Pension fund goes long futures

Publication: Futures (Cedar Falls, Iowa)
Date: Feb 1994

YES, VIRGINIA, THERE ARE SAFE MANAGED FUTURES

Eleven days before Christmas, Bear Stearns told the Virginia legislature that there are safe managed futures, and the state pension fund made five trading managers the present of quadrupling its funds under their management to $640 million, making it one of the world's largest managed futures programs.

So it seems peace may reign after an acrimonious dispute that arose last year over whether a $160 million program established in May 1991 threatened the safety of the $16 billion Virginia Retirement System (VRS) pension plan.

The Joint Legislature Audit Review Committee had hired Bear Stearns Fiduciary Services to examine the futures program and other elements of the pension plan. The consultant concluded the futures program had "sophisticated and extensive risk controls, reduced volatility" and had earned a good rate of return. Annualized returns were 9.84% per year, and annual volatility was 9.59%, for a risk-adjusted return of 1.03%. By comparison, the S&P 500 had slightly higher absolute returns (10.38%) but higher volatility (11.07%) for a lower risk-adjusted return of 0.94%.

The returns were largely uncorrelated to other asset classes the fund invests: specifically 0.16 correlation to the S&P 500; 0.48 to the Lehman Government /Corporate Bond Index; and 0.10 to the Russell NCREIF, a real-estate index.

"Since our program expectations were to earn the same return as stocks with lower risk, it met our expectations," says John McLaren, managing director at VRS. "The non-correlation makes it a real winner."

The increased funds will go to the five trading managers already in the program: Kenmar, Hart-Bornhoft, Ramsey Financial , KP Futures and Centurion Trust. The Bear Stearns study wasn't a blanket endorsement. Fees came under fire: The study concluded that using an outside consultant -- RP Consulting -- plus five trading managers made fees higher than they might have been.

It also criticized RP's fee for being based on the number of round turns. That raises the possibility of conflict between keeping commissions down and RP's own compensation .

Richard Pike, president of RP Consulting, notes that "no one said the costs were too high for a $160 million program -- only that they might have been lower if there were not so many managers." The large number, he says, was needed so the program could be expanded. The CTA fees came down, he adds, as larger scale allowed VRS to get economies of scale and big-customer discounts. His own fee was initially set on a per round turn basis to give his firm time to analyze its cost basis for processing all trades for the fund. With that established, RP now has negotiated a fee based on equity capital under management.

The study also said more guidelines for trading managers and CTAs should be in writing , and that the retirement system's staff could check some things itself, rather than rely totally on the consultant.

There is a substantial risk of loss trading futures, forex and options. Before investing please understand that changes in the cash and commodity futures price do not typically correlate on a one to one ratio with the corresponding commodity option price. Moreover, past trends in cash and futures prices on specific commodities do not necessarily forecast current profitability of options on those commodity futures. All known market news will not necessarily affect option prices since the news is usually already factored into the underlying futures price, as well as option value.