Updated: January 1, 2018
Issue: Periodically, the value of the U.S. stock markets will experience larger-than-normal fluctuations that reduce the individual value all investments, including the public equity investments of TRS. These fluctuations are reflected in the indexes which track the day-to-day value of the public equity markets.
TRS members worry what the effect of these sharp declines in value of the stock market will have on the TRS investment portfolio, and the viability of the System to pay retirement benefits.
For instance, during the last week of August 2015, the Dow Jones Industrial Average and the Standard & Poor’s 500-stock Index, along with other public equity indexes, experienced six days of sharply falling values. On August 24 during trading, the Dow briefly dropped by 1,089 points before recovering 500 points by the end of the trading day to close with a loss of 588.4 points — the eighth worst one–day point decline in the history of the New York Stock Exchange.
Any time there are sharp declines in the value of the highly–publicized Dow and other stock market indicators, media coverage of the event is extensive, with an emphasis on the financial losses experienced by the owners of stocks. Since large institutional investors like TRS and other public pension systems are heavily involved in the stock market, part of the coverage of these fluctuations describes the losses seen by the members of these pension systems.
Discussion: TRS strives to protect the value of our members’ money through a long–term investment strategy designed to mitigate any losses in value that result from sharp fluctuations in the stock market or the economy in general.
Sharp declines in the value of the stock market have occurred throughout history at regular, yet unpredictable, intervals. As result, the TRS investment strategy anticipates that these fluctuations will occur in the future and plans for those events. The TRS investment portfolio is continually prepared to absorb value reductions when they happen.
TRS has been successful over the last 25 years in expanding the size of TRS member assets, despite the ups-and-downs of the world economy and insufficient funding from the Illinois General Assembly. Since 1990, TRS assets have grown by 511 percent, from $8.079 billion to $49.4 billion.
Here is an overview of the TRS investment strategy:
Long–term emphasis: As a perpetual entity, TRS will always stress a long-term view of investment results rather than emphasize short-term gains or losses. The media may get fixated on single-day returns, but TRS understands that its relationships with most of its members will last decades. Steady, positive returns over 10, 20 or 30 years are more important to people with a long-term stake in TRS. At the end of fiscal year 2017, the 30-year TRS investment return was a positive 8.1 percent, which exceeded the System’s assumed 30-year rate of return for that fiscal year of 7 percent.
Diverse investments: TRS maintains a highly-diversified investment portfolio set up to mitigate sharp drops in the value of the stock market or any other segment of the economy. In other words, not all of the eggs are in one basket.
A diverse portfolio safeguards TRS assets because sections of the worldwide economy do not grow or shrink in unison. Throughout history, as a rule of thumb, when stock values are expanding, bonds slow down. But when stocks slow down, bonds pick up speed. Real estate, as an investment market, is not tightly connected to the movements of stocks so real estate can make money when stocks lose. Other markets TRS invests in — private equity, hedge funds and commodities – also are not influenced greatly by the equity markets.
When the stock markets experience a sharp drop in value, other TRS investments in real estate, private companies and commodities, for example, hold their own. They may make money, or not lose as much money as the stocks lose.
Public Equity Markets: Since the U.S. stock exchanges are the most visible parts of the U.S. economy many people, including members of the media, have advised TRS to place its entire $49.4 billion portfolio in “index funds.” Index funds are designed to track the average value of the public equity markets on a day–to–day basis and not to “better” the average value. This advice is especially prevalent in a “bull” market where stock values are climbing regularly.
But the value of index fund investments also drop accordingly when the value of the markets drop, so when the market loses 500 points in a day, those investors lose 500 points in that day. Index funds match the volatility of the market.
With stocks, both in U.S. markets and overseas markets, TRS invests money to be actively managed so returns, it is hoped, beat the market averages. With this strategy, TRS has been successful over the long term. At the end of fiscal year 2017, TRS investments in domestic stocks returned a positive 20 percent, net of fees. International stocks returned a positive 22 percent return, net of fees, in that time period.
Currently, TRS has 36.4 percent of its total investment portfolio in stocks, or $17.8 billion. The public stock markets over time, remain the most efficient money maker. Over the last 115 years, the average total return per year from U.S. stocks is a positive 9.4 percent.
Fixed Income: Also known as the bond market, TRS currently invests 19.5 percent of the total portfolio, or $9.5 billion, in fixed income securities around the world. At the end of FY 2017, the Fixed Income portfolio returned a positive 6.3 percent.
Real Estate: TRS currently invests 14.5 percent of the total portfolio, or $7.1 billion, in properties of all types throughout the world — office buildings, hotels, apartment complexes, retail and industrial. At the end of FY 2017, real estate investments generated returns of a positive 7.6 percent.
Private Equity: These direct investments in privately–held companies around the world generated a return at the end of FY 2017 of 17.4 percent. TRS currently invests $6.4 billion in this strategy, which is 13.2 percent of the entire portfolio.
Diversifying Strategies: This investment strategy includes “hedge funds” and other “absolute return” investments. These allocations are designed to provide steady positive returns regardless of the state of the world economy. In other words, these investments “hedge” the risk that is present in other investment strategies. TRS currently invests $3.07 billion in hedge funds. At the end of FY 2017, hedge funds returned a positive 1.7 percent.
Real Return: This relatively new strategy also focuses on protecting TRS assets from the fluctuations or downturns of the economy. These investments include various commodities and inflation–linked securities. TRS currently invests $3.9 billion in this strategy, or 8 percent of the total portfolio. At the end of FY 2017, the strategy’s returns were a positive 4 percent.