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Riley: Market Volatility Shows Weakness of Magaziner’s “Back to Basics”

Tuesday, February 27, 2018


Seth Magaziner

January 2018 was a great month for investors and presumably the Rhode Island state pension plan. The S&P 500 finished the month with a 5.33% gain.  A 60/40 portfolio would have gained approximately 3%+.

But close inspection of the “Back to Basics” portfolio shows that our Treasurer may have surprisingly and unwittingly taken on more risk after jettisoning $600 million in hedge fund holdings since September 2016.

Risk Returns with a Vengeance

Then came February 2018 and within a few days, January’s gains were wiped out and then some. Who would possibly be selling the S&P 500 down at 2560 when it was 2860 10 days prior? A loss of -11.86 % in 10 days.

Sadly, the answer may be Rhode Island was among those who were actively selling S&P futures at the bottom. How could that be? There will be an investment committee meeting Wednesday and hopefully, someone will ask the question.

Back to Basics? Not Exactly....

First, we need to define what "Back to Basics" means. I have about 25 more years of portfolio management experience than Mr. Magaziner, who has been learning on the job since 2014. After stubbornly defending Gina Raimondo’s high fee/low return allocation to hedge funds for 2 years, Mr. Magaziner finally threw in the hedge fund towel and developed a plan to go “back to basics."

“While our pension system has achieved positive performance and beaten our benchmark since I took office, I believe that we can do better,” said Mr. Magaziner in the news release. “Our 'Back to Basics' approach will improve returns through commonsense investments that have proven they can deliver growth and stability.”

The implication is that ” basic” prudence would be 60% invested in stocks and 40% invested in fixed income for a public pension fund portfolio. The table below shows the difference between a Riley basic portfolio and Seth Magaziner’s “Back to Basics” portfolio.

As you can see, Mr. Magaziner’s and Rhode Island’s pension portfolio appears to be anything BUT basic. Still, [there are] hundreds of paid managers and consultants, but most interesting to me was the decision to take $600 million in hedge fund Investments and re-allocate that money to a trend following strategy. This new manager is told by Rhode Island to follow the herd and buy stocks on the way up and sell stocks aggressively on the way down. This is similar to portfolio insurance attributed to the crash of 1987 that I experienced firsthand and most recently the risk parity and short Volatility sellers of the February 2018 collapse just a few weeks ago.

Mr. Magaziner managed to fully fund this trend following CTA strategy, known as Crisis Protection Class (CPC) at year-end. 2017 was an ideal year for this strategy with record low volatility and persistent trend.

It is critically important to see how this Crisis Protection Class manager handled the deep sell off a few weeks ago. If the CPC lost money in that environment, then what’s the point?  Both Raimondo and Magaziner told us the hedge funds purpose was to dampen sudden downdrafts, not to exacerbate them.

Now Magaziner says that was a mistake and trend following reduces risk. I think he is dead wrong and has it backward. So now this is the perfect opportunity for Magaziner to show us how well his “protection" worked. He already has the real-time results but likely won’t tell us. Here is the non-Hedge Fund, hedge fund Magaziner hired for this strategy. 

New CIO comments on Strategy

Mr. Magaziner recently summarized 2017 performance. He gave credit for that feat to strong manager selection. He touched on both the QVM and CPCs’ strong performance and applauded the more exotic allocations of the portfolio. The CPC’s systematic trend allocation returned 1.94%, although it underperformed its benchmark’s return of 2.31%. Fiscal year to date, the systematic trend followers have earned 15.14%, significantly exceeding their benchmark’s return of 9.77% over the same timeframe.

For 2018, new CIO Mr. Stais noted that while the Crisis Protection Class main objective is to deliver outsized returns in times of market turmoil, the trend-followers had been performing very well in January. He noted that since inception, the CPC allocation is up 11%. Mr. Stais concluded by letting the Board know that he believes the plan is in line with reaching their targeted allocations.

Let’s hope the early February Stock Market downdraft was a mirage.

Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC News, Yahoo TV, and CNBC. 


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