Thursday, June 16, 2016

Why Does the Texas Teachers Retirement Fund Own Gold?

Whenever the topic of gold comes up it always seems like to me that there is way too much emotion about it. Mainstream analysts and financial advisers tend to react to gold as if it was the worst possible asset in the world for anyone to even think about owning. On the flip side, some gold advocates can't understand why everyone doesn't sell everything they have and put it all into gold.

Obviously, I'm exaggerating somewhat, but that's what many people seem to do when gold is mentioned for whatever reasons. I think there is a more reasonable approach to the whole subject and the Texas Teachers Retirement System seems to "get it" to me. The June 2016 edition of Gold Investor published by The World Gold Council has a great interview with Shayne McGuire. He is portfolio manager of the Gold Fund for the Teacher Retirement System of Texas. 

Mr. McGuire shows us how its possible to take an unemotional and rational view of how gold can be used to diversify a portfolio. He explains why the Texas Teacher Retirement System has done so. The article is in pdf form so I can't directly link you to it.

However, below I pasted in the first two question and answers along with the last question and answer in the interview. You can read the full article by going to this link first. Go to the June 2016 issue and find pdf download link which will give you the full publication in pdf format. This article is on page 8 of the publication.


Q: TRS (Teacher Retirement System) has been investing in gold for a number of years. Why did the pension fund decide to invest in gold as an investment separate from commodities?

A: One of the main reasons we considered gold was the diversification benefits it provides to portfolios dominated by equities, as most pension funds are. We began work on gold in 2007 and the Gold Fund was launched in October of 2009. Gold, which has different demand and supply drivers than financial assets, is generally negatively correlated with stocks. Since the end of Bretton Woods, every time the S&P 500 has fallen more than 10% in a year, gold has been up. Despite the collapse of commodities during the 2008 financial crisis and the metal’s initial decline, gold was one of the few assets that ended positive for the year. We thought that adding gold as a relatively small percentage of total assets would improve the Trust’s long-term risk adjusted returns due to diversification benefits.

Q: What were the main hurdles that had to be overcome to launch the Gold Fund? What convinced pension fund directors to deploy the strategy? 

A: Gold presents a number of investment challenges that provided for intense discussion when we were deciding on the Gold Fund. Most notably, the metal does not offer a dividend or coupon that can allow for cash flow based valuations that we, as financial professionals, are comfortable with. There was also the memory of the 20-year bear market the metal endured during the 1980s and 90s. (What if we get another bad one?) Since the price of gold was fixed before 1971 (excluding the few turbulent years after the Civil War and during the early FDR administration), we only have two very different bear markets and two very different bull markets for the metal, which provide a weak basis for statistical analysis. (It is important to point out that the bear markets were so different because the first started with very high real interest rates and the second one with negative real rates, which persist today.) Furthermore, there is the issue of where gold should reside in asset allocation. The precious metal is listed on the FX page on the Bloomberg financial system, but also on its Commodities page. It is an inflation hedge (it rose 2,300% during the inflationary 1970s), and yet a deflation hedge in times of deep economic stress (such as the early 1930s and 2008) – it tends to rise as investors begin to anticipate the need for dramatic inflationary monetary intervention. Given these difficulties, it is no surprise to me that, to this day, many funds struggle to implement a gold strategy. Ultimately, our decision to invest in gold as an asset separate from commodities was based on the diversification benefits to the overall portfolio.

Q: Gold thrived during the inflationary 1970s and then languished in a protracted bear market. In recent years, we have confronted the risk of deflation and gold has declined significantly from its 2011 peak. Why does it make sense as an investment now? 

A: Gold generally competes with other asset classes, like stocks, bonds and real estate, on a weak footing since it does not offer a dividend or coupon with which to value it in a formal sense. Over the very long term (since the 1830s), gold has returned 1.1% per annum in real terms in US dollars (see Barro and Sanjay, “Gold Returns,” February 2013, NBER Working Paper No. 16026). But for an investor today, knowing this is perhaps less helpful than knowing that gold rose 2,300% in the 1970s and that it had a 20-year bear market in the 1980s and 1990s: it has higher volatility than long-term returns would imply, making holding a large position relative to other assets a complex decision. Considering that the metal has effectively only been trading as a risk asset for 45 years I believe gold is, very ironically, one of the newest major asset classes, one that funds with a very long term time horizon will be taking more seriously in the years ahead. With the exception of brief periods I mentioned before, when it traded free of a dollar link, gold has only had two bull markets (three, if you include 2016) and two bear markets in US financial history. Since gold has low to negative correlations with traditional asset classes, most notably stocks, investors should consider the outlook for larger markets to arrive at their outlook for gold.
My added comments: The underlines in portions of the answers above were added by me to feature what I felt were some key points made by Mr. McGuire. Wouldn't it be great if more people who discussed gold talked about it in a rational way like Mr. McGuire does here. All he does is point out a very simple truth that most everyone can easily grasp. Notice how he repeats that the TRS allocates funds to gold as a way to diversify their holdings. This is a concept virtually every financial adviser I have ever heard endorses. My wife is a retired teacher in Texas with a small pension so I am happy to see this kind of prudent management by the TRS.

If you want to be truly diversified, you have to allocate some portion of your savings/investments to assets that have "low to negative correlations with traditional asset classes."  Mr. McGuire also notes that gold historically has provided "an inflation hedge" (see 1970's for example), but also "a deflation hedge in times of deep economic stress."

These are very simple truths. Gold (and silver) offer a way to better diversify savings or investment funds. It can also be an important hedge (insurance) in both inflationary times and deflationary times.

Going further, holding some precious metals in physical form (like some coins for example) offers diversification against risks beyond what Mr. McGuire mentions. If we ever did experience "deep economic stress" it might be impossible to access any money you hold in digital form for a period of time. No serious analyst would take the position this could never happen. It already has happened as we saw last summer in Greece where people were restricted from access to their funds for awhile.

Suppose for whatever reason the electricity grid goes down for a week (or a month). Those who were wise enough to properly diversify into some form of money that could be used under those circumstances are the ones who are truly diversified properly. Those who were not wise enough to be prepared are not really fully diversified in my view.

It's just common sense and there is no reason for any analyst or adviser to dismiss this as a reasonable strategy for anyone who has funds or savings to manage. (Jim Rickards argues his case for gold in this recent interview on CNBC). Even those with very little savings should try to build up some kind of emergency fund. Again, it's just common sense.

Added notes: Even the US Government encourages people to have some kind of plan in mind in case of an emegency event.  (see page 35 of this Basic Disaster Supplies Kit list - "cash and coins" are on the list). Also, Financial writer Scott Burns has this recent article on Mr. Mcguire that says in its conclusion:

"So, when you put all the drama aside, gold is just another asset, a minor asset at that, and a careful investor owns some -- sometimes more, sometimes less, but some."

Also, a thank you to Dan Popescu for a mention of this article on his twitter feed. Here is an interesting chart Dan posted on this twitter feed. If fund managers were to add gold and silver such that they were to equal just 1% of all the global financial assets, the price of both would rise considerably. 

Many seemed unaware that Texas is a fairly pro gold state. See this article for more information. The University of Texas owns actual physical gold bars in its investment fund and the Texas legislature recently passed a bill to setup a precious metals depository in Texas to house any state owned gold and also private citizens gold or silver.

This article had generated quite a bit of interest. A thank you to Jim Sinclair for posting this article here on his site. Also, a thank you to all the following for re-tweeting a link to this article - Alex StanczykTrader StefJim RickardsArt MattersJeff LeeBarbara NegrescuDaily Debt Watch and any others I may be unaware ofI appreciate it as it really helps the article get broader distribution.

1 comment:

  1. Thanks friend for this important information about retirement fund. I am impressed with your research! Thanks so much for your input and for taking the time to this post. Keep it up..

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