Rudy Fichtenbaum: Alternatives to the Current STRS Investing Strategy

Alternatives to the Current STRS Investing Strategy

Rudy Fichtenbaum

In my last post, I wrote that one way to fix our pension was to increase employer contributions, and the second was to improve STRS investment performance. In this post I want to concentrate on the later by looking at some alternatives to STRS investment strategy.

One alternative is to look at a purely passive investing strategy such as investing in index funds. A second is to look at innovations being used by other pension funds.

Imagine if there were another public pension that had an alternative investment strategy that yielded greater returns with less risk and is more than 100% funded. Wouldn’t it be worth looking at their investment strategy? Well, such a pension exists, and it is the Healthcare of Ontario Pension Plan (HOOPP). HOOPP has a discount rate (the assumed rate of return, which has a major impact on the unfunded liability and the funding ratio) of 5% and is more than fully funded. Like other pension funds, HOOPP has faced the challenges of two stock market crashes in the 2000’s but was better able to weather that turmoil and emerge stronger. What is HOOPP doing that STRS is not doing?

Let’s look at HOOPP’s actual returns. In 2020 they reported a 11.42% annual of return, and a 10-year return of 11.16%. Moreover, HOOPP achieved these returns while taking considerably less risk than STRS. How do they invest? They use an approach called liability driven investing. The scatter plot below shows HOOPP in the upper left-hand corner and STRS and most other pensions, all earning less than their assumed rate of return and taking more risk.

 

Pension funds like STRS view total expected returns as being driven by three main components:1) risk free return, 2) contribution from the overall market return, and 3) returns from superior management skill. But what this approach ignores is that it is possible to increase returns through the use of transactional trading expertise and technology “TET”. This fourth contribution to returns is what Wall Street banks and hedge funds earn when they sell TET to pensions like STRS! But HOOPP has shown that it is possible for pensions themselves to use their comparative advantage of permanent capital that is not subject to withdrawals or redemptions to enhance returns and reduce risk through the use of transactional trading.

Is this the answer for STRS? I don’t know but given HOOPP’s performance it seems like failing to at least examine this strategy is an abdication of the Board’s fiduciary responsibility. Using HOOPP’s investment returns, STRS would be 114% funded. Not only would we have a COLA, but we might also be looking at cutting member contributions.

At the end of the day, beating manipulated benchmarks jointly chosen by STRS staff and the consultants who depend on STRS for business, as well as continually telling us that STRS is in the 90th percentile compared to peers, means nothing if STRS does not have enough assets to keep its promises to members. Telling members that we are doing better than many other pensions,is cold comfort to members who have lost their COLA or are paying 14% of their salary for a pension that has an actuarial value of 10.8%.

How do we increase returns without increasing market risk? I don’t pretend to have all of the answers. But clearly one component of that strategy needs to be reducing investment expenses,most of which are generated by STRS’s alternative and real estate investments. Another component would be to use transactional trading to enhance returns, as an alternative to active management which has clearly failed to solve our problems.