Risk mitigation strategies have provided an important performance seam at $95.7 billion New Jersey Investment Council, governor of the state’s main retirement plans. New Jersey’s allocation to hedge funds has mitigated the size of the drawdowns in public markets, committee members at the Trenton-based fund heard in a recent markets update.
New Jersey has an assumed rate of returnof 7.3 per cent, above the current 6.9 per cent median for US public pension funds. It also has one of the lowest funded ratios of US public pension funds, according to the latest research from New York based nonprofit Equitable Institute. In Fiscal year 2021 New Jersey returned 28.6 per cent net of fees.
Macro and systematic strategies have performed particularly well like short treasuries and long commodities (boosted by inflation and the impact of Russia’s invasion of Ukraine on commodities) while long US dollar and short equity strategies have also done well.
“All in all, hedge funds have fared better than in past dislocations like 2008 and at the beginning of COVID,” Daniel Stern, senior managing director at external asset manager Cliffwater told the New Jersey board. In 2019, New Jersey dropped the hedge fund share of the portfolio to 3 per cent from 6 per cent following a spate of enduring high fees and mediocre returns.
In a hybrid approach, New Jersey invests directly with hedge fund investment managers and in a number of fund of funds, seeking diversification and uncorrelated returns from the strategy during times of significant sell offs and unanticipated periods.
Charting the allocations recent success, Stern explained that last year, many hedge funds actively de-risked, selling off and reducing risk levels. The approach meant they were able to protect capital ahead of the 2022 sell off, and position for an inflationary period and one of rising rates.
New Jersey’s RMS portfolio took off once the Fed began hiking rates and yields began to rise – and equities and fixed income sold off, he said. The 3 per cent allocation to RMS – equivalent to around $2.7 billion – has put on $147 million.
Looking ahead, committee members heard that the outlook for hedge funds looks positive because of enduring uncertainty. Alpha opportunities will emerge if geopolitical uncertainty continues, while rising rates and divergent Central Bank policies could all contribute to higher levels of volatility and greater dispersion creating an environment where hedge funds typically thrive.
“We expect continued, above average alpha generation for hedge funds and a stronger performance than we’ve had in the previous five-year period, and this is reflected in your asset allocation,” said Stern.
Hedge funds and alternatives have been one of the few places to shelter in volatile markets.
Shoaib Khan, CIO, New Jersey Investment Council, told board members that public markets across the board are struggling. Equities across geographies and sectors, fixed income and real estate are all meaningfully down and providing few hiding places.
“Bonds have not proved to be the safety umbrella in this downturn,” he said, adding that losses in corporate credit and high yield fixed income have added to the sea of red.
New Jersey’s asset allocations are close to target for much of the portfolio. Unlike many institutional investors the pension funds allocation to private markets has not extended beyond its allowable range – yet. The only allocation that is over range is the cash equivalent, currently 9 per cent. Early in the year the fund reduced its exposure to equity and fixed income in favour of cash in a strategy that has pushed the allocation outside its range but is also providing protection in volatile markets and ensures dry powder on hand. The short duration allocation is also benefiting from a changing rate environment and earning a more positive return now than in recent years, he said.
The fund’s performance in public markets is in line with expectations, either aligned or better than benchmarks. However, the allocation to non-developed equities has underperformed the benchmark mostly since the portfolio tilts towards growth, and growth allocations have trailed value.
Khan, who joined New Jersey from Florida SBA and replaced former CIO Corey Amon towards the end of fiscal year 2021, said he is focused on the longer-term outlook; liquidity and the fund’s liabilities. He voiced confidence in the latest private market contributions providing some protection when performance numbers, which lag public markets, come in. Moreover, pockets of opportunity in some asset classes continue to exist like high yield, one area New Jersey is building the allocation.
New Jersey recently decided to increase its allocation to high yield from two to four per cent, paring back on the allocation to Treasuries and investment grade to make room. So far, the allocation stands at 3 per cent, a 100-basis point increase from the end of last year, but still frustratingly lower than planned.
Building the high yield allocation while also maintaining performance is challenging. Particularly given the inverted yield curve makes it difficult to judge if economies are going into, or in, recession. Moreover, high yield is illiquid and broker-dealer risk budgets are lower.
“They are not actively looking to provide balance sheet,” Kevin McGrath, credit trader and high yield portfolio manager for fund, told committee members. It has led to various approaches to try and build the allocation to add mass and size more quickly. For example, basket trades whereby investors trade 200-odd securities in one trade rather than individual bonds allow better execution and reduce transaction costs.
The committee heard how in the short-term high yield is attractive, with the opportunity to buy into aggressive dips. Red flags are starting to appear with stress and defaults rising as companies struggle to refinance their balance sheet.
The pension fund’s asset allocation is divided among five broad categories. According to the latest annual report the largest allocation was global growth (58.34%), which contains domestic equity, developed markets international equity, emerging markets equity and private equity. The income category (16.4 per cent) contains high-yield fixed income, private credit and investment-grade credit.
The defensive category (15.4 per cent) holds U.S. Treasuries, risk-mitigation strategies and cash equivalents, The real-return group (7.82 per cent) contains real assets and real estate. “Other” accounts for the remainder.
I am an expert in investment strategies and risk mitigation, with a deep understanding of financial markets. Over the years, I've closely monitored and analyzed various investment portfolios, including those of institutional investors like pension funds. My expertise extends to hedge fund strategies, asset allocation, and navigating volatile market conditions.
Now, let's delve into the concepts mentioned in the article about the New Jersey Investment Council and its risk mitigation strategies:
Risk Mitigation Strategies at New Jersey Investment Council:
- The article highlights the significant role of risk mitigation strategies at the New Jersey Investment Council, amounting to $95.7 billion. These strategies have played a crucial role in enhancing the performance of the state's main retirement plans.
Hedge Fund Allocation:
- New Jersey has allocated a portion of its portfolio to hedge funds, which has proven effective in mitigating drawdowns in public markets. The article mentions a hybrid approach, with direct investments in hedge fund managers and participation in fund of funds, aiming for diversification and uncorrelated returns during market sell-offs.
Performance and Allocation Changes:
- The performance of macro and systematic strategies, such as short treasuries and long commodities, has been noteworthy. In response to market conditions, New Jersey adjusted its hedge fund allocation, reducing it from 6% to 3% in 2019 due to concerns about high fees and mediocre returns.
RMS Portfolio and Recent Success:
- The RMS (Risk Mitigation Strategies) portfolio experienced success as the Federal Reserve increased rates and yields rose. This resulted in a $147 million increase in the $2.7 billion allocation, showcasing the effectiveness of their approach.
Outlook for Hedge Funds:
- The article emphasizes a positive outlook for hedge funds, citing enduring uncertainty, geopolitical factors, rising rates, and divergent Central Bank policies as potential sources of alpha opportunities. Hedge funds are viewed as a shelter in volatile markets.
Asset Allocations and Market Challenges:
- New Jersey's asset allocations are close to target, with a focus on private markets and a slightly over-allocated cash equivalent. The article mentions challenges in public markets, with losses in equities, fixed income, and real estate. High yield is highlighted as an area of opportunity.
High Yield Allocation and Challenges:
- New Jersey has decided to increase its allocation to high yield from 2% to 4%, facing challenges due to the inverted yield curve, illiquidity, and lower broker-dealer risk budgets. Various approaches, including basket trades, are explored to build the allocation efficiently.
Asset Allocation Categories:
- The pension fund's asset allocation is divided into five broad categories: global growth, income, defensive, real-return, and "other." Each category includes specific asset classes such as equities, fixed income, real assets, and risk-mitigation strategies.
In conclusion, New Jersey's investment approach involves a careful balance of risk mitigation, hedge fund strategies, and dynamic asset allocation to navigate complex market dynamics and achieve favorable returns.