The Indiana PERS five-year asset-liability study yielded a newly approved target rate of return that IOC Scott Davis calls one of the most realistic in the country, and a drastically different asset allocation. Next on the agenda is a research project examining the fund’s sources of alpha, which could have big implications for how it works with managers.
Indiana’s $ 37 billion public employee pension system completed a five-year balance sheet study delayed by COVID in May, resulting in a new asset allocation that attributes more assets to “everything outside of stocks” according to CIO Scott Davis.
The new asset allocation is more streamlined and simpler, adding layers of diversification aligned with a liability-driven agenda.
“One thing we really focused on was how the assets fit into the liabilities,” Davis said. “We looked at what the ultimate goal is and not just an asset goal just to achieve a return.”
This meant that much of the modeling of asset allocation focused on volatility and its impact on employer contributions or the state of funding.
“It allowed us to focus on the real risk you take with the different portfolios,” he says.
This modeling combined with the analysis of scenarios of different economic environments, with contributions and projections from a number of fund managers and consultants, resulted in the asset allocation of 65% to public assets, 25 % to private assets and 25% to multi-asset assets. This is the first time that the fund has transparently revealed its leverage by expressing its total exposures at 115%.
Of government assets, 20 percent is allocated to government stocks, 20 percent to fixed income securities, 15 percent to inflation-linked bonds and 10 percent to commodities.
While equities edged down 22 to 20 percent, the fund also significantly increased its exposure to risk parity which also includes equities, fixed income and commodities.
The risk parity allocation, which first appeared in the portfolio in 2012, has been doubled to 20 percent, with an absolute return allocation of 5 percent making up the multi-asset portfolio.
Davis says the risk parity portfolio – managed by Bridgewater, AQR and Panagora – has worked well for the fund and has fulfilled a few roles for the portfolio, including inspiring a more balanced total portfolio allocation.
“The risk parity allocation started as a pilot program, to find the most diverse portfolio we can find,” he says. “With the rest of the portfolio outside the risk parity allocation, we tried to get as close as possible to equilibrium without leverage. “
Davis also points out that the strategy has been a rough time considering the performance of the stocks, but it has proven to add value and provide a smoother ride.
In the absolute return portfolio, which has been cut in half to 5 percent, the focus is on macro and technical trading strategies. Davis says the fund will still invest in these but with fewer managers and works through which strategies “make the most sense.”
The allocation of private assets is split between private equity, private credit and real assets, with for the first time an allocation dedicated to infrastructure.
“This is a historic moment for the plan. We are so confident in this asset allocation for the future and in the new target, ”said Davis. “The board deserves a lot of credit for where we are at. “
The team’s next big project is to analyze the different sources of alpha in all asset classes. The idea is that alpha is distributed across different asset classes and viewed in a holistic sense so that the fund has access to the best alpha no matter where it is in the portfolio. It will use a combination of Barra tools as well as some risk modeling on the private asset side by Aksia.
“We have done active versus passive analysis in our long-only portfolio in the past, but never compared the entire alpha,” said Davis. “It could be that the result is that we change where the alpha lives and how it is structured. For example, does it make more sense to have two unconstrained managers instead of 10 long-only active managers?
Make the money work
The entire portfolio is managed by external managers, with Davis seeking to work closely with the managers in a strategic manner.
An example of this is Parametric, which manages the fund’s liquidity overlay and helps it achieve some leverage on fixed income and stocks.
“They are a true strategic partner and collaborate on the portfolios to be built and on how to manage our treasury portfolio,” he says. “I’m really proud of the team and the way we think about it.”
A few years ago, Indiana PERS decided to maintain three months of retirement payments as a cash allowance and use futures contracts to overlay them. This was recently expanded to also include a 30 percent draw buffer for margin calls in the liquidity overlay portfolio. The fund therefore has approximately $ 1 billion in liquidity.
“By having the overlay, we have this money working for us. Our official cash allocation is 0%.
The fund is also considering a longer-term approach to liquidity, particularly given a 25 percent allocation to private assets.
“We’re looking at our five-year liquidity needs and we have about twice the coverage today. We are therefore far from having to sell assets, there is a lot of cushion. “