The Stamford Police Pension Board has gradually shifted its $37 million traditional fixed-income allocation to multi-strategy-securitized credit and hedge funds. The move is continuing to pay off. On a year-to-date basis, through March 31, Stamford pension’s securitized credit exposure was up 8.5%, while its standard fixed income index, the BloombergBarclays US Aggregate Index was down 1.5%. Since inception, the securitized credit exposure has provided an annualized net return of 15.64%.
“We have been selling traditional fixed income and replacing it with multi-strategy-securitized credit and hedge funds,” said Mike Noto, Chairman of the Stamford Police Pension Board.
“We were an early adopter of securitized credit beginning in early 2009, and began to increase our allocation to the sector over the past several years,” said Noto. “As interest rates have moved up due to Fed action (175 basis points since December 2015), we insulated the downside interest rate risk of a traditional core bond holding by investing in securitized credit. Investments such as asset-backed, mortgage-backed and residential mortgage-backed securities provided a higher coupon rate, and have less downside price sensitivity to rising rates,” he said. The $216.1 million plan’s consultant Clearbrook has been advising the fund on the move.
The shift, in effect since 2009, is complete for now, said Timothy Ng, CIO at Clearbrook. “An estimated 41% or $16 million of the traditional fixed income allocation is invested in securitized credit, and an additional estimated $15 million is invested in a securitized credit hedge fund,” he added. Clearbrook began to lower its clients’ portfolio allocations to corporate bonds during 2017, due to concerns about the large amount of issuance in the market, the amount of BBB bonds being issued versus the higher rated investment grade bonds, and the easing of covenants for newer bond issues, said Ng. “At the end of March 2017, we had 3.5% of fixed income assets invested in the Vanguard Long Term Corporate Bond Index, and as of end of the June 2018 quarter, that allocation was down to 0%.”
“The proceeds from the sale of the Vanguard Long Term Corporate Bond Index has been used to increase our existing exposure to securitized credit, including asset backed, mortgage-backed and commercial-mortgage-backed-securities funds,” Ng continued. “This has helped our performance in the fixed income bucket as the short- to long-term corporate bond indexes went down 0.20% and 5.8%, respectively, as of the end of June 2018,” he noted.
“On a comparison basis, over a one-year period, ending March 2018, our fixed income portfolio has achieved a 1.5% return, while the benchmark BloombergBarclays US Aggregate Index has lost 1.5%. The overall corporate bond market is about $5 trillion in value – if the economy starts to falter, trillions of dollars’ worth of bonds could roll into the high-yield market, causing a market dislocation we haven’t seen since 2009,” Ng said.
A change in equity strategy
The Stamford Police Pension Board’s equities portfolio is allocated as follows: U.S. is 37%, Europe is 20% and China and EM is 5%. In early 2018, Clearbrook switched strategies to advise its clients to overweight their portfolios to U.S. equities, due to Brexit after-effects and tensions in Spain and Italy.
“We believed that the geo-political uncertainty in Europe would cause a slowdown in consumer spending and corporate expenditures, which would prompt a decline in expected GDP growth in Europe versus the U.S.,” Ng said. “The U.S. had the tail winds of improving consumer spending, the effects of the corporate and individual tax rate cuts, and the expected rise in U.S. corporate earnings. We are seeing the effects of this foresight as U.S. GDP growth in Q2 just came in at 4.1% and expectations of European growth will be more in the 2.0% range. This, in turn, has benefitted U.S. equities. Through June 30, 2018, the S&P 500 was up 2.65% and the Russell 2000 was up 7.66% year-to-date. By comparison, the MSCI Europe Index was down 3.23% on U.S. dollar basis, over the same time period.
The asset allocation of the Stamford Police’s entire portfolio by asset class is as follows:
– U.S. Equity Composite: 17.81%
– International Equity: 15.82%
– Alternatives Composite: 30.44%
– Fixed Income: 19.50%
– Real Estate: 13.50%
– Cash: 2.93%
Bullish on financial stocks
The Stamford fund is also a fan of financial stocks. “The present weighting of financial stocks in the S&P 500 is 16.2% of the entire index. When we had conviction that financials stocks would outperform the S&P 500 index, we added an additional 4.5%, weighting to our portfolio by purchasing the KBW Bank and Regional Bank ETF,” said Ng. “Thus, our weighting to financials is 20.7%, versus the S&P’s 16.2%. Along the same lines, technology has a present 23% weight in the S&P 500 – we specifically like the cybersecurity area of technology, thus we added a 2.5% position to a cybersecurity ETF. This brought our allocation to technology versus the S&P 500 to 25.5%,” Ng said.
“In October of 2017, we increased our exposure to Japan by 1% versus an index weight of Japan at 16.2%, as represented in the MSCI ACWI ex US index, thus we are at 17.2%,” continued Ng. “The reasons behind our decision was the super majority that Japan’s Prime Minister Abe received in the snap election in October that would permit the Japanese government to move forth with the pro-growth agenda that began in 2012. In addition, the Japanese equity market was trading at a forward P/E ratio of 12X, when the S&P 500 Index was 18.2X. Finally, the economy in Japan still had the tailwind from the accommodative monetary policy from the Bank of Japan,” he said.