(May 23, 2012) — The $6.5 billion Wyoming Retirement System has lost faith in alpha — here’s why.
Its recent embrace of MSCI’s global ACWI Risk Weighted Index in December 2011 reflects the growing reality that 1. success in active management is increasingly rare, and 2. risk-adjusted returns are a growing focus for public schemes worldwide, according to Jeffrey Straayer, a senior investment officer at WRS.
The pension plan’s final strategic allocation after partnering with the index provider was 70% of the total equity allocation assigned to passive managers, and the other 30% mandated to active long-only managers and alpha strategies, according to a newly released paper by MSCI’s Raman Aylur Subramanian published this month.
“We wanted to do this all on a passive basis, since a lot of active managers do the same thing through active management but with much higher fees,” Straayer said, explaining the scheme’s use of MSCI risk premia mandates in its strategic allocation.
“If we ascertain that opportunities in the market for true alpha are rare, we’ll allocate to the high end of our systematic passive approach, but always with the ability to allocate more to active strategies should markets present the opportunity. We’re saying that in general it’s very hard to find alpha, and that we can capture different risk premia passively.”
The goal with the equity portfolio transition toward increasingly passive management was to lower volatility and correlations, Straayer said, improving risk-adjusted returns while decreasing fees. MSCI’s global risk-weighted index that overweights lower volatility equities, often defensive sectors, and underweights more volatile, often cyclical, sectors, was thus increasingly appealing.
Straayer described the transition to the MSCI mandate as one part of a three-level cake of passive beta, active alpha, and risk-adjusted Sharpe Ratio ratio-focused strategies. “The way we wanted to do passive was different compared to what we had previously been doing,” he said. The scheme introduced unique systematic risk premiums into its passive allocation through premium in size, with smaller-cap companies traditionally outperforming, value, with stocks with lower valuations traditionally outperforming, and low-volatility investments.
Describing the specifics of WRS’ final strategic allocation, the paper by MSCI’s Subramanian continued: “This allocation provided a strategic overweight of approximately 10% to global small caps (size risk premium) in addition to capturing the core global equity risk premium. They also elected to make two strategic allocations—each of 15%—to portfolios that passively tracked the MSCI ACWI Value Weighted and MSCI ACWI Risk Weighted Indices. The two portfolios aimed to capture the value and low volatility risk premia, respectively. By design, these two portfolios were tilted towards lower capitalization stocks, which led to approximately equal allocations to the size, value and low volatility risk premia in the overall strategic equity allocation.”
Following WRS’s decision to seek MSCI’s mandate, Taiwan Labor Pension Fund (LPF), the largest pension plan in Taiwan with assets totaling over $43 billion, chose MSCI in May as the benchmark provider for its new passively managed Global Minimum Volatility Equity Indexation portfolios totaling $1.5 billion.
Will other passive mandates such as MSCI’s become more commonplace as the reality sinks in among schemes that skill in active management may be similar to a diamond in the rough? Straayer noted that other schemes may follow in this Wyoming scheme’s footsteps as it becomes increasingly difficult to add active alpha over the long-term. “We continue to question the traditional sources of alpha,” Straayer said.
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