Pension funds are sticking with bonds for the most part

Last year was rough for U.S. pension fund bond portfolios. With the Bloomberg U.S. Aggregate Bond index down 14.6% after a year of high volatility, investors had to look to other parts of their portfolios to bolster returns.

For the defined benefit plans among the 200 largest plan sponsors in Pensions & Investments' survey, the evidence of that volatility is obvious in the data. A significant portion of the plans in the survey reported smaller bond portfolios as of Sept. 30, with many dropping more than 20%.

The $430.4 billion California Public Employees' Retirement System, Sacramento, for instance, saw its U.S. fixed-income exposure drop 38.3% in the year ended Sept. 30 to $77.2 billion.

Other plans posted declines in assets that closely tracked the index. The $288.6 billion California State Teachers' Retirement System, West Sacramento, for example, saw its domestic bond exposure fall 12.9% in the 12 months ended Sept. 30 to $41.3 billion.

There were a few plans that posted increases over the year, however. The $40.4 billion Texas County & District Retirement System, Austin, had one of the largest increases in U.S. bond portfolios, up 10.4% to $12.5 billion over the survey period. The $50.5 billion Western Conference of Teamsters Pension Trust's U.S. bond portfolio was up 2.9% to $15.2 billion.

Some investors have opted to stick to their current asset allocation strategy, with only slight changes at the margins. Boston-based Massachusetts Pension Reserves Investment Management's U.S. bond exposure declined only 6.13% in the year ended Sept. 30 to $16.8 billion.

In response to emailed questions, Chuck LaPosta, director of fixed income at the $88.5 billion pension fund, said the fund has a "carefully constructed portfolio structured to withstand various market conditions. Specifically, within core fixed income, short durations and inflation-linked bonds have benefited to some degree from recent market volatility, while (aggregate bond) and long duration were impacted more; within value-added fixed income, our public market portfolios (high yield, loans and emerging market debt) were impacted by current conditions while our Other Credit Opportunities investments have proven to be more resilient."

Mr. LaPosta is undeterred by current volatility. "Big macro trends are unlikely to impact our strategic asset allocation decisions. The disruptions created by higher rates, inflation and volatility may lead to increased opportunities for our managers to add value."

MassPRIM's active bonds portfolio was up 9.2% over the year to $9.6 billion, while the passive portfolio declined 21% to $7.2 billion.

If MassPRIM does make any changes, it will be within existing asset allocation strategies and targets. "We are seeking to enhance relationships with partners who have the ability to add value by navigating these changing market conditions," Mr. LaPosta said. "We continue to seek out Other Credit Opportunities investments that provide better control, credit protection and yield premiums which will add value across both the risk and return dimension. We have room to add/increase these types of investments within our current asset allocation bands."

The $173.3 billion Texas Teacher Retirement System, Austin, is taking a similar view. The pension fund maintains a 16% allocation target to long-term Treasuries of 10 years or longer in duration with a focus on diversification. James Nield, who leads the risk and portfolio management team, said the pension has been underweight Treasuries due to concerns about rising rates. However, rising yields on 10-year Treasuries "make them a little more attractive. But, that's with an asterisk because of the cash rate. If the cash rate stays high and we end up with an inverted Treasury curve, that could make cash more attractive."

Texas Teachers is planning to begin its next strategic asset allocation study, and Mr. Nield says that questions about the right mix of fixed-income exposures are on the table. "We value the diversification of Treasuries but it's also important to look at premiums. When we did the previous study, the cash rate was at almost zero. That has changed."

The dispersion in bond portfolio exposure is often an indicator of how investors tend to view risk and manage it within their portfolios.

The $61.4 billion Maryland State Retirement & Pension System, Baltimore, pointed to the benefits of active management. Maryland's bond exposure was down 7.55% for the survey period to $15.2 billion. According to commentary in the retirement system's most recent performance report for the period ended Sept. 30, "manager selection within real estate, U.S. credit, natural resources and infrastructure, private equity, and nominal fixed income were the most additive while selection within public equities detracted" from the system's overall return. Maryland's U.S. and global fixed-income exposure was 24.8% and 0.85%, respectively, as of Sept. 30, according to the survey data.

CalPERS, too, is looking toward active management with the hopes of turning things around.

CalPERS includes a variety of fixed-income exposures in its portfolio including Treasuries, a spreads strategy and interest-rate sensitive exposures. The pension fund's active and passive fixed-income exposure amounted to $77.4 billion and -$206 million, respectively, as of Sept. 30, 2022, vs. $91.6 billion and $33.6 billion a year earlier.

According to commentary delivered during CalPERS' board meeting on Sept. 19, Arnold Phillips, managing investment director for global fixed income, said that interest rate hikes and the war in Ukraine created a negative dynamic within the U.S. Treasury market last year and led to "broad underperformance across the Treasury rate curve regardless of the level of duration."

Slides in the board presentation showed that the pension portfolio tracked the Treasury benchmark closely, accounting for the drop in assets. Mr. Phillips added that "the relatively large interest-rate exposure in the spreads segment (of the portfolio), along with the spread widening, did result in a relatively large absolute return underperformance this year."

He noted, however, that the current market could provide "opportunities to tactically deploy assets when managed through an active risk governance model," which could help turn performance around.

The $123.2 billion New York State Teachers' Retirement System, Albany, uses a mix of U.S. fixed income, short-term bonds, global bonds and high yield. According to commentary from the pension's most recent board meeting on Jan. 25, "domestic fixed income underperformed as negatives from credit positioning outweighed the positives from rates positioning."

NYSTRS' short-term bond portfolio is providing support with yields over 4.2% on the back of interest rate increases. High-yield exposure also "slightly outperformed due to rates positioning and credit selection," the commentary said.

NYSTRS' U.S. bond portfolio totaled $25.9 billion as of Sept. 30, down 6.4% for the year.