Risk Mitigation Opportunities: Taking Time to Re-evaluate Portfolio Strategies and Board Governance

Image by Michal Jarmoluk from Pixabay 

By FLOYD SIMPSON III & MALLORY SAMPSON/PFM Asset Management

The traditional 60% S&P 500 - 40% Aggregate Bond index investment portfolio has been the benchmark for portfolio construction for decades due to the inverse return relationship between equities and fixed income and higher historical bond yields. This simplistic mix had provided returns for pensions that allowed them to meet their actuary assumed returns. The S&P 500 index posted an approximate annualized average return of 11.3% for the past 10 years (ending 2019)[1], while the current yield on the Aggregate Bond Index less than 1.5% (coupon rate of hovering around 3%). The correlation between the two indexes has been slightly negative for the past ten years, and bonds have not provided a consistent offset for drawdowns within the S&P 500 index. Over the next five years, earning a 5% annualized return will be tough. Based on recent comments from the Federal Reserve (the Fed), the expectation for higher interest rates in the intermediate term is minimal. While investors cannot control what the Fed is doing, we can recalibrate current positioning and take a serious look at the risk within the portfolio and its governance.

Investment Strategy

The first question that most investors have started to ask themselves is how to replace the missing yield from the fixed income market. When seeking a replacement, many forget to fully vet the additional risks associated with finding an alternative. While there might be other public and private options, each one brings a different type of risk profile to the portfolio, which must be considered. Hence, swapping one investment for another is a naïve approach that could have detrimental effects if the understanding of current and potential strategies is vague. This is an important area to focus on, and what an investment advisor is paid to do. You might have a relationship with an advisory firm in which they present you with options or a fiduciary that does the decision-making and portfolio construction for you. In either case, this is the time for an investment committee to focus on oversight elements that are usually glazed over. From an investment perspective, members should take this time to:

• Re-evaluate their Strategic Allocation
• Update their Investment Policy
• Refresh their Objectives
• Evaluate their tactics around allocation of assets and assessment of those decisions
• Revisiting their Spending Policy

This is also an appropriate time to rethink how the committee gauges success of their portfolio. Instead of looking exclusively at the traditional aspects of asset classes and benchmark performance, committees should start to consider:

• Gauging the overall risk of their exposure
• Homing in on their underlying market exposures to events that could be detrimental to returns
• Measuring the volatility of returns for each fund and portfolio as a whole
• Considering drawdown of the portfolio

Governance Structure

Understanding and addressing the potential holes within the governance of a board is equally important to understanding current market conditions. Unfortunately, this rarely gets the same attention as the latest news from the stock market does.

As investment professionals, we spend far too much time talking about the markets, but clients’ governance structure usually has glaring holes and creates just as much risk for plans. The adoption of good governance starts with:

• Addressing educational needs within the board
• Introduction of term limits
• Staggering board terms
• Independent, third-party reviews of board investment process
• Proactively minimizing conflicts of interest
• Re-evaluate current investment advisor beyond investment performance
• Utilizing board assessments

While most boards would say they follow a couple of these best practices, very few that take time to adopt many of these items because they can be tedious and cumbersome to carry out. The board assessment can help in numerous areas. It can inform a board about members that are not contributing, bring up potential conflicts or educational gaps in knowledge and could even help in determining term-limits based on board needs. Pinpointing weak areas within the governance structure can help prevent surprises during times of distress.

It is crucial for boards to maintain discipline in their governance and review processes; while it may not seem as exciting as stock and fixed income movements, it is equally as important of an exercise for more efficient portfolio management.

PFM is an Associate Member of TEXPERS. The views expressed in this article are those of the authors and not necessarily PFM nor TEXPERS. 

Sources

[1] Bloomberg

About the Authors

Floyd Simpson III, CFA, CFP, is Senior Managing Consultant with PFM Asset Management LLC. As part of PFM’s OCIO business, Simpson works with clients across the country to develop and implement multi-asset class strategies for their portfolios. He also serves on the Multi-Asset Strategies Group and the Multi-Asset Class Investment Committee.

Mallory Sampson, CFP, is Senior Managing Consultant with PFM Asset Management LLC. Sampson manages PFM’s institutional multi-asset class relationships in Texas, with a focus on higher education, endowments, foundations and OPEB trusts.

Governor's disaster declaration extension includes Open Meetings Act provisions; tips to safeguard public access

By TEXPERS Staff

UPDATE 8/14/20 -- Texas Gov. Greg Abbott on Aug. 8 issued a proclamation extending the state's Disaster Declaration in response to the COVID-19 pandemic. The declaration includes all Texas counties and includes a provision that allows governmental bodies such as state and local pension boards to continue hosting remote meetings.

"Renewing this Disaster Declaration will provide communities with the resources they need to respond to COVID-19," Abbott stated in a news release. "I urge Texans to remain vigilant in our fight against this virus. Everyone must do their part to slow the spread of COVID-19 by wearing a mask, practicing social distancing, and washing your hands frequently and thoroughly. We will overcome this challenge by working together." 

The state's disaster declaration includes Texas Open Meetings Act suspensions allowing governmental bodies to host public meetings remotely to reduce in-person meetings of large groups of people. 

Abbott initially issued the disaster declaration on March 13. On March 16, the governor granted the office of the attorney general's request for temporary suspension of certain open meeting statutes. The suspension allows for telephonic or videoconference meetings of governmental bodies as long as they remain accessible to the public. 

      > LEARN MORE: Open Meeting Act suspensions

State and local public pension systems should be aware that this temporary suspension leaves significant open-meeting protections in place. According to the governor's March 16 news release:

• Members of the public will be entitled to participate and address the governmental body during any telephonic or video conference meeting.
• To hold a telephonic or video conference meeting, a governmental body must post a written notice that gives the public a way to participate remotely, such as a toll-free dial-in number, and that includes an electronic copy of any agenda packet that officials will consider at the meeting.
• A governmental body must provide the public with access to a recording of any telephonic or video conference meeting.

"As we continue to respond to the COVID-19 pandemic, our top priority remains the health and safety of all Texans," Abbott stated in a news release announcing a previous extension of the Disaster Declaration. "By extending the disaster declaration, we are ensuring that Texas has the resources and capabilities in place to safely and strategically open the state while containing the spread of this virus. As we move forward in our response, I urge all Texans to continue following the health and safety guidelines laid out by the CDC and Texas' team of medical experts."

The History of Texas' COVID-19 Emergency Declaration

On March 13, the governor announced actions the state is taking to mitigate the spread of the novel coronavirus, which causes the COVD-19 disease, including declaring a State of Disaster in all Texas counties.

 

The governor extended the March 13 declaration on April 12. 

The governor extended the April 12 declaration for another 30 days on May 12.