Talk About Being Bass Ackwards – Revisited!

You may recall that in August 2016, I penned the following blog post –

New Jersey slashes hedge fund portfolio in asset class overhaul
The New Jersey State Investment Council on Wednesday unanimously approved an overhaul of its hedge fund portfolio for the New Jersey Pension Fund including cutting the target allocation in half, reducing the number of hedge funds and cutting fees significantly. (P&I Daily)

I don’t know who first had the “brilliant” idea to allocate so much of NJ’s DB pension portfolio to alternatives following the GFC when cheap beta was so severely discounted, but to now slash the allocation when equity and fixed income valuations are stretching their limits is ridiculous!

First, DB plans have a relative objective (plan liabilities) and not an absolute objective; despite the fact that plans think they need to achieve the ROA.  These aren’t endowments or foundations with positive spending policies. Liabilities are missing in action when it comes to investment structure and asset allocation decisions, and it is leading to the injection of too much risk into their funds.

We are huge proponents of DB plans being the retirement vehicle of choice, but they need to be managed responsibly.  First, identify the primary objective (liabilities) and manage to that objective.  Second, STOP buying high and selling low. Furthermore, I think that the fees associated with hedge funds are outrageous and in most cases, unwarranted, but the NJ plan already has the exposure. Don’t sell it now, as you just might need some uncorrelated assets in the coming months.

I bring this up again, because focusing on the return on asset assumption (ROA) keeps plans chasing performance. I have no idea what NJ was trying to “hedge” in 2009 after the U.S. equity market was already haircut by 50%, but they built a very large hedge fund portfolio only to unwind about $7 billion of it by 2016, which was well after they already suffered the lost opportunity cost of not having been in cheap beta after the GFC. I suspect that they would have loved that exposure heading into 2020. Unfortunately, NJ is not unlike many (most) pension plans that chase performance in the HOPE that they achieve the ROA.

How many pension systems moved into commodity or other inflation hedges in 2009, as a result of fear that Federal stimulus would prove to be inflationary? I don’t know to what extent, but I know that it was massive. Well, it shouldn’t be shocking that we didn’t get inflation, but worse, the S&P GS Commodities Index is down -10.6% / annum for 10-years! Pension systems would have done so much better had they just managed to their plan liabilities during the last 20-years, as bonds (BB Agg.) have outperformed equities (S&P 500) during this period of time, with so much less volatility. But, we never learn!

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