IMN’s annual conference in Scottsdale, Arizona earlier this year attracted a standing room only crowd.
As one of the many beneficial owners in attendance, The Texas Municipal Retirement System’s (TMRS) Dev Outlaw came to hear experts discuss the securities lending market. TMRS provides retirement, disability, and death benefits to employees of 842 participating cities and, as of 2010 year-end, the statewide agent had over 140,000 employee accounts, and over 38,000 retired members.
SLT: What prompted you to take a closer look at securities lending?
Dev Outlaw: First, some important background about TMRS’ investments. Prior to 2008, TMRS was entirely invested in high grade fixed income instruments for an income-based strategy. The TMRS pension plan design prior to 2008 did not allow the crediting of unrealised gains to member or city accounts and the income-based investment strategy was appropriate for the plan. TMRS made its first equity investments in 2008 and, following the passage of legislation in 2009 that allowed the crediting of unrealised gains to employer accounts, moved to a total return strategy and expanded the diversification of investments.
That diversification will continue over the next few years. TMRS began its securities lending programme in 2003. With the income strategy in place at that time, securities lending potentially added incremental income to the portfolio.
SLT: How did you find the information presented in terms of making you feel confident pursuing securities lending?
Outlaw: TMRS attended the conference to expand our knowledge of the current issues affecting securities lending and to help us determine additional opportunities given our expanding diversification.
The key takeaway from this year’s very informative conference was the movement toward risk reduction through focusing securities lending programmes more on the intrinsic value of lending instead of cash collateral reinvestment. This knowledge will influence TMRS’ focus on the securities lending component of our custodial review in 2012.
Historically, we have incorporated securities lending as part of a bundled overall custodial service. However, we will be evaluating securities lending on both a bundled and unbundled basis in our planned 2012 custodial review.
SLT: Does securities lending make sense for TMRS?
Outlaw: Currently TMRS only lends to agencies and treasuries from our fixed income portfolio. No decisions on other asset classes or types of fixed income have been made. Our attendance at the conference was part of the research and fact-finding process that will culminate in recommendations to the Board at some future date.
SLT: How do current market conditions fit in with any decision on pursuing securities lending?
Outlaw: Diversifying our portfolio in the current market provides both challenges and opportunities, but our overall strategy has not been significantly changed by market conditions.
We think the entire sec lending market is challenged by the current low rate environment, especially in reinvestment of cash collateral. This is one of the key drivers of our desire to focus our sec lending programme on the intrinsic value of lending. However, the challenge TMRS currently faces is difficulty in finding consistent intrinsic value in the asset classes we currently lend, treasuries and agencies. We see potential opportunity in adding corporate and foreign bonds as assets to lend, however, we are reluctant to add to the reinvestment risk of our securities lending programme in the current environment.
SLT: How has your programme been adjusted in recent years and for what reasons?
Outlaw: TMRS’ equity allocation is invested through commingled passive index funds and TMRS initially selected funds that were permitted to lend securities. In 2008, at which time the total equity allocation was approximately 7.5 per cent of the total portfolio, liquidity issues within the collateral pool surfaced. TMRS determined that the benefit from securities lending within those funds did not outweigh the liquidity risk, and so transitioned those investments to comparable but non-lending passive commingled funds.
SLT: What would you need to see happen to expand your securities lending activities to include other instruments such as stocks?
Outlaw: Market changes in cash collateral reinvestment risk or non-cash collateral opportunities would provide more incentive for us to expand our programme to add other assets. Also, working with our lending agent to adopt more conservative investment guidelines for TMRS cash collateral reinvestment strategies would provide additional incentive to expand the program.
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