diversification benefits, and expected information ratios play a significant role in these decisions. This institution's approach is characterized by a gradual evolution that prioritizes careful risk assessment and cost-benefit analysis.

How to leverage liquidity management in illiquid markets?

With a substantial allocation to illiquid assets, this institution places a strong emphasis on liquidity management. The organization employs a waterfall approach to leverage sourcing, with a diverse set of options ranging from low-cost repo operations to equity derivatives. Stress testing scenarios are regularly conducted to evaluate the impact of extreme market conditions on liquidity requirements. This proactive approach ensures that this institution is well-prepared to manage liquidity challenges and minimize the risk of forced selling in turbulent times.

How to optimize resource allocation in times of uncertainty?

Running a successful asset management program requires a dedicated team of skilled professionals. While it's not necessary to have an army of personnel, having the right people with expertise in portfolio management, financing, and collateral management is essential. Additionally, support from middle and back-office operations teams is critical for executing strategies effectively. This institution's approach to resource allocation emphasizes a balance between skill and efficiency, ensuring that they have the necessary infrastructure to execute their strategies seamlessly.