In a document obtained by CIO Thursday, the New Mexico State Investment Council released its annual investment plan for fiscal year 2018—in which it expressed slight optimism for macroeconomic growth as well as a desire to essentially continue the broad investment strategy of the previous few years.

The Council expects the next seven to 10-year period to consist of sluggish economic growth, modest interest rates, and stable inflation rates.  It predicts modest improvement in conditions and returns. In addition, the $21.5 billion permanent endowment manager feels that conditions will continue to be “less supportive” than normal for its equity-based investments—the fund’s best returning assets, creating “ample challenges” in generating targeted long-term returns. Additional challenges will be the resolution of high valuations on many of the Council’s largest available investment markets.

In terms of the Council’s broad investment strategy, the fund will focus on reduced exposure to equity risk, investments that return a majority income on their overall rate of return, and structuring downside mitigation into asset class portfolios. To combat the aforementioned challenges, the Council is focusing on protecting capital rather than chasing gains.

To diversify its equity exposure, the fund is expecting its 65%/35% stock and bond combination to produce an average 5.7% return—well below long-term averages and the Council’s 7% return target. To combat this, the Council is considering shifting the portfolio to add a custom combination of core and value-add real estate. It expects a 7.9% annual rate of return over a longer period, with 15.8% annual volatility and 70% of returns coming from income.

The fund’s current custom mix of these assets has an expected 7.7% return rate, with 11.7% volatility. It suggests it could generate 75% or more of the return from income.

When it comes to the downside crisis mitigation, the Council seeks to utilize strategies that tend to favor income-producing investments over capital gains, such as active management—which includes smart beta—in the publicly equity portfolio.

In terms of asset allocation, the fixed income portfolio will split into two allocations, core and non-core, following the 2017 Asset Allocation Study. The core allocation will consist of “a highly liquid, highly-rated portfolio with the primary objective of serving the traditional role of a fixed income portfolio while providing liquidity to the overall portfolio in the event of a severe market disruption,” while non-core’s goal will focus on producing yield and traditional fixed income or credit strategies—most of which will be non-liquid, allowing the Council to take advantage of available illiquidity premiums.

In addition to the fixed income changes, the absolute return portfolio will be re- categorized from an asset class to a strategy. The study will transfer hedge funds into the non-core allocation.

In mid-2017, real estate assets were increased from 10% to 12%. For fiscal 2018, the Council will the focus of new commitments toward tactical investments.

The Council’s real estate portfolio expects the strategic (core/core plus) section to generate a 4% to 6% income in the medium term. In addition, components of the tactical (value add/opportunistic) portfolio will include mezzanine debt strategies for its income focus.

For real returns, the pacing model incorporates just the real assets component, which is 9% of the broad portfolio. Thepacing model shows approximately $300 million of commitments in 2017, followed by roughly $175 million per year thereafter to continue to push the “invested NAV of the real return portfolio toward the long-term target allocation.” After building out its agriculture and timber portfolios, the fund will focus on commitments in the energy and infrastructure sectors.

Finally, the Council is expecting to make $600 million in annual commitments over the next three to five years to reach its 12% target for its private equity portfolio, which consists of buyout, growth, special situations, and venture capital categories.

“Goals over the past few years have been to diversify publicly-traded equity exposure into private market assets; to build greater income generating ability at the total fund level; and to build downside mitigation into the asset class portfolios,” Robert “Vince” Smith, the Council’s deputy state investment officer and CIO, told CIO. “Challenges have been identifying high-quality managers in the private asset space, gaining commitments to the funds, and getting capital drawn. Challenges on the horizon include the high valuations of most risk assets that we are observing at present, and a future macroeconomic environment that likely won’t be as supportive of our historically best-performing investments (equity) than it has on average in the past.”

Tags: 2018, Fiscal Year, Investment Plan, New Mexico State Investment Council