The biggest, most-sophisticated public pension funds have been embracing alternatives in recent years, but the public system with one of the best returns in 2008 is a hard-core traditionalist.
The Texas Municipal Retirement System was down just 1.3 percent in calendar 2008, compared with the double-digit losses that most funds are reporting. The reason: The $12 billion fund had more than 90 percent of its assets in bonds for most of the year; on average, public funds usually hold 27 percent in fixed-income investments.
Past performance is no guarantee of future strategy, though. The Austin-based fund is reducing the massive overweight bond position it has maintained throughout its 60 years of existence. Even as stocks plummeted last year, the fund began shifting 1 percent of its assets every month out of bonds into stocks; it ended the year with a 12 percent equity allocation. Now, pending approval from the Texas legislature this spring, it plans to diversify further, eventually moving as much as 70 percent of its assets into equities, real estate and other alternatives. “When we set out on this path, some questioned us,” says Eric Henry, executive director and CIO since 2007. “But our timing probably couldn’t be better,” he says, noting that the fund is buying up cheap stocks.
Henry, 42, the former executive director of the Pennsylvania State Employees’ Retirement System, concedes that the strategic shift wasn’t about smart market timing. Instead, it’s a response to cost-of-living benefit increases and low bond yields that forced TMRS to seek higher returns.
TMRS isn’t a typical defined benefit plan that pays pensioners guaranteed sums based on years of service and final salary. It’s a cash-balance plan, in which TMRS pays annual interest on assets in accounts to which employees and employers have contributed. On retirement, TMRS pays an annuity based on the account balance. Fixed-income investments have provided a reliable return that sustained a minimum annual interest credit of 5 percent, and often much more.
The plan began to take on elements of traditional defined benefit plans 17 years ago, when the Texas legislature enacted a provision that automatically gave municipal retirees a cost-of-living increase unless a city council acted to stop it. Most cities didn’t act, and with benefits increasing steadily, the system’s ratio of assets to liabilities fell, from 85 percent in 1999 to 74 percent in 2007. Then the decline in bond yields to record lows threatened the system’s ability to maintain returns; not only did it reduce income, it also exposed the fund to big losses if interest rates rose and bond prices fell. That left a stark choice: Either raise contributions by employers and workers or shift assets away from bonds and into other assets. “We weren’t predicting that [interest] rates would rise, but we didn’t think it prudent to bet the farm on that,” Henry says.
