Updated: December 13, 2019
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.
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 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.
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 560 percent, from $8.079 billion to $53.4 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 20 or 30 years are more important to people with a long-term stake in TRS. At the end of fiscal year 2019, the 30-year TRS investment return net of fees was a positive 8.04 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. Currently, TRS maintains 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 $53.4 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:
This asset class is broken down into three components – “public” equities (stocks) traded in markets around the world; “private” equity, or financial stakes in private companies that do not sell shares in a public market; and certain types of real estate investments.
Currently, TRS has $26.7 billion in the Equities asset class, which comprises 50.7 percent of the total portfolio. At the end of fiscal year 2019, TRS investments in all equities returned a positive 5.7 percent, net of fees.
TRS has 34.4 percent of its total investment portfolio in public stocks, or $18.1 billion. The System has invested $7.2 billion in private equity, which is 13.8 percent of the entire portfolio. The real estate portion of this asset class totals $1.35 billion, or 2.6 percent of the total portfolio.
This asset class is composed of most types 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 2019, real asset investments generated a positive 1.57 percent return.
TRS currently invests 12.4 percent of the total portfolio, or $6.5 billion in all real assets. The System at present has invested $6 billion in properties of all types throughout the world — office buildings, hotels, apartment complexes, retail and industrial. TRS currently invests $527 million in other “real assets,” or 1 percent of the total portfolio.
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 2019, the Income asset class returned a positive 7.04 percent.
TRS currently invests 24.9 percent of the total portfolio, or $13.09 billion, in fixed income securities around the world. Short-term investments account for $879.5 million in assets, or 1.7 percent of the total portfolio.
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 $5.5 billion in diversifying strategies. At the end of FY 2019, these investments returned a positive 2.13 percent for the year.