The Tennessee State Pension Fund Has A North Korea Problem...Really

This one is a doozy.
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I don’t know this for sure because I’ve never conducted any interviews, but my guess would be that the roughly 140,000 retirees who depend on Tennessee’s state pension fund would be surprised to learn that their financial fate at least partly depends on whether Donald Trump and Kim Jong-Un accidentally stumble into an armed conflict.

According to its 2016 annual report, the Tennessee Consolidated Retirement System (TCRS) has over $43 billion in assets. Presiding over those assets is CIO (and man who is really surprised to see you) Michael Brakebill:

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Earlier this week, Brakebill showed up in a Bloomberg article the subject of which was Tennessee’s exposure to South Korean equities. Simply put: their allocation is what one might fairly call “considerable.”

Specifically, Tennessee’s Treasury Department is the single largest holder of the iShares MSCI South Korea Capped ETF:

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To be sure, there’s nothing inherently “wrong” with that, but if you do the math there, that’s a $500 million bet on South Korean equities - by a retirement plan.

South Korean shares do look cheap on the fundamentals. The P/E ratio for the MSCI South Korea is a bargain basement 8.5X. Also, Tennessee is hardly the only interested party. As of July for instance, inflows were running at their fastest pace in five years.

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“The difficulties of trying to trade assets in a nation that offers great rewards, but stands almost alone in also carrying the risk of physical annihilation somehow remind me of the catch line from 1953’s ‘Robot Monster,’ a classic, truly awful cult sci-fi film: “I cannot — yet I must. How do you calculate that? At what point on the graph do ‘must’ and ‘cannot’ meet?,” Bloomberg’s Garfield Reynolds wrote last month, summarizing the conundrum.

But that doesn’t change the fact that this seems like a risky proposition for a pension fund, especially when you consider that, at least according to what he told Bloomberg, Brakebill is basing this allocation on a possibly dubious assumption.

“The long-term history with this situation is that it’s a lot of posturing and not much reality,” he said, regarding the prospect of an armed conflict on the Korean peninsula. He’s not alone in trotting that out to justify a position in South Korean assets and it is kinda, sorta true (if you forget that there actually was a Korean war one time). But given that there are now two irrational actors in this equation (Trump and Kim) as opposed to one, it’s not clear that historical precedent is a good guide.

Brakebill went on to make an even more dubious assertion. “If fear is rising dramatically about this issue, it would be odd that these things are performing as well as they are,” he told Bloomberg, in the same interview. That seems to suggest that Michael doesn’t have a firm grasp on the dynamics at play across assets. 2017 has been defined by a disconnect between geopolitical uncertainty and market-based measures of volatility. That disconnect is to a large extent attributable to developed market central banks who have created a global hunt for yield. Thanks to lackluster inflation, DM policymakers have been able to justify keeping policy accommodative and that, in turn, has ensured that carry trades remain viable. In short: saying that because risk assets are performing well it must mean no one is afraid, is an assertion that has been refuted by a veritable parade of analysts from virtually every sellside shop on the Street.

Additionally, it’s not entirely clear that Brakebill is looking hard enough for evidence of “fear.” For instance, South Korea CDS is now considerably wider than that of Thailand:

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Meanwhile, it’s worth noting that Tennessee Gov. Bill Haslam is actually in Asia this week hoping to secure more foreign investment from South Korea, which has already invested some $1 billion in the state. I’m not saying there’s a connection there, but I’d be remiss not to at least mention it.

Here’s the other thing: Tennessee’s emerging market ETF exposure doesn’t stop with South Korea. They are also the largest holder of the iShares MSCI Brazil Capped ETF, which is of course subject to all manner of political risk tied to embattled President Michel Temer:

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And then there’s the iShares MSCI Taiwan Capped ETF where Tennessee is, again, the largest holder:

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Obviously, the fund is also heavily invested in things that aren’t emerging markets, but as Bloomberg observes, the South Korea ETF is “Tennessee’s second-largest holding after Apple.”

When you consider all of the above with the very real possibility that further Fed hikes, balance sheet rundown, and any movement on tax reform could catalyze a potentially sharp rally in the dollar, this looks like a lot of risk to be taking for a pension plan.

Finally, all of the above seems especially ironic given that this would be the same CIO who was profiled in a 2013 piece that carried the following subhed:

Michael Brakebill is fine letting other public-pension chief investment officers blaze trails in search of better risk-adjusted return — and take on the attendant risk that it won’t work out. “We are undeniably a laggard on innovation,” said Brakebill, CIO of Tennessee Consolidated Retirement System. “We try to take the good ideas other people have done and vetted over a long period of time, and implement them in what we do.”

Well, to the extent hanging on to a $500 million position in South Korean equities at a time when a “mentally deranged dotard” and a despotic boy king he nicknamed “Little Rocket Man” are engaged in a game of nuclear brinksmanship counts as “innovation,” it’s safe to say Tennessee is no longer a “laggard.”

Catch more Heisenberg over at Heisenberg Report.

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