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Rebalancing is back in vogue

Date: Tuesday, June 30, 2009
Author: Pia Sarkar, Pensions & Investments

Pension funds, foundations and endowments that had been reluctant to rebalance their portfolios because of wild swings in the market are now starting to come around.

Many of them had held off on rebalancing earlier this year, but some industry observers expect far more activity in the second half.

“Clients see the need to change policy allocations or rebalance,” Mark Keleher, CEO of Mellon Transition Management Services, said in a telephone interview from London. “What investors shouldn't do is sit on their hands and say maybe things will come back.”

Some of those rebalancing are easing into equities again, albeit slowly. A survey by J.P. Morgan Asset Management, New York, found institutional investors appear to be maintaining their long-term commitment to equities and have begun to rebuild their holdings.

The survey noted that “some investors have set a course to "de-risk' portfolios,” but added that “those moving dramatically away from equities represent a clear minority.”

Only 4% of investors are increasing their equity allocation targets, according to the survey, but 52% are leaving them unchanged from their original 2008 levels.

Among the 44% cutting their equity targets, slightly more than half are reducing them by less than 10 percentage points, while the remainder are reducing equity exposure by 10 percentage points or more.

In April, the board of the $5.14 billion Oklahoma Public Employees Retirement System, Oklahoma City, voted to rebalance by moving $152 million into international and domestic equities from fixed income.

The fund's target is 40% domestic equity, 24% international equity and 36% domestic fixed income, said Tom Spencer, executive director. The fund's actual allocation at the end of March was 36.45% domestic equity, 19.8% international equity and the balance in domestic fixed income.

Since then, Mr. Spencer said the fund has moved $75 million from fixed income into equities but has not had to move the remaining money given the recent market rally, which brought the fund up to its target allocations.

Earlier this month, the $6.7 billion Oklahoma Teachers Retirement System, also in Oklahoma City, agreed to rebalance back to equities over the next three months, said CEO James Wilbanks.

Last year, the fund sustained losses of more than $2 billion, which prompted the board to temporarily shift 10% out of equities and into high-yield investments.

“In the last six months of 2008, everyone got beat up pretty badly in the markets, and equities got hit hard and we drifted from our strategy allocation,” Mr. Wilbanks said. “For a period of time, we thought we'd go with that drift for defensive purposes. We didn't want to rebalance in the middle of the crisis.”

Now that things are starting to look up, the board has decided to go back to its equities target of 70%, Mr. Wilbanks said.

Back to 23%

The $18 billion Iowa Public Employees' Retirement System, Des Moines, is planning to get its domestic equity exposure back to 23% by the end of September, according to spokeswoman Julie Economaki. The fund's current domestic equity allocation is 21.1%.

John Hunt, CEO of J.P. Morgan Asset Management's institutional business in the Americas, said that between the end of last year and the beginning of this year, clients were in no rush to rebalance because market volatility was so high. High volatility drives up rebalancing costs.

Investors rebalancing at the beginning of 2008 ended up getting hurt when the market soured, he added.

“Some investors that were earlier to the game to rebalance and be opportunistic suffered additional losses, and that has caused institutional investors to pause and be less in a hurry to rebalance as we got into 2009,” Mr. Hunt said.

Institutional investors also were distracted by liquidity concerns, counterparty risk exposure, risk management and securities-lending issues — all of which made rebalancing a low priority. But Mr. Hunt expects that to change.

“We believe that as we get into second half of this year, more decisions will be made to rebalance,” he said. Mr. Hunt expects the rebalancing to take longer than usual because market dislocation caused a wider-than-normal drift away from strategic norms.

Mr. Hunt predicts a pickup in international and global strategies.

Any move into equities still has its risks, said Grant Johnsey, vice president and head of transition management for North America at Northern Trust Global Investments, Chicago.

“In these volatile markets, it's a gutsy decision to rebalance into equities right now,” Mr. Johnsey said. “It takes a very cohesive organization, board and staff to all be on the same page to go into equities.”

Mr. Johnsey sees a lot of examination of asset allocation among institutional investors, but as far as wholesale rebalancing, “that's not happening on a large-scale basis.”

A lot of what goes into determining whether to rebalance has to do with timing the market, he said. He added that he does not expect a big second half of the year in terms of rebalancing “because you don't know if you're going to need to rebalance.”

Mellon Transition's Mr. Keleher disagreed. He predicts record rebalancing later this year and has hired nine people within the last quarter to prepare for it.

“We're staffing for this activity,” he said. “It's real and it's coming.”

He said he is also seeing clients that are rebalancing move back into equities, noting that institutional investors are simplifying their strategies and shifting into indexing.

Broadening scope

Charlie Shaffer, managing director and global co-head of transition management for Credit Suisse Securities LLC, New York, said institutional investors are “considering broadening the scope of equity mandates” by, for example, adding long-short managers or equity market neutral managers.

“If you add the right (manager), it provides a better risk-adjusted return across the broader equity class,” Mr. Shaffer said.

Robin Pellish, CEO of Rocaton Investment Advisors LLC, Norwalk, Conn., said she has seen some instances where clients have aggressively moved back into equities as part of their rebalancing, but for the most part, they remain cautious.

She said clients are looking at more opportunistic strategies, like the Public-Private Investment Program and the Term Asset-Backed Securities Loan Facility, as well as opportunities in credit and mortgage markets.

“Rebalancing is taking risk in opportunistic strategies, rather than taking risk by going full bore into the equity market,” Ms. Pellish said.

As for when to expect institutional investors to rebalance their portfolios en masse, Ms. Pellish is making no predictions.

“The only universal truth I can say about rebalancing is that everyone is agonizing about it,” she said.