Why Wyoming's Pension System Lost Faith in Alpha

Jeffrey Straayer, a Senior Investment Officer at the $6.5 billion Wyoming Retirement System (WRS), says that the scheme's embrace of MSCI's risk-weighted index reflects an overall skepticism of active management and a propensity toward passive.

(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.

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“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.

Related article: What Keeps Wyoming’s Pension CIO Up at Night?

(May 22, 2012) — The International Monetary Fund (IMF) has asked the United Kingdom to consider a further wave of Quantitative Easing (QE) to help to continue stabilising the economy, as institutional investors struggle with negative real yields and burgeoning deficits.

QE, the process of issuing government debt only for it to be bought back by the Bank of England, has helped liquidity in the financial sector but has been vilified by some due to it pushing down the yields on these bonds. Gilts are a staple for most pension funds in the UK as they are used to measure liabilities and are yielding far less than inflation, which was reported today at 3%.

Today, in the IMF’s Article IV Consultation Concluding Statement of the Mission on the UK economy, it stated: “Anaemic nominal wage growth and broadly stable inflation expectations suggest underlying inflationary pressure is weak, providing space for greater monetary easing.”

The statement continued: “Evidence suggests that QE can continue to support demand by lowering long-term interest rates and improving banks’ liquidity.”

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However, some in the pensions industry have warned this could prove even more harmful than the previous QE actions.

Joanne Segars, Chief Executive of the National Association of Pension Funds (NAPF), said: “If there is to be more QE then the government needs to do more thinking about the impact on pension funds. QE has driven pension funds further into the red and leaves those trying to buy an annuity with a worse deal, which they are then locked into for life.”

Last year, de-risking specialist Pension Corporation’s Co-Head of Asset-Liability Management Mark Gull said QE had carried out a ‘double whammy’ on pension funds.

By September, Gull estimated that the first round of QE had wiped increased funding deficits owned by UK pension funds by £74 billion and as most companies operating these funds were not large enough to tap capital markets, they could not take advantage of low interest rates on offer.

Segars at the NAPF said: “We are being told it will all be worth it in the long-run, but in the short-run pension funds and pensioners are being left to deal with the pain. They need, and deserve, much more support.”

In its report, the IMF praised the UK government’s actions to so far stabilise the country’s economy and help build the financial sector – one of its major revenue drivers – and started to reduce its deficit. However, the IMF criticised that as a result of this action the overall growth had been flat and it added that this performance was likely to remain in a similar state until at least the end of the year, despite the country’s recovery looking set to speed up.