Alpha Pages: Are investors becoming frustrated with the lack of performance in some alternatives or are they simply happy to get overall returns? How difficult is it to sell your managed futures product?
Lee Partridge: We had a phenomenal year last year. The challenge we have has been more idiosyncratic. People who understand managed futures understand what went on this year. We were up 22% last year and we are down roughly 15% year-to-date this year. People like things that are going up, so do I. There is nothing that generates a big positive return without any volatility. When we run our managed futures strategy we run it at a 20% volatility. We believe in higher volatility inputs in the portfolio because then if you [take] 1% out of equities and put it in managed futures, it actually makes a difference, where if you are running at 5% or 8% volatility, taking money out of equities and putting it in a low volatility fund is almost no different than putting it in cash. … Long-term trend-following is the most stable signal and it is the one that is most negatively correlated with equities.
AP: Has there been a return to equities and is there a risk that pension dollars will be less prepared for a market crash then they were in 2008?
LP: They are less prepared for sure than they were in 2009-2010. The other side of the trade is that pensions probably had the highest allocation to equities in history in 2007 and they got chopped off at the knees in the bear market, and then they were not only way under-weighted in equities, but instead of rebalancing and buying equities they reduced their allocation to equities so they were net sellers of equities after they already had a 40% decline. All of their models told them they should be buying and rebalancing into the market but they were doing the opposite, they were trying to diversify after the horse already left the [barn]. And now you are seeing the flip side of it. They have added to equities, they increased their allocation systematically. Their [allocations to equities] are not as high they were in 2007, but they are at the highest level since this whole expansion and they haven’t been rebalancing out of equities as a general rule. We are approaching a point of susceptibility again.
AP: When we spoke a few years ago you expressed concern that pension funds across the United States were dangerously underfunded. That situation may be worse now. How bad is it? What needs to be done to try and correct this problem?
LP: It’s not that bad. The average funding of pension plans is around 83% to 84%, which from an historic standpoint is not that bad. The way it is calculated is based on a higher discount rate than what a corporate pension plan would use. But despite that the pension industry has improved dramatically since the dark days of 2008-09, [aided greatly] by the equity rally, but the question is ‘where do we go from here?’ Like I said, they have more equity exposure today than any time since after [the crash]. It gives us some concern.
AP: The big problem besides underfunding is that we have been in this zero-interest-rate environment for five years and will be there at least for one more year. How is that affecting pension plans?
LP: It’s tough. It makes it very difficult for these guys to meet their return assumptions in an environment that interest rates are not only at zero but there is still more stimulus coming out of the monetary side.
Politicians are very aware of the hurdles. There are a lot of critics of public employment benefits. I think there is an unfair attack going on against public pension plans that really isn’t warranted. That is not to take away from the fact that it is a challenging investment environment.