Riley: A New Low Cost Strategy for Treasurer Magaziner
Tuesday, July 05, 2016
It’s one thing to criticize Seth Magaziner for poor Investment performance in the Rhode Island Pension Fund but it’s quite another to tell him how to improve. Our treasurer can reduce complexity, reduce costs and eliminate the dozens of Wall Street managers collecting fees from RI taxpayers. This can be done while at the same lowering the risk profile of the fund and maintaining an investment profile that will provide adequate returns.
Today’s investment environment is treacherous, especially for those public and private entities who have yet to fund their long term liabilities like Pension Obligations or Insurance, such as long term care or life. Negative or zero interest rates prevail in much of the world making returns of 7 or 8% very difficult for anyone to achieve. This environment has created a new risky asset called long term Government Debt including US Treasuries. In a standard 60/40 asset allocation both stocks and now fixed income expected returns are very low.
A Multi-Strategy Fund
GET THE LATEST BREAKING NEWS HERE -- SIGN UP FOR GOLOCAL FREE DAILY EBLASTAs a financial adviser, fund consultant and professional money manager, I have managed assets 35+ years with great success. Our Hedge Fund, “Narragansett Multi-Strategy Fund," now ten years young, is having its tenth anniversary this month.
Introducing the Buffer or Hedge Strategy
Suppose you could, one year in advance, create a portfolio of diversified stocks virtually matching the S&P 500. Then, let’s say you could design your own parameters of risk and reward to match your outlook. For example, many investors think that today July 2016 market is expensive and returns will be modest, they also believe a 10% correction is more likely than normal. What to do?
We suggest a buffer or hedge strategy that allows for no loss to the investor for the first 10% of the decline after you invest, If the index is down 9% you lose nothing, if the index is down 25% like 2008 you would lose 15%. A more likely scenario would be a market that is up 5% over the next year. Using our hedge strategy your gain is not 5% but is approximately 7% or 1.4x the positive performance of the S&P 500. In order to receive this amazing risk reward, you would have to accept a capped return of approximately 10%.
This hedge strategy has been available and used for 20 years or so. Today we are calling for a revolution in pension investing. We think pension funds including Rhode Island would be better off with an 80%-90% allocation to this strategy. Using a combination of one-year term strategies like the hedge above and the “evergreen” strategies developed by Exceed Investments. The evergreen strategies appear above.
The statistics are amazing and have been confirmed and back tested. The strategies accomplish their State Investment Commission goal of Equity-like returns with much lower volatility and risk. The period above shows the hedge index Outperforming the S&P 500 and at less risk which is shown below. This can be accomplished without 55 different managers, multiple consultants and a large staff. Rhode Island could reduce costs by millions annually. The pension Fund could also reduce fees by 40 million or more.
This is no longer an idea. It is a reality that is made for today’s uncertain environment especially applied to underfunded Pension Plans where owning fixed income assets represent abnormally high risk and low value.
Disclosure: MG Riley is the co-founder of Coastal Management Group LLC, Beach Street Financials Services LLC and CoManages Narragansett Multi-Strategy Fund LLC. Coastal Management Group LLC has an equity stake in Exceed Investments. The advice here is meant for Rhode Island Pension Fund and not a solicitation for investment.
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.
Related Slideshow: Timeline - Rhode Island Pension Reform
GoLocalProv breaks down the sequence of events that have played out during Rhode Island's State Employee Pension Fund reform.
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