Written by Michael Markov | MPI
Do pensions and endowments contain hidden potential stressors on their portfolios akin to what brought down Silicon Valley Bank?
It’s hard to tell. And that’s a problem when we are talking about some of the largest, most important investors in the marketplace.
The recent collapse of Silicon Valley Bank shines a light on the need for more reporting and transparency from large pensions and endowments. Most report only annually, so any impact from the second-largest bank failure in U.S. history, and the follow-on effects across private equity and venture capital, may not be known until August or September.
Based on proprietary data from our Transparency Lab, we already know that pensions appear to have rebounded from their losses in FY2022, but those pensions that benefited from a lack of liquidity through concentration in private markets are likely to underperform in FY2023, as the asset values are marked down.
Yet, we don’t know what exposure, specifically, funds may have from holding that stock and others that have collapsed, nor do we know whether Silicon Valley Bank’s impact has further eroded the allocations to private equity and venture capital that these funds typically make. Remember, many endowments have an almost-even split between private and public market investments. The only indication we have so far comes from journalists who reach out and ask.
We are fortunate because , for years, MPI has utilized its proprietary technology and public data sources to peek quantitatively behind the curtain of pension and endowment investments, providing information that is often otherwise impossible to obtain.
Yet, we shouldn’t be the only ones providing this data, and the media shouldn’t have to ask. There is a need for greater transparency within pensions and endowments. The larger these funds get, the more they may not only be affected by markets, but also exert an influence on investments, both public and private. It’s fair to wonder what exactly is inside these tax-sheltered or tax-advantaged investing machines.
College endowments are notoriously opaque, providing so little information that their once-a-fiscal-year reports have become a regular autumn spectacle. Seldom do these reports contain much real information about how endowments achieve results, how they decide which risks to take, or how outsiders can independently verify their results.
Likewise, it is getting more difficult for stakeholders to obtain relevant risk exposure details on many U.S. pension funds that have been plagued by chronic underfunding and decreased disclosure. Even when this information is available, peer-to-peer comparisons are almost impossible because every institution is unique in how it defines asset classes and categories of alternative investments.
So, what do we know so far? Before Silicon Valley Bank’s collapse, pension performance was recovering. Performance of the Global 60-40 benchmark for the second half of 2022 was 0.2%, with -6% loss in the third quarter and 6.6% gain in the fourth quarter of 2022, which gives a basis for projections about most pensions’ experience. However, given the differences in pensions’ asset allocations, both the magnitude of the swing and the end-result vary.
According to our analysis, the biggest variable in how pensions are faring is private-market exposure. The lowest estimated performers in the group for the second half of 2022 are state employees’ pensions of Washington, Oregon, and Pennsylvania. Interestingly, last fiscal year, these three pensions reported the highest performance in the group. Indeed, Oregon PERS reported a 6.3% gain in FY2022, while most peers lost more than 5% and some lost even more than 10% over the same period.
What makes this group of three pensions unique is their outsized allocations to private assets. When pensions report their annual results, they usually use previous-quarter valuations for their private assets: e.g., first quarter private valuations for June fiscal year report. In 2022, that was enough to propel these three funds to the top: Cambridge Associates Private Equity index performance for the first quarter was -0.35% (vs. -5% for the second quarter) and at the same time the second quarter return of the S&P 500 Index was -16.1%.
In the last half of 2022, these three pensions will have to absorb the 5% loss for private equity in the second quarter, since it was not counted in the last fiscal year number.
And then there’s a question about Silicon Valley Bank, and that issue’s impact. It’s important to remember that Silicon Valley Bank, as a regulated financial institution and a public stock, had very open reporting standards and transparency. Yet, it still failed.
Over the years, it has become more difficult for stakeholders to obtain relevant risk exposure details on many U.S. pension funds, which have been plagued by chronic underfunding and decreased disclosure. Even when this information is available, peer-to-peer comparisons are almost impossible because every institution is unique in how it defines asset classes and categories of alternative investments. Our approach standardizes allocation types across investors, providing a common denominator for comparison.
Because pension funds refuse to report quarterly returns, stakeholders up to now have had to guess or wait for annual reports. We believe the public and the marketplace are better served with more transparency, and these projections mark a step toward shining light on the performance, risk, and styles of these important investors.
(Michael Markov is co-founder and chairman of MPI. In 1992, recognizing the power that quantitative analysis delivers investors, he led the development of the industry’s first returns-based style analysis application based on Bill Sharpe’s groundbreaking methodology. Continuing this spirit of innovation, he co-authored Dynamic Style Analysis, a significant advancement to legacy returns-based modeling techniques for investors seeking the most precise analysis of managed investment products and portfolios.)
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