Asset Allocation Like The Pension Funds

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On today's show we are talking about how pension funds manage asset allocation and whether individual investors can learn anything from mirroring what the world’s most professional money managers do.

Pension funds are the bedrock of retirement security for millions worldwide. Their primary mission is to ensure that future liabilities the pension payments promised to retirees can be met. Achieving this delicate balance between growth and stability hinges critically on their asset allocation decisions. 

So the obvious question for each of us as investors is, what is our ideal asset allocation? Do you think of it consciously?

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Episode Transcript

(00:01):
Welcome to the Real Estate Espresso podcast, your morning
shot of what's new in the world of real estate investing.
I'm your host, Victor Minash. On today's show, we're talking
about how pension funds manage asset allocation.
But first, at my development company, Y St.
Capital, we have a number of development projects in the
storage and light industrial arena.
Our storage fund is a great way to gain exposure to a breadth of

(00:24):
projects in the storage space that touch on several segments
of storage, including retail storage, industrial storage, and
boat and RV storage. As of today, these assets are
geographically diversified across 3 states with more being
added all the time. To find out more, visit
whystcapital.com and register for our Investor Portal now.
This is not a solicitation. Any investment would be by

(00:46):
prospectus only for accredited investors residing in the US in
compliance with US SEC regulations.
On today's show, we're talking about how pension funds manage
asset allocation, whether individual investors can learn
anything from mirroring what professional money managers do.
Pension funds are the bedrock ofretirement security for millions
of people worldwide. Their primary mission is to

(01:07):
ensure that future liabilities, those pension payments, can in
fact be met. Achieving the balance between
growth and stability hinges critically on asset allocation
decisions. These aren't simple choices.
They involve complex financial modeling and a deep
understanding of the market dynamics with a keen eye on long
term obligations. Market volatility in each sector

(01:28):
means that diversification is one of the keys to risk
mitigation. Now, unlike individual investors
who might focus on just say, maximizing personal wealth,
pension funds operate under a fiduciary duty to pay out
defined benefits, often for decades to come.
That longer term view is both a blessing and a curse.
It allows for investments in less liquid, higher returning

(01:48):
assets, but also exposes the fund to prolonged periods of
market volatility. It actually doesn't matter
whether we're talking about a defined benefit or defined
contribution. Pension plan principles are the
same, even if the details are going to be a little bit
different. Pension funds typically have a
long investment horizon, often spanning 3050 years or maybe
more. That allows them to stomach

(02:08):
short term market fluctuations and pursue illiquid higher
return strategies that might notnecessarily be suitable for
individual investors that have ashorter time frame.
One of the key questions is the funded status, the ratio of
assets to liabilities, and that's a critical metric.
A well funded plan may have moreleeway to take on risk, while an
underfunded plan might need to prioritize higher returns to

(02:31):
close the gap, potentially leading to more aggressive asset
allocation or perhaps increased contributions in order to
preserve cash. When interest rates were near
record lows for nearly a decade,we saw some pension plans make a
more aggressive investment in search of higher yield.
And when it comes to risk, professional money managers
don't discount the possibility of a market downturn.

(02:52):
It is expected. It involves assessing the
potential impact of market downturns on the plans ability
to meet its obligations, both inthe short term and in the long
term. Pension liabilities are
sensitive to changes in interestrate and changes in inflation.
The asset allocation has to consider how different asset
classes perform under different scenarios to hedge against those

(03:13):
risks. For example, long duration bonds
are often used to match interestrate sensitivity for some of
those long term liabilities. Now when we invest as investors,
we're not just putting money into new investments.
There has to be a pathway for money to go in and for money to
come out eventually. That's the goal, after all, has
to be forward-looking. So the pension fund managers use
the asset liability study to figure out what they can invest

(03:35):
in long term, when the money needs to come out, and so on in
order to make those risk decisions.
Based on that, they put togethertheir bedrock portfolio,
defining the target percentages for different asset classes,
what percentage goes into publicequities, how much in fixed
income, how much in private equity, what percentage in real
estate, infrastructure, cash andso on.
The allocation is designed to achieve the funds objectives

(03:58):
over the long term, and it's typically reviewed and adjusted
periodically as market conditions, as regulations, and
as liability profiles change. Core principle of the asset
allocation is diversification both across and within asset
classes. That means investing in a broad
range of assets domestically, internationally, maybe
government and corporate bonds, perhaps private equity, real

(04:19):
estate, infrastructure, and so on.
The goal is to minimize the impact of a single asset class
performing poorly. When you actually look at what
the pension funds are doing, they have a very large
percentage in this category called alternative investments
that increasingly includes private equity, real estate,
infrastructure and hedge funds. These segments offer

(04:40):
diversification benefits, potentially higher returns and a
hedge against inflation, but they're usually less liquid and
they come with higher fees. So let's look at a few of the
large pension funds out there. We're going to start with
CalPERS. This is the California Public
Employees Retirement System. As of June 30th last year,
CalPERS had a policy target asset allocation with 40% in

(05:03):
public equities, basically stocks, 29% in fixed income, 15%
in private equity, 15% in real assets and 3 1/2% in private
debt. Now it's worth noting the
CalPERS has been aggressively reshaping its private equity
exposure and it's on track to increase its total private asset
allocation to 40% of the plan assets, private equity

(05:24):
specifically increasing to a target of 17% and private debt
to 8%. The Washington State Investment
Board as of March 31st this yearhad 26.35% in public equity, 29%
in private equity, 19% in real estate, 17% in fixed income, 7%
in tangible assets. These are things like

(05:46):
commodities, 1% in an innovationportfolio and almost 0 in cash.
Then there's the California State Teachers Retirement
System. They have 38% in public
equities, 14% in private equity,15% in real estate, 7% in
something called inflation sensitive, I don't know what
that is, and 10% in risk mitigation strategies, 14% in

(06:10):
fixed income and only 2% in cash.
So the obvious question for eachof us as investors, what is our
ideal asset allocation? Do you have an asset allocation
that you think of as being idealfor you?
What is it? Do you think of it consciously
and does it drive your investment decisions?
And if your own ortfolio is out of balance, how would you change

(06:31):
it and over what time frame? As you think about that, have an
awesome rest of your day. Go make some great things happen
and we'll talk to you again tomorrow.