Subprime Loans defaulting? Structured investment vehicles collapsing? Housing prices in a free fall? What a time for value investors to buy into real estate. That is the opinion of a handful of major public pension funds that are inching their way into mortgage-backed securities and other mortgage-related investments at their low ebb. Others that already owned such securities are holding on rather than joining the ranks of panic sellers.
“Pension fund investors are long-term investors,” points out Keith Brainard, research director of the National Association of State Retirement Administrators. “This would seem to fall into the category of contrarian investing, and public systems are taking advantage of the opportunity.”
To be sure, only a few, aggressive statewide funds say they are taking the plunge. The Missouri State Employees’ Retirement System board, at a special meeting in February, authorized the transfer of up to 10 percent of its $8 billion fund out of equities and into “opportunities resulting from the current credit crisis.” (Fund officials, however, aren’t saying whether they have yet started to do so.) The South Carolina Retirement Systems has put $8 million of its $30 billion in assets into a managed fund that includes some subprime mortgages and might increase that to as much as $100 million.
The $34 billion Pennsylvania State Employees’ Retirement System concedes that it has taken a hit on its $26 million in subprime mortgage instruments, but it’s holding tight. As a spokesman says, “Not to make light of the decline in mortgage-backed holdings, but the focus here is on the long-term performance of the entire portfolio.” The mortgages are part of an $800 million pool of prime and subprime mortgage instruments in separate portfolios run by Standish Mellon Asset Management Co., Morgan Stanley Investment Management and Pyramis Global Advisors.
To be sure, not every fund that takes a look at MBS opportunities decides to act. Earlier this year the State Retirement and Pension System of Maryland considered adding to its mortgage-related investments, both prime and subprime, which constitute about 10 percent of its $36.6 billion portfolio. But CIO Mansco Perry III, hired at the end of April, dropped the idea because it didn’t fit in with the new asset allocation strategy adopted early this year, says executive director R. Dean Kenderdine.
Mark Ruloff, director of asset allocation at Washington-based consulting firm Watson Wyatt Worldwide, says public retirement funds still have the flexibility that corporate funds lost when the Pension Protection Act of 2006 required them to mark their assets to market. Thus the pension institutions can take a longer-term view and ride out the volatility of investments that are at the mercy of interest rates and prepayment risks. Still, mortgage-backed paper isn’t ideal for all public funds. Ruloff says small plans should steer clear of these instruments because they likely lack the professional staff needed to analyze the investments or to adequately oversee the outside managers making potentially risky bets. “You want to have at least a CIO and a handful of analysts, as opposed to an investment committee that works on the pension investments only part-time,” he says. At PennSERS the fixed-income staff does a valuation check by comparing the outside managers’ pricing information with mortgage-market data from the fund’s custodian.
Money managers and CIOs may be used to the risk-taking involved in contrarian investing amid market volatility, but the teachers, court officers, voter registration clerks and other public employees whose retirement incomes are at stake are not. Knowing that their funds are investing in mortgages, and reading headlines about mortgage markets tanking, will plan participants bombard their fund officials with criticisms and complaints?
Thus far, apparently not — but neither do they have a clear sense of what their funds are holding. “The only reason they would find out would be because of some news item,” Ruloff says. Even PennSERS’ trustees don’t know specifically which mortgage securities the fund has a stake in, the spokesman says. “There are managers out buying and selling every day. It would be unusual for the board to focus in on specific trades any manager did,” he adds.
Brainard of the National Association of State Retirement Administrators notes that contrarian and value investing are common and managers don’t flinch at what they consider good opportunities that happen to be in beaten-down MBS deals. “That’s why we pay these people,” he says.
