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TRS Investment Strategy During Stock Market Fluctuations

Updated: November 15, 2020

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.

A concern of TRS members is how these sharp declines in value of the stock market will affect the size of the TRS investment portfolio, as well as the viability of the System to pay retirement benefits.

These concerns were amplified in 2020 when the COVID-19 pandemic and the resulting lockdown of society seriously wounded the international economy. For instance, during the January – March quarter of calendar year 2020, the coronavirus effect devastated investment markets in the United States. The Standard & Poor’s 500-stock Index experienced a -19.6 percent return for the three months after experiencing a +9.1 percent return during the October-December quarter of calendar year 2019.

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 affecting the members of pension systems on that day.

Discussion: TRS strives to protect the value of 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 a 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.

For example, during the January-March quarter of 2020, all institutional investors lost money. But at a time when the S&P 500 returned a -19.6 percent, the TRS portfolio recorded a -9.96 percent return. This meant that the TRS investment strategy lost less than the stock market and preserved more assets than the market. That is exactly how the System’s investment strategy is designed to work.

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. Between fiscal year 1990 and FY 2020, TRS assets have grown by 538 percent, from $8.079 billion to $51.6 billion.

Here is an overview of the general TRS investment strategy:

Manageable Risk 

The overarching goal of the TRS investment strategy is to maximize revenue while keeping the risk inherent in all investment opportunities below the average risk factors accepted by other comparable public pension systems across the United States.

In the investment world, “risk” is simply the likelihood that an investment will not do what it’s supposed to do – make money for the investor.  All investments carry a degree of risk. There are no “sure things.”

Using standard risk measurements, the TRS investment portfolio currently is outperforming its peers in revenue generated while the keeping its overall risk below the median risk carried by other pension systems.

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 30 or 40 years are more important to people with a long-term stake in TRS. At the end of fiscal year 2020, the 40-year TRS investment return net of fees was a positive 9 percent. That exceeded the System’s assumed long-term rate of return 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.

Active vs. Passive 

The TRS strategy is to maintain a mix of “passive” and “active” investment strategies. At the end of FY 2020, TRS maintained 66.9 percent of its public equity investments in “active” strategies and 33.1 percent in “passive” strategies.

“Passive vs. active” is a fundamental question for large institutional investors with public equity investments: Should investments be allowed to “passively” ride with the average value of the market? Or should assets be invested by managers that “actively” seek out opportunities to generate revenue beyond the average value of the market?  A passive strategy is especially prevalent in a “bull” market where stock values regularly increase over the long-term.

Since the U.S. stock exchanges are the most visible parts of the U.S. economy the argument has been made that TRS should place its entire $51.6 billion portfolio in passive “index funds” to take advantage of the gradual increase in stock prices.

A “passive” strategy is less costly to administer than an “active” strategy because the System is not employing asset managers and brokers to oversee trades. However, in a passive strategy, the value of investments drop accordingly when the value of the markets drop. When the market loses 500 points in a day, those investors lose 500 points in that day.

The argument for an “active” strategy is that the greater returns generated by stocks that are increasing in value help the System better mitigate the times when the average value of the stock markets is dropping. In this way, “active” investments protect the portfolio. An “active” strategy is more expensive to administer because of the work needed to select the correct investments and to initiate the necessary trades.

The TRS passive and active mix is monitored closely and continually attempts to balance and take advantage of the positive effects of both strategies.

Asset Class Mix 

Key elements of the System’s strategy involve determining what kind of investments to make, and how much money should be dedicated to investments in each particular asset class. These decisions are reviewed continually by the TRS Board of Trustees and staff and are based on extensive research. The goal is to find the right mix of investments to take full advantage of economic conditions around the world.

TRS has divided its investments into four different asset classes:

Equities

This asset class is broken down into three components – “public” equities (stocks) traded in markets around the world and “private” equity, or financial stakes in private companies that do not sell shares in a public market.

At the end of FY 2020, TRS had $23.5 billion in the Equities asset class, which comprises 45.6 percent of the total portfolio. At the end of the fiscal year, TRS investments in public equities returned a positive 6.55 percent, net of fees and private equity returned a positive 3.3 percent.

TRS had 32.9 percent of its total investment portfolio in public stocks, or $17 billion. The System invested $6.5 billion in private equity, which is 12.6 percent of the entire portfolio.

Real Assets

This asset class is composed of real estate investments as well as commitments to opportunities designed to protect TRS assets from fluctuations or downturns of the economy. These investments include various commodities and inflation–linked securities. At the end of FY 2020, real asset investments generated a positive 0.4 percent return.

TRS invested 15.7 percent of the total portfolio, or $8.1 billion in all real assets at the end of FY 2020. The System invested $7.7 billion in properties of all types throughout the world — office buildings, hotels, apartment complexes, retail and industrial. TRS invested $391.7 million in other “real assets,” or 0.8 percent of the total portfolio.

Global Income

This asset class is composed primarily of investments in domestic and international bonds, as well as short-term investments that are designed to make sure that TRS can access cash if necessary to meet its benefit obligations. At the end of FY 2020, the Income asset class returned a positive 3.4 percent.

TRS invested 25.2 percent of the total portfolio, or $13 billion, in fixed income securities around the world. Short-term investments accounted for $1.5 billion in assets, or 2.8 percent of the total 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 invested $5.6 billion in diversifying strategies at the end of FY 2020. These investments returned a positive 1.9 percent during the year.