A longtime bond investor in insurance-linked securities (ILS), the Pennsylvania Public School Employees’ Retirement System (PSERS) plans to withdraw from the sector as part of a planned divestment of all absolute return strategies.
The Pennsylvania Public School Employees’ Retirement System (PSERS) has been investing in Insurance-Linked Securities (ILS) since mid-2011 when it made its first allocation to a strategy by ILS fund manager Nephila Capital.
Since then, the PSERS annuity has been reassigned to a number of other strategies, building a portfolio of third-party managed ILS, catastrophe bonds, and collateralised reinsurance investments.
The ILS portfolio at PSERS was valued at over $ 1 billion, making it one of the larger ILS allocators on our list of end investors, but has benefited from catastrophe losses in recent years and was at $ 835 million by year-end dropped in the middle of this year.
Even so, the ILS portfolio remained a core part of the absolute return portfolio, which categorized most of the alternatives and hedge fund managers.
However, because returns have been volatile and these absolute return strategies have often diversified PSERS ‘investments away from the stock markets, which have risen sharply in recent years, the board of the pension has chosen to move away from all absolute return – Separate investments to make its allocations from public shares.
It seems counterintuitive to move away from diversifying asset classes, which have little to zero correlations with the broader financial markets, in favor of stocks.
However, PSERS believes it can achieve far better returns in the equity markets while paying far fewer investment manager fees.
So the ILS fund manager’s allocations will be wound down and sold off over the coming months and years, in a process that the pension said will take some time to complete.
The PSERS Board of Trustees recently approved the change in investment strategy.
The allocation changes, which include increasing the allocation of public stocks and removing all positions in absolute return strategies (including the ILS funds), are expected to be implemented “over the course of months or years,” according to the trustees.
The goal is to get more from the rising public markets, it seems.
“The Board’s decision to change the asset allocation by adding more public equity over time will help increase PSERS ‘net investment income in positive market conditions,” said Board Chairman Chris Santa Maria.
However, Santa Maria also noted that “However, this allocation also increases our risk profile slightly in declining market conditions.”
The approximately $ 72.5 billion pension fund held approximately $ 6 billion in absolute return strategies, of which $ 835.2 million in ILS funds as of June 30, 2021.
That ILS allocation was likely to have continued to decline in the meantime, as it is expected to have further effects due to the European flooding and Hurricane Ida.
PSERS had allocations to two of the ILS funds focusing on retrocessional reinsurance that will be affected by these events, RenaissanceRe’s Upsilon Fund and Aeolus’ Property Catastrophe Keystone Fund, so following these catastrophic events with a decline in ILS Assets is to be expected.
PSERS also has an allocation in Nephila Capital’s weather-focused ILS fund Nimbus and its Palmetto reinsurance strategy, as well as RenaissanceRe’s catastrophe-bond Medici strategy and DaVinci Re-vehicle.
However, PSERS has not specifically earmarked ILS for the sale, but falls into the absolute return chain, in which all investments are to be eliminated.
Most of this capital is said to be invested in US stocks, where public markets have seen significant gains recently.
“I look forward to working with the Board to implement this new asset allocation in the best interests of PSERS members and voters,” said Bob Devine, acting chief investment officer of PSERS.
Diversification or the desire to invest in uncorrelated asset classes is not mentioned at all in PSERS ‘statement on divestment of absolute return strategies including hedge funds.
It is likely that this initial divestment of the absolute return portfolio could be a first step towards a more comprehensive rebalancing of the pension fund’s portfolio was applied to the absolute return bucket.
The performance of the ILS systems may not have been optimal since 2017 due to the catastrophe damage. But over a three-year horizon, the returns on ILS strategies are not as unfavorable compared to other alternatives or market areas such as private equity that PSERS assigns.
However, a look at the fees paid can shed some light on why absolute return strategies were chosen, given that the absolute return bucket generated $ 196 million in capital expenditures from fees and profit shares through the year through June 2021 .
This comes from a total allocation of less than $ 6 billion across the absolute return strategies, compared to an allocation of $ 21.5 billion in fixed income that resulted in just $ 121 million in capital expenditures , or a $ 17 billion global equity portfolio that cost only $ 93 million in investment.
So absolute return strategies have proven to be more expensive, and in recent years the public markets have achieved returns that PSERS missed out on, which, along with the fees paid, appear to be the main drivers behind PSERS’s allocation changes.