Tag: asset allocation

Deep Learning for Liability-Driven Investment

Mary Pat Campbell

Link: https://www.soa.org/sections/investment/investment-newsletter/2022/february/rr-2022-02-shang/

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This article summarizes key points from the recently published research paper “Deep Learning for Liability-Driven Investment,” which was sponsored by the Committee on Finance Research of the Society of Actuaries. The paper applies reinforcement learning and deep learning techniques to liability-driven investment (LDI). The full paper is available at https://www.soa.org/globalassets/assets/files/resources/research-report/2021/liability-driven-investment.pdf.

LDI is a key investment approach adopted by insurance companies and defined benefit (DB) pension funds. However, the complex structure of the liability portfolio and the volatile nature of capital markets make strategic asset allocation very challenging. On one hand, the optimization of a dynamic asset allocation strategy is difficult to achieve with dynamic programming, whose assumption as to liability evolution is often too simplified. On the other hand, using a grid-searching approach to find the best asset allocation or path to such an allocation is too computationally intensive, even if one restricts the choices to just a few asset classes.

Artificial intelligence is a promising approach for addressing these challenges. Using deep learning models and reinforcement learning (RL) to construct a framework for learning the optimal dynamic strategic asset allocation plan for LDI, one can design a stochastic experimental framework of the economic system as shown in Figure 1. In this framework, the program can identify appropriate strategy candidates by testing varying asset allocation strategies over time.

Author(s): Kailan Shang

Publication Date: February 2022

Publication Site: Risks & Rewards, SOA

Wrong Way CalPERS: Dumping $6 Billion of Private Equity After Struggling to Put Money to Work and Then Increasing Target

Mary Pat Campbell

Link: https://www.nakedcapitalism.com/2022/01/wrong-way-calpers-dumping-6-billion-of-private-equity-after-struggling-to-put-money-to-work-and-then-increasing-target.html

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When CalPERS does something as obviously nonsensical as planning to dump $6 billion of its private equity holdings, nearly 13% of its $47.7 billon portfolio, when it just committed to increasing its private equity book from 8% to 13%, it’s a hard call: Incompetent? Corrupt? Addled by the latest fads (a subset of incompetent)?

And rest assured, the harder you look, the more it becomes apparent that this scheme is as hare-brained as it appears at the 30,000 foot level. But unlike another recent hare-brained private equity scheme, its “private equity new business model,” beneficiaries won’t have the good luck of having it collapse under its own contradictions. CalPERS has loudly announced that Jeffries & Co. will be handling these dispositions, so they will get done….at least in part. But the fact that CalPERS’ staff has gone ahead and merely informed the board, as opposed to getting its approval, is yet another proof of how the board has abdicated its oversight and control by granting unconscionably permissive “delegated authority” to staff.

The one bit of possible upside would not just be unintended, but the result of CalPERS acting in contradiction to its expressed objectives: that its allocation to private equity would undershoot its targets by an even bigger margin than otherwise.

Author(s): Yves Smith

Publication Date: 14 Jan 2022

Publication Site: naked capitalism

Newly Flush With Cash, Retirement Funds Struggle to Find Appealing Investments

Mary Pat Campbell

Link:https://www.wsj.com/articles/newly-flush-with-cash-retirement-funds-struggle-to-find-appealing-investments-11636293602?mod=e2tw

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California transferred an extra $2.31 billion to its teachers’ and public workers’ pension funds after stock gains and the economic recovery bolstered income tax collections, according to budget documents. Connecticut Treasurer Shawn Wooden is transferring an additional $1.62 billion to that state’s teachers’ and workers’ pension funds in accordance with a mandate that excess revenue be used to pay down debt.

This year New Jersey is making the full pension payment recommended by its actuaries for the first time since 1996, plus an extra half-billion dollars, funneling a total of $6.9 billion to the state’s deeply underfunded retirement plan, the New Jersey treasurer’s office said.

Asked how the money would be used, a spokeswoman for the state’s division of investment said it “will continue to move forward toward the previously established allocation targets.” The $101 billion fund’s private equity, private credit, real estate and real assets portfolios each contained between $1 billion and $3 billion less than the goal amount as of Aug. 31, records show.

Author(s): Heather Gillers

Publication Date: 7 Nov 2021

Publication Site: Wall Street Journal

Insurance Companies and the Growth of Corporate Loan Securitization

Mary Pat Campbell

Link:https://libertystreeteconomics.newyorkfed.org/2021/10/insurance-companies-and-the-growth-of-corporate-loan-securitization/

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The rating-based mapping was partially altered in 2010, when the NAIC enacted a regulatory change that essentially allowed insurance companies to report CLO tranches that were purchased at a discount, or highly impaired, in a lower NAIC category than that implied by the rating-based mapping. The new capital regime for CLO investments likely increased insurance companies’ incentives to invest in higher-yielding CLO tranches.

The following chart presents some evidence consistent with reach-for-yield behavior, particularly since the regulatory reforms of 2010. The left panel shows the time series of insurers’ new CLO holdings falling into the NAIC 1 designation as a percentage of the total volume outstanding of these tranches based on percentiles of the distribution of CLOs yields for each year. As expected, there is a clear preference for the riskiest tranches within NAIC 1 (those with yields above the 66th percentile) throughout the sample period, with the exception of the financial crisis, when all yields are squeezed at their minimum levels. Interestingly, the market shares of CLO tranches with yields above the 33rd percentile experience a sharp increase in the two years following the 2010 regulatory reform, then register a significant drop in 2019, when the reform was repealed. We do not find similar evidence in insurance companies’ corporate bond investments (right panel).

Author(s): Fulvia Fringuellotti, João A. C. Santos

Publication Date: 13 Oct 2021

Publication Site: Federal Reserve Bank of New York

Dream Big — KKR Insights, Global Macro Trends

Mary Pat Campbell

Link: https://www.kkr.com/sites/default/files/Dream_Big_20211006.pdf

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To compensate for the ongoing pressure on interest rates,
CIOs participating in our survey have made substantive,
structural shifts in their asset allocations. Why did they
make this transition? We believe that CIOs are embracing
complexity and the thoughtful use of illiquidity, as public
market assets roll off and excess cash builds up. Improved
asset-liability matching and more robust risk management
have also helped, we believe. Reflective of these shifts,
non-traditional investments, including Real Estate Credit
and Structured Credit, collectively experienced almost a
1,200 basis point increase in market share. As a result, total

non-traditional investments now account for 31.8% of total
portfolios surveyed, compared to 20.3% in 2017. As we
detail below and in Exhibit 21, our work shows that 100%
of the gain came at the expense of traditional public credit,
which fell to 48.5% of portfolios surveyed, compared to
60.7% in 2017. Meanwhile, the allocation to Liquid Equities
(predominantly by Property & Casualty and Reinsurers that
typically favor Public Equities for liquidity) slipped to 5.5%
from 9.1% over the same period. Cash as a percentage of
assets is now at 4.9%, which is almost double the level
it was the last time we did the survey. See below for full
details on this increase but we think high cash balances
are fueling thoughtful moves into longer duration assets.
However, there is obviously more work to be done, as the
supply of yielding, long-term assets remains limited.

Author(s): KKR

Publication Date:

Publication Site: KKR Global Institute

Johnson and Sunak urge UK pensions to back riskier investments

Mary Pat Campbell

Link: https://www.theguardian.com/business/2021/aug/04/johnson-and-sunak-urge-uk-pensions-to-back-riskier-investments

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Boris Johnson and Rishi Sunak will urge UK pension schemes to back Britain’s “entrepreneurial spirit” with billions of pounds of savers’ funds to fuel the economy’s post-pandemic recovery in a message to investment bosses.

The prime minister and chancellor will issue a joint call to action on Thursday aimed at “igniting an investment big bang” that would “unlock the hundreds of billions of pounds sitting in UK institutions”.

Citing the success of long-term investment programmes by Australian and Canadian pension schemes, Sunak and Johnson will say that British pensioners are missing out on “better retirements” after investors focused too heavily on the returns from stock market listed companies.

…..

Critics warned that pension schemes would become riskier and more expensive to run and accused the prime minister of failing to understand how they worked.

John Ralfe, an independent pensions consultant, said: “This is 90% hot air from the prime minister.

“Defined benefit pension schemes need assets that generate a guaranteed inflation linked return to pay guaranteed pensions. Most of the things the PM is banging the drum for don’t do this.

Author(s): Phillip Inman

Publication Date: 4 Aug 2021

Publication Site: The Guardian UK

Public Pension Plans Are Thirsty for Liquidity

Mary Pat Campbell

Link: https://www.plansponsor.com/public-pension-plans-thirsty-liquidity/

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Chicago’s municipal pension plan recently redeemed $50 million from a large-cap equity fund. Seems like a non-event. Happens all the time. But the reason the pension plan did so is chilling: It was done specifically in order to make pension benefit payments. This should be a cautionary flag to underfunded pensions and to the state and municipal governments that sponsor them.

….

First, when pensions are underfunded they have a tendency (or need) to take on more risk in order to try to generate higher returns.

For example, underfunded pension plans are increasing their allocations to private equity. Nothing wrong with that. But that means more of the portfolio is illiquid. It would be very unlikely that private equity positions would be sold to “make payroll,” specifically because they are so illiquid. But this leaves fewer assets that are liquid enough to be sold, and that increases the pressure on those liquid assets to be sold at a decent price. Moreover, if the plan has significant assets in liquid securities, such as large-cap equities or Treasurys, those assets can easily be sold, but then the portfolio will be out of balance and will require additional trading and rebalancing anyway.

Secondly, the pension plan must keep more cash on hand than it otherwise would. If your policy portfolio calls for a 3% allocation to cash, that is designed for diversification and dry powder. But a pension plan sponsor should be providing significant amounts of cash into the pension each year. If the sponsor is not making its contributions, then the pension plan has to carry more cash than it otherwise would.

Author(s): Charles Millard

Publication Date: 7 April 2021

Publication Site: Plansponsor

KRS APPROVES NEW INVESTMENTS

Mary Pat Campbell
KRS Approves New Investments

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The Kentucky Retirement Systems (KRS) Board of Trustees held a special meeting Thursday morning to approve more than $170 million in investments. The move comes just one week before a new County Employees Retirement System (CERS) Board of Trustees takes control of the local pension system and its investments; the timing was not lost on several board members who questioned why they needed to act before the April 1 separation. CERS elected representative Betty Pendergrass pointed out that a majority of the money being allocated was CERS funds, which account for 76% of KRS pension assets.

Publication Date: 25 March 2021

Publication Site: KLC City Limit

The Relationship Between Public Pension Investments and Declining Bond Yields

Mary Pat Campbell
The Relationship Between Public Pension Investments and Declining Bond Yields

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The visualizations display how private equity investments have grown in popularity. Private equity allocations are now the third-largest asset class for public pension plans, growing from 3.62 of nationwide plan portfolios in 2001 to 9.15 percent in 2019.

Portfolio managers should be free to pursue whatever investment philosophies they believe are in the best long-run interests of their plan members. However, policymakers, pension plan members, and taxpayers should be aware of these trends and the risks that come with them. Pension systems and lawmakers need to address the growing risk of volatility in ways that maintain a plan’s resiliency to unpredictable market factors. Also, plan stakeholders should be wary of a situation where the tail wags the dog—with pension systems swapping safety for risk and volatility as they chase outdated and overly optimistic investment return assumptions.

Author(s): Jordan Campbell

Publication Date: 25 February 2021

Publication Site: Reason