Fund managers plan to would slash the fund's share of investments in global equities and slightly increase its allocations in hedge funds, private debt and high yield bank loans.
By MATT MURPHY
BOSTON - After posting the second largest annual investment return in the state pension fund’s history, the Pension Reserves Investment Management Board voted on Tuesday to restructure its approach to investments, changes that officials said are designed to maintain returns while reducing market risk.
Under the plan approved by the board, the state pension fund would slash its share of investments in global equities and slightly increase its allocations in three other areas – hedge funds, private debt and high yield/bank loans – while entering the emerging market debt class for the first time at 2 percent.
Steven Grossman“We’re trying to lower the risk of the portfolio and get the same return we would otherwise,” Treasurer Steven Grossman said, describing a new asset mix that increases investments in fixed income, private debt, and hedge funds while reducing total equity investments.
The portfolio mix, presented to the board by NEPC, LLC Managing Partner Mike Manning as the recommended option, is projected to produce 7.7 percent annual returns over the next five to seven years, with a greater 9.1 percent return over 30 years at a reduced level of risk from the fund’s current portfolio.
Pension board member Alexander Aikens cast the lone dissenting vote, questioning whether the board had enough information about entering the emerging market debt investment field.
The changes will come on the heels of the fund’s second best annual investment performance in its history. In fiscal 2011, a year when Treasurer Tim Cahill ceded the chairmanship of the board to his successor, Treasurer Steven Grossman, the fund earned 22.3 percent, or $9 billion, with its balance finishing the year on June 30 at $50.3 billion. In fiscal 1986, the fund’s earnings rose 28.1 percent.
The gains were driven by strong investment returns from value-added fixed income, timber and hedge funds.
State statute mandates that the pension fund return at least 8.25 percent on its investment. The fund hit that target two years in a row in 2009 and 2010 after suffering significant losses in 2008, improving the funded liability from 62.7 percent in January 2009 to 71.2 in January 2011.
“We still believe that’s achievable in the long-term,” said Michael Trotsky, the executive director of the fund about the 8.25 percent return benchmark, despite projections of smaller growth over the next five to seven years.
Trotsky received his first evaluation on Tuesday, overwhelmingly positive, as the director of PRIM.
Grossman said the fund’s fiscal 2011 performance combined with scheduled increases in state funding from $1.5 billion in fiscal 2012 to $2 billion by fiscal 2017, an extension of the pension liability funding schedule to 2040 and pending pension reform legislation on Beacon Hill puts the state on track to achieve a fully funded pension system.
Due to the actuarial formula used to calculate liabilities that “smooths” returns over five years, the unfunded pension liability is expected to increase over the next two years before rebounding again in 2014.
“The piece of this we need to accomplish is to get pension reform passed this fall. It could not be more important,” Grossman said. Gov. Deval L. Patrick has filed legislation that would alter benefits and increase the retirement age, and the Senate has identified the issue as a priority after Labor Day.
The board also voted to approve a private equity investment of $100 million in Denham Commodity Partners Fund VI, which will make investments in industries, companies and assets involving energy and commodities, and a $15 million investment with Kepha Partners Fund II.
Kepha Partners invests primarily in seed and early stage companies in Massachusetts, particularly in the technology sector with a focus on digital media and internet infrastructure software. Grossman said Kepha Partners invested 90 percent of its first $100 million fund in Massachusetts’ companies, helping to grow those firms from 40 to 189 employees from 2007 to 2008.
A third investment of 100 million euros, or roughly $145 million, was approved for Avenue European Special Situations Fund II, focused on distressed real estate properties across Europe.
Following an audit conducted by Framingham-based FX Transparency that reported in June that BYN Mellon overcharged the PRIM board by approximately $30.5 million for executing foreign securities trades for the pension fund, the PRIM board approved a request for proposals to explore using another vendor.
An official from BNY Mellon in June called the claim of overcharging “wrong,” but Trotsky said the board wanted to “test the market.” The board also approved an RFP for a contract to perform regular evaluations of the pension fund’s foreign exchange transactions.
The charges originate from stock trading in foreign countries where U.S. dollars need to be exchanged into foreign currencies to buy in foreign markets and then return the money to state accounts, according to Treasury officials.
The audit, conducted by Framingham-based FX Transparency, looked at the period from Jan. 2, 2000 to May 11, 2011.
Trotsky said PRIM remains satisfied with BNY Mellon’s performance as a custodial bank for the pension fund, but is “clearly not happy” with the foreign exchange services and wants to explore other options.
The board also voted to approved a three-year, $360,000 annual contract with Cleveland-based Townsend Group to provide general real estate and timberland consulting services.