Friday, July 12, 2019

New PRB Chair Stephanie Leibe aims to continue work set by predecessor


By Joe Gimenez, Guest Contributor

Public finance attorney Stephanie Leibe chaired her first meeting for the Pension Review Board on June 27. Leibe is taking over from former chairman Josh McGee.


Stephanie Leibe
“It is truly an honor that I recognize and am humbled by the confidence that has been placed in me by Governor [Greg] Abbott, and for that I am thankful,” Leibe said in her opening statement. “I am also thankful for guidance and leadership that Josh has provided to this Board for the last three-and-a-half years.” 

Leibe served for 13 years as an assistant attorney general in the Texas Attorney General’s office where she was chief of the public finance division. She also served as general counsel to the Texas Bond Review Board providing legal advice on both state agency bond issuances and private activity bond allocations. She currently works in the Austin office of the global law firm Norton Rose Fulbright. Her firm provides legal counsel to the city of Wimberly, and she was recently reported as advising city leaders they could impose a property tax to pay down debt without holding an election. 

Unlike McGee, Leibe does not have a well-publicized record of her views on public employee pension funds, but she has set her sights on continuing work begun by McGee.

“I would like to see a future which looks very much like our recent past,” she said. “I think the intensive reviews that the board has been undertaking have provided lots of good valuable guidance both to the funds that have been subject to the reviews and also for funds that can benefit from the information that has come out of those reviews.”

McGee instituted intensive review processes to be a sort of early warning system before triggers require funds to create Funding Soundness Restoration Plans to bring their amortization period below 40 years. The Pension Review Board established wide-ranging criteria for starting an intensive review process. The criteria expanded beyond the amortization periods set in statutes so that any metric, like funded ratio or unfunded liabilities, may catch PRB staff’s eye.

McGee also was active in forming legislation for the Houston and Dallas pension reform efforts in 2017. He also had a role in shaping legislation recently passed in Senate Bill 322 and SB 2224. Leibe acknowledged the new state laws requiring funding policies and independent consultant reviews of investments.

“The agency and the board have been given additional mandates by the Legislature,” Leibe said, “and so I look forward to working cooperatively with the funds, with the board, with the agency itself to implement those mandates in a way that is both open and transparent and has good communication both between the funds and the state.”

McGee participated as a board member at the June 27 meeting. It is unclear when he will formally resign to take up a research assistant professorship at the University of Arkansas this fall. 

The governor’s office cannot officially begin a search for his replacement until he formally resigns, but McGee did say he looks forward to watching the Pension Review Board in the future as an outsider. He has not established, in public comments, a timeline for stepping down.

The Pension Review Board took a few minutes after their June 27 to capture the new leadership assignments. From left are trustees Andrew Cable and Ernest Richards, chairwoman Stephanie Leibe, PRB Executive Director Anumeha Kumar, and trustees Keith Brainard, Josh McGee and Marcia Dush.  Photo credit: Joe Gimenez



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Monday, July 1, 2019

TEXPERS names new executive director

Today is Art Alfaro's first day on the job as executive director of the Texas Association of Public Employee Retirement Systems.

In his position, Alfaro oversees TEXPERS' business operations and reports to the nonprofit association's board of directors. He may already be a familiar face to the association's membership, however. In addition to having served on boards of three public pension systems in Austin, he has attended TEXPERS conferences.

"I am excited to be joining TEXPERS as its executive director," he says. "My official start date is July 1, and I'll be officing out of the association's offices in Austin."

Alfaro comes to TEXPERS after spending 31 years with the city of Austin. The last 13 years of his tenure were as the city's treasurer, responsible for the city's cash management program - the $5.9 billion debt management program and $3.3 billion investment portfolio. Alfaro also served as a trustee on several city boards, including the City of Austin Employees Retirement System, Austin Firefighters' Relief and Retirement Fund, Austin Police Retirement System and the Austin Deferred Compensation Committee.

"I have a passion for defined benefit pensions," he says. "In the early 1990s, I began executing trades for pension funds. I have seen the industry change in the 2000s and watched it rebound from the Great Recession of 2008."

Also, Alfaro served on the Government Treasurers' Organization of Texas, Government Finance Officers Association of Texas, Austin Convention Center Enterprises, Austin Convention Condominium Association, Austin-Bergstrom Landhost Enterprises, Travis County Investment Committee, Public Trust Advisors Texas CLASS Investment Advisory Board, Texas TERM Investment Advisory Board and Hispanic Business Alliance Fund. Alfaro also served as president of the Government Treasurers' Organization of Texas in 2010 and as its legislative committee chair.

TEXPERS' board of directors formed a search committee, chaired by the association's second vice president John Jenkins. TEXPERS also retained The Woodlands-based Lowry Rhoads Associates to assist with the search. The firm focuses on recruiting senior- and mid-level leadership to a broad range of organizations.

You can learn more about Alfaro in TEXPERS' upcoming edition of its membership magazine, TEXPERS Pension Observer Vol. 3, 2019. The magazine publishes quarterly, and the next publication is to be mailed out to members July 25.

Monday, June 24, 2019



Texas' population is aging: U.S. Census data


BY ALLEN JONES, TEXPERS


The population of Texas is aging, but it isn’t quite as gray as the nation as a whole.

The median age – the point when half the population is older and half younger – of Texans grew to 34.8 years in 2018, according to new U.S. Census Bureau population estimates released June 20. And although the median age of Texas’ population is 3.4 years lower than the median age of the national population, both populaces grew older since 2010.

Federal statisticians looked for the median age of the nation, states, and counties. Data analysts look for the median age of a population as it provides a slightly better picture of what an age distribution resembles.

Monitored over eight years, Texans are getting older. The median age of Texans increased 1.2 years from 33.6 since 2010.

Texas’ aging population is in line with regional and national trends showing increases in the median age of various demographics. The median age of the nation increased to 38.2 years in 2018, up from 37.2 years in 2010. In the southern U.S., the geographical region that includes Texas, the median age increased to 38.1 years in 2018 compared to 37 years in 2010.

Click graphic to enlarge.

Among its southern peer states, Washington D.C. has the youngest population with a median age of 34 years. The southern state with the highest median age is West Virginia at 42.7 years. Delaware had the most significant increase in median age among the southern states. The median age in that state grew 1.9 years from 38.8 years in 2010 to 40.7 years in 2018.

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Among all states, North Dakota is the only state with a population that got younger. The median age decreased 1.8 years to 35.2 years in 2018 from 37 years in 2010. Main had the largest increase in median age, going from 42.7 years in 2010 to 44.9 years in 2018, according to the bureau. And Utah had the state population with the lowest median age in 2018 at 31 years.

“The nation is aging – more than four out of every five counties were older in 2018 than in 2010,” said Luke Rogers, the chief of the Population Estimates Branch at the Census Bureau, in a news release. “This aging is driven in larger part by baby boomers crossing over the 65-year-old mark. Now, half of the U.S. population is over the age of 38.2.”

Also, according to the new data, 16 percent of the nation’s population is made up of people age 65 and older, and it grew by 3.2 percent in the last year. The age group increased to 30.2 percent since 2010. Compare that to those under the age of 18, which decreased by 1.1 percent during the same period.

Click graphic to enlarge.

Along with a general aging trend, Rogers said the bureau’s researchers also noted a variation among race and ethnicity groups both in growth patterns and aging. He also stated that alone-or-in-combination groups overlap and individuals who identify as being two or more races are included in more than one of these race groups.

Amongst the different race groups in the U.S.:
  • The white alone-or-in-combination population increased by 1.0 years
  • The black or African American alone-or-in-combination population grew by 1.4 years
  • The American Indian and Alaska Native alone-or-in-combination population increased by 2.2 years
  • The Asian alone-or-in-combination population increased by 1.7 years
  • The Native Hawaiian and Other Pacific Islander alone-or-in-combination population grew by 2.6 years
  • The Hispanic (any race) population increased in median age by 2.2 years
Learn more



Friday, June 21, 2019



BY PHIL DESANTIS, Westwood Holdings Group

As a high-performing equity market environment lifted most stocks over the last decade, the value proposition for active management in efficient asset classes such as U.S. Large Cap has been scrutinized by both institutional and retail investors alike.

Low active share, otherwise known as “closet indexing,” high turnover and lofty management fees all contributed to a trend of marginal performance results for active products relative to benchmarks. In response, many investors have chosen to reduce their allocations to active managers and increase passive holdings, particularly in efficient asset classes.




During this period of dominance by passive products, the relationship between asset owners and investment managers has transformed, increasing fee pressures to improve alignment over existing fee structures. While overall fees have come down over the last decade, the industry has done very little to truly level the playing field for investors and solve the real problem — aligning fees to the value of active management and improving the probability of a favorable outcome depending on manager skill and the efficiency of the asset class.


Mutual fund investors paid a staggering $100 billion dollars in expenses to underperforming asset managers over the last ten calendar years.

We believe the industry is primed for a major disruption that will better reflect the value- added returns of active management by solving the fee problem, altering the probability of winning for investors, and in turn radically changing asset allocation decisions.

Read more in our whitepaper, “Mission Possible: Changing the Probability of Winning for Active Investors.”

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Westwood Holdings Group nor TEXPERS, and are subject to revision over time.

About the Author:




BY STEFFEN REICHOLD, Stone Harbor Investment Partners

Sustainable investment assets globally reached $30.7 trillion at the start of 2018, an increase of nearly 35% in two years, according to the Global Sustainable Investment Alliance. And while the majority of these assets are invested in equity strategies, bond investors are actively participating in the growth of environmental, social and corporate governance, or ESG, investing through various approaches, including purchasing green, social and/or sustainable bonds, launching ESG funds, benchmarking against ESG indices, and embedding ESG factors into the overall investment framework. 


In our view, integration of ESG factors into the fixed income investment process is complementary with fundamental credit analysis and engagement activities with sovereign and corporate issuers. Importantly, active investor involvement can drive change and positively affect sovereign and corporate issuers by creating incentives for them to improve ESG performance and by supporting economic development through fixed income investments.

Of the primary ESG factors, governance is particularly important to bondholders due to the impact it can have on improving institutions and on the rule of law that supports economic development. From a bondholder’s view, the sovereign’s commitment to political stability and security, and the strength of the institutional framework that supports the financial sector are strong indicators for improving creditworthiness. Considerations that are particularly relevant with corporate issuers include management incentives to ensure that their actions do not disadvantage bondholders in favor of stockholders, the structure of the board of directors, and the nature of the shareholding structure, among other factors.

Social issues and environmental factors, while still relevant and important, are somewhat more narrowly applicable compared to the governance factor. For a bondholder, the ability to influence social issues (e.g., worker rights, fair pay and adequate living standards, etc.) is limited. However, where these social issues are inequitable, concerns about the stability of the country are raised, along with questions about the sovereign’s ability to service its debt. Environmental factors are crucial for sectors such as the extractive industries. Again, from a credit perspective, the ability to effectively manage environmental risks (e.g., lapses and accidents) is a key concern as the company’s approach could have significant economic implications for the company, thereby affecting its debt servicing capabilities, as well as causing potential fatalities.



Click graphic to enlarge.

Improvements in ESG scores, particularly as they apply to governance, are often connected to better returns as the market prices in the improved fundamental (and thus lower risk premium). Therefore, the incentives for both issuers and investors to take actions to positively impact ESG scores are clear: improved ESG factors tend to be associated with lower spreads and thus better returns, benefitting bondholders; and countries and corporations that experience improving ESG scores also tend to undergo economic development and reduce their borrowing costs.



Click graph to enlarge.

The increasing demand for fixed income ESG products have also led to the development of tools for investors. Morningstar introduced their Sustainability Rating, which measures how well the holdings in a portfolio are performing on ESG factors relative to a portfolio’s peer group. Fixed income ESG indices have also been developed to provide a comprehensive and efficient coverage of the investable universe. For the JP Morgan ESG index suite, weights are set by scalar as determined by ESG score. For fixed income asset managers, tools that aid in analysis of ESG factors and provide better transparency are critical in managing ESG strategies.


Click graphic to enlarge.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Stone Harbor Investment Partners nor TEXPERS, and are subject to revision over time.

About the Author:


BY NICK CLAY & ANDREW MACKIRDY, Newton Investment Management

The long-term returns from U.S. equity markets eloquently illustrate the role of dividends in wealth creation. While capital gains accounted for the growth of $1 invested in U.S. equities at the beginning of 1900 to $215 at the end of 2011, the additional effect of income and its reinvestment turned that original investment of $1 into $21,978.[1]



Dividends Can Boost Long-Term Earnings Growth

It is often suggested that, by following a dividend-focused strategy, investors are likely to suffer since paying a dividend may be viewed as evidence of the paucity of a company’s investment opportunities. However, various international studies have shown that there is actually a positive correlation between a company’s payout ratio and subsequent long-term earnings growth.[2] They suggest that the payment of a dividend actually encourages greater capital discipline which, in turn, leads to better long-term returns.

Of course, companies may choose to carry out share buy-backs rather than pay dividends.

Proponents of buy-backs argue that, not only are they more tax efficient, they are also equivalent in terms of their effect on the capital structure of a company. While these observations may be theoretically true, it is human nature and incentives that drive human behavior. If done at a price above intrinsic value, share buy-backs are in fact a dilution of shareholder value. Furthermore, a share buy-back is only equivalent to a dividend if it is maintained in a downturn. We observe, however, that companies tend to carry out share buy-backs when times are good and quietly drop them subsequently when conditions deteriorate.[3]



A Focus on Dividends Helps to Lower Volatility

Even during periods in which capital returns fall, dividend income tends to be relatively stable. Once a dividend is established, companies tend to try to keep paying it to avoid the negative signal that the market receives when the payment of a dividend is halted.[4] Crucially, if a dividend continues to be paid after a share has fallen in price, investors receive a greater number of shares upon reinvestment of that income than if the share price had not fallen. Therefore, investors may, by concentrating on the income they receive, withstand the volatility in the economy and in the capital value of their portfolios with greater equanimity.


The Need to Be Active

While the profound role of dividends in long-term real returns is statistically demonstrable, yield alone is not necessarily an indicator of corporate strength. The difference between forecast yields and realized yields, shown in the chart below, demonstrates that in order for an equity income strategy to be successful an active approach to investment is necessary.


Comparing Forecast Yield of FTSE World Income Stocks Versus Actual Yield Achieved, End-1995 to December 31, 2018


Click graph to enlarge.

Source: FTSE World. SG Quantitative Research, Factset, December 31, 2018.


Clearly, companies that are over-distributing to shareholders and underinvesting in their business will be likely to harm their fundamental prospects and jeopardize the sustainability of a dividend. A fundamentally healthy business, receiving enough reinvestment to maintain itself and grow, is a prerequisite for a sustainable and growing dividend stream.

In this context, it is our view that an active approach can improve on the statistical tailwind of dividends in three key respects:

  • by ensuring that dividends are backed by sustainable cash-flow streams
  • in an uncertain world, establishing that the range of future cash flows and intrinsic valuation is favorably asymmetric
  • ensuring that the current share price offers a reasonable degree of margin of safety.
By focusing on these disciplines, we believe an investment approach centered on dividend income – the dominant source of long-term real returns – can boost long-term earnings growth and reduce volatility.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Newton Investment Management nor TEXPERS, and are subject to revision over time.
Article Sources:
[1] Credit Suisse, Global Investment Returns Yearbook (2011) and Elroy Dimson, Paul Marsh and Mike Staunton, Triumph of the optimists: 101 Years of Global Investment Returns (Princeton University Press, 2002), with updates from the authors; February 2012.
[2] Arnott and Asness, Surprise! Higher Dividends = Higher Earnings Growth, Financial Analysts Journal, (2003); Gwilym, Seaton, Suddason and Thomas, International Evidence on the Payout Ratio, Earnings, Dividends and Returns, Financial Analysts Journal (2006).
[3] Jagannathan, Stephens and Weisbach, Financial Flexibility – the choice between dividends and stock repurchases, Journal of Financial Economics (2000).
[4] Laarni T. Bulan, To Cut or Not to Cut a Dividend, International Business School, Brandeis University (November 2010).


About the Authors:
 



BY JAMES PERRY & MARK WEIR, Maples Group

A challenging investment environment over the last two decades has forced institutional investors to embrace a wide range of alternative investment strategies to achieve their performance objectives. At the same time, this has also dramatically increased the complexity of managing an institutional investor’s portfolio. These dynamics have led a growing number of institutions to consider outsourced chief investment officer, or OCIO, platforms as an alternative to establishing and maintaining the in-house investment expertise and operational infrastructure necessary to run a successful investment program in today’s market environment.

While the OCIO market has rapidly expanded in recent years, demands from these larger investment programs regarding transparency, a growing client base and increasing competition from new entrants has pushed leading OCIOs to find innovative ways to better serve their clients, differentiate themselves from competitors, and effectively scale their businesses. Solutions in the key areas of structuring, operations and technology that enable OCIOs to monitor, allocate and report on a broad range of asset classes, strategies and structures have arguably become the cornerstones of their success.

Pillar 1: Structuring

OCIOs are increasingly seeking optimal investment structures to facilitate portfolio rebalancing, maximise alignment of interest with underlying investment managers, and improve transparency, liquidity and control. Bespoke solutions such as fund of ones or managed accounts can assist OCIOs in differentiating themselves from their peers who may only invest through commingled funds. OCIOs are also recognising the benefits of managed custody accounts which introduce an innovative way of redefining the traditional relationship between asset allocators and managers and can play a significant role in enabling outperformance.

As OCIOs direct more of their alternative investments into customised vehicles and realise the benefits of structures such as MCAs, they must ensure that they have the robust technological infrastructure and expert support needed to maximise "structural alpha."



Pillar 2: Operations

Similar to optimising investment structures, establishing effective operations has become more and more difficult for OCIOs. With investment programs, client requirements and reporting needs becoming ever more demanding, OCIOs must ensure they have the resources, expertise and infrastructure necessary to deliver. Key areas of focus include data management, portfolio accounting and portfolio reporting and analytics.

Outsourcing these functions can improve operational efficiency and allows OCIOs to focus on engaging with their underlying clients and asset managers to drive performance and build better portfolios. In addition, this serves as a valuable way of introducing an added layer of independence that can supplement governance practices and enhance stakeholder reporting.



Pillar 3: Technology

Superior information delivery systems and the ability to make data useful is a necessity in today’s environment. For OCIOs in particular, the reporting and level of oversight that underlying clients demand is typically quite complex and fulfilling operational requirements demands the optimisation of existing processes through a single robust yet scalable technology platform. Conversely, sub-optimal technology solutions create myriad challenges for OCIOs.

Given increased complexity and competition across the industry, OCIOs are unquestionably under more pressure than ever before. The capabilities of an OCIO are determined by their ability to provide services tailored to the individual needs of a wide range of clients. This is something that can only be accomplished by a significant investment in resources and systems. With this in mind, many OCIOs find it useful to outsource specific processes and engage third party experts who provide proven operational and technological solutions.

Note: Visit the Maples Group’s website for more information on the pillars of success for OCIOs and the resources and support available to this rapidly expanding market.


The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Maples Group nor TEXPERS, and are subject to revision over time.

About the Authors: 




BY MARK SHORE, Coquest Advisors

Investment volatility, or “vol,” as it is known on the street, is often measured by the standard deviation. Investors frequently use the standard deviation as a proxy for risk. But is the standard deviation a proxy for risk or a proxy for dispersion around the mean?


Mathematically, the standard deviation is the dispersion of data around the mean as the data points move farther from the mean (towards the distribution tails), the standard deviation increases. In a normal (bell-shaped) curve, one standard deviation should capture about 68% of the possible movement around the mean. A two-standard deviation move captures approximately 95%, and three standard deviations should capture an estimated 99.7% of the distribution. Therefore, volatility is both above and below the mean.

Investors often talk about volatility when portfolios are losing value. For example, you probably won’t hear much discussion about the stock market being volatile when it rallies. That discussion usually occurs when stocks decline. However, when an investment has profitable returns, it is still technically defined as volatility, sometimes known as upside volatility or positive volatility. Investors are usually accepting of the upside vol, as it implies the investment experiences positive returns. It’s the downside vol investors are often losing value as that is the tail risk they are usually trying to reduce. To paraphrase from my paper, Skewing Your Diversification, volatility is comparable to cholesterol. There is good and bad volatility.

The traditional view perceives higher standard deviation equating to higher risk. But is that always the case? As I often tell the students in my managed futures class, you should understand if the volatility derives more from the positive returns or the negative returns. If derived more from the positive side of the distribution, that is the dispersion of the positive gains that is inflating the standard deviation. If the volatility is derived more from the negative volatility than it is the dispersion from the negative returns and is the tail risk, that usually concerns investors.

Modern portfolio theory assumes a normal return (bell-shaped) distribution. However, distributions may be skewed (asymmetrical curve) to the right causing positive volatility or skewed to the left, causing negative volatility. The negatively skewed distribution may cause increased tail risk and losses, as noted in the chart below.




Understanding how an investment’s allocation impacts the portfolio’s skewness helps understand the behavior of the allocation relative to the portfolio. Does it expand the skewness to the left or the right? This concept is also known as co-skewness, according to the authors of Conditional Skewness in Asset Pricing Tests, published in The Journal of Finance.

In other words, an investment with a high standard deviation but more volatility coming from the upside could potentially reduce a portfolio’s volatility when the investment is allocated to a portfolio. It sounds counter-intuitive for a high standard deviation investment to reduce a portfolio’s standard deviation, but it’s the positive volatility that is offering the benefits to the portfolio to reduce the tail risk and downside vol.

An investment with a high standard deviation derived from positive skewness and coupled with a low or non-correlation to the portfolio may increase the added value of the allocation. It’s also possible for an investment with a low standard deviation, but more volatility attributed to the downside increasing the portfolio’s tail risk.

Therefore, only accounting for a standard deviation to be high or low is not enough. Drilling down to understand where the volatility is good or bad is an essential factor to consider. If the tail risk can be more efficiently controlled, than the portfolio’s drawdowns may also be reduced.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Coquest Advisors nor TEXPERS, and are subject to revision over time.

About the Author: 
Mark Shore is the director of educational research at Coquest Advisors. He is also an adjunct professor at DePaul University. He is a candidate to receive his doctorate in business administration in 2020. He has a master's degree in finance from The University of Chicago Booth School of Business. He also has a bachelor's degree in finance from DePaul University.


BY JIM MCKEE, Callan

Looking for improvement from your hedge fund allocation? Co-investing with hedge funds is a chance for investors to enhance returns while reducing overall fees.

Although co-investments have been a popular supplement to a fund sponsor’s private equity and real estate programs for decades, co-investing with hedge fund managers became a widespread practice only after the global financial crisis of 2007-2008.

The appeal of co-investing with hedge funds today arises from attractive opportunities that lie between the vast pools of liquid capital markets dominated by algorithms and indexers on one side, and the mountain of dry powder controlled by private equity providers on the other.

What are co-investments?

Co-investments are one-off investments that a hedge fund manager has identified which are typically too illiquid or oversized to absorb within the manager’s flagship fund. Another key feature of such opportunities is that they need to be assessed quickly for a decision to buy or pass—often within days or weeks. 

Fast-moving markets or events are frequently forcing the trade; being able to respond within a few days or weeks is the key for successful participants. Because market values of such opportunities are often not observable due to their size or illiquidity, the allure for co-investors is an asset trading at a notable discount to fair value, in addition to lower fees charged by the sourcing manager versus its commingled fund vehicle.


What have co-investments looked like in the past? 

Depending on the manager’s domain expertise, they could be Lehman claims, Icelandic bank debt, Puerto Rican bonds, Argentinian debt, Egyptian T-bills, CLO equity tranches, late-stage private equity, or an activist-controlled stake in a targeted public stock. Other investment opportunities may not be co-investments, per se, but are similarly attractive to experienced buyers looking for direct investments offered by motivated sellers at a material discount, such as hedge fund secondaries.


Motives behind offerings

Motives behind managers offering co-investments are many. In addition to a position being too big or too illiquid for their primary commingled fund, co-investments represent an opportunity to create and improve relationships with strategic clients while developing a supplemental revenue base. Since co-investments are usually offered under carefully described circumstances, investors in such opportunities should not construe them as the manager’s “best ideas”—one should expect those to continue going first into the manager’s flagship fund.


Investor expectations

Since co-investments are offered at lower fees, the investor’s expectation should be to improve performance at least by reducing the fees being charged. A collateral benefit is that co-investing efforts provide improved access to deal flow via dedicated sourcing experts. Furthermore, co-investing provides more transparency into a manager’s investment process. Because the manager’s compensation is typically driven by incentive fees, the investor can also be more confident in aligned interests to create desired investment outcomes. Nevertheless, working with multiple co-investing partners helps to improve diversification of trade risks.

Because resources and experience widely vary among investors, co-investment solutions have three primary forms to consider:

  1. If limited partners lack resources to quickly vet and approve opportunities presented to them, they can consider a turnkey solution provided by a fully discretionary adviser, whether a hedge fund or fund-of-funds manager. The adviser of this turnkey solution sources the co-investment deals, underwrites them, and uses its full discretion to implement a commingled fund solution. It is the most fee-laden solution, but it is cheaper than the manager’s full-fee commingled fund.
  2. Limited partners with demonstrated experience and ability to move quickly on any presented opportunity can oversee a managed account of approved co-investments that conforms to customized investment guidelines set up with the manager.
  3. If an investor has significant size, experienced staff, and demonstrated resources, it can be a strategic partner working with manager sourcing, vetting, and investing directly in deals.
Like any private transaction lacking clear pricing or exit strategies, the motives of all participants are particularly important to understand. Investors need to know their limitations and act accordingly. When opening the door of co-investment opportunities, carefully understand your odds of investment success before the door shuts behind you.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of Callan nor TEXPERS, and are subject to revision over time.

About the Author: 
Jim McKee is a senior vice president in Callan's Hedge Fund Research group. He is a shareholder of the firm. McKee earned a master's degree in finance from Golden Gate University in 1987. He received his bachelor's degree in economics/environmental studies from Dartmouth College in 1982.




BY SCOTT KRAUTHAMERAllianceBernstein

In recent weeks, the U.S. yield curve has been making investors nervous again. The curve has inverted before each of the last seven recessions, and it did so again on March 22. But what does an inversion really mean for equity returns?

The yield curve simply tracks how long-term interest rates stack up to short-term rates, and it’s said to invert when short-term rates are higher than long-term ones. After three-month Treasury bill rates topped those of 10-year Treasury yields for the first time since 2006, we took a closer look at what happened to equity returns after the 11 other inversions that have occurred since the 1960s.

In the very short term, the effect of an inversion is negative. In recent years, that may be because the yield curve has gained incredible power in the minds of financial market participants as a foolproof signal of impending recession. In other words, the signal itself, rather than any fundamental conditions it signifies, might make investors nervous. In earlier years, when yield-curve inversions didn’t even warrant a mention in the New York Times, concern over how rising short-term interest rates would affect loan conditions seemed to be more top of mind.

However, average stock returns were negative only in the first month after an inversion. Further out, average returns were positive. And the more time that elapsed since the inversion, the more positive the average returns were.

Looking more closely at long-term trends, however, the picture is more nuanced. Three months after an inversion, stock investors booked positive returns nearly three-quarters of the time. But by the time a year had passed, the results were usually much more extreme: either very positive or very negative.



Click chart to enlarge.


What’s the Central Bank Got to Do with It?

The Federal Reserve may have contributed to those extreme results. During the three best yearlong periods of post-inversion returns, with gains ranging from 27.1% to 33.6%, the Fed was generally in loosening mode.

On the flip side, the Fed was generally in tightening mode during all but one of the five yearlong post-inversion periods in which investors experienced negative returns. And the one year of negative returns in which the Fed was not strictly tightening, having both raised and lowered interest rates between October 1980 and October 1981, turned out to be the “best of the worst.” The returns of –7.3% that year compare favorably to double-digit losses in other post-inversion periods.

At the moment, the Fed has put further rate hikes on ice, and some investors even believe cuts are in the offing. Historical data reinforce the idea that cutting would likely be better for markets, but the data also show that it’s possible for equity markets to keep going up even under tightening monetary conditions.

Zooming Out: The Bigger Economic Picture

Much depends on the broader economic context in which inversions occurred. For example, when the yield curve inverted in September 1988, the US economy was in its eighth year of expansion. The Asian financial crisis hit many global economies hard, but it failed to slow job creation, arrest the falling unemployment rate or nudge inflation higher in the US. The economy continued to expand into 1999, and US stock investors enjoyed the best returns of all 11 post-inversion periods.

The worst post-inversion returns, however, came soon after that period, with the April 5, 2000, inversion. The Fed had hiked interest rates five times since June 1999, unemployment began rising in May 2000 and technology stocks melted down. The disputed presidential election in November 2000 only added to the tumult. The US ended a 10-year run of economic growth with a recession that began in March 2001.

Investors can and will debate whether history will remember 2019 more like 1998 or 2000. And in the late stages of an economic cycle, it’s tempting to let events like a yield-curve inversion influence investment strategy. But we think investors should not be guided by these impulses.

The yield curve is a signal with no precision: though inversions have preceded recessions, they don’t pinpoint when they’re coming. We’ve also never seen an inversion in the post-QE age, and we’re skeptical that it’s a valid signal for equities this time around. Rates are still historically low, global central banks have paused any move toward tightening and some countries are even unleashing fiscal stimulus. This inversion was also quite brief, and the curve has since steepened, making this a faint signal at best.

Perhaps most importantly, however, inversions say very little about the fundamental ability of individual corporations to grow and prosper under a range of economic conditions. That’s why returns at any point after an inversion aren’t reliably positive or negative. Companies with high-quality growth, low leverage and high-rated credit are likely to fare well whenever the cycle finally turns. It’s best to stick with what works for now.

The views expressed herein do not constitute research, investment advice or trade recommendations, do not necessarily represent the views of all AB portfolio-management teams nor TEXPERS, and are subject to revision over time.


About the Author
Scott Krauthamer is managing director of AB’s equity business development and covers the U.S., international and global services for both its institutional and retail growth products. Prior to joining the firm, he held a variety of investment and product-management roles at Legg Mason, U.S. Trust, Bank of America and J.P. Morgan Private Bank. He holds a bachelor's degree in finance and management information systems from the State University of New York, Albany. He is a CFA charterholder and a CAIA designee.


The Challenge: Generating Sufficient Returns


BY BOB PARISE, Northern Trust Asset Management

Increasing pressure to reduce risk coupled with a challenging market environment will make generating sufficient pension returns harder in the coming years. Volatility has returned, the yield curve has flattened and global growth has slowed — all of which can contribute to lower future returns.

To illustrate the magnitude of these negative shifts in the return expectations, we utilized our five-year risk and return forecasts to simulate various optimal portfolio outcomes. Compared to just 10 years ago, these hypothetical diversified portfolios have a ~2% drop in returns across all levels of risk, which compounded over time, can become a significant unfunded liability for pension plans.

Historical approaches to bolster returns generally involved increasing certain risk exposures, such as adding alternative and private investments. However, some plan sponsors are limited in the amount that they can increase their risk budgets. Others are already at their liquidity limits for more aggressive allocations. These limitations diminish a plan sponsor’s ability to meet its target return objectives of 6% to 7.25% without taking too much risk.

The Solution: Quantitative Multi-Factor Strategies

Multi-factor strategies could offer a consistent alpha contributor to your equity allocation without increasing your pension’s risk budget.


What Are Multi-Factor Strategies?

Factor-based, or quantitative, equity strategies seek to outperform a benchmark by exploiting market anomalies and behavioral biases using proprietary and quantitative models to select securities, construct portfolios and manage risk to deliver targeted outcomes.


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Why Invest in Factors Now?

We do not advocate trying to “time” factors over short periods of time, but it is important to note the cyclical nature of factor returns. Factors have tended to perform well in any economic environment, but they have historically been at their best when the economy is moving out of periods of high expansion (Exhibit 1).


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While markets can be cyclical, in our 20+ years of managing factor-based strategies, we’ve found quality to be a diversifier that potentially makes outperformance more consistent over varying returns cycles.

Similarly, in rising rate and low return environments, we have seen the same pattern of high excess returns, primarily in the low volatility and quality factors (Exhibit 2). While not all of these factors may align with your plan’s objectives, this framework can provide a helpful guide to gauge whether your portfolio is aligned to capture these potential drivers of outperformance.



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Learn more about multi-factor strategies on northerntrust.com or contact Bob Parise.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of Northern Trust Asset Management or TEXPERS. Click here to read Northern Trust Asset Management's full disclosure.

About the Author
Bob Parise is practice lead, Public Funds & Taft-Hartley Plans at Northern Trust Asset Management and a member of the Business Leadership Council. Parise has more than 24 years of financial industry experience, most of it at J.P. Morgan Asset Management and its predecessor firms. He earned a bachelor's degree in Finance from Western Illinois University and a master's degree from DePaul University. He holds Series 3, 7, 24, and 63 licenses.