Pennsylvania SERS Sees Gain from Rebalancing

By David G. Barry

Timing is everything.

If you don’t think so, just ask James Nolan, chief investment officer of the Pennsylvania State Employees’ Retirement System (SERS). He recently saw the $35 billion pension system register an unexpected gain while rebalancing a portion of its portfolio – a situation that more institutions are finding themselves in or may face because of the decline in stocks.

Specifically, after altering its asset allocation mix, SERS found its largest investment segment – U.S. Large Cap stocks – at 22.8%, or more than 5% below its 28% target. To get closer to that target, the pension fund transferred $1.5 billion to a large cap index fund, $1.12 billion of that amount coming from three of its small-cap index funds and the remaining $375 million from its cash reserves.

What made the transaction noteworthy is that SERS invested the capital in the index fund in late May on what proved to be a bad day for stocks. So bad, in fact, that by the time Nolan appeared before the SERS’ investment committee on June 3, the market, he said, had gone up by 7% – giving the $1.5 billion investment a gain. Just how much was not clarified by Nolan at the meeting or by a spokesperson contacted by Markets Group.

“It’s nice to have but it’s not something you can plan for,” said Nolan.

Indeed, generating short-term gains is clearly not the hope of those rebalancing portfolios. In fact, for many institutional investors, rebalancing portfolios has become a challenge – thanks to the unfortunate oddity of both stocks and bonds going down.

Jay Kloepfer, an executive vice president with Callan and co-head of the firm’s Capital Markets Research Group, said there’s normally a “flow from one asset class to the other” but with both stocks and bonds down, the institutional investment consulting firm is hearing from clients that “we don’t have the normal flows.” Kloepfer said that in general, most institutions aren’t that far from their targets so there is no pressure per se to sell off bonds or utilize cash to get equity levels back to where they should be.
That being said, some institutional investors have plowed ahead or are taking steps to bring their equity allocations in line with their targets.

The Illinois State Universities Retirement System (SURS), for example, found the equities portion of its portfolio underweight versus its policy target. As a result, the system’s cash overlay manager increased its exposure in the segment by purchasing $480 million in global equity futures in mid-May.
Another fund, The Public School and Education Employee Retirement Systems of Missouri (PSRS/PEERS), has during the fiscal 2021-22 year rebalanced its equities portfolio 17 times. Eleven of those events occurred between August and November 2021 – when the stock market was surging. The systems removed exposure totaling approximately $815 million, according to a presentation made by CIO Craig Husting.

However, as the stock market fell, PSRS/PEERS between the end of February and the end of May made six moves to add “exposure” totaling $400 million. This capital came primarily from utilizing U.S. equities and derivates because of trading costs, Husting said.

In remarks during Alaska Permanent Fund Corp.’s May meeting, CIO Marcus Frampton said that he and his team are continuing to rebalance the fund’s portfolio but are doing so “less” and “in different ways.” At the time of that meeting, APFC was underweight by 4.5% to public stocks while overweight 4.5% on private equity – a situation that Frampton descripted as a “neutral equity risk.”

The fact that bonds are also down has investors like APFC looking at alternatives. Frampton told his board that he is looking to other areas of its portfolio, especially since more than half the fund’s assets could be liquidated in a “couple of days.” It, for instance, in May put $300 million from its Risk Parity managers toward rebalancing. It also took advantage of the market being up by 2% one day in May to execute trades aimed at rebalancing its public portfolio.

But the key question, said Frampton, is “rebalance to what?” He said that instead of rebalancing a target asset class he is focused on rebalancing the sum of the private and public equities target verse their aggregate target.

Such moves explain why JPMorgan Chase & Co. recently projected that pension funds, sovereign wealth and balanced mutual funds will have shifted some $250 billion from bonds to stocks by the end of this month to reach their appropriate equities target. Pension plans would account for $167 billion of that, according to JPMorgan. As a result of this projected activity, the bank is projecting that stocks could increase 10% by the end of the month.

In a paper on rebalancing, Meketa Investment Group said investors can utilize one of three strategies to rebalance: directing necessary cash flows, using index funds and shifting actively managed assets. The key, said the investment advisory and consulting firm, is how much institutions wish to put out in transaction costs.

In looking at investors’ actions between January 1979 and March 2018, Meketa found that those who were active in rebalancing their portfolios had better returns than those used a “buy-and-hold” approach. The ones who did the best were those who did rebalancing on an annual basis rather than on a monthly basis, the firm said.