Alternate Routes

Remember how those alternate routes designed to prevent traffic congestion often turned out to be almost as popular as the main routes? A modest version of that phenomenon is unfolding at the Minnesota State Board of Investment. Alternative investments—basically, everything other than stocks or bonds—have become the apple of the board’s eye. Located in St. Paul, the board directs the investment of all state funds and the pension assets of the statewide public pension systems for teachers and correctional employees, among others. 

Pensions & Investments newspaper reported last year that the Minnesota State Board of Investment, the nation’s 19th-largest administrator of public pension funds, ranked 14th highest in alternative investments. It said the board ranked even higher in two subcategories: private equity (10th) and oil and gas (1st). The board’s own comparison showed that as of September 30, it had 9.7 percent of its assets in alternatives; its peers had 7.4 percent. Ultimately, the board wants to boost this to 13.5 percent.

That September date marked the end of five quarters in which the Minnesota board pumped roughly $1 billon in additional funds into various alternative investments. And in December, the board voted to direct up to $450 million more into this category. That includes up to $275 million to be invested in new funds that Minnetonka-based CarVal Investors, which was founded by former Cargill money managers, and EBF & Associates in Minnetonka, are opening. 

“Alternatives have been fantastic,” says former State Attorney General Mike Hatch, who left the board in January. “We’ve done very well with them.” Hatch voted for the CarVal and EBF investments at his final board meeting, in December, but not without hesitation. While the board hasn’t experienced any major blow-ups with its alternative investments, Hatch notes that some states’ funds have encountered problems. He cautions: “My issue is, never be a hero when you’re dealing with investors’ money.”

Fueling Growth

The board’s greater stress on alternative investments reflects global trends. Last year, Watson Wyatt, a financial management consulting firm based in Washington, D.C., found that internationally, pension funds sunk $77 billion into alternative investments in 2005, up from $62 billion in 2004. In December, Pensions & Investments reported that officials at J. P. Morgan Asset Management expect defined-benefit plans (those that pay a set amount to eligible retirees) to have 30 percent or more of their assets in alternatives within the next five years.

The alluring returns seen in recent times are one big reason for the increase. The Minnesota State Board of Investment’s returns from alternative investments shot up to 16.6 percent for the year ended June 30, 2004, and they’ve been sizzling ever since: in 2005, 27.2 percent; in 2006, 43.7 percent.

Such returns have helped to bring on a refreshing mid-decade rebound at the board, which saw billions of dollars in asset shrinkage during the stock market plunge of 2000 to 2002. Because public pension benefits are tied to returns averaged over five years, retirees’ pension increases failed to keep up with inflation in 2005 for the first time in 15 years.

“The SBI, like other pension plans, is a long-term investor that is striving to maximize returns within acceptable levels of risk,” says Howard Bicker, the Minnesota board’s executive director. “Any increase in overall returns will lead to the funding of the state’s pension obligations, which in turn could lead to increased benefits and/or reduced contributions from employees and/or the taxpayers of Minnesota.”

Booming activity in private equity funds continues to fuel the rise in alternative investing. These funds accounted for nearly half of the value of board’s alternative-investment portfolio at the end of fiscal 2005. Low interest rates, gobs of available institutional money, and the equity funds’ ability to attract much of the top talent in the money-management industry, have sustained the boom. Bicker says another important factor has been the board’s ability to diversify its portfolio by choosing from a variety of alternative investments.

All of these forces have come together to create an industry within the investment industry. Today’s money-management scene offers conferences such as the Alternative Investment Summit and the Alternative Investment Round-up, in addition to the Alternative Investment Journal.