OCIO Roundtable (Part 1): Portfolio Rebalancing During COVID-19 Mayhem

Biagio Manieri, Managing Director and Global Chief Investment Strategist, PFM Asset Management: The way we think about it, there’s a number of different approaches that you can take. I think not one approach is best for everybody. It’s what you’re comfortable with. You probably should have some rebounds and policy as opposed to doing absolutely nothing and letting the portfolio drift, but if you’re going to have some policy, what we typically see is a policy that’s either based on the calendar so they’re rebalanced at the end of the quarter or the end of the year, or based on certain triggers. So, if your strategic allocation is ‘x’, you would let it rise to ‘y’, let it fall to some level, and then you automatically rebalance. That’s better than doing nothing. The way I think about it, it’s better than doing nothing but it’s not the best way.

We tactically allocate based on our views of the economy and based on our views of the market. So, we do fundamental analysis: What is happening in the economy? What’s happening with monetary policy? What are the fundamentals of different asset classes? And based on that view, we then adjust the weights. We don’t automatically rebalance back to some target because a particular asset class has risen from our tactical target. We’re always asking the question, can this asset continue to appreciate because the fundamentals are getting better or if we’re on the weight or out of an asset class, do we want to go in or not if the fundamentals continue to deteriorate?

In the current environment, we have been more active than typically. So, typically we make five or six tactical decisions in a given year, so not trying to day trade, but we have been a lot more tactical this year given that the situation that we face, which is unprecedented—I’m not the first to say that—and given the volatility, so, in mid- to late February, we cut equities, for example. We cut equities, credit dramatically, and then we added back some to the rest of the portfolio, then we took some profit.
We have made a number of different decisions over the past few months, which is a lot more active than we typically do, but the way we think about it is we don’t want to rebalance just because it’s the end of the quarter, we don’t want to rebalance just because equities are up 10% or down 10%. We want to assess what’s going on in the economy, what’s going on with capital markets and, based on the news, are we happy with the portfolio the way it’s positioned? If not, what changes do we want to implement?

Sona Menon, Head of the North American Pension Practice, Cambridge Associates: To answer your first question, no, we don’t have an automatic rebalancing approach, although we do believe that having rebalancing framework is important for our clients. I’ll also say, because we serve institutional clients that are very different—we have health care organizations, corporate pension plans, endowments, etc.—that we really tie the rebalancing first and foremost to the specific institution’s liquidity needs. For example, a hospital may be suffering at this point in time, given the health crisis, with respect to cash flow needs. We take that very much into consideration before rebalancing. The decision is not made in a vacuum. We also want to make sure we’re mindful of other spending that’s going to be happening or private investment capital calls.

After that, we do agree that once equities or credit sells off to a certain magnitude, it is important to rebalance, because you’ve become quite misaligned and you also miss upswings very much, in the way that we had in March where we had huge sell-off days and we had huge recovery days. So, given the magnitude of sell-off we saw after mid-March, we did start buying equities and also buying credit because the spreads had blown out, but I would say that we did not get to target and that was very deliberate because the crisis seems to still be unveiling as well as the economic impact is unclear. So, I would say we inched towards our targets, but did not get there.

Stan Mavromates, Partner and Americas CIO, Mercer: I think this is an obvious point: Each market crisis is unique. I think this one is very unique [with] the velocity and the speed by which it impacted financial assets and organizations. And I think because of that, you have to appreciate the value of what I would characterize of an enhanced governance structure, which we promote. I’m responsible for the OCIO and we run quite a few different asset pools. Enhanced governance to us and what we practice is preparing before the storm, during the storm, and after the storm, and that basically tells you that you have to have a plan and experience matters.

So in this particular situation, the first couple of weeks, let’s say March 9, the infamous Monday after the Sunday of the Saudi Arabia and Russian oil event, it was really volatile that week. So, you had to look at the landscape of the say defined benefit plan: the trading cost to rebalance for credit was exorbitant, probably 140 basis points [bps]. We try to go halfway back, but we also want to examine the cost involved in that. So, we didn’t get all the way back at the beginning, as Sona said. I think that’s similar. But then once the Fed stepped in, liquidity got a little better, the trading costs went down. We’re almost back to target because the investment policy statements [IPS] we follow very closely and that extracts the emotional component of it. That’s why you have a battle plan.

I think also because we have various asset pools—that was a particular example of defined benefit that are very much focused on their value at risk to their funding ratio and things of this nature. So we let that run a little long in equities. We’ll rebalance into equities but not to the full target. Not-for-profit: we go right back to target. Defined contribution is a pretty much an auto-pilot type of thing between the target-date fund [TDF] and the frequency of rebalancing, and we focus basically on the outcomes of our clients, on what their objective is, which I think is similar to what Sona and others have already said.

Opportunities now: obviously credit, high yield. The surprise last week was the Fed stepped in to back credit which they’ve never done in the history ‘of ever.’ It moved 6% in a day after spreads rose the fastest in history. So, there’s an opportunity there. We are cautious about downgrades but that also breeds opportunity for investors that have a longer time horizon and perhaps want to wait it out.

Heather Myers, Partner, Nonprofit Practice Leader, Aon: I’ll just make a couple really quick comments since most of it has been covered. So yes, just focusing on rebalancing, yes, we have policies on rebalancing (and I’m talking about our US portfolios as opposed to portfolios managed in other domiciles that we have). So we have balancing ranges. It’s already been raised. We thought about it, depending on DB versus nonprofit within nonprofit health care. All the different asset owner types have different targets and different considerations, so there are different recommendations for those. But, yes, in general, we’re rebalancing.

Back within policy, a point was raised that I agree with: We’re not selling clients to get back to target. We were not taking our OCIO clients back to target. Another point that was raised was how illiquid the markets were at the time and how challenging it was, especially a few weeks ago. So we’re very cognizant of that. And now with equities coming back, we’re not telling our clients to overweight equity, so again you want to be within policy but not overweight. So rebalancing has been very important and something we’ve been actively doing. We actively do anyhow, but given the volatility of the market, it’s been something very present in our discussions over the last seven weeks.

Jon Pliner, Senior Director, Investments – Head of Delegated Portfolio Management, US, Willis Towers Watson: Just to echo, not to repeat what’s been said because I would agree by and large with pieces of what everybody said. We have overbalancing framework. We don’t mechanically rebalance at any point in time back to targets, and similar to Biagio, we will have dynamic positions around the absolute strategic asset allocation targets. So one of the things that Stan said which I think is very important is having a plan, and we have been a little bit underweight risk for some time but one of the key components of that is having a plan to re-risk back towards our neutral risk level knowing and having a plan as to when to rebalance back or start buying back into risk. With that it’s not steadfast but it’s having a framework to do so, so that you can take some of the emotion out of buying back in while things are so volatile.

With that in mind, we did rebalance some in the middle of March back towards our risk assets, but given the price of those transactions, given the volatility on seeing the swings, with things moving so quickly, there is no way to actually get back to a specific target. Everything was an estimate because things were moving so quickly. So it was really more of a framework of getting back towards a risk position that you’re comfortable with given your overall views of the markets and the economies more broadly.

Mavromates: It depends on the type of plan. Obviously, we have different asset pools. In defined benefit, we measure the success on the increase or decrease and the deterioration of the funding ratio. So, if you take the S&P 1500 in times of crisis, (the S&P 1500 is the 1,500 top companies with their funding ratios in their corporate pension plans,) if you take that, our strategies are designed to de-risk and do better than most. And in both crises in 2008 and now we are doing better than the overall 1500.

In other asset classes, with DC, it’s about the target-date fund versus the benchmark, individual options. With not-for-profit, it’s about preservation of capital and hitting their 5% bogey, plus 5% which is very difficult in this, so it’s allowing that institution to survive.

Manieri: How do we assess the value that we add? We do performance attribution on a regular basis and we report to clients. So, what did we add or subtract through our asset allocation decisions? If we’re overweight, underweight the asset classes, and then how did we do in picking managers (because we don’t buy individual securities ourselves.) We don’t buy Google or Microsoft. We do buy ETFs [exchange traded funds], (which are securities, but it’s a basket of securities.) We do asset allocation and manager selection. We do performance attribution, and we see what each decision added or subtracted. And then we have composites that are GIPS compliant. Every client has a benchmark and we’re able to show how we performed relative to that benchmark and, whether it’s regarding asset allocation or manager selection, what did each decision add or subtract? We do that on a regular basis and report that to clients.

Pliner: And I’d add one more piece to that. We’re doing attribution on a similar manner, but I think the first step of attribution is: What value has your strategic asset allocation added, and any diversification you’ve added in, beyond just a very simple long equities investment grade bond portfolio? That’s at the risk level you’re seeking to achieve. What did your asset allocation do relative to that, then, any dynamic positioning relative to that, and your manager selection? So it’s trying to parse out the different levels of decision-making that you have throughout the portfolio, construction portfolio management process and where are you adding value for clients ultimately to achieve their long-term objectives?

Myers: I think everything that’s been said is absolutely true. You want to look at how your portfolios—on both asset allocation and manager by manager—have they performed versus their benchmarks, and that’s an imperative. And then, again, based on the different types of asset pools, how are they relative to the needs of that pool. (So funded status for a DB plan, for instance.)

There are so many other ways that we are adding value at this point: We’ve produced over 45 documents. We’ve had multiple webinars. We have clients who are thinking a lot about liquidity. Yes, you went through the liquidity crisis during the financial crisis. We saw the issue of liquidity coming up now. And so, if you had planned well, or learned a lot from the global financial crisis, a lot of what you learned then is coming to bear now. How did you think about liquidity?

Yes, we’re in a different market today and there’s a heck of a lot more going on, but so much of the conversation reverts back to what we learned then and how to apply that today. I think Sona was the first to raise this earlier in the conversation, but for nonprofits, liquidity is a huge issue. And whether they have a liquidity credit line available or what other ways that they can tap liquidity right now? That is part of the value-added conversation that I think is happening. It’s way beyond just, ‘How am I performing?’ It‘s all the other things that we have to do to help these pools of capital.

Menon: And I would just build on what everyone has already said by saying that one of the ways that I think we get evaluated is whether, particularly in a crisis time, we‘re playing smart defense and smart offense. And by that, I mean: Have we protected the portfolio where we had intended to, through whatever asset classes we use, whether it‘s fixed income or hedge funds? And that‘s obviously going to be measured in the ways that were discussed. And then also: Are we priming the portfolio for opportunities as we see a dislocation in the market, whether that means risking up or looking at new strategies, or getting into managers or strategies that were previously closed. So that‘s where the sort of the smart offense would come in. But I think it‘s really the balance of both that people are looking to us to evaluate.

Biagio Manieri is a managing director and global chief multi-asset class strategist at PFM Asset Management, and he chairs the firm’s Investment Committee. He is responsible for the investment management of more than $20 billion in institutional assets. Prior to joining PFM Asset Management, he was the investment officer with the Federal Reserve overseeing the system’s pension plans.

Stan Mavromates is the Americas chief investment officer (CIO) for Mercer, where he is responsible for managing investment professionals in the United States and Canada overseeing over $100 billion in OCIO assets. He previously worked at the Massachusetts Pension Reserves Investment Trust Fund and for John Hancock Financial Services. He served in the U.S. Marine Corps and is a graduate of Bentley College’s MBA program and Northeastern University.

Sona Menon is the head of the North American Pension Practice and an OCIO at Cambridge Associates, a global investment firm, where she oversees investment portfolios for discretionary and nondiscretionary clients. She earned her master’s from Harvard Business School and her bachelor’s in government from Cornell University.

Heather Myers is a partner and nonprofit practice leader at Aon, where she is also chair of the U.S. Investment Committee. She joined Aon in 2016 after 27 years with Russell Investments and has been in investment industry for more than 30 years.

Jon Pliner is the US head of Delegated Portfolio Management for Willis Towers Watson. He has more than 15 years of investment industry experience and has been with Willis Towers Watson since 2004.