The financial crisis left its
mark on nearly all pension portfolios, and Metropolitan
Government of Nashville and Davidson County was no exception.
The Nashville, Tennessee-based public pension fund had an
outsize equity allocation of 79 percent before shrinking by
more than a quarter in the disastrous 2008 fiscal year, from
$2.2 billion to $1.6 billion in assets.
As part of a change in
direction, CIO Fadi BouSamra sought out so-called alternative
fixed-income strategies to take advantage of dislocated credit
markets. In late 2008, BouSamra won board approval to invest
$25 million, or 1.5 percent of Nashvilles assets, in
Pimco Distressed Mortgage Fund II, offered by Newport Beach,
California-based bond giant Pacific Investment Management
That was a smart move. Through
November 30, 2012, the Pimco allocation had yielded a
cumulative 173 percent. But BouSamra was just getting started.
In 2009, Nashville bolstered its new alternative fixed-income
portfolio by committing a total of $65 million to alternative
investment manager Angelo, Gordon & Co. and credit
specialist Marathon Asset Management. The two New York based
firms were making use of a new federal government program:
public-private investment partnerships. Were not an
endowment, but we have a lot of opportunistic and risk-aware
investments, says BouSamra, who had become
Nashvilles first investment professional when he joined
the then-$1.1 billion fund in November 2003.
Since 2008, Nashville has halved
its target equity allocation and taken stakes in some two dozen
alternative fixed-income funds. For the three years ended
November 30, these investments returned an annualized 16.74
percent. Alternative fixed income makes up 15 percent of
Nashvilles total portfolio, which at $2.1 billion is
almost back to its precrisis level. Devoting 30 percent to
traditional fixed income no longer works, says BouSamra, who
now targets 20 percent. With yields below 4 percent, explains
the former American Express Financial Advisors stockbroker,
that model is yesterday, and its broken.
| Metropolitan Government of Nashville and
Davidson County CIO Fadi BouSamra
Fixed-income alternatives arent new, but theyve
evolved. They first appeared in the 1980s, when Michael Milken
of New York investment bank Drexel Burnham Lambert began
peddling high-yield, or junk, bonds. Since the recent credit
crisis, pension plans have stepped into a void left by banks
and fellow lenders like GE Capital and CIT Group, investing in
vehicles created by hedge fund firms and other alternative
managers. Also, the second and third Basel Accords and other
global regulatory standards have forced banks to set aside
capital in case borrowers with no ratings default on their
loans. Borrowers are not willing to shell out a huge fee
to Moodys and S&P, explains Barbara McKee,
principal and co-founder of White Oak Global Advisors, a San
Francisco-based firm that offers alternative fixed-income
products. For their part, banks avoid such loans because they
dont want to pay equity-size premiums, McKee says.
Thats left a big opening for managers like White Oak to
offer loans, package them and sell them to pension
Five years ago, as interest
rates fell, HGK Asset Management began working on a strategy to
help its public pension clients reach their goal of a 7 percent
or greater return. The Jersey City, New Jersey-based firm went
on to launch a senior loan fund that targets a 9 percent yield.
We were hesitant to move into the high-yield space
because of its correlation to equities, says president
Arthur Coia. So we looked for something different.
HGKs Strategic Income Fund I invests in portions of
senior loans to middle-market companies looking to expand; it
features a floating rate so clients wont get hurt if and
when interest rates rise. For the three years since inception,
the fund has posted a 9 percent annualized return.
Banks desire to rid their
balance sheets of long-term debt from infrastructure projects
they underwrote has given Nashville and its peers yet another
option. Ten years ago the leveraged-loan market was all
syndicated by banks, observes Robert Dewing, a New York-based
portfolio manager for J.P. Morgan Asset Management
Infrastructure Debt Group, one of Nashvilles holdings,
but today many of these loans are made by asset managers and
other nonbank entities, with price data such as bid-ask spreads
readily accessible online.
Opportunities still abound, BouSamra notes. They include
lending to energy producers, making private loans to the middle
market, buying whole loans from banks and investing in some
asset-backed securities. There is still some opportunity
in senior loans, primarily because spreads over Libor are still
good and most now have a Libor floor giving some insulation if
rates rise, BouSamra says. The opportunity in
lending and asset-backed securities is still there because most
pools of money cannot invest in them due to the reduced
liquidity or lower credit quality. And with the U.S.
Federal Reserve promising to keep interest rates low for the
next two years, BouSamra will probably continue his search for
alternative fixed income.