And it is clear from the article that the pension managers are jumping from one strategy to the other inevitably chasing past returns....and "consultants" and managers from Wall Street are at the ready to offer the latest and greatest new strategy.
The losses that these same institutional investors suffered in hedge funds and private equity showed that there is no prospect of increased returns without increased risks. The large returns of these strategies that attracted these investors masked the fact that the higher returns came at greater risk due to leverage and illiquidity. I have a sense that the same will happen with the new "hot" strategy to boost returns.
from the wsj my bolds and my comments in blue
JANUARY 27, 2010
By CRAIG KARMIN
Public pension funds needing to boost their returns but frustrated with hedge funds and private-equity investments are turning to one of the oldest investment strategies—using borrowed money to boost performance.
The strategy calls for leveraging pension funds' safest asset—government or other high-grade bonds—while reducing exposure to stocks.
It's not completely clear from the article what the strategy is composed of but it seems to be composed of leveraging up bond holdings to buy more bonds while reducing stock holdings. This would be a variation of the sort of carry trade that many investment banks are pursuing financing short term at very low rates and investing longer term with the bond holdings. While the immediate environment may be attractive for this strategy it is hardly riskless. Long term bonds bottomed last year after a tremendous rally : treasury bonds rose in a flight to quality in 2008 and have pretty much declined in price since then. Corporate bonds recovered in 2009, the economy improved and spreads of corporates over treasuries declined bringing prices up.
At this point it would seem that most of the easy money has been taken out of these strategies :interest rates are likely to rise as the fed unwinds its easing strategy. The result would be doubly negative for the strategy: financing costs would go up and there would be capital losses on the bond holdings. I am getting the uncomfortable feeling that these pension managers are chasing returns, entering into a strategy just as the prospects for its success are declining. Will they be nimble enough to avoid the double whammy of higher financing costs and lower bond prices that will accompany a future move up in interest rates...I doubt it. And there is little doubt they are dialing up the risk in search of higher returns.
The State of Wisconsin Investment Board, which manages $78 billion, became among the first to adopt the strategy when it approved the plan Tuesday. The fund will borrow an amount equivalent to 4% of assets this year, and as much as 20% of its assets over the next three years.
Fund officials say that use of leverage could eventually go higher—in theory, at least, up to 100% of assets, according to the staff analysis. But Chief Investment Officer David Villa says that level wouldn't be palatable for the Wisconsin fund. He said the pension fund was advised by four money managers, including Connecticut hedge-fund firms AQR Capital and Bridgewater Associates
The quants did their best to contain the damage, but they were like firefighters trying to douse a raging inferno with gasoline—the more they tried to fight the flames by selling, the worse the selling became. Quant funds everywhere were scrambling to figure out what was going on.Not only was Mr. Asness current fund bleeding money the fund he created at his previous employer was quite possibly at the center of the market meltdown:
Tuesday, the downturn accelerated. Applied Quantitative Research, the Greenwich, Conn.-based quant fund giant run by former Goldman Sachs Group whiz Cliff Asness, booked rooms at the nearby Delamar on Greenwich Harbor, a luxury hotel, so they could be available around the clock for stressed-out, sleep-deprived quants.
Nervous managers traded rumors by email and phone in a frantic hunt for patient zero, the sickly hedge fund that had triggered the contagion. Many were fingering Goldman Sachs's Global Alpha, the quant fund founded by Mr. Asness in the 1990s that had grown to massive proportions. But no one knew for sure.The article on the pension funds continues:
Wilshire Consulting, which advises pension funds on investments, says leverage helps the funds meet their long-term return targets without relying too heavily on volatile stocks, or tying up their money for long stretches in private investments. Low interest rates make it impossible to meet those targets with simple bond investments. Wilshire managing director Steven Foresti says he has been in discussions with about a half-dozen funds that are interested in the leverage strategy. ..
My views are certainly in line with these skeptical views in the article in pension funds' new strategy: