Wisconsin Investment Board approves allocation cushion to combat ‘denominator effect’

Private valuations have stayed high, despite erratic public markets, inflation fears and geopolitical shocks.

State of Wisconsin Investment Board increased the range around its allocation towards private debt and equity to 5 percent in either direction to prevent it from having to sell public equities to balance the portfolio.

SWIB’s policy change reflects the concerns pension boards face due to the “denominator effect” that boosts the allocations of private equity and debt as plunging public holdings shrink the total value of the investment portfolio.

As public markets have swung wildly amid inflation and supply-chain woes, along with geopolitical shocks, private valuations have stayed generally high, leading to unbalanced investment portfolios.

SWIB uses a “corridor treatment” that serves as a range around its target allocation. According to its investment policy, if an allocation of private equity and debt exceeded the threshold of this range, it would sell public equities in order to rebalance.

SWIB has a target allocation of 12 percent to private equity and debt. However, the systems actual allocation recently jumped to 14 percent.

Before the board vote, the range around the 12 percent target was 3 percent in either direction – putting the fund perilously close to having to sell off public equities, likely at a loss, said Christopher Levell of NEPC, which advises SWIB.

Extending the range to 5 percent in both directions means the private equity and debt allocation would have to breach the 17 percent mark before mandating a sell-off of publicly traded stocks, according to Levell.

“Expanding the range for now gives us some breathing room and lets us take an in-depth look at possible changes to policy controls later,” Levell said in an interview after the meeting.

Levell also recommended a “deep-dive” review of its asset class ranges as part of the 2022 asset allocation process and plans to present its analysis in October.

This article first appeared on affiliate title Buyouts.