Last October, I penned a post for Dealbreaker in which I gently suggested that the Tennessee Consolidated Retirement System reconsider its allocation to emerging market equities.
That piece was focused on TCRS’s allocation to the iShares MSCI South Korea Capped ETF at a time when Donald Trump and Kim Jong-Un were busy exchanging absurd insults and threatening each other with nukes. The overarching point, though, was that there needn’t be a nuclear war between Washington and Pyongyang for something to go wrong with that EM allocation.
Here are some quotes from that linked post:
Here’s the other thing: Tennessee’s emerging market ETF exposure doesn’t stop with South Korea. They are also the largest holder of the iShares MSCI Brazil Capped ETF, which is of course subject to all manner of political risk.
And then there’s the iShares MSCI Taiwan Capped ETF where Tennessee is, again, the largest holder:
Obviously, the fund is also heavily invested in things that aren’t emerging markets, but when you consider [the idiosyncratic risks inherent in EM] with the very real possibility that further Fed hikes, balance sheet rundown, and any movement on tax reform could catalyze a potentially sharp rally in the dollar, this looks like a lot of risk to be taking for a pension plan.
Fast forward 10 months and there was indeed “movement on tax reform” and there were indeed “further Fed hikes” and although the Bloomberg dollar index is sitting about where it was when that piece was published, it is indeed up “sharply” since the lows in February.
(Bloomberg)
Well, in addition to the allocation to South Korea, Taiwan and Brazil, TCRS was the biggest institutional holder of the iShares MSCI Turkey ETF as of June 30. Specifically, the fund held some 880,000 shares, according to filings.
(Bloomberg)
As you’re probably aware, TUR has collapsed this year amid Turkey’s ongoing currency crisis and the country’s descent into authoritarian rule. Specifically, it’s down some 53% from the highs.
Again, none of this is to say that TCRS is in some kind of dire straits. Their allocation to U.S. equities (including high fliers like Apple) has clearly done well as have, I’m sure, many of their other positions. So save me your allegations of fearmongering.
Rather, everything said above is meant simply to underscore the points made in the post linked here at the outset nearly a year ago. Namely, that when you’re managing retirement plans and scholarship money, it might be a good idea to make sure you’re fully apprised of the risks associated with an imminent reversal of the dynamics that have driven investors into EM assets since the crisis.
Now, let’s revisit a fun comment posted on that Dealbreaker piece, shall we? This was from one “Fuzzy Investicle”:
Fuzzy Investicle· 44 weeks ago
This article is inflammatory and stupid. Further, this is why most professionals with employment options have zero desire to work for a public pension. Absurd press and below market compensation; what a way to spend a career.
Heisenberg: Moron says what.
Fuzzy Investicle: What?
It’s the age old game of “Don’t touch the Stove”…no matter how many times you warn them, no one believes they will get burned until they do…unfortunately, by that time, they have 3rd degree burns and the skin is peeling off…
This boils down to Nashville being a college town as well as state capital. Sure it’s trying to manage its pension fund effectively in the modern economy, but it also needs revenue and the modern university model demands evidence for a worldview that doesn’t reflexively condemn the emerging economies.
Hedging hedges with hedges while Bloomberg bashes the IPhone X incessantly today….fun times…
That comment appended was f’n hilarious….
Admittedly, this investment was ill advised, but we would do well to ask ourselves why they made that decision. Presumably, they have an MBA or similar qualifications, so they must understand the implications.
I’ve seen various studies indicating that pension funds need about an eight percent annual return to satisfy their responsibilities to retirees on an ongoing basis. I imagine that TSRS is no different.
Because of the near-zero interest rate regime, all pension funds (not just TSRS) are falling well short of their objective. It would be one thing if this situation occurred for a year or so, but it has prevailed for a decade. Doubtless, their actuaries are pressing the fund asset managers to take action to close the ever-yawning hole in their balance sheet.
The pension funds have only so many choices, none of them good. Alternative one: they can continue to invest in things that are investment grade. For the most part, pension funds have done this year after year after year. And with each passing year the hole in their balance sheet has gotten larger and larger. They can only hope that eventually the situation will not merely normalize but reach the point that for several years they can earn an investment grade return north of ten percent. Since the chance of this is rather remote, it is virtually certain that the funds will eventually have to slash the benefits paid to their retirees.
Or…they can go further out on the risk curve, purchasing things like corporate junk bonds or (as in this case) EM debt. Yes, the “investment” may crash and burn; but at least now there is a chance (however remote) that they can make the black hole on their balance sheet disappear.
And this is not just their worry. If (as seems likely) a number of pension funds fail, we are looking at a multi-trillion dollar problem. This would be akin to having an elephant die on your doorstep. Almost certainly, Congress would vote to bail them out. If you think we have a budget deficit problem now, just wait till that happens.
That is why we would do well to get ahead of the curve by supporting the Fed’s program to aggressively raise rates. That would provide the pension funds with a measure of relief. Will it be enough to save the pension funds? Possibly not, but at least the crisis would not be quite so severe when the day of reckoning comes.