Public pension funds branch out globally: state investors put money into real estate, private equity, even steel mills.
Sixty years ago, such retirement funds invested primarily in fixed-income assets like government and corporate bonds. As regulations relaxed in the 1980s and '90s, the funds began investing in publicly traded stocks, including global stocks, and alternative investments, such as hedge funds, real estate and private equity. Although such investments usually are riskier, they also carry the potential for higher returns.
Now, big funds like the Arkansas Teacher Retirement System ($15 billion) and the Arkansas Public Employee Retirement System ($7.8 billion) are putting money into property on Park Avenue in New York and, in the case of ATRS, enterprises such as Big River Steel, the $1.3 billion project under construction in Mississippi County.
These big funds are able to make big investments in part because of their size and because they're governed by the "prudent investor rule," which emphasizes the total quality of a portfolio and risk management rather than avoidance of all risk.
"Once you reach a point of about $8 billion or so, in order to be a prudent investor,... you often need to get into longer term investments that provide a great level of safety and also enhance the smoothing of risk while at the same time providing enhanced returns," said George Hopkins, executive director of ATRS.
He noted that the average individual investor doesn't have the ability to lock down his retirement fund for up to 20 years, but "we have that because we have excellent liquidity at ATRS, so based upon that excellent liquidity, we can often get a premium return on our investments while at the same time actually reducing risk."
ATRS reported an overall investment return of 5.2 percent in fiscal 2015. The average investment return for 265 public pension plans with assets exceeding $1 billion was 3.2 percent, according to Callan Associates Inc., an investment consulting firm.
A Volatile Environment
Betting on stocks worked well through the boom market years of the 1990s, but the market from 2000 to the present has been volatile, encompassing the financial crisis of 2008 and recent losses tied to a slowing Chinese economy. The S&P 500 had an annualized return of about 18 percent from 1990 to 1999, but only 4.4 percent from 2000 through 2014.
And prolonged low interest rates resulting from central bank quantitative easing also have threatened pension funds' health.
APERS increased its holdings in alternative investments "largely in response to the fiscal crisis in '08," said the system's executive director, Gail Stone. Although "truthfully, when you have a crisis like that, diversification doesn't do anything because everybody heads for the door.
"But that being said, those strategies --diversified strategies and real assets --retained value better than stocks and bonds."
Beyond stocks and bonds, APERS invests in "diversified strategies," which include a hedge fund of funds and holdings in stocks, bonds and cash throughout the world, and real assets, which include commodities and real estate.
Stone said 11 percent of APERS' portfolio is in what she considers alternative investments, which are real assets, the majority of that being real estate.
"When we went into the hedge fund of funds... the idea was not to outperform the stock market at all; it was to do something between stocks and bonds, so you don't have the volatility of the stock market but you have a far better return than the bond market. And that's exactly what it's been doing for us."
From New York to California
As for its real estate, APERS doesn't hold any individual pieces of property anymore because, Stone said, the retirement system isn't large enough to diversify sufficiently by geography. "The manager who was managing our bricks and mortar said, 'We're creating a comingled fund for other public funds like yourselves so that together we can give you a piece of buildings all around the country.'
"So we own some prime real estate on Park Avenue in New York, for instance, and we own distribution centers in the Central Valley in California," Stone said. "We own apartments in Portland, Oregon. We own office buildings in the technology corridor on Route 128 in Massachusetts, so it's all over the place. It's very well diversified. It's what's called a core fund so there's very little leverage in it.
"And its generation is basically a rental generation because they invest in grade A buildings where not a whole lot of work needs to go into them, so they're not flipping buildings."
But "on the other end of the spectrum," APERS invests in value-add real estate, Stone said. She cited the recent example of a closed-end fund's purchase of an abandoned distribution center, which was fixed up and sold "at a huge profit."
Stone said she has been satisfied with the performance of APERS' alternative investments. "Real estate has been exceptionally solid," she said. "And the diversified strategies have been doing very well, particularly the hedge fund of funds."
APERS reported an overall investment return of 2.45 percent in fiscal 2015, which ended June 30.
The ATRS portfolio includes a 30 percent target investment in alternative categories: 15 percent investment in real assets, 10 percent in private equity and 5 percent in what the system calls "opportunistic," a catch-all for investments that don't fit elsewhere.
Real assets include real estate funds, timberland, farmland and infrastructure funds.
Some examples of real assets held by ATRS are in Little Rock: the Victory Building at 1401 W. Capitol Ave., the Rose Law Firm building at 120 E. Fourth St. and adjoining parking lot, and the ATRS Building at 1400 W. Third St. Along with Cooper Communities, ATRS owns the American Center office buildings in Nashville, Tennessee.
"Diversification across all asset classes is vitally important," Hopkins said. "We do not want to have an over-dependence on any one area."
"You know, we're not just in Arkansas, not just in the United States, not just in North America or the Western Hemisphere," he said. "We're invested all over the world in real estate, private companies, public companies, bonds, even within our hedge funds."
And when ATRS makes an alternative investment like private equity, "we are choosing who invests our money for us and holds it directly," Hopkins said. "We try to invest with the elite managers that have a proven track record where we're not dependent upon the swings of the market. We're really buying the best of talent in the world that just a regular investor cannot do."
By Jan Cottingham
[PHOTO BY JASON BURT]
Caption: George Hopkins: "We can often get a premium return on our investments while at the same time actually reducing risk."
[PHOTO BY JASON BURT]
Caption: Gail Stone: APERS seeks to mitigate the volatility of the stock market.
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|Title Annotation:||SPOTLIGHT: The Business of Retirement|
|Date:||Sep 28, 2015|
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