May 27, 2021

How Allocators Are Honing Asset Strategies, Amid a Problematical Future

Many institutional investors have positioned their funds to generate returns, while others are girding for further volatility.

Reported by Sarah Min

Art by James Yang

By and large, allocators across the board have recovered nicely from last year’s market sell-off and are getting ready for a post-pandemic world where higher interest rates and other headwinds may roil progress.

How they met 2020’s challenges is instructive. What looked to be a year of double-digit losses for many asset owners in March 2020 eventually gave way to small gains by June. By the end of last year, as some parts of the economy recovered, the equity markets came roaring back, with the S&P 500 gaining 16.26% for the entire year.

Of course, there has been little opportunity in 2021 for asset owners to rest easy. The frothiness of the markets, helped by a growing influx of retail investors, remains concerning for many allocators awaiting another possible drop-off. Investors are scrutinizing the Federal Reserve for signals on interest rate hikes. Meanwhile, analysts are parsing through economic indicators for possible indications of inflation.

Many institutional investors can point to clever investment strategies that helped them net some stellar returns. Others are less concentrated on running up hot performances than on positioning their portfolios for further volatility.

Here is a cross-section of returns from asset owners:

Spreading higher-conviction bets across fewer asset managers helped the James Irvine Foundation outperform last calendar year. In 2016, when its investment chief, Tim Recker, first joined the fund, he organized an exit from about a quarter of the portfolio’s outside manager base over the following two years.

Altogether, the foundation employs just 25 asset managers to invest about 85% of its assets. Such a short list is a rarity among investors who may be wary of the risk that comes with spreading their bets across so few managers, especially what it may mean for their jobs should those investments not pan out. Other endowments and foundations can easily retain up to 60 to 100 asset managers.

Recker has instead deployed more money to the fund’s highest conviction ideas. In the first year of his tenure, energy was tossed from the portfolio, accounting now for about 30 or 40 basis points (bps), down from about 6% in 2016. The fund took a decades-long outlook and allocated more money to its hedge fund and venture capital strategies.

“We generally lean toward the world economy and disruption,” Recker said. “We want to own the portfolio of tomorrow, not the portfolio of yesterday.”

In 2020, those changes have helped the $2.4 billion endowment gain up to 30.8% for the calendar year, placing the fund in the top decile of foundations in performance terms. It’s also not an anomaly. Over the past three years, the portfolio has returned 17% on an annualized basis.

“To a large degree, we’re very fortunate that pretty much everything that could go right has been going right and I want to acknowledge that,” Recker said.

Among the factors that helped was asset allocation. The foundation generally keeps four asset classes in its portfolio—public equities, private investments, a multi-strategy portfolio, and fixed income—with a roughly 30-30-30-10 allocation for each class.

A strong governance structure at the foundation was also key in helping the investment team focus on investing the portfolio. Recker said he takes the time to communicate his process at length with his investment committee.

“I had a great opportunity to articulate to the committee what we’re doing, why we’re doing it, how decisions are made, and whether we’re making the right decisions,” Recker said. “And I try to get them to focus on measuring decision-making, not performance.”

Other asset allocators have also been boasting strong recent returns. In its most recent fiscal year ending in March, the Canada Pension Plan Investment Board (CPPIB) netted a record 20.4% gain, thanks to outperformance across all six of its asset categories. The previous year, the $413.2 billion pension fund had returned just 3.1%.

Energy and resources, Canadian public equities, and emerging private equities netted the pension fund its highest gains, with 45.8%, 40.8%, and 38.5%, respectively.

Over the same time period, the $254.8 billion New York State Common Retirement Fund posted the largest one-year return in its history with 33.55% for the fiscal year ending March 31. That’s much higher than its annual target rate, which is just 6.8%. Domestic equities, global equities, and non-US equities gave the fund its highest returns.

Still, the pension fund’s comptroller warned that the record gain “comes with a caution,” given how volatile markets remain. “I will continue to manage our state’s pension fund with prudence and a focus on stable, long-term results,” New York State Comptroller Thomas P. DiNapoli said.

New York is not alone among state retirement programs in running up double-digit increases. North Carolina’s state pension fund, for instance, returned 11% for 2020.

Allocators are also positioning their portfolios for further volatility. At the New Mexico State Investment Council (NMSIC), investment chief Robert “Vince” Smith runs a more diversified portfolio than most public funds. Since the chief investment officer arrived at the sovereign wealth fund in 2010, he and his team have built up the portfolio’s alternative asset allocation. The real assets segment is up to 10% of the total from zero, with a target of 12%. The real estate portfolio is up to a 12% allocation, from 3% a decade ago.

That has built a portfolio that can weather volatility. Most of the time, the flagship Land Grant portfolios in the $32 billion total fund outperform the median “by a little bit” and deliver in the second quartile in terms of performance against a peer group of pension funds, he said.

“We generally outperform the median in normal markets, and it takes kind of an extreme move, a big move in stocks moving up or down to shut us out,” Smith said.