Kathie Bracy's Blog: CLARIFICATION OF RESEARCH

From Mario Iacone, July 11, 2009

I have submitted and circulated quite a bit of information regarding STRS Asset Allocation

I can see how it is possible to draw two conclusions from that information.

INVEST ALL IN TREASURY BONDS and such would by its nature lead to the conclusion that the STRS Investment Department should be severely reduced or perhaps, eliminated.

Neither is my intent. Advocating an Asset Allocation minimizing the risk of huge losses is.

My response to Rich should clarify my position.

I am not advocating investment in all Treasury Bills although that would give us a very stable fund. However, a substantial percentage would be wise.

The payroll of the Investment Department is small compared to the fees that are paid for purchases, etc... About 135 million in fees during 2008 fiscal year. Treasuries have none or little in the way of fees unless the yield drives up the price and it would be a good move to sell on the secondary market.

I have attached an investment model from a seminar I attended many years ago, circa 1969. It protects from drastic downturns and yet gives you the opportunity to make money when times are good.

Please review.

The Investment Department would not have to be eliminated. Reduction could take place through attrition and retirement. And, if a model such as I have attached were used, they might be more effective with a smaller workload.

It is not what we pay the Investment Department that has endangered pension benefits, it is huge Investment Losses.

Mario

Below is listed a sample model which utilizes True Diversification and proactive Risk Management

If you would let me share my limited knowledge on diversification, I would appreciate it. I am not presenting this information to win a debate with STRS or anyone else, but doing so to provide input that may help the situation and possibly get STRS to consider a possible defect in diversification of STRS asset allocation.

Looking over the performance of the STRS fund value since 1998, all the investments go up together and all of them go down together. That would indicate a problem in the diversification of their assets. It is not true diversification to buy stocks of different risk level because when serious economic downturns occur, all stocks go down.

The information below was a lesson in a seminar many many years ago.

The instructor was attempting to show that true diversification to protect a portfolio in serious economic downturns or even “depression like” circumstances, the investments must not be interconnected or interdependent. Because if they are, they will all go down together. He provided the following simple example to illustrate his premise.

TRUE DIVERSIFICATION must have mutually exclusive investments so that not all go down together in tough times.

He presented the following simple portfolio. (Click image to enlarge.)

Gold is never traded short term. Only to be used as a recovery asset or to raise capital in disastrous circumstances.
Stocks are liquidated at 20% loss, either collectively or individually. His premise was that a general market decline of that magnitude signaled a problem, even if it is not evident. Depending on original purchase value, such a policy would produce two good results, limit loss or protect profit.
- If stocks are liquidated, WAIT. The waiting period could be extensive, even several years. Wait until the situation allows you to risk 25 cents to make a dollar, rather than risk a dollar to make 25 cents. Small short term returns are preferable to large losses.
- Portfolio is constantly adjusted to maintain the above percentages.
  - Stocks become 65% of the portfolio, reduce back to 50%.
  - Gold falls below 10%, increase it back to 10%.
  - Maintain Treasury Bonds at 40%. They are the base of the structure.
    - Such is the best form of Risk Management because it is a proactive approach rather than a reactive approach.

He also commented that the percentage of Risk Equities should be governed by what you can afford to lose. Only risk an amount, that if totally lost, would not change your lifestyle. In my opinion, that advice would apply even more so to a pension fund because losses in a pension fund can alter the lifestyle of tens of thousands.

Let’s look at the current value of STRS when the fund was valued at 80 Billion according to the above guidelines.