WINTER 2019
6
The Future of Liabilitydriven Investing, Preserving DB Benefit Plans
VOLUME 2 | ISSUE 1
11
Underfunded Plans and Poor Returns Go Hand in Hand: CRR Study
22
Carolyn M. Weiss, CFO, The New York Community Trust
40
Ford Foundation Embraces Affordable Housing, Financial Services
TABLE OF CONTENTS COVER STORY
ASSET OWNER SPOTLIGHT 34 Pension, E&F Investment Pros
6 The Future of Liability-driven Investing, Preserving DB Benefit Plans
19 Elizabeth Burton, CIO, Hawaii Employees’ Retirement System
11 Underfunded Plans and Poor Returns Go Hand in Hand: CRR Study
A WORD FROM THE BOARD
22 Carolyn M. Weiss, CFO, The New York Community Trust
ASSET ALLOCATION 27 Kentucky Forges Debut Co-Investment: A Euro RE Fund with Barings
14 Cal. State’s Controller Betty Yee 28 University of Utah Endowment Speaks from her Seat on CalPERS, Eyeing “Specialty” Investments CalSTRS Boards
INVESTMENT STRATEGY 30 New York Common Retirement Fund Delves into the Complexities of Investing in Private Debt 32 New Mexico Formulates PreRecession Strategy: Less Public Equities, More Cash, RE, Bonds
2
INSTITUTIONAL ALLOCATOR
Cautiously Optimistic on Hedge Funds
ESG: IMPACT INVESTING 36 IDB Launches LAC GenderFocused Fund; Says Region Ripe for Impact Capital 40 Ford Foundation Embraces Affordable Housing, Financial Services
PEOPLE MOVES 41 People Moves
EDITORIAL TEAM Leslie Kramer Managing Editor CREATIVE DIRECTOR Tony Patryn Senior Graphic Designer & IT Projects Manager EXECUTIVE STAFF Adam Raleigh Chief Executive Officer Tim Raleigh Chief Financial Officer Samantha Pitre Head of People Operations Giseli Akaboci Head of Operations & Logistics Group Jessica Kaplan Operations Associate Joyce Riley Operations Associate Paul Hamann Head of Alternatives and Strategic Partnerships Paloma Lima-Mayland Head of Private Equity Group
Kim Griffiths Head of Institutional Sales & Co-Head Institutional Production Andres Ortiz Head of Private Wealth Investor Relations; Head of Production‚ EMEA Jason Peet Head of US Investor Relations Michelle Quilio Head of Real Estate Investor Relations John Zajas Marketing Manager & Data Protection Officer William Kazlauskas Office Manager Grayson Sanders Office Manager
Paola Segura Head of Asia Pacific PROGRAM MANAGERS/INVESTOR RELATIONS Jane Popova Adena Baichan Amanda Jiang
Kaitlyn Mitchell
Andrew Schulte
Kari Walkley
Ann Lee
Karishna Perez
Audrey Kadenge
Kevin O’Connor
Ben Ettlinger
Leslie Kramer
Betty Ho
Logan Brodsky
Brett Friedberg
Lucas Alexandre
Brian Intemann
Mandy Lam
Carolina Gomez-Lacazette
Maxime Laurent
Christopher Hoarty
Nicole Morisette
Christopher Nelson
Nicole Vranizan
Georgia Quinones
Olga Gorlatova
Gerlim De La Cruz
Patrick Murray
Harry Garland
Stephen Deiner
Jacopo Gaspardone
Sunil Mampilly
James Silverman
Xiang Qin Lim
RELATIONSHIP MANAGERS Adrienne Bills
Orlanda Poblete
Brendan Davey
Poola Prithvi
Cory Stavis
Thomas Mallon
Earl Blasi
Tom Hind
Jade Benoit
Tony McLean
Lissa Campos
Will Hamilton-Hill
Max Tattersall
William McArdle
Nawshad Noorkhan DELEGATE SALES Andrew Baranich
Michelet Cimeus
Brett Windisch
Roberta Dalla
Eliseo Giusfredi
Sean Walsh
Javier Grullon
Stephen Patchen
MARKETS GROUP ADVISORY BOARD MEMBERS Vicki Fuller, former CIO, New York State Ian Toner, CIO, Verus Investments Common Retirement Fund Bob Jacksha, CIO, New Mexico Carolyn Weiss, CFO & Treasurer, The New Educational Retirement Board York Community Trust Joe Cullen, CIO, Montana State Board of Mansco Perry, Executive Director and Chief Investments Investment Officer, Minnesota State Board Tim Barron, CIO, Segal Marco Advisors of Investment Cameron Black, CIO, Treasurer, Blue Cross Chuck Burbridge, Executive Director, Blue Shield of Arizona Chicago Teachers Pension Fund Anand Philip, Vice Chairman of the Investment Committee and Trustee, Ohio Wesleyan University
PRODUCTION Institutional Allocator (Volume 2, Issue 1) is published 4 times a year by Markets Group. No part of this publication may be reproduced or transmitted in any form without the publisher’s permission. Authorization to photocopy items for internal or personal use, or the internal or persnal use of specific clients, is granted by Markets Group. © 2019 Markets Group. Entire contents copyrighted.
LETTER FROM THE EDITOR
Leslie Kramer, managing editor, Markets Group
Welcome to the third edition of Institutional Allocator’s quarterly magazine. It’s a new year, and we are very proud to be putting out another edition of Markets Group’s new magazine. Needless to say, the end of 2018 turned out to be a downer, as far as the U.S. equities markets were concerned. The major stock indexes posted their worst yearly performances since the financial crisis, with the S&P 500 and Dow Jones Industrial Average plunging 4.38 percent and 3.48 percent, respectively. The Nasdaq Composite lost 2.84 percent, according to Morningstar Direct. The drops marked the first time the S&P 500 and Dow have fallen in the past three years and six for the Nasdaq. The times, they are a-changing. Market pundits are blaming the plunge on nervous investors—fearing both an economic slowdown and continuation of rising interest rates from the Federal Reserve. The ongoing trade negotiations between China and the U.S. are also a cause for concern. So, as we enter 2019, lots of uncertainty remains about the direction of the markets, the economy and the country, in general. Chief investment officers at pensions and endowments & foundations, it turns out, were a lot less phased by the recent market volatility. In fact, Robert “Vince” Smith, CIO of the New Mexico State Investment Council, has been planning for this downturn for years. “We have been decreasing equity, since late 2014, early 2015,” he said in an interview with IA. Smith has also been planning for the next recession, which he predicts will hit in mid-to-late 2019 or 2020. “Obviously, we don’t know how bad the next recession will be, but we have modeled for a 35% downturn in stocks, that would make it an average bad one,” he remarked. Read about his full recession planning strategy on page 32. On a happier note, IA is proud to be featuring two dynamic, impressive women in our Asset Owner section of the magazine. We were the first to get a sit down with Elizabeth Burton, the new CIO of the Hawaii Employees’ Retirement System, who left her job at the Maryland State Retirement and Pension System, this summer, to move her family to Honolulu for the job. Yes, we are all jealous. Read about her rapid ascent to CIO on page 19. IA also profiled Carolyn M. Weiss, chief financial officer and treasurer of The New York Community Trust. Weiss’s career trajectory has had her globe trotting, including a move to Berlin for an auditor position with KPMG and to Xi’an, China, where she taught MBA students. Weiss also took some time out to raise a family, before making her way back to New York to join the Trust, an organization she had her eye on from the early days in her career. Find out how many languages Weiss speaks, and how she approaches her role as CIO on page 22. And finally, we offer our cover story which takes a step back and looks at the current state of affairs for defined-benefit pension funds. It’s no surprise to anyone in the industry that many pension funds are highly underfunded, struggling to meet their growing liabilities. So, IA spent some time at Market’s Group Sixth Annual Texas Institutional Forum, talking to panelists about the ins and outs of liability-driven investing and threw out the question that no one wants to answer: Will defined -benefit pension plans survive? Turn to page 6 to read their responses. We hope you find this edition of the magazine informative, thought provoking, and at best a good read. Onward! Leslie.Kramer@marketsgroup.org VOLUME 2, ISSUE 1
3
4
INSTITUTIONAL ALLOCATOR
NO FUNDS FOR PENSION FUNDS
For this quarter’s cover story of Institutional Allocator, the editorial team took a step back to look at the state of U.S. pension funds—how bad or good of shape are they in, who’s to blame, can chief investment officers (CIOs) invest their way out of the hole, and what the future holds for these--what some now see as dinosaur plans. To get a sense of what’s inside industry players’ heads, Editor Mark Fortune spoke with a group of pension fund CIOs, asset managers and consultants who attended Market Group’s Sixth Annual Institutional Forum in Austin, Texas. The group discussed the state of affairs of public versus corporate plans, how to best invest for liabilities, regulations and more. The mood was a mix of trepidation and hopefulness that things will improve, as all participants agreed that they would like to see defined-benefit plans live on. Managing Editor Leslie Kramer then dove into some recently released research from The Center for Retirement Research at Boston College, which offered some startling news. It showed that the worst funded plans are doing a poorer job than their peers when making investment choices, thereby bringing in lower returns. In fact, many were hit hard during the Great Financial Crisis (GFC) and were not able to fully recover, due in part to getting out of public equities too soon after the crisis and investing in expensive hedge funds that charged a lot in fees, but didn’t bring in the desired returns. “The biggest culprits, however, it seems, are state and local governments, who often ignore the advice of actuaries and contribute less than what the actuary deems necessary to make these plans thrive. So what does the future hold for defined-benefit pension plans? Read on to hear what the experts have to say > > >
VOLUME 2, ISSUE 1
5
THE FUTURE OF LIABILITY-DRIVEN INVESTING, PRESERVING DB BENEFIT PLANS BY MARK FORTUNE
Panelists at Markets Group’s Sixth Annual Texas Institutional Forum, in Austin, gathered together to tackle the pros and cons of implementing liability-driven investment (LDI) policies at pension funds. The discussion was predicated on the idea that the typically complicated process of administering the investments of a pension plan can be simplified, somewhat, by focusing on a fund’s obligations or liabilities. The approach is built on two very hard to dispute assumptions: Most pension plans have very well-defined and predictable, required pension payments, and the long-term nature of pension obligations allows pension investments to have very long investment horizons. Though the panelists differed, somewhat, on the finer points and nuances of the issues being discussed, on one question there was agreement: the continuing closure of defined benefit plans, due to the depletion of funding, is both lamentable and avoidable, and large factor in a potential retirement income crisis. The panelists included Moderator Eileen Neill, a managing director and senior consultant at Verus, David Wilson, a managing director and head of taxable fixed income, client portfolio management at Nuveen Asset Management, Christopher Shelling, director, private equity, Texas Municipal Retirement System, Colin Kerwin, retired global pension fund manager, ExxonMobil, and Jeffery Blazek, managing director, Cambridge Associates. Neill observed that when she joined this industry, in the early 1990s, the tech bubble had just started building. At that time, portfolios were returning double digits—equities and bonds. Because assets were performing so well, little attention was given to the liabilities, she said, recalling attending client meetings and quarterly meetings that were generally short and the lunches long. “And that occurred until 2000 when the tech bubble burst, followed by Enron, followed by Long Term Capital Management, followed by the subprime crises, and then, ultimately followed by the global financial crisis,” Neill said. “During that period—the early 2000s—we all woke up and said ‘Oh, we’ve been focused on the assets side and here are liabilities that have grown, and we’re all underfunded. And the regulators came in, and they implemented the PPA [Pension Protection Act] in 2006. So, that really was a game 6
INSTITUTIONAL ALLOCATOR
changer for corporate defined benefit plans. They started to think about structuring their plans very differently than the public plans.” Neil began the discussion by asking panelists how they each think about structuring their portfolios, in terms of incorporating the effect of liabilities for which they have oversight.” DAVID WILSON: I work with corporate pensions, endowments and foundations and public pension funds and insurers. All have unique liabilities. In the case of defined benefit plans, employees accrue benefits that are going to be paid out at retirement. Now, accounting rules have made corporate and public pensions very different. So, for example, with a corporate pension plan, you are still paying out cash flows for the life of the retiree. But, that liability has to be marked to market using high-quality corporate-bond yields. So, if you want to defease that liability, or mitigate the funded-ratio volatility, corporate bonds that match the duration of the liability is your best tool. If you are talking about public-plan liabilities, there is no real duration because the liabilities are discounted using a relatively static discount rate. So, if you want to hedge that liability, cash-flow matching is the preferred approach. By contrast, endowments and foundations have spending rules. Let’s say their spending rule is five percent. Well, that’s an obligation that has to be paid every year; they need to construct portfolios that minimize the volatility—or I should say, maximize the probability of meeting that spending rule without depleting the portfolio. So, very different approaches depending on the accounting and regulatory environment. COLIN KERWIN: For me, I think it starts with understanding first and foremost what is the purpose of a pension plan? Is it to pay for benefits that are being accrued, or is it to secure the benefits that have already been accrued? I would argue that it is the latter. Certainly, under ERISA, the purpose of the plan is to safeguard qualified retirement benefits. The funded plan assets are there to secure those obligations. Separately, it’s the responsibility of the sponsoring organization to fund those obligations. So, if the purpose is to secure the obligation, what is the purpose of risk taking inside the
pension plan or, said differently, how does a risk mismatch between the assets and the liabilities help to safeguard existing benefits? I don’t think it can. I would argue that if the purpose of the plan is to safeguard the obligation then the goal should be better matching of the risk characteristics between the obligation and the assets. So, for pension plans, that should mean very long duration, high-quality, fixed income on the investment side. From a plan participant’s perspective, they arguably own what should be a riskfree promise—one backed by both the sponsoring organization and the funded plan assets. So, a portfolio of long-duration, high quality fixed-income that closely matches the duration and convexity of those liabilities will effectively track the liability, no matter what happens to interest rates, no matter what happens in the financial markets—thereby safeguarding it. The last observation I would make is that this approach should be a win-win for both the plan participants and the sponsoring organization. From the plan participants’ perspective, they are better off if the assets are managed this way, because the assets are collateral for a promise made to them. From the sponsoring organization’s perspective, they too should be better off because, in most cases, the business of the sponsoring organization is not to take risks in financial assets— shareholders (and taxpayers on the public side) can already do that for themselves. CHRISTOPHER SCHELLING: I still am employed with the Texas Municipal Retirement System (audience laughter) so I will try to split the difference between the house view and some of my own thoughts. Colin makes an excellent point on securing retirement versus providing retirement. Our actual mission statement is to provide a secured retirement—so we have to do a little bit of both. I’ll take a step back and maybe differentiate between Texas Municipal and a typical old, state defined benefit plan. Generally, in a state defined benefit plan, you have a legislature that will set the contribution rate and will determine what the benefits are. The benefits are often constitutionally guaranteed. You then have a target rate of return and an asset management division that manages those. Texas Municipal, seventy years ago, was set up to be a cashbalance hybrid plan. So, it was very innovative in that regard. But, we don’t receive funding from the state. We are a quasi-agency; we don’t have a budget line item in the state’s budget. All of our funding comes from individual cities that are voluntary participants in our plan. So, we have different benefit levels that our board gets to determine and offer those packages to our constituent cities. And we require different funding levels for those different benefit packages. And our board actually gets to set on an annual basis
what the contribution rates are for our member plans, and gets to determine what the required rate of return is. So, we think of it as a slide rule—we kind of have control over both sides of the slide rule, which helps us smooth out those changes over time, and weigh the tradeoff between generational wealth creation and wealth transfer, so to speak. So, we kind of view—as the investment team—our job as to hit the rate of return that the board sets up. And we certainly can opine on some of the cash-flow characteristics of the short-term obligations, and think about those in the construction of our portfolio. JEFFREY BLAZEK: I think one of the interesting things about my role is that I get to work with a variety of clients. And the way that we think about the liability is that it is driven by a very simple question: Is the plan still open or not? The trend has been that many are closing, and I think that is tragic for a lot of reasons that we might touch on in this panel. But that’s not our choice—we just take the orders. Where does the plan stand? And if it is closed, then we look a lot at the liability. We want to reduce balance-sheet risk and the funded-status risk as much as humanly possible. PPA changed the rules on that—it may have well been called the bond manager employment act! I mean, it was going to drive a huge boon of assets to long-duration strategies. Because that is the largest risk that a hard-frozen or soft-frozen plan will face. And so, we are going to invest that portfolio thoughtfully, but it’s going to be very focused on the liability. But my former employer, New York Presbyterian Hospital, still has an open and accruing plan. So, when I was in-house at that investment office, we invested it identically to the endowment, because the way we looked at it from the hospital’s perspective was a dollar was a dollar, and if we had a shortfall we were going to own it one way or another as a plan sponsor. So, we may as well seek to maximize income with this open and accruing plan. At Cambridge, when we have open plans, we do the same. We take some liquidity risk, we maximize equity, thoughtfully. We look at the liability. We want to make sure that we put the sponsor in a position to succeed and really make up return to service costs that they are going to face in the future. NEILL: That’s a good segue into the fact that investors’ time horizons do have an influence, in terms of their ability to take risk. And with many public pension plans today, with bond yields so low and the equity risk premium lower than historically is the case, we are seeing kind of a pedal-to-the-metal investment approach occurring across the board. The sentiment is we have this very, very long time horizon. But, I know that there is some difference of opinion on the panel about whether or not a very long time horizon should drive or influence how you structure the investment program. So, let’s talk a
David Wilson, managing director, head of taxable fixed income, client portfolio management, Nuveen Asset Managemen; Eileen Neill, managing director and senior consultant, Verus; Christopher Schelling, director, private equity, Texas Municipal Retirement System; Colin Kerwin, retired global pension fund manager, ExxonMobil; Jeffery Blazek, managing director, Cambridge Associates
VOLUME 2, ISSUE 1
7
little bit about what are some of the pitfalls of that approach. KERWIN: For me, I like to think about the return inherent in the liability as the starting point. So, put yourself in the shoes of a public plan participant. You are promised a lifelong defined benefit from your employer when you retire. You accrue these benefits during your working career by accepting lower current compensation (there is no free lunch). So, ask yourself, what is the return I’m getting on this deferred compensation? Another way to think about it is the plan participant is making a loan to their employer (by accepting a lower cash salary) and will be repaid with interest when they retire in the form of a lifelong annuity. What is the appropriate interest rate on that loan? Well, given the loan in theory is fully collateralized with pension assets and further guaranteed by a sponsoring organization often with taxing authority, the return should be close to a risk-free rate. So, regardless of accounting or actuarial standards, the economics are that the returns inherent in a public defined benefit cash flow stream should be close if not equal to a risk-free return. If the return is risk free, then I would argue that the only return that trustees need to generate to keep pace with the economic growth in that liability through time is a risk-free return, which can be easily generated in a simple low-cost fixed-income portfolio. As soon as the trustees introduce a large risk mismatch, in either an attempt to close a funding gap or to meet future pension obligations, then not only are they undermining the safety of the existing promises, but they are also transferring wealth from future taxpayers to current taxpayers. It’s like saying ‘I’m not going to fully fund the bill for services already delivered. Instead, I’m going to rely on the financial markets and long-term risk premia to fund the balance.’ But it’s the future taxpayers that are bearing the risk of that choice. And if it all works out, and the fund grows, and obligations are satisfied, then the future taxpayers that took all the risk never receive the benefit because the current taxpayers have already claimed it by underfunding the plan. So, I think introducing a risk mismatch, particularly in public plans, is really nothing more than a wealth transfer from future generations to the current, under the guise of intelligent investing. NEILL: Chris, when we had a prior discussion I thought you had some really good points particularly given perspective as a very long-term investor in private equity. SCHELLING: Sure, I have a slightly different view. I would point to a kind of an analogy: In a defined contribution plan there’s a twentysomething-year-old investor. You would be considered grossly in violation of your fiduciary duties if you told an investor to put 100% of their 401k in bonds. So, there’s got to be some kind of trade off from value creation from the investment returns versus taxing the public, and I’m not claiming that generational wealth transfers in the public pension have been effectively managed. Certainly, we have room to improve as a sector. If you compare some our governance and processes versus the Canadians or Brits, Nordic or Australian plans, they’ve done a different job. I think that part of that comes from explicitly managing both sides of the balance sheet—liabilities plus assets together—and when you look at some plans that have done it right—I could point to the State of Wisconsin—they have different assumed rates of return and discount rates. So, they are discounting at a lower rate and targeting a slightly higher rate of return. And that’s kind of a margin of safety as opposed to introducing too much risk. You should be saving more, but if you can make the assets work harder for you in the long run, then I think it is your responsibility to 8
INSTITUTIONAL ALLOCATOR
do that. And that is reflected sort of in our mission statement, which it is to provide that. We are a little bit different as a cash-balance hybrid plan. So our benefits payments tend to be a little bit lower than a true DB, and our contribution rates are a little higher than a true DB. And we do have some market forces at play, because we have voluntary participation from all of our constituent cities. So, we have to offer them a package that is attractive for them to participate in. The flip side of that is we can’t charge too much for it, otherwise they wouldn’t participate. But we can also grow. We are healthy from an active to retiree participant perspective, because we are able to add new cities every year. It is truly a hybrid plan, but that doesn’t flow into our asset allocation. When you look at a cash-flow perspective, we have a very low spending rate. It just turned negative for the first time ever, and it won’t reach above 2% for a couple of decades out. So, I think you really can invest that portfolio markedly different from one that has a vastly higher percentage of retirees to active participants and different cash-flow characteristics. WILSON: I think there are two issues at play here. Let’s talk about demographics first—the demographics of our country. Baby Boomers, people born between 1946 to 1964, 80 million strong; Generation X, people born between1964 to 1982, roughly 65 million—so 15 million people less. And then you add millennials, that’s approximately 85 million people. So, there is a generational inequality in the population that is wreaking havoc on any promised obligation, whether it is Social Security, Medicare or defined benefit pension plans. So, when you talk about time horizon, think about the demographics of your plan, there are some hard numbers that can give you guidance on what your investment time horizon really is. If you look at the active-to-retiree ratio in your plan, and you look at the trend, it’s getting close to one-to-one—one active employee to one retiree. If you look at the net cash outflow of your plan as a percentage of the asset base, that’s going more and more negative— your investment time horizon is shrinking. We always think about pension funds as having this really long investment time horizon. But that isn’t the case anymore. As the baby boomers retire, pension cash flows go up—the obligation goes up for the next 20 to 25 years, and that’s causing a lot of deficits with pension plans in our country. Now, how do you discount that liability? So, I disagree that that’s a risk-free liability. I think the pensioners of the City of Detroit and other places would say ‘that wasn’t too risk free.’ Yes, many are guaranteed by state constitutions. But until they are tested—it was assumed that the City of Detroit’s pension plan was guaranteed until their Supreme Court ruled it as a contract not a guarantee. So, we would have to test these to really truly say they are risk free. I would say they are collateralized or secured, therefore the discount rate for the liabilities should be lower than seven and a half percent. Then there is the reality of the situation. If you discount public pension plan liabilities at the risk-free rate, the aggregate unfunded liability would increase from about $1.5 trillion to about $5 trillion now—you would have a massive debt crisis on your hands. So, I don’t think the liability is risk free, but I do think that the liability is discounted at a higher rate than it should be. BLAZEK: I think that the discounting mechanism is important. If you do have a new person who starts working as a teacher, and they’re in their twenties, and you know they are not going to retire for another 30 years, you have to use that time to your advantage if
“I think introducing a risk mismatch, particularly in public plans, is really nothing more than a wealth transfer from future generations to the current under the guise of intelligent investing.” you are the [plan] sponsor. If there are 30 years before they will start drawing cash from you, and you are a believer in the equity risk premium, then you would not be serving either the participant or the state well if you did not invest in equities to some extent. You have to be thoughtful about how you take that risk and monitor it—there’s a lot of complexity to that. I think the overall problem though is that these plans, particularly at the state level, have not been well-funded at all. It’s been about the willingness of political forces to put cash in, and the plans I work with, which are largely not in the public realm anymore—hospitals, non-profits, corporations—have been told very clearly for about 10 years now these are the rules, this is how you will be funded. It’s not been a lot of fun, but we have managed through it, and we have an average funding level of 90 percent on ERISA plans, despite a very choppy trading environment. And yes, that has caused a lot of them to close down, and that’s the tragedy of it—that’s how they’ve tried to solve the problem. But we are not going to have people that are going to have to eat [suffer] less benefits than they were promised. We’ve solved the math. I think the public realm has a real problem where they have simply not put enough money into these plans. NEILL: I think part of the difficulty is how we are actually valuing the liabilities of the plans, and what truly is the level of underfunding or fully funding? On the corporate DB side, the regulations basically force corporations to discount liabilities at a corporate bond rate—it treats liabilities as a bond. Whereas on the public fund side, it’s a little bit circular, but the discount rate is a function of your asset allocation. So, I’d be interested in hearing panelists’ views on that, given that you have a regulatory framework, and given that you have an investment framework that drives the value of your liabilities: how can you use that to potentially structure the portfolio, so you maximize the benefit or growth of those assets, while still working within the framework of that regulatory environment or practice paradigm?
BLAZEK: It’s going to depend on how large the pension is relative to the balance sheet and the overall risk level of the enterprise. When we do see things like the PPA imposed and the way that liabilities are measured, whether we agree with it or not, that’s the reality and that affects their funding level. The accountants have taken away smoothing for their financial statements. So, we used to have the ability to kind of amortize shortfall, but they basically mark-to-market now. And it’s a risk they think about daily. And they agonize over a 30-year move of 20 basis points. So it does influence the way we invest the portfolio, because if we don’t manage that risk effectively their debt could get downgraded, or they may not have cash for their core operation. KERWIN: I guess it’s not going to surprise you that I see it a little differently. For the last 34 years I’ve practiced corporate finance at ExxonMobil. And one of the things I was taught at business school was that if you have a cash-flow profile in an open marketplace, that cash-flow profile can have only one value from an economic perspective. Otherwise it would simply be arbitraged away. Let’s assume you have two identical defined benefit plans, one in the private sector and one in the public sector. Because the cash-flow profile is exactly the same in both cases, there is no way on earth that those two streams should have different values. I don’t care what the accounting or actuarial standards may say, from an economic perspective, they have to have the same value. And I guess if they have the same economic value and they have the same risk profile, the investments you manage against them should also be the same. And they should also be the same whether the plan is open or closed. As I said earlier, it is not the responsibility of the pension plan to pay for that future liability. It’s the responsibility of the sponsor or, in the case of a public fund, the taxpayer, to pay for that additional liability. You can’t ask the asset to work overtime without creating a risk mismatch and getting into trouble. VOLUME 2, ISSUE 1
9
BLAZEK: I think there is tremendous value in operating a DB plan. And if you treat it as a high-quality fixed-income instrument and quantify it on day one, that’s worth so much. To our teachers in Texas, and all throughout the country, that benefit is worth tremendous value. And if we see them converted to defined contribution plans, then they are getting short changed. Either their salaries have to go up to make up for the loss of that substantial benefit or the DC plans need to be structured in such a way that they are not taking WILSON: I agree with many elements of that approach. But the one on more of the burden. I think that conversation is such a dramatic thing it is ignoring is time horizon. If you breakdown a pension liability, conversion—we’ve seen it in the private market to the greatest extent. it has three components: retirees, vested terminated employees The salaries for public employees are often much lower, and it’s and active employees. So the essence of demographic-based because they do get a very generous retirement benefit. That should investing at Nuveen is to align investments with the characteristics not go away without some commensurate return that they get. of the liabilities. The retiree liability has more certain cash flows and is shorter in tenor. One can match this liability with assets that WILSON: I think pensions are freezing and closing their defined provide high cash flows like fixed income or certain alternatives. benefit plan at the very worst time, due to the demographic issue. For active employees, where there’s an inflation component due to It dramatically accelerates the shortening of your investment time wage growth, that’s an uncertain cash flow with an uninvestable horizon at the same time you are underfunded. So it puts a really characteristic, namely how long people live. That liability needs an big burden on the sponsor. If it’s in the public space, it puts a burden asset that provides growth. And it aligns with a longer time horizon on the taxpayer. And it creates a future retirement problem for using growth assets like equities. So, I think you can incorporate individuals with no acceptable solution in the defined contribution growth assets into your investment program, but you have to really space, in my mind. Target-date funds are good for a very novice investor who doesn’t have the time or capability to understand consider the liability components of your plan. investment. But if you look at target date funds, and you look at the SCHELLING: I think Colin raises an interesting point on corporate risk profile that they have when a person is nearing retirement, it’s finance versus investment finance. What I would point to is in the unacceptable. There is too much capital at risk before retirement. We corporate sector the pensions are inarguably healthier. They are saw this during the financial crisis. For example, most 2010 target90% funded on average, with a 4 percent discount rate. In the date funds lost 20 – 30 percent of their value in 2008. Now think public sector, call it 60-70 percent funded on average with a 7.5 about that if you are about retire and you are in a 2010 target-date percent discount rate. So, they are inarguably in a better position, fund. How scary would that be? And guess what happened? A lot better hedged against those long-term liabilities. I would say there of people sold out of them and crystallized that loss. So, if you’re may be an arbitrage that does occur with that long-term capital. going to terminate defined benefit plans, which I would argue has an And you see it actually in LDI. So, they fund up, and then they sell a extraordinarily large social good to them, you also have to present a big portion of those liability streams to insurance companies. And viable substitute retirement plan, which we have not done. those insurance companies can earn more by investing in private equity. So, I’m saying there is a premium that can be harvested by KERWIN: I’ve recently retired from ExxonMobil after 34 years of being long term and investing in private markets, that’s kind of the service. I could be out playing golf with my son right now (audience take that we’ve had. We know our cash flow needs with a relatively chuckles), but I feel really strongly about the defined benefit system. I high degree of certainty, and we can project what our cash flow was fortunate to work for a company that not only offered a defined from income and amortization of principal, etcetera is, and we are benefit plan but continues to offer them for new hires around the world. I want to see the next generation of workers and the trying to earn an excess return. Now, I would agree that there is governance at institutions that generations after that enjoy the same kind of retirement income doesn’t necessarily allow that to be implemented effectively, and security that I am now enjoying. And there is no reason at all that it that’s where we should address some of the problems in the public can’t be done. If the defined benefit system is managed properly, it sector. There is a scale that is required. There are resources that is no more costly than any other retirement system. But it is one that are required in order to effectively access that premium. But that’s can provide secure lifetime income to potentially millions of people how we’ve taken it. We’ve moved the portfolio from the traditional that don’t have the financial skills to manage their own portfolios. So, 60/40, and even prior to that 100 % fixed income, to more 50/50 given the opportunity to speak on panels like this one and to defend equity/fixed income. So we are probably more fixed-income the defined benefits system and to say there is a simpler, cheaper oriented than many of our peers, but we’ve got a lot of that exposure way to manage them, I’m going to come every time. through private markets. SCHELLING: On that we can completely agree. I do think the hybrid NEILL: Partially as a result of PPA, there have been a lot of corporate plan, as an intermediate step, is a little bit more salable. It may DB plans that have been shut down. And even in public fund land give a little bit less, but it accomplishes a lot of the benefits of a there have been funds that have been frozen and replaced by pension system in that it allows you to pool assets, invest for the defined contribution plans. I think the issue is are we opening up long-term premium, etcetera. But it takes the decumulation problem Pandora’s Box for a different kind of crisis than the perceived crisis of off the beneficiaries, by actually monetizing it for them. We take our the defined benefit plan, by forcing participants to invest in defined obligation to provide a secure retirement seriously and to make that available in perpetuity contribution plans. Keep in mind that for every $1 of pension benefits, there are only two ways you can have an underfunded plan: 1. You didn’t fund it fully in the first place, which is a big part of the problem we see. Or you did fund it and then you lost the money relative to the liability because you had a risk mismatch between the asset and the liabilities. Both things are happening. Both things don’t need to happen.
10
INSTITUTIONAL ALLOCATOR
UNDERFUNDED PLANS AND POOR RETURNS GO HAND IN HAND: CRR STUDY BY LESLIE KRAMER
A recent study released by The Center for Retirement Research at Boston College, titled Stability in Overall Pension Plan Funding Masks a Growing Divide—found that those pension plans that ranked lowest in terms of funding status also reported lower returns on their investments. “The plans in the bottom third in terms of funded ratio have achieved worse returns on average than plans in the top two thirds,” said Jean-Pierre Aubry, associate director of state and local research and the lead author of the report. The CRR—which looks at the funding ratios of state and local pension plans around the country— also found that the amount of benefits being paid to retirees had little relation to a plans funded status. The CRR study is based on annual data on the funding level for over 180 pension plans tracked in the Public Plans Database (PPD). “The PPD tracks 180 of the largest state and local pension systems in the country. Ninety five percent of all state and local workers are covered in these plan, so we are talking about almost the whole state and local (public) workforce across the U.S.,” Aubry said. Typically, the CRR analyzes the annual change in the average funded ratio for all plans–which is usually a percentage point up or down. But this year, the CRR study organized the country’s public pension plans into three equal groups based on their 2017 funded level and compared the benefits levels, returns and contributions for each group. The researchers found that in 2017, the average funded ratio for the bottom third of funded pension funds was 55 percent, 73 percent for the middle third, and 90 percent for the top third. The numbers are quite startling considering that in 2001 (the first year of data in the Public Plans Database) the average funded ratio for each group was at or above 90 percent. The CRR also found that the plans that were closest together in terms of funding levels in 2001 have since been growing apart. “There has been a steady separation of funds over time, so the question now is, ‘What is driving the dispersion?’” Aubry stated. The answer, according to the research, is inadequate contributions made by state and local governments combined with poor investment performance.
IT’S NOT ROCKET SCIENCE; A LACK OF FUNDING RESULTS IN WORSE FUNDED PLANS A key reason that a third of pension funds are less funded than their peers is that, plainly stated, “the worst funded plans don’t receive their annual required contribution from state and local governments,” Aubry said. “The actuary estimates a required contribution for the government that–combined with employee contributions¬–will fund newly accrued benefits and any existing unfunded promises within 30 years,” Aubry explained. However, the actuary’s estimates are merely a suggestion for sound funding. Governments ultimately have to make the decision whether to appropriate the funds, and not all governments actually make the actuary’s suggested payments. So, it should come as no surprise that the funds with governments that make the suggested payments are better funded than those that don’t. In fact, much of the problems that the funds face come back to a lack of adequate funding. “It is a serious problem if governments do not put aside the money to meet the benefit promises they make,” according to Aubry. The CRR researchers found that “contributions to the worst-funded plans have fallen well short of what is required to maintain reasonable funded levels. Jean-Pierre Aubry, associate director of state and local research, The Center for Retirement Research at Boston College
VOLUME 2, ISSUE 1
11
POOR INVESTMENT DECISIONS On the investing side, the correlations continued, with the average investment returns for the worst-funded plans lagging behind the other groups. “Our presumption had been that all plans invest relatively similarly and that differences in performance were not that large,” said Aubry. “But it now turns out that over the past 17 years there has been some meaningful differences in performance and that has played a role in some of these plans being at the bottom of the group,” Aubry said. Many of the plans that turned in the worst returns were more heavily weighted towards equities leading up to the financial crisis, so were more vulnerable when the crisis hit, Aubry observed. “After the crisis, many of these plans shifted into hedge funds and commodities, both of which have under-performed since the crisis,” he said. Conversely, the plans that shifted into alternatives earlier were less exposed to the stock market when the financial crisis hit DON’T BLAME THE EMPLOYEES and often held private equity and real estate, which performed better The CRR’s findings also debunked an oft-held view that some plans than hedge funds and commodities. Based on simple projections, are suffering more than others because employees are demanding if the worst funded plans had achieved returns similar to the besttoo generous of benefits. “Many believe that the benefit promises funded group, their funded ratio would be about 11 percentage being made are what is bankrupting some plans, but there is no real points higher–eliminating about one-third of the gap in funding relationship between the benefit generosity and the funding ratio of between the two groups, according to the CRR report. a plan,” said Aubry. “In fact, we found that the benefit generosity between the best and worst funded plan isn’t that different,” he SOLUTIONS ARE SLIM Across the country, policies are being designed to shore up the state noted. To assess the impact of retirement benefit levels on a fund, the and local pension systems and many benefit reforms have been CRR examined the average normal cost of benefits as a percentage made since the financial crisis, Aubry noted. “The challenge is still of payroll for each group. According to the report, “the normal cost that the returns in the market are difficult to predict and manage, and measures the present value of retirement benefits earned by active in some cases it’s the luck of the draw (in terms of market timing),” he workers in a given year, and is often used as a single measure to said. But while investment officers cannot always control the outcome compare the complicated benefit provisions offered by plans. The of their investment strategies, “You can control the promises being data shows that the normal costs for the three groups are relatively made and the amount of money you put in to fund your system,” similar and that the worst-funded plans generally had the lowest Aubry stated. Today, many state and local governments are being more normal cost. These results suggest that difference in benefit levels stringent about figuring out how much more money to put into their is not driving the widening gap in funded status among the three employee pension plans and are actually putting that money aside groups.” to make improvements in funded status of the plans, said Aubry. To add fuel to the fire, the researchers found that the better-funded “The rules around how to pay down the underfunded liabilities have plans typically had higher average normal costs than the worsetightened up, and best practices are being developed in terms of the funded ones. In short, “the data shows that the worst-funded plans ways to calculate required contributions,” he noted. But at the end have not provided higher levels of benefits over the past 17 years,” of the day, “it all boils down to putting in more money.” the report stated. The funding problem often lies with the state government rather than with smaller local governments, Aubry stated. “It’s not a hard and fast rule, but when the localities are presented with a bill to fund the pension they typically pay it in full, but at the state level, there are a lot more budgetary negotiations that happen, so you often find that it’s the state governments that are not paying the full contribution levels,” he said. As part of its study, the CRR compared annual government contributions with the amount needed to both fund accruing benefits and pay off the existing unfunded liability within 30 years, in level dollar payments. According to the report, “from 2001-2017, the average contribution for all three groups was less than this funding benchmark, with the best-funded group receiving 80-90 percent of the benchmark in most years, and the worst-funded receiving 60-70 percent in most years.”
“Many believe that the benefit promises being made are what is bankrupting some plans, but there is no real relationship between the benefit generosity and the funding ratio of a plan.”
12
INSTITUTIONAL ALLOCATOR
ASSET ALLOCATION ACTUALS VS TARGETS FIGURE 2. RETURNS FOR STATE AND LOCAL PLANS, FY 2001-2017
FIGURE 1. STATE AND LOCAL PENSION FUNDED RATIOS, FY 1990-2017 120.0%
12.5%
12.6%
17.3%
21.7% 13.4%
11.2%
15.8%
0.9%
1.4%
70.0%
3.6%
10.0% 3.9%
80.0%
10.7%
72.0%
79.4%
90.0%
20.0%
86.5%
100.0%
18.4%
102.7%
30.0%
110.0%
-4.3%
0.0%
60.0%
-6.2%
-10.0%
40.0%
-6.0%
50.0%
30.0%
-20.0%
-20.0%
20.0% 10.0%
-30.0%
0.0% 1990
2000
2007
2017
2001
2003
2005
2007
2009
2011
2013
2015
Note: the 2017 funded ratio involves projections for 18 percent of PPD plans, representing 26 percent of lianilities. Sources: 2017 actuarial valuations (AVs); Public Plans Database (PPD) (2001-2017); and Zorn (1990-2000).
Source: PPD (2001-2017)
Aubry also cautions pension officers against thinking that cutting benefits to employees will be a quick fix. “Lots of plans have cut benefits, but in most states cutting benefits for current employees is hard. There are legal protections,” he noted. “You can more easily make changes to benefits for new hires, but the impact of those changes will only trickle in over the course of many years as the old force is replaced by new hires. ” As a short-term fix, “many plans are increasing the amount that employees must contribute to the plan,’” he noted. “Governments are in effect, saying, ‘employees pay for it, instead of the government pay for it.’ That’s an immediate way to reduce costs to the government.”
FIGURE 3. AVERAGE FUNDED RATIOS BY 2017 FUNDED STATUS, 2001-2017
WHAT’S AHEAD? Looking forward, “The top third of plans now has an average funded ratio of 90 percent and should remain on track with continued maintenance,” according to the report. “The average funded ratio for the middle third of plans has remained relatively steady, around 70 percent since the crisis, and these plans can improve by adopting more stringent funding methods. However, the average funded ratio for the bottom third of plans is currently 55 percent and has continued to decline in the wake of the crisis. These worst-off plans will likely require intervention beyond traditional reforms to change the trajectory of their funded status.”
2017
120.0% 110.0% 100.0% 90.0%
110% 100% 90%
90%
80.0%
73%
70.0% 60.0%
55%
50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2001
LEGEND
TOP THIRD MIDDLE THIRD BOTTOM THIRD
2003
2005
2007
2009
2011
2013
2015
2017
Source: PPD (2001-2017)
VOLUME 2, ISSUE 1
13
A WORD FROM THE BOARD
CAL. STATE’S CONTROLLER BETTY YEE SPEAKS FROM HER SEAT ON CALPERS, CALSTRS BOARDS BY LESLIE KRAMER
Betty Yee, California State Controller, State of California
14
INSTITUTIONAL ALLOCATOR
Betty Yee, California’s 32nd state controller and chief financial officer, delivered the Breakfast Welcome Address at Markets Group’s 6th Annual California Institutional Forum in Sonoma, this winter. Yee is a board member of the $346.8 billion California Public Employees’ Retirement System (CalPERS) and the $219.2 billion California State Teachers’ Retirement System (CalSTRS), the two largest pension systems in the country. Leading up to the Forum, Yee spoke with Institutional Allocator’s Managing Editor, Leslie Kramer, about how her unique upbringing led her to a career in the public realm, her views on CalSTERS’ decision to divest from private prisons, the controversy surrounding the hiring of CalPERS CEO Marcie Frost, and her thoughts on applying environmental, social & governance (ESG) criteria to investing. To open the conversation, Yee addressed the question of the overall viability of public pension funds, and the seriousness with which she takes her role as a fiduciary of California’s public retirement systems. Yee: The funding status of CalSTRS is currently 64 % and CalPERS is 71%. I want to focus on that, because there has been a lot written about how sustainable public pension funds are, in general. We are not the only defined benefit pension plan that is underfunded, but we are the largest. I take my fiduciary responsibility seriously, about honoring the retirement benefits that have been earned by our public workforce and educators, and I think that the best way to do that it is be sure that we continue to provide good direction to the investment staff. To really understand the conditions under which our pension assets are being invested means looking at global and geopolitical events, looking at the future of our economy, and working to be always informed. It also means staying on top of things that are evolving that could affect
our ability to see how companies can create long-term value that then affects the returns that we get. Since becoming controller, I’ve been very focused on California as a global economy, and what we can do to be sure we continue to lead—with regard to creating the future of our economy—and making sure we have a workforce that can support the future of our economy; it’s about the resolve and the ability of the state to sustain itself in terms of our financial obligations. IA: How are you working to improve the funded status of the pension funds? Will it be through investment returns or from more infusion of funds from the state? Yee: At this point, I don’t believe the state will be giving more money to the fund [CalPERS]. The SB 84 money that the state gave to CalPERS [a $6 billion supplemental payment, paid through a loan from the Surplus Money Investment Fund in FY 2017-2018] came at good time. It helped when we were beginning to implement the reduction in the discount rate. It was
also warmly received. We have continued to see good returns and the timing of it helped us get to 71% by the end of the calendar year 2017 [it was previously at 68.3% at the end of FY 2015-16], so we were grateful for the assistance. IA: Is there an experience that inspired you to want to become a public servant and ultimately State Controller. Yee: My background is in state and local finance and tax policy. I’ve been doing that work for 35 years now. Finance has been part of my life from a very young age. I grew up as a daughter of immigrants. I’m the second oldest of six kids, born to immigrant parents from China, so I’m first generation American. My parents owned and operated a laundry and dry cleaning business in San Francisco for 30 years—for any family business like that the children are the best employees—not that we got paid handsomely for it. (chuckles) My parents didn’t speak English fluently, so I served as a translator along with several of my siblings. I really took to the business side and the financial side and to all of their banking needs. I negotiated with venders and customers, filing tax returns for various public agencies, so it gave me an inside look and perspective on what it takes to run a business. But I think it was really my interface with the vendors. I mean, I grew up poor—there were six of us that my parents were raising. To not negotiate a good price on whatever supplies we needed could have meant we weren’t going to have that carton of milk in the fridge that week. So money became a very important concept to me, and how it had to be valued—really understanding the value of a dollar—that became so much of what drove my orientation to life: where money goes, who gets it and who makes decisions about who gets it. At the age of 13, I actually stood up for my parents, along with many other families that were opposed to a school busing program in San Francisco that was going to involve my younger sister. I remember standing up at a town hall school meeting to say on behalf of several of the families in my neighborhood, who didn’t speak English very speak well, ‘look, we don’t oppose the goals of the school busing system, but if an emergency were to arise with any of our children, we don’t drive; we have businesses to run, we would have to shut down the business. It would take us well over two hours on public transportation to pick up our child and take them home. So, how about instead of spending the money on the busing system, spending it on programs to improve the quality of the schools throughout the city?’
The school board did implement the busing program, but speaking up in front of the school board at the town hall meeting made an impression on me. Since that time, I have always wanted to be a voice for someone. It’s not so much that I ever wanted to be in politics, but the idea that here we were, allowed to speak our mind about the allocation of [town] resources, that just seems to be the most important public policy decision-making in which you can be involved. IA: As a Board member how much do you voice your opinion about the investment style of the CalPERS and CALSTRS funds? Yee: The board has a role, we have a primary role, with respect to the asset allocation and also to the asset/liability management. In terms of my take on whether we should be doing active or passive management, from my perspective, I think we are prudent to be in both. It’s actually not a debate we have very often, although it does come up from time to time. When I look at passive management, I think it makes perfect sense, when we are talking about global equities and global fixed income—from a cost consideration—those should be passively managed. But it’s also important to have active management where we can actually pursue new opportunities that may prove valuable, or have some long-term value for the fund. We are comfortable with the decision now, because things are changing so much. I wouldn’t say it’s settled, but it’s prudent in terms of where we want to be right now. IA: How focused are the two systems on lowering management fees? Yee: We do pay attention to fees. At CalSTRS we are looking at a more collaborative model (of investing) as a way to reduce fees. Where the fee issue came into question is with the private equity asset class. Those fees tend to be very high, but it’s also our best performing asset class, so I think it’s about having the diligence to find opportunities. IA: Jason Perez, (a sergeant for the Corona Police Department and president of the department’s police officer association) was recently elected to serve as CalPERS’ new board president, unseating Priya Mathur, who had served as board president for 15 years. Perez has been critical of the System’s strong commitment to applying ESG principles to its investment policies. What is your view on the topic? Yee: I can’t speak to Jason Perez’s comments because he is not a board member yet, [he joins in January] and I don’t really understand his perspective about it fully, so I don’t want to comment on it. What I will say is that VOLUME 2, ISSUE 1
15
ESG considerations are becoming more and more accepted in the investment community, certainly globally, and even here in the U.S. There is more focus on how to integrate ESG into investment considerations to the point of where, being a fiduciary, it’s incumbent upon us to make these considerations. It’s hard to say if it [ESG] is going to drive the ultimate decision, but I think it has to be a factor on where we put our pension assets. I have to say, over the last couple weeks, with all these reports coming out about climate change, [from the National Climate Assessment] the urgency and just the devastation that climate change effects could have, [highlights] that this is a business risk for anybody that the pension funds do business with. So, just based on that aspect of ESG considerations, I would hope that there really is a ready acceptance that we have to engage with these companies, and we have to work together on how we can do our part to reduce our climate risk. I’m in Sacramento today, and the air quality is quite poor—although a bit better, due to the rains. The fire is now contained, and what we are learning is that even though we can see the blue skies today, there are other potential impacts to the air quality, in particular from the fires that contain their own kind of air pollution. IA: There has been some controversy surrounding the hiring (in Oct. 2016) of CALPERS CEO Marcy Frost, due to what some say was a lack of disclosure about her educational background—resulting in a call for an examination of the hiring process. What is your take on the situation? Yee: I am very sorry that this issue has gained such heightened attention, because from my perspective there is no issue. She fully disclosed her educational background, and there is nothing that we know today that we didn’t know then. Look, she became the CEO of this fund, and I don’t know if she even has any spare time to think about going back to school and actually taking classes. She has been 100 percent on the ground, and seeing what she has been able to accomplish in her short time here, I have full confidence in her abilities. During the hiring process, she was more than forthcoming about her background. So, I do not think this is an issue that warrants an investigation. IA: What accomplishments of Frosts have impressed you most, to date? Yee: She was very instrumental in the lead up to the board’s decision to reduce the discount rate [the rate is gradually being reduced from 7.5% in 2016 to 7.373% in FY 2018-19, 7.25% in FY 2019 16
to 2020 and 7.0% by FY 2020-21]. Also, her leadership and her ability to reach out to stakeholders and her workings with the administration—she has been very astute about all the pieces that needed to be in place for the board to have full information about how this [the reduction of the discount rate] could be done and implemented and to make sure we have the support to do it. Also, looking at how we are able to reduce the amortization period for public employers to pay off their unfunded liabilities from 30 years to 20 years, and dealing with our pension obligations, so that we can have our local public agencies not sitting on such huge liabilities for long
controversy surrounding the accuracy of credentials stated on his resume.] I think we have implemented a more robust hiring process going forward, which then led to our now being able to recruit and hire Michael Cohen, the former director of the California Department of Finance [in August]. I’m thrilled that he is here; he is more than amply qualified and really comes with lots of credentials that will benefit the fund. IA: CALSTRS, in November, decided to divest its holdings in private prison companies CoreCivic and GEO Group. What are your thoughts on the decision? Yee: I voted against it. This is one among many issues that came before both
“We do have a strong corporate engagement program; when companies are approached by large institutional investors, like CalSTRS, they listen.”
in a public, transparent way, and it was more helpful that the staff undertook the robust analysis that it did. IA: In March, CalPERS board voted against a proposal to move towards divesting its investments in assault rifle retailers and wholesalers, in favor of engagement. In May, CalSTRS announced it would also follow a plan of engagement and consider divestment only if engagement efforts were unsuccessful. In June, the System announced it would divest from firearms manufacturer, Remington Outdoor. What are your thoughts on these decisions? Yee: This is an outgrowth of what a good engagement process gets us. We do have a strong corporate engagement program; when companies are approached by large institutional investors, like CalSTRS, they listen. Even before this initiative, some of the retailers that sell guns, by virtue of us even raising this as an issue of concern, on their own, decided not to sell gun stock. So, engagement did change the behavior on the part of the retailers. As for the manufacturers, this is truly their bread and butter, so they needed to see
periods of time. And she continues to work with the local public agencies—they bear the brunt of a lot of the decisions made by the board. She is also very clear that we have an open-door policy; our actuary office is open and available to help any agency with managing their responsibilities in this regard, so I think she gets high marks for that. She has also really done a lot with the organization internally. You do not see her going to a lot of global conferences or summits, because she really has wanted to be with the organization to ensure that it has a healthy culture. I think when you see so much support for her, even when she is under attack, that says a lot. She is very visible and hands-on as a problem solver and is developing the leadership the organization is going to need going forward. IA: CalPERS has seen a lot of executive turnover this past year, in particular in the role of Chief Financial Officer (CFO). Could you speak to why that may be? We had one acting CFO, Marlene [Timberlake D’Adamo] who stepped up internally to be the interim CFO, so that we could do a broad search [after CFO Cheryl Eason exited CalPERS in 2016]. With respect to what happened with Charles [Asubonten] and that whole hiring process, steps have really been taken to find out what took place. [Asubonten was let go in May amid
INSTITUTIONAL ALLOCATOR
pension funds. It really began to tug at the heart strings, and we needed to look at whether the funds should be involved with these entities or not. Our holdings were fairly small. On one hand, you could say that we should divest, and there would be no harm. But there is a cost to divest and most of these investments are in contractual relationships. I voted against it, because I thought the CalSTRS staff did a wonderfully robust risk analysis. They utilized the CalSTRS 21 ESG Risk Factors, which was the basis of our analysis and why they were put in place. To me it was an important step to take. Not because I support private prisons that are holding our immigrant or migrant families in their facilities—it could be private prisons or it could be any number of different types of business entities that do business with the pension funds. We have to be able to hold up our analyses and make the case for when we should and when we shouldn’t get out of this, and frankly, from the analysis, I didn’t believe we made the case that we should divest. First of all, none of the facilities that we are involved in are in the practice of detaining migrants, and secondly, the holdings [in these companies] are minimal and weren’t growing. I am confident that the investment staff understands the concerns of the board, and obviously it could have gone the other way, and it did; we are going to divest. It was just helpful to have the decision made
a divestment decision. It is really all a part of the engagement process. We did not do this as an attack on the manufactures; we did engage with the manufacturers, and we are still seeing results. IA: Do you engage in any hobbies when you are away from work? Yee: I love to cook. I grew up in a big family, so I like to cook for large groups of people. I cook all kinds of food; I have lots of cookbooks, but I never follow a recipe. I can tell you what was a hit during this Thanksgiving dinner: my shaved fennel salad! I also like to garden, but I don’t get much time to do that, so I’m in the process of putting in a new drip system in my garden. And I like to read historical nonfiction. One of my favorites was The Founding Gardeners, [by Andrea Wulf] which talks about the founding fathers and the role of gardening and botany and horticulture in their lives. It’s a fascinating account of the role the discipline of gardening played in how they led our country. IA: Tell us about your family. Yee: I’m married, and I have stepchildren, who are all grown up. I also have seven nieces and nephews, all of whom I like to spoil
2019 US & CANADA INSTITUTIONAL EVENTS www.marketsgroup.org
6TH ANNUAL
Central States Institutional Forum February 26 | St. Louis 6TH ANNUAL
Ohio Institutional Forum March 13 | Columbus 7TH ANNUAL
Tri-State Institutional Forum March 27 | New York 7TH ANNUAL
Mountain States Institutional Forum April 10 | Denver 4TH ANNUAL
Pacific Northwest Institutional Forum April 30 | Seattle 4TH ANNUAL
Canada East Institutional Forum May 9 | Toronto 7TH ANNUAL
Mid-Atlantic Institutional Forum May 14 | Washington DC 6TH ANNUAL
Midwest Institutional Forum June 4 | Chicago 5TH ANNUAL
Southwest Institutional Forum September 12 | Sante Fe 6TH ANNUAL
Great Plains Institutional Forum September 19 | Minneapolis INAUGURAL
Michigan Institutional Forum Fall TBD | Detroit 7TH ANNUAL
New England Institutional Forum October 17 | Boston 7TH ANNUAL
Southeast Institutional Forum October 23 | Atlanta 6TH ANNUAL
Pennsylvania Institutional Forum November 5 | Philadelphia 7TH ANNUAL
For speaking opportunities, please contact: Kim Griffiths Head of US and Canada Institutional Sales Phone: +1 646.416.6214 Email: kim.griffiths@marketsgroup.org
Texas Institutional Forum November 14 | Austin 7TH ANNUAL
California Institutional Forum December 4 | Napa *Dates may be subject to change VOLUME 2, ISSUE 1
17
ASSET OWNER SPOTLIGHT Elizabeth Burton, chief investment officer, Employees’ Retirement System of the State of Hawaii (ERS)
18
INSTITUTIONAL ALLOCATOR
ASSET OWNER SPOTLIGHT
ELIZABETH BURTON, CIO, HAWAII EMPLOYEES’ RETIREMENT SYSTEM B Y K A I T LY N M I T C H E L L
E
lizabeth Burton was hired as chief investment officer by the $16 billion Employees’ Retirement System of the State of Hawaii (ERS) at the end of July 2018, and reported for her first day of work on October 1. Her first interview with the fund was in late spring, several months after former CIO Vijoy Chatterjy departed the role. Institutional Allocator Reporter Kaitlyn Mitchell spent an hour with Burton and learned much about this multi-tasker’s colorful life experiences and how she has become a public fund CIO at a mere 36 years young. Burton hails directly from her role as a managing director in the quantitative strategies group at the $55 billion Maryland State Retirement and Pension System (MSRA).
IA: You’re three months into your new job. What’s shaking? Burton: The ERS team did a fantastic job
during the seven months since the former CIO’s departure—it’s tough to lose a CIO, and they stayed on top of pacing across the plan, which is tough with a lean organization. They did not seem to miss a beat. In general, the guidance of Executive Director Thom Williams of ERS and then-acting CIO Howard Hodel kept the Plan running like a well-oiled machine!
IA: What consultant does ERS use? Burton: Pension Consulting Alliance (PCA) is
our general consultant. They recommend asset allocation to the board of trustees. We have around 50-60 “foundational” managers across public markets, private equity and real estate. ERS has the appropriate amount of managers for its asset and internal investment team size, and it’s been smart in allocating where it makes sense and not overlapping exposures. At Maryland SRA, the CIO and board worked with the consultant Meketa.
IA: How did you make the leap from Maryland
to Hawaii?
Burton: Hawaii is a risk-based plan. And I believe
it was looking for someone with a risk focus who
photograph by Jaja Kang
had also managed assets—it was a good fit. In Maryland, I had a view of the entire portfolio while running its risk strategy. Andy Palmer, the CIO, and Robert Burd, the deputy CIO, were willing to show me the ropes and all 15 team members had the opportunity to be involved on any investment that we were interested in. I never felt like I had blinders on. It was one of those circumstances where I wasn’t looking to leave at all—I have really strong, positive feelings for the Maryland team. The Hawaii opportunity was too good to be true—there are only so many public funds, it has an experienced, smart investment team, the ED (Executive Director) is talented, and of course, the location. The CIO community is small—even when I was a managing director, several CIOs throughout the country were very helpful to me.
the president of Rothschild Financial Services, the head of investment banking and public finance and the board of directors at Interstate Johnson Lane and the member investment advisory committee of the Virginia Retirement System. I attended boarding school in Pennsylvania for my last two years of high school, and my parents sold the farm around that time. I then attended a small liberal arts college, Washington and Lee University in Lexington, Virginia, where I double majored in politics and French. I wanted to be local for my sister’s senior year of high school. My mother is a full-time mom and part-time businesswoman.
My dad worked on Wall Street for a couple of decades, but he was always a professor of economics, following his PhD from Northwestern University in 1971. He taught at Cornell, Rice, York and currently teaches at the University of IA: What is your institutions’ asset allocation Virginia. He began his Wall Street career in 1975. breakdown? My dad used to take me in a bassinet while he Burton: In 2014, Hawaii ERS moved to a risk- was working as a senior v.p. at Smith Barney—my based, functional asset allocation framework with sister and I were born just 13 months apart, and each class designed to achieve a certain goal or to my dad occasionally took me to work, placing my gain exposure to specific macroeconomic risks. For carrier under his desk. When I asked why, he told example, Broad Growth consists of assets that are me that he wanted to spend more time with me. exposed to changes in global growth and corporate Nowadays, he takes his grandchildren to board profitability (growth risk). Our asset allocation as meetings. of June 30th is as follows: 74.7% broad growth, 12.9% crisis risk offset, 8.3% principal protection, The summer before my junior year of college, 3.1% real return, 0.2% opportunities, and 0.9% my dad brought me along to a conference in California, where he was giving a talk on hedge other. funds. On the plane, he had to explain to me what IA: How has your life path led to becoming a CIO? a basis point was. After that, I tried out a fund-ofBurton: I was born in Manhattan, New York. funds internship during my junior year at Santa My family moved to York, Pennsylvania in the Barbara Alpha Strategies. Fund of funds are a step early ‘80s and then to a horse and beef cattle farm removed from the market, and I wanted direct outside of Charlottesville, Virginia in the late ‘80s, exposure. I ended up getting a job in San Francisco where I swept the barn and my sister watered the through a connection, trading mortgage-backed cows as chores—but I could jump on a horse securities (MBS) at Tuttle Risk Management whenever I wanted, and attended horse shows a Services; I hedged mortgage pipelines for banks, most of which are not around now post-credit few times per year. crisis. The hours were great, being on the West I always liked stats and math—my dad taught my Coast, but I didn’t want to be a trader. sister and I calculus in the fifth grade. During that time, my dad worked in a variety of roles, including I always wanted to go to business school, so after as a consultant to the American Stock Exchange, a few years at Octane I decided to go back. I spent VOLUME 2, ISSUE 1
19
ASSET OWNER SPOTLIGHT
two years at the University of Chicago, fully intending to continue working for Octane. But I graduated in 2011, after the crisis. I had met my now husband, Mike Cottet, in 2009 while visiting Baltimore, Maryland and moved there to live closer to him after graduation. I decided to try something other than hedge funds and got a job as a consultant with First Annapolis Consulting, a payments consulting and mergers and acquisitions (M&A) firm, where I learned more about the equity side of the business. I ultimately decided that I’m not a long-term payments person. I later worked with Criterion Economics on econometric modeling and analysis—I’ve always been interested in economics, given my dad’s profession.
debt securities (Tuttle), experience in equities (First Annapolis), experience in hedge funds (Santa Barbara Alpha Strategies and Octane), risk (Santa Barbara, Tuttle, Octane, First Annapolis, economic consulting) and in translating complex concepts for stakeholders. I feel like I have a very different and non-traditional but well-rounded career path. I was named as one of CIO Magazine’s “Forty Under Forty” during my time there. IA: How would you characterize your investment
philosophy?
Burton: I try to stay away from fads. I generally try to invest along sound, time-tested economic principles. When dealing with the assets of retirees, In March 2013, I created my own LLC, William I always take a long-term view. I have a bit of a Street Advisory to continue work in economic problem with some smart-beta strategies, the consulting. I started my family in 2014, and reason being that they rely heavily on back-tests wanted to cut down on travel so I started looking and are highly sensitive to model inputs—some for something more local to Baltimore. In 2016, I’ve seen are not based on proven economic theory. an opening became available at Maryland State IA: What was the best experience in your career? Retirement and Pension System, and I jumped Burton: Getting this job. Throughout my career, I at the chance of managing both the hedge fund have found that those in the allocator community, portfolio and the total fund’s risk, as a senior despite being stressed for resources and people, investment analyst. I interviewed there one week really support each other. This was not present after I had my daughter and was also taking care of in my other jobs, where you had to be super my 19 month old son at the time—I hadn’t slept in competitive. months. After seven months there, I was promoted to managing director of the quant strategies IA: What has been the worst experience in your group. By that time I had experience trading career? Elizabeth Burton, chief investment officer, Employees’ Retirement System of the State of Hawaii (ERS)
Burton: In ’07 and ’08, a lot of my friends in finance got laid off. Since my bonus made up a good portion of my pay, for a while I worried if I was going to have rent money.
My sister, Lindsay Burton, and father, Ed Burton, had both worked with Lehman Brothers prior to the crisis (although my father was not an employee; he had previously contracted to them)—luckily, my sister had already left to work at a secondary private equity shop. She now owns Kayo Conference Series, a women’s private equity, energy, power, credit, venture and real estate conference series on the East Coast. She’s the real deal. IA: What’s it like being a powerful woman in finance? Burton: It’s exciting. Throughout my career I’ve been supported by both men and women— including here at Hawaii, both at the staff and board level. It’s wonderful to see women in top roles across all industries. I had the privilege of attending the Wahine Forum (Wahine means woman in Hawaiian) here in Hawaii, last November, and was blown away by the caliber of attendees and speakers. The energy in the room was exciting—from both men and women alike. IA: In what part of the industry have you witnessed the most change? Burton: The hedge fund industry is very different from 2004—it’s hard to source alpha and hard on investors and managers to figure out the economics. I’m not in the camp that the days of hedge funds are over. As my dad would say, if the cows have eaten all of the grass in one pasture, move them to another. IA: What aspect or element of the industry would you most like to see changed and why? Burton: There is so much great technology in the
hands of the managers we work with. I would really like to see a bigger focus on getting technology into the hands of allocators. Some things are pretty cheap. Coding, for example, is free to learn. We need to find a way to get allocators access to good tools at an affordable price. Most young people coming into finance now know how to code using Python and MATLAB. Budgets are tight at public pensions, but there needs to be more spend on tech in-house to keep up.
IA: What is your fund’s funded status? Burton: ERS is currently 55% funded, based on the last study analysis of liabilities. IA: What are your plans to address the
underfunded status?
Burton: There’s no easy answer. My job is to implement the asset allocation approved by the board. Our risk-focused plan is designed so that we may sacrifice some upside performance for better protection on the downside; we also have to care more about potential downside than some other plans with a higher funded status. In 2016,
20
INSTITUTIONAL ALLOCATOR
ASSET OWNER SPOTLIGHT
RISK-BASED POLICY FRAMEWORK 100.0% 90.0%
LEGEND
ACTUAL
70.0% 60.0%
TARGET
74.7% 72.0%
80.0%
50.0% 40.0%
Broad Growth
Principal Protection
Crisis Risk Offset
Real Return
0.9% 0.0%
0.0%
0.2% 0.0%
10.0%
12.9% 13.0%
8.3% 8.0%
20.0%
3.1% 7.0%
30.0%
Opportunities
Other
Asset allocation as of June 30, 2018 State of Hawaii Employees’ Retirement System
ACTUAL PERCENTAGE
TARGET PERCENTAGE*
ALLOCATION DIFFERENCE
BROAD GROWTH
74.7%
72.0%
2.7%
PRINCIPAL PROTECTION
8.3%
8.0%
0.3%
CRISIS RISK OFFSET
12.9%
13.0%
-0.1%
REAL RETURN
3.1%
7.0%
-3.9%
OPPORTUNITIES
0.2%
0.0%
0.2%
OTHER
0.9%
0.0%
0.9%
100.0%
100.0%
Source: BNY Mellon. Target Percentages are the interim Risk-Based Policy Targets effective 1/1/2018. Numbers subject to changes and rounding errors.
the board of trustees lowered the assumed rate of return to 7% from 7.55%. Although we are long-term investors, we review our assumed rate of return regularly, keeping in mind what the market environment may look like over the mediumterm and how that affects our ability to fund our liabilities. At the same time, we don’t want to be tinkering with target returns and asset allocation constantly because it’s expensive to the portfolio. For example, you churn a lot of fees buying and selling assets. It’s better to have a long-term view, particularly as it’s difficult to time the markets.
IA: Switching gears, who makes up your family?
IA: What are you reading?
Burton: My husband Mike moved with me to Hawaii and is currently working remotely with his employer back in Maryland, as a vice president of sales for the Agora Companies. Our kids, a son and daughter, are four and two years old. My son is a beach bum; he’ll be a surfer one day. They both love their new school and love being outside. Also, my commute is not as long, so I get to see them more now.
Burton: Lately, I’ve been reading boring finance
books with titles like “Build a Better Vision Statement” or “Python for Finance.” Sometimes I wish I was in the matrix and could just download those books instead of reading them (laughs).
I’m also reading a Hawaii-based book called Broken Trust by Samuel P King. It’s about Princess Bernice Pauahi Bishop, the largest landowner and richest woman in the Hawaiian Kingdom, until her death IA: What are your hobbies? in 1884, when she entrusted her property to five Burton: Mike and I are very active. He likes to cycle, and I like to surf. He also does any kind of trustees to create an institution to benefit the local IA: Is Hawaii ERS involved in ESG initiatives? water sport, and we do a lot of hiking outdoors schools—and how it all went sour in 1997 when Burton: Our executive director attended the here. We’ve been going to the beach with the trust was charged with gross incompetence and PRI (Principles for Responsible Investment) in flashlights almost every night to look for sand massive trust abuse. person in September 2018, and in May 2018 crabs with the kids. IA: What are your next travel plans? the ERS joined the UN PRI. We also have one The food prices are higher here on the islands, so investment staff member who is motoring how we’ve been doing a lot more cooking. There’s a lot Burton: We’re staying local for the next year. It’s to best execute on ESG strategies. Our primary of food sharing here at the office—in fact, I just hard to fly with a two- and a four-year-old! Our focus on the investment team remains to achieve won third place in the ERS chili cook-off with a in-laws will come to visit, and we plan to visit the our target rate of return. neighboring islands together vegetarian recipe! photograph by Jaja Kang
VOLUME 2, ISSUE 1
21
ASSET OWNER SPOTLIGHT
CAROLYN M. WEISS, CFO, THE NEW YORK COMMUNITY TRUST BY MARK FORTUNE
C
arolyn Weiss is the chief financial officer and treasurer of The New York Community Trust (The Trust), Community Funds Inc. (CFI), and The James Foundation, a position she accepted approximately five years ago. Weiss is responsible for all financial operations of the three nonprofit grant making organizations, which combined manage approximately $2.8 billion in assets. “I have several titles. We are a non-profit grantmaking organization—so, we exist to do good. I have very talented colleagues who have expertise in education, human justice, the arts, people with disabilities and more—I am here to support them. We make grants to organizations primarily in New York City and try to make New York a better place,” Weiss said.
We also have immigration initiatives. We try really hard to stay in the center—politically neutral. But, any philanthropy is a do-good philanthropy, by definition. And what that means is that we fund legal aid societies and try to help where someone is entitled to have attorney representation, by funding organizations that will provide those attorneys. IA: What is the structure of The Trust’s funds? Weiss: We are almost 100 years old; Cleveland,
Chicago and Boston have foundations similar to us. Many major cities have community foundations like ours, where there is a deep understanding of a small geographic region’s needs. There are around 700 community foundations across the country. In the early 1900s, banks had high-net-worth clients who wanted to give to charity. This practice Institutional Allocator Editor Mark Fortune spent generally wasn’t within the skill set of banks at that some time with Weiss recently, during which she time. Banks knew more about investing money discussed her current role, her career path and her than giving it away. So, they created trusts for general outlook on institutional investment. individual families—for the Fortune family, for IA: What kind of grants does The Trust make? the Weiss family, etc. The New York Community Trust owns the charitable assets, but they are still Weiss: We fund programs; we don’t run any programs here ourselves. But, we support managed by the banks in trust form. organizations that do that really well. We fund That’s half our balance sheet—that’s over $1 billion historic preservation, community development, of trust assets. These are old assets. It’s a testament job training and some environmental initiatives. to what we do really well and what community But what we really do is follow what our donors foundations do really well, which is to maintain an want. Donors will indicate to us that they want endowment and spending-plan discipline where a to help with preschool reading initiatives, for calculated percentage is given out to charity every instance, and that’s what we’ll do. Program officers year. For next year, it will be somewhere in the will scout around New York City, and they will range of three to six percent of assets, and around find out where are the best organizations—where three percentage points more than the prior year’s there’s the most success helping the most children. spending plan, which approximated inflation. 22
INSTITUTIONAL ALLOCATOR
IA: What are The Trust’s total assets? Weiss: We were almost $3 billion, up until a couple of weeks ago, but with October’s stock market volatility, we’ve dipped a little lower. Approximately fifty percent of those assets are managed by banks in the form of trust accounts. We work with eight major New York City money center banks. That’s how part of our balance sheet is managed and it works extremely well. Our goal is to increase charitable assets while preserving capital. We have traditional investment pools as well within our corporate entity, Community Funds Inc. Donors who establish funds in the corporation have a choice of four investment vehicles: Vanguard Federal Money Market Fund, Vanguard FTSE Social Index Fund, and Community Funds’ investment pool and income pool.
We are working with trust assets on the one hand—fulfilling the wishes of donors that have passed on—and we have living donors on the other side. Charitable gifts come to us from living donors and are contributed to donor-advised or field-of-interest funds, for example. While those assets are on our balance sheet, they are invested in our investment pools or in money market accounts, according to a donor’s preference. Donors can make frequent gifts and give us $1 million each year—that can happen. But what is more common is the donor will have some kind of liquidity event, i.e., she’ll sell her company and come to us with $10 million in assets. But she doesn’t have time to identify charities at that point. She will come back to us in three, five or seven years and say ‘now I want to work on this plan for STEM education’, or whatever is important to her. photograph by Tony Patryn
ASSET OWNER SPOTLIGHT
Carolyn Weiss, chief financial officer and treasurer, New York Community Trust, Community Funds
VOLUME 2, ISSUE 1
23
ASSET OWNER SPOTLIGHT
philanthropy. I thought ‘I want to work there.’ So, I made an effort to network with different colleagues, different staff members at conferences, and so on. I learned from them what it was like working here; learned what their attitudes were; learned if it was a good place to work, whether they were committed to the mission of the organization—and they were.
two days as an administrator in the international group within Fidelity Bank in Philadelphia. I made my leap from Philadelphia to New York, the next year, to Bayerische Landesbank, where I could use my German language skills. From there, I went to a Lebanese bank, Bank Audi (USA). That gave me the opportunity to speak conversational Arabic.
Leading up to joining The New York Community Trust, I was at three prior foundations as chief investment officer and/or chief financial officer. I worked for a donor-advised fund platform with Jewish roots—FJC Foundation. That was a great experience. At the time I joined, investments were tracked on spreadsheets. With support from the board, I implemented front-to-back systems— IA: With which consultant does The Trust work? from a new donor portal through investment Weiss: We only use consultants on an ad hoc reporting. It’s the name of the game these days, basis. Other than that, our team works directly working with systems and being able to improve with the investment committee to develop the them. The entire staff was involved, and we allocation and to implement strategy. We recently improved procedures dramatically. enlisted Cambridge Associates for an active I was the first staff member at The Leona M. and manager review and Albourne for a hedge fund Harry B. Helmsley Charitable Trust in 2009. It portfolio fee analysis. was a rare opportunity to build a new organization from the ground up. IA: Tell us about your career path?
The best take-away from my jobs in banking was meeting my husband Cyrus Weiss. He encouraged me to pursue an MBA. Because I was studying when I wasn’t working, my husband would cook our meals. And it worked. It was great. It took me three and a half years to complete my MBA at Baruch College. I’ve recently been appointed to the Dean’s Advisory Council for the Zicklin School at Baruch.
I was an undergrad foreign language major at Penn State University, where I studied Arabic, French and German—I got a well-rounded liberal arts education and had a fantastic time. I graduated in 1981 and then backpacked through Europe. When I returned to the U.S., I got a job within
I left KPMG to join Deutsche Bank in 1993. Seven years is a long time in public accounting. I interviewed at only two places—Goldman Sachs and Deutsche Bank. Goldman Sachs offered me a job as controller for China. And I thought ‘China? There’s nothing going on there…’ (chuckles). I
IA: What is The Trust’s investment pool’s asset
allocation breakdown?
Weiss: The asset allocation includes public and private equities, fixed income, hedge funds and real assets—a classic investment allocation. We are pulling back from hedge funds right now and investing more in real assets and private equity. But other than that, our focus is on U.S. equities, international equities from developed markets, emerging markets equities and fixed income. The Community Funds Inc. portfolio is invested approximately 27% in U.S. equity, 21% in global and international equities, 21% in bonds and cash, 15% in hedge funds, 6% in emerging markets equities and 5% each in private equity and real estate.
Weiss: They tell you at business school to build up a list of companies that you would like to work for. Nobody does that, right? (chuckles). I thought, ‘you know what, I would like to work at The New York Community Trust. Why not?’ We’re the biggest player in New York City in charity and
From there, I went into public accounting. I joined KPMG in 1987, as an auditor in the financial services practice. I really liked KPMG. I stayed there for seven years. It was very interesting to work on a variety of client engagements. I was transferred to Germany when the Berlin Wall came down, and there was a tremendous need for audits of former East German companies.
“We exist to help the New York City region. Our investment portfolios are classic investment portfolios, with risk and return decisions.” Carolyn Weiss, chief financial officer and treasurer, New York Community Trust, Community Funds
24
INSTITUTIONAL ALLOCATOR
ASSET OWNER SPOTLIGHT
turned down the job and went to Deutsche Bank as head of financial reporting for all North American entities. Later, I became the deputy business area controller for equities worldwide. In my last position, I was chief operating officer for Latin America. The last job was the best job—I was responsible for all operations, systems, people— everything necessary to run the business smoothly. Our daughter Luisa was born in 1999, and I decided that it was time to stay home. My mother-in-law dubbed her the ‘million-dollar baby’—implying that I would have been making a million-dollar salary if I had continued to work. (laughs).
we are changing a lot of those procedures. We are interviewing system providers to create a scalable system. Some programming will be done in house. The finance team is without a doubt the best I’ve worked with, and they are up to the challenges. IA: How would you describe your management
style?
Weiss: I would say ‘empowering to my staff.’ IA: How would you characterize your investment
philosophy?
Weiss: Steady as she goes—we’re here for the
long term. We’re not risk averse, but we don’t make rapid changes based on market fluctuations My primary focus became raising my sons Daniel or current trends. and Andrew and my daughter Luisa. I then became IA: Have you made any interesting investment an accounting professor at Kean University in allocations recently? New Jersey, where I taught undergraduates and Weiss: I think we did the right thing by exploring MBA candidates at night school. The majority of other investments for our hedge fund money. I students had full-time jobs and were completing think that hedge funds, in general, have run their degrees on a part-time basis. I taught in Xi’an, course. The liquidity premium is absent. The China as well. investment committee is looking closely at private IA: What was your experience like teaching in equity, natural resources and real estate. China? IA: What’s your view on active vs. passive Weiss: Around 2000 to 2005, there was a
strong demand for instructors from American universities with an interest in teaching business courses in China. I accepted and would drop into China for 11 days at a time. I taught accounting in English through an interpreter. The students were government employees seeking to gain some American business sense by enrolling in an MBA curriculum. It worked because numbers are a common language, and I would use my own materials. Teaching was the toughest job I’ve had. After seven years, I wanted to get back to a more traditional job—a Monday to Friday job. A friend of mine served on the board of a foundation in New Jersey that needed someone to take charge of the growing endowment, The Healthcare Foundation of New Jersey, in Millburn. I lived two towns away from the office and I could ride my bike there. That was my first job back after teaching and raising children. I was lucky to transition with this job.
management?
Weiss: About twenty five percent of our portfolio is passively invested. An important point with regard to active management is that it makes for more interesting investment committee meetings. The investment committee doesn’t want to get together for a sandwich and cup of coffee just to look at the performance of an S&P 500 fund. They enjoy meeting managers, getting to know managers—they enjoy debating managers. Performance aside, I expect that we’ll continue to invest with active managers. IA: What’s your view on ESG? Weiss: We exist to help the New York City region.
Our investment portfolios are classic investment portfolios, with risk and return decisions. To date, we don’t have ESG entering into our investment portfolios. What we will do, however, and what we are having conversations with donors about is impact investing. We’re willing to work individually with donors to explore what they IA: What changes have you made at The Trust want to do. That is separate from our investing. since joining? I don’t think that’s inconsistent. Our investment Weiss: I think my staff would say sweeping committee brings a range of experience to our changes. This place is clean, was always clean, and investment decisions. At this point in time, I don’t the trains ran on time. That’s what I was told, and think anyone on the committee has expertise in that there wouldn’t be any need to make changes. ESG. That group of experts is our program team. But when I started here, I think my staff had IA: What was your best experience in your career PTSD from the prior leadership. I like to hear so far? opinions; I like staff to be in the room; I like staff Weiss: My international experiences are at the to speak first and then I’ll chime in. I believe I top. Any time I worked in South America for have a very different management style from my Deutsche Bank, or in Germany for KPMG, or predecessors. I think that was the biggest change speaking at a Markets Group meeting in Sao I brought. Paulo [Market Group’s 10th Annual Private Also, I saw that our system was really archaic and Equity Latin America Forum], that’s what I enjoy certain investment accounting methodologies were the most because I like different viewpoints. It’s a duplicative and inefficient. With my colleagues, big world out there. I like to hear what is going photograph by Tony Patryn
on. When I spoke at a Markets Group meeting in Peru, we discussed investing in shopping malls. Because shopping malls are safe and secure— they are destinations. People go to shopping malls to hang out and to make purchases. That is something unique and location centric. In the United States, increasingly, a lot of shopping is done away from shopping malls. When I prepare for a speech or panel discussion, we convene with other investment professionals. It’s evident right away who is the chatty one, who is the technical one, who is most up to date on current events. You work it out—it’s about the group dynamic, not about my knowledge, per se. IA: What was the worst experience in your career
so far? Weiss: The environment at Deutsche Bank could be tough. Think back to the culture of New York financial institutions in the 1990s. We had two female vice presidents out of a team of 38. IA: What would you like to see changed in the
investment industry? Weiss: I’d like to see defined benefit (DB) plans continue. I understand that it is a commitment by a corporation, based on future unknowns. But the social investment DB plans offer is that staff members who either don’t save or can’t save—will be taken care of in their old age. IA: What’s your next planned business trip? Weiss: I travel tonight to Napa Valley to visit the vineyards. I’m travelling with Markets Group, in December, to the Latin American private equity conference. For personal travel, I went to Croatia in August and Sweden in June. We have friends in Sweden, who work for the Swedish government. It was our 34th wedding anniversary, and we wanted to do something special to celebrate. There were long days—we would picnic at a park until 10 pm with other families. IA: What are your hobbies? Weiss: The same as yours: talking to people. IA: What was the last book you read? Weiss: Ego vs. EQ, by Jen Shirkani. It’s good. You have to watch out for ego traps—watch out for ‘am I being a micro manager?’ The author suggests that one think about hiring people who are not identical to themselves. As a matter of fact, hire those who are opposite to you, because they will fill in the gaps. It’s a good refresher Editors’ note: Carolyn Weiss is a member of Markets Group’s Advisory Board
VOLUME 2, ISSUE 1
25
ACTIVE IS: ALLIANZ GLOBAL INVESTORS Active is the most important word in our vocabulary. It doesn’t just describe how we manage your money. It defines our entire approach as an asset manager: active is our commitment to creating and sharing value with our clients. Get active at us.allianzgi.com/institutional
Value. Shared.
The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
ASSET ALLOCATION
KENTUCKY FORGES DEBUT CO-INVESTMENT: A EURO RE FUND WITH BARINGS BY MARK FORTUNE
T
he Frankfort, Ky.-based Kentucky Retirement Systems (KRS), with $17.6 billion in assets under management, has embarked on an approximately $350 million strategic investment partnership with Barings, a global investment management firm, and Barings parent company, Mass Mutual, to launch the Barings Real Estate European Value Add I Fund. KRS was initially approached in mid-2018 by two Barings managing directors, James Fink and Kevin Ryan, who were actively recruiting a variety of LPs to raise the $350 million needed to launch a European real estate investment fund, said Andy Kiehl, director of real estate and real return investing at KRS. The strategy would seek investment opportunities in value-add real estate in Europe. The fund would target assets in office, retail and logistics for repositioning and exit. The Barings team could also look for development and special situations opportunities, but only as a minority allocation in the fund. At the time it was approached by Barings, KRS had been interested in investment strategies and opportunities in Europe. But, after hearing that seed capital of approximately $90 million was coming from Baring’s parent, Mass Mutual,
Andy Kiehl, director of real estate and real Return investing, KRS
KRS proposed the idea of a strategic partnership, in which it would invest side by side with Mass Mutual and provide half of the capital Barings was looking to raise for the fund, Kiehl explained.
the GP. “Many of the GPs and fund constructs will apply a “catch-up carry”, which means once they deliver a stated return, they then go back and collect an incentive fee on that return, and then “For KRS and the benefit of our plans, we are an additional 20% on all other returns delivered. looking to be an important piece of capital to the In our agreement with Barings, we have an agreed GP [general partners], and we believe co-investing upon ‘hurdle’ return, and once delivered, they will shoulder to shoulder with the parent company only collect an incentive fee or carry on the return makes us pretty important. In the interest of above the hurdle rate.” efficiency, we are looking to have larger, broader, The fund’s investment strategy is to acquire multi-faceted relationships (where possible) with mispriced or mismanaged assets in supply established institutional firms, and Barings and constrained locations in major European Mass Mutual fit the bill,” Kiehl said. markets, according to a Barings spokeswoman. According to Kiehl, “We have made a concerted The investment focus will be on leasing or capital effort over the last two years to seek out asset improvement opportunities primarily within the managers and GPs that offer an attractive value office, retail and logistics sectors, she said. “This proposition, favorable LP [limited partner] asset-level strategy will be driven by stock selection economics and a true ‘alignment of interest’. We and active asset management and informed by believe that LPs don’t just have to accept GP- both cyclical and long-term structural factors,” friendly terms like fees on committed capital, she said, declining comment on the fund’s fees or catch up carry provisions or long-dated funds anticipated returns. with extensions.”
KRS’ real estate allocation is approximately $615 The Barings Real Estate European Value Add I million currently, representing a little over 3% of its Fund closed in November and is scheduled for AUM. “The European real estate fund represents a three-year investment period. Kiehl noted, about 1% of assets, so that takes our RE position however, that with seed assets already in hand, up to about 4%.” The Kentucky plan includes real and absent the burden of a second, third or estate in what it has labeled a “diversifying” bucket, fourth closing, the Barings team believes the fund’s the allocation to which stands at 25%. capital can be deployed even more quickly than KRS is one of the nation’s most severely originally anticipated. “It’s just another benefit of underfunded public pension funds. According to the strategic partnership. Pace of deployment and the Pew Charitable Trusts, among state-sponsored return of capital are important considerations of retirement systems, those with the poorest funded GP/LP investment vehicles. Giving Barings the ratios are New Jersey and Kentucky, at only about ability to execute the strategy more quickly than 31% funded, and Illinois, at 36% funded. Kiehl they could have otherwise is beneficial for both said that “not unlike many other state pension parties.” plans, we have experienced some challenges; we’re KRS’ agreement with Barings requires no fees to be paid on committed capital, only on drawn (invested) capital. “What this means is that we are not charged until our money is invested,” Kiehl said, adding there is also no catch-up carry for
underfunded. We’ve had staff turnover. But for the last going on three and a half almost four years, the same group of staff—just four of us—along with a pretty sophisticated investment committee, are just doing some interesting [investment] things.” VOLUME 2, ISSUE 1
27
ASSET ALLOCATION
UNIVERSITY OF UTAH ENDOWMENT EYEING “SPECIALTY” INVESTMENTS BY LESLIE KRAMER
T
he $1.1 billion University of Utah endowment is currently talking to several “specialty investment” managers with an eye toward investing in this “alternative-alternative” asset class in 2019. “Based on our research, some of the attractive non-correlated strategies we’ve identified are: litigation finance, life settlements, and oil and gas royalties,” said Mark Waite, director of endowment investments at the University. The Utah university endowment has also researched investment in catastrophic reinsurance and royalties from companies in the healthcare, music and entertainment industries. It has no stated investment amount in mind, at this time.
are extremely high and deployments have slowed. All of these factors are worrisome,” said Waite. In response, the endowment has been “looking for investments with idiosyncratic risk, which can offset the market, or system risk present elsewhere in the portfolio.”
this type of investment is, typically, less than three years, Waite said. That time frame is much less than for private equity or venture capital investments that can go on for five to seven years, he noted. “So, we like that they are able to invest and work through the cases and that you will get Given the current low-interest rate environment, your money back in a shorter time frame to lessen securing income has been challenging, prompting the risk.” Because some cases do go on for many the U. of Utah endowment to also look for years, “the duration on the fund is typically a 10investments that are unrelated to typical fixed- year structure, similar to that typically seen in a income securities. Waite noted that during the limited-partnership investment, but [most cases] great financial crisis, “everything dropped together, are settled sooner than that,” Waite said. and since then everything has risen together. It’s hard to get meaningful diversification, so we Life settlement Another area of high interest for the endowment wanted to explore some non-correlated areas.” is life settlements, or investment in life insurance Litigation finance policies. “We think it’s an attractive area,” Waite Of all the “specialty asset” classes it is considering, said. As policy owners age and leave the work force, litigation finance is at the top of the University of Utah’s wish list for this year. “We think it’s the most compelling area, and it has an attractive risk-return profile,” said Waite. “The returns that the top managers are generating in the space are 30 plus, net IRR (internal rate of return). We like that they are non-correlated, as you are essentially underwriting the outcome of the legal cases, which has no correlation to stock and bond markets or any financial markets,” he noted. “It’s also recession resistant, regardless of the global economy—there is always going to be litigation Mark Waite, matters,” Waite said.
For the past 18 months, the endowment’s investment team has been doing due diligence on both the asset class and on specialty managers that offer these types of niche funds. “We decided we should focus on the ones that offer an attractive risk-return opportunity set, and therefore, we would be rewarded by devoting some time and research to it, where we can make a couple key investments,” Waite said. The move is part of the endowment’s overall push to better diversify its portfolio to protect against higher market volatility and big market declines. “In our view, capital markets are in a vulnerable spot with high prices and high correlations across the board, including in real estate, stocks and private equity/venture capital. On the private side, we’ve seen massive capital inflows and managers are sitting on record Most commercial cases settle on average in 2.5 amounts of dry powder. Purchase price multiples years, so the average investment duration for 28
INSTITUTIONAL ALLOCATOR
director of endowment investments, the University of Utah
ASSET ALLOCATION
they may find they no longer need the policy. At that point, the policy owner can continue to pay their premiums, surrender their policies and redeem the value, or have a third party purchase the policy and take over the premium payments. “There’s about $100 billion per year of whole life policies that either lapse or are surrendered each year. A good portion of these policies could be acquired by life settlement firms, but most of these policy holders are unaware that they could have sold their policy, instead of letting it lapse or surrender,” Waite said.
mangers that can acquire oil and gas royalty rights and structure good contracts, we think the return potential there can be pretty attractive,” Waite said. Top managers in the space have generated high-teens net returns, he noted.
Other sectors which generate royalties are healthcare and entertainment. “There are healthcare royalties where you are buying the future cash stream on a prescription drug product,” Waite explained. “The driver of that is that it is very costly to develop a drug and to go through the FDA (Food & Drug Administration) process to bring Returns for the asset class have come down a bit the drug to market. Often these drugs will change over what they were five years ago. At that time, hands, maybe an initial group develops it and will “you could expect returns in the mid-teens, net take it so far in the FDA process and then sells it to IRR, and now they are down to 10% to 13%. But another party that then takes it further. But these you also have low standard deviation; it’s about companies need money to generate for their R&D 5%, so you get a very attractive risk-adjusted (Research & Development) efforts. So it’s become return on them. Also, these investments are non- a growth industry during development,” he said. correlated, so they are recession resistant. That’s In the entertainment sector, royalties are often paid on why we think they can be very value additive to a revenue from music and movie sales. When investing portfolio,” Waite added. in this sector, “you are paying a cash amount for the future expected cash stream on a movie or piece of Oil and gas royalties music from an artist,” Waite detailed. However, it’s The third area of prime interest for the university’s hard to predict what consumers’ future interest in a endowment in the specialty sector is royalties. In movie or piece of music will be. “So there is a certain particular, “we like oil and gas royalties, because amount of unpredictability about what the future we think they have an advantage over royalties in cash flows will be. That is the key risk with those the music industry in that the future demand for types of royalties.” oil and gas is pretty constant,” said Waite. While the prices for commodities will fluctuate, the Choosing the right manager demand for oil and gas should remain steady over The University of Utah endowment’s investment the next 20 to 30 years, he said. “So, if you can find team is currently speaking to specialty managers
who run private funds that offer structures similar to that of a private equity fund, as opposed to hedge fund and private equity managers, who may dabble in the space, but have a much broader investment mandate. “We are investing in managers that are dedicated mangers and are only doing these types of strategies. We want to find mangers who are dedicated to the space and not some generalists and large hedge fund shops doing a variety of things,” Waite said. The endowment is currently conferring with its consultants about these specialty products, however, given the uniqueness and newness of these investments, the consultants may not have the time or expertise to do a deep dive into this niche area, Waite noted. That puts the burden more on the investment staff. “We have to do a lot of research on our own, so it takes time for us to feel comfortable in the space and to do the due diligence,” he said. “We also need to do the due diligence on the managers and to identify who we think the top players are,” Waite added. Once the specific investment choices have been identified, the endowment will likely include them in the diversifying strategy portion of its portfolio, which is currently comprised of hedge fund investments. “We will start out with two or three investments and gradually build out that part of portfolio and continue to look at and make investments into these non-correlated areas,” Waite said
“Based on our research, some of the attractive non-correlated strategies we’ve identified are: litigation finance, life settlements, and oil and gas royalties.” VOLUME 2, ISSUE 1
29
INVESTMENT STRATEGY
NEW YORK COMMON RETIREMENT FUND DELVES INTO THE COMPLEXITIES OF INVESTING IN PRIVATE DEBT BY LESLIE KRAMER
R
eginald D. Tucker, senior investment officer of opportunistic investments and absolute return strategies at the New York Common Retirement Fund (NYCRF), took some time out to answer questions IA posed about the Fund’s allocation to private debt, a fairly new asset class for the NYCRF. Tucker gave details about the breakdown of the asset type in the Fund’s opportunistic portfolio, the returns it looks for and the challenges it has found in benchmarking the asset class. The pension fund currently has $210 billion under management and is the third largest public pension plan in the nation.
In which investment bucket in your portfolio do you put private debt?
Private debt investments sit primarily in our opportunistic portfolio, which has about $6.5 billion in commitments and about $2 billion invested within the alternative credit sub-strategy. Depending on the return profile, certain private debt strategies may be considered in other asset classes, like private equity, real asset and real estate. The opportunistic portfolio was created in 2009, following the GFC (global financial crisis) to take advantage of market dislocations as well as to fill gaps in the markets created by increased regulation and traditional financial providers vacating those lending markets.
What kind of returns do you look for? Have you had trouble figuring out how to measure returns in the asset class?
The opportunistic portfolio has an overall target investment return of roughly 9%. This is based on a formula calculated by our plan’s actuarial required rate of return plus a premium or, currently, 7% + 200bps. Our plan’s consultant 30
INSTITUTIONAL ALLOCATOR
uses a blended custom benchmark to model the opportunistic portfolio for asset allocation and risk purposes. This blended benchmark is currently a combination of non-core fixed income, non-core real estate (including value add and opportunistic) and PE/VC (private equity/venture capital).
benchmarking, and I’ve discussed some of the pros and cons with other investors and consultants. Due to the disparate nature of the strategies in private debt, the idea of one benchmark for the whole portfolio versus benchmarking specific strategies and exposures seems easier, because we generally won’t be able to get total loan or investment transparency from GPs (general partners) to benchmark specific strategy exposures.
As the portfolio is the youngest in the plan and started investing over the past few years, we hadn’t had any issues related to benchmarking. However, as these investments have matured and overall Other general challenges we’ve found in private exposure to this class of investments has grown, debt benchmarking include: it has recently become an important focus for us. §§ Defining the ‘universe’ and strategies to include in it. Does the universe include both public and What percent of your entire private strategies? portfolio is invested in the
asset class?
§§ Lack of an actual investable indices that actually Three percent of the overall Plan is allocated to the mirrors the private debt space; opportunistic portfolio. Of that total allocation, 20§§ The general lack of holdings and performance 50% of the opportunistic portfolio is targeted to data available; be allocated to alternative credit. Depending how you define private debt, or for us alternative credit, §§ A question of if the quarterly reporting nature of most strategies skews certain risk and we are either towards the high end of this range or correlation statistics. over it. NYCRF’s periodic asset allocation review is coming up in 2020, and the allocation will be formally reviewed at that time. Also, since most of the opportunistic portfolio commitments are in closedend vehicles that will drawdown capital over time, the sub-strategy allocations can shift significantly depending on what’s happening in the markets.
Have you found it difficult to benchmark for the asset class?
One of the challenges you might find in benchmarking private debt is defining how different investors define what fits into the class itself. For us, alternative credit is fairly broad and includes both public and private credit investments. There are many options for
Reginald D Tucker, senior investment officer, New York Common Retirement Fund (NYCRF)
INVESTMENT STRATEGY
“Due to the disparate nature of the strategies in private debt, the idea of one benchmark for the whole portfolio versus benchmarking specific strategies and exposures seems easier…”
How long have you been invested and do you plan on increasing the allocation?
In what underlying asset classes are you invested in the sector? Types of Investments:
Our first alternative credit investment was in §§ Non-investment grade credit exposure, including high yield, leverage loans, 2013 to a middle-market direct-lending fund. convertibles, mezzanine and bridge loans We are currently more specifically assessing the sizing of these investments in the opportunistic §§ Stressed/distressed debt portfolio as they have grown. §§ Asset-backed securities What strategies do you follow, or opportunities do §§ Middle-market lending you seek for the portfolio? §§ Purchase of non-core portfolio assets from bank, insurers, etc. Targeted Opportunity:
or don’t invest. To that end, in alternative credit, we focus on non-core or below-investment-grade opportunities.
Do you plan on increasing investment?
There are no definitive formal plans right now to increase, but this could change in the 2019 asset allocation study *At press time, IA learned that Reginald Tucker was leaving the NY Common Retirement Fund to take a newly created managing director position at The Orange County Employees Retirement System (OCERS)
§§ Exit or substantial weakening of capital What do you see as the main providers after the recent credit crisis focus of the portfolio? §§ Limited access to capital for small/medium The opportunistic portfolio is intended to be a diversifier for the broader plans, which like most enterprises plans, generates most of its risk through equities. §§ Enhanced yield over investment grade- The portfolio also focuses on finding alpha in fixed income parts of the market where other asset classes can’t VOLUME 2, ISSUE 1
31
INVESTMENT STRATEGY
NEW MEXICO FORMULATES PRE-RECESSION STRATEGY: LESS PUBLIC EQUITIES, MORE CASH, REAL ASSETS, BONDS BY LESLIE KRAMER
Robert “Vince” Smith, chief investment officer (CIO), of the $24 billion New Mexico State Investment Council (NMSIC), a permanent endowment for the state of New Mexico and the third largest domestic sovereign wealth fund in the U.S., is all about planning ahead. In a roundtable discussion at MarketsGroup’s Southwest Forum in Santa Fe, in September, Smith stated: “We think we’ve entered the late cycle [of the U.S. economy] and our biggest concern is raising and structuring liquidity ahead of the next recession.” IA’s Managing Editor Leslie Kramer caught up with Smith to find out more about NMSIC’s investment strategy with regard to an anticipated recession, how the CIO sees the next economic phase unfolding, and what he has been doing to prepare for it. IA: What indicators have you been focusing on to
gauge the current economic cycle?
Smith: Our analysis indicates that we’ve moved into the late stage of the business and investment cycle. At the broadest levels, the late cycle entails:
§§ Economic growth peaks and rolls over; §§ Inflation picks up; §§ Interest rates rise; §§ Risk asset valuations generally are high; and §§ Investment returns become more volatile and dispersed.
to do as the late cycle shows itself: Diversify equity We drew the lesson that we need to raise and exposure; raise and structure liquidity; and refresh structure liquidity just as we were getting into the investment policy statements and other guidance. late cycle, so that when we do get a downturn we In terms of diversifying our equity exposure, we would have plenty of liquidity to be balanced back are reducing our allocation to publicly traded into our risk assets.
equities and increasing exposure to investments IA: How would you compare this economic cycle that produce a preponderance of their total rate to the last one? of return in income, i.e. real estate, real assets and Smith: The last cycle ended in 2009, with only credit. a six-month late cycle. From the time we were To raise and structure liquidity, historically, solidly in the mid-cycle until the recession it was traditional core bonds were used for liquidity and only about six months. Normally, a late cycle lasts as a buffer against equity market volatility, but a while longer. with interest rates at today’s low levels, core bonds We think with this one there is potential that it have lost a significant degree of their traditional will last long longer than normal. Fiscal stimulus advantages. coming into the economy has been a little weirdly Instead, many funds have been looking into other timed. We normally don’t see tax cuts in the late ways to structure liquidity, such as using very long- cycle. We are running a budget deficit, and usually duration Treasuries and crisis-risk-offset (CRO) in the late cycle we are running a surplus. Also strategies, which mix very long-duration Treasuries monetary stimulus hasn’t become restrictive yet, with trend‐following commodities strategies and and we think the Fed is now catching up to normal “alternative-risk-premia” strategies. We’ve looked policy interest rate increases, so we see it still as into those two strategies, but have settled on using more normalization than tightening. good, old-fashioned cash and shorter-duration Treasuries to pre-position expected liquidity needs. We still have some stimulus in the system, but we think it will go away pretty quickly, although it The last market downturn (2008‐2009) caught can come back quickly too, if the Fed determines many public funds by surprise, and they appeared to not have—or for other reasons, to not have deployed adequate liquidity to fully rebalance their risk assets.
We have a group investment staff who looked at the portfolio positioning of over 70 large public funds during the Great Financial Crisis (GFC). The stock market bottomed in March 2009, and according to these fund’s June 2009 CAFR reports, many funds were underweight relative to their targets or risk assets, so we surmised that IA: Given that, what is the NMSIC doing with people either ran out of liquidity, or they didn’t the sovereign wealth fund’s portfolio in reaction rebalance to their risk targets correctly when the to this late economic expansion? major risk markets were about as cheap as they Smith: Generally, we think there are three things were going to get.
Recent U.S. economic and market activity have been consistent with that, and we should expect it to continue as a normal course. We think we’re fairly early into the late cycle at present. However, late cycles can last awhile; this one has the potential to be on the more durable side.
32
INSTITUTIONAL ALLOCATOR
Robert “Vince” Smith, chief investment officer, New Mexico State Investment Council (NMSIC)
INVESTMENT STRATEGY
“Obviously, we don’t know how bad the next recession will be, but we have modeled for a 35% downturn in stocks, that would make it an average bad one.” things are turning over. We think the Fed feels Obviously, we don’t know how bad the next pushed to get rates up so it can cut them in the recession will be, but we have modeled for a next recession and have some impact. 35% downturn in stocks. That would make it an Also, this time around, the pressures we normally average bad one. start to see building in the economy, at this point, are rather muted right now. Inflation is relatively tame, for example. Overall, we think there is more potential that this could be a longer late cycle than normal.
When did you start decreasing public equity in your portfolio?
We have been decreasing equity, since late 2014, early 2015. We did an asset study in 2014, and cut our target weights modestly, while the economy IA: When do you expect the next recession to hit? was still mid-cycle but valuations had risen to quite Smith: We wouldn’t look for a recession until high levels. We worked our way into the lower 2020, and that could be at the back end of the targets during 2015 and 2016. year. But the stock market will sniff that out six We raised the weight of our real estate, real return month early and start rolling over. We could see and private equity allocations. Essentially, we are some worse market environments than we have lowering our allocation to stocks by selling to fund now in mid-2019 and early 2020. capital calls, as they come in from those three areas. One of our consultants is Macroeconomic Advisers [St. Louis-based independent research firm, which was acquired by IHS Markit in Sept. 2017]. Joel Prakken, chief U.S. economist at the firm, indicated to us that some recession modeling they’ve been doing says the same thing. The late cycle could last till 2020, and there is risk of a recession in 2020.
IA: How do you see the stock market reacting to the current cycle? Smith: We still see growth in the economy, but the
stock market has it priced in already, so we wouldn’t expect to see double digit stock market returns, but instead a weaker market, with returns 0% to 7%. You never know though, the market could take off tomorrow and could give us good returns, but there is a low likelihood that will happen. I think we will continue to see volatility, but we still have a good economy. We tend not to get bad markets when corporate profits are still growing and other indicators are saying that the economy is still in decent shape. But one feature of the late cycle is that we normally get more volatility in stocks.
The 2016 election results surprised the markets, including us, and stocks repriced to correctly account for the potential impact of tax cuts, increased government spending (military, infrastructure) and deregulation. The stock market literally jumped 35%-40% from the election through last January, from already high valuation levels. We cut allocation targets to stocks again in the fall of 2017. Since the end of 2017, stocks have done very little. This year’s returns are less than 1% or flat, which is classic late-cycle activity: volatility and lower return. Our target stock allocation is 40%; that may be as low as we go. We are now at 44%, so just under the public fund medium of 46% to 50%–not too far off pace, but below. If stocks really ran from here up another 30% to 50% we might go back to the Council and suggest we take some more out of that allocation, but no one anticipates that. IA: You mentioned increasing your allocation to
other risk assets; can you talk about your weighting in those assets?
Smith: Since the end of 2014, we have been moving into other risk assets, which would include real estate, private equity, real assets and non-core fixed income; we include them all in our “other risk assets” allocation or portfolio. Generally, we moved away from public equity and into those areas, because we are focused on income-pricing assets at this point in the cycle. Real estate and non-core fixed income produces a lot of income; our real return portfolio produces a boatload of income, so we are really trying to get out of things that need the price to go up for us to make returns (stocks) and into things that generate income. That is the basic direction. IA: Can you talk about your overall portfolio
strategy going forward?
As we mentioned earlier, we are in the process of raising and restructuring liquidity for this next downturn. We have looked at a number of ways to do it. The traditional way is to depend upon core bond allocations for liquidity, as interest rates always fall in economic downturns and bond portfolios gain value when rates fall. But interest rates are already so low, they’ll fall, but they won’t fall far. So the gains out of normal bond portfolios will not be that much, or can’t be; making the risk /reward of the traditional approach less attractive. So, we have put that strategy aside and others seem to be doing the same thing and looked into other ways to raise and restructure liquidity. The CROs, we described earlier did not appeal to us very much either. The long duration nature of the bonds in a rising interest-rate environment can really produce some bad returns. We were not very comfortable with the trend-following strategies either. I’ve never invested in them. We had a little experience with risk-premia strategies, but were not satisfied with those returns when we had it in 2011 through 2016. So, we took the strategy of having low-duration fixed income, which is mainly cash, just old-school cash, ahead of the recession. We did a liquidity study about a year and quarter ago and came up with a figure of 10% cash that we needed to hold. During the early- to mid-cycle we hold very little cash, because markets are usually rising swiftly and reliably and producing good returns. So, we will invest it (the cash) in risk assets during the next recession. IA: Any advice for other investors looking to weather the current cycle? Smith: I’d suggest that investors make sure that their fund’s investment policy statements and other guidance, particularly regarding rebalancing procedures, risk limits and lines of authority are in place. You don’t want to be making “Game Day” decisions regarding those things when the world is falling apart. We actually think that was part of the issue with some funds we reviewed in 2009. Game Day decisions don’t work
VOLUME 2, ISSUE 1
33
INVESTMENT STRATEGY
PENSION, E&F INVESTMENT PROS CAUTIOUSLY OPTIMISTIC ON HEDGE FUNDS B Y K A I T LY N M I T C H E L L
T
hough just five percent (or 400) of 8,000 hedge funds (HFs) are even considered investable, according to Joe Marenda, a managing director and hedge fund specialist at Cambridge Associates, “the beauty [of hedge funds] is really in the eye of the beholder—based on portfolio need,” he said. Though institutional investors are currently holding their allocations to hedge funds flat, at best; at worst they’re exiting the class, according to a recent report from EY titled 2018 Global Fund Alternative. Investors that spoke with IA last week largely substantiated Marenda’s “beauty in the eye” explanation regarding their approach to the class. The hedge fund industry has changed markedly since 2004—it’s much harder now for managers to source alpha, and the economics (what allocators should pay and what hedge funds should earn) are challenging for both investors and for the hedge funds, said Elizabeth Burton, chief investment officer (CIO) of the $16.8 billion Hawaii Employees’ Retirement System. Burton does not view hedge funds as past their time. Nor does Craig Husting, CIO of the $44.5 billion Public School & Education Employee Retirement Systems of Missouri. “I don’t think the days of hedge funds have passed,” he told IA. “We think the right hedge funds continue to have the opportunity to offer consistent alpha. Additionally, hedge funds can bring needed diversification to a portfolio. We believe the economics with hedge funds have improved in the favor of the investor.”
fund managers is difficult for several reasons, she said, including limited transparency into hedge fund managers’ positions. “And fees are high—it used to be 2% and 20% of profits, but many now ask 1% and 20%. But with so much press about mega rich hedge fund managers it’s difficult for an investor to have gotten 3% to 4% returns and then read about how many yachts their hedge fund manager has in the Mediterranean,” Slocum said. It can be difficult for investors to retain the alpha that was generated from a hedge fund investment due to high fees, agreed Christopher White, a portfolio manager for special opportunities investments within the $154 billion Teacher Retirement System of Texas. “What is considered investable for us is a much higher bar than the typical investor—a hedge fund needs not only to be of institutional quality, but must have the capacity to invest large amounts of capital,” he said. “The hedge fund industry is not delivering the same returns it once did, thus there is pressure on hedge funds to produce more opportunistic products and drawdown structures,” he added.
Two funds lower allocations to HFs
The $8.3 billion Employees’ Retirement System of Rhode Island opted to eliminate most of its hedge fund investments in 2016, when it adjusted its strategic asset allocation, according to Evan England, communications director for Rhode Island General Treasurer Seth Magaziner. “We redeemed about $600 million from hedge funds, Niche strategies are the safest way to approach reducing our target allocation from 15% to 7%,” hedge fund investment, stated Susan Slocum, he said. CIO at the $750 million Children’s Hospitals of Minnesota. “We are looking at hedge funds He explained that the performance of many hedge again, using very specific, narrow strategies,” she funds did not justify the cost at that time. “We said. “Returns dropped significantly over the last also decided to increase our allocation to private five to seven years, plus the equity markets have equity, which has consistently outperformed been a better place to have money, until October even after expenses over the course of five years. occurred,” she explained. Pinpointing good hedge We found that hedge funds were the only asset 34
INSTITUTIONAL ALLOCATOR
class where, in the previous three years, more money had stayed with the manager in the form of fees and expenses than had been returned to the fund as performance. We made this change after thorough analysis of our entire portfolio and adopted a strategic asset allocation designed to provide long-term growth and stability.” “We [now] have five funds in our Opportunistic portfolio, where there used to be a few dozen,” said Anthony Chiu, director of alternative investments at the $17.6 billion Kentucky Retirement Systems. “KRS originally invested with funds-of-funds several years ago, but all of that has been redeemed. Today we’re looking on an opportunity-by-opportunity basis. This portfolio has an 0%-10% allocation range, so it doesn’t have to be filled if we don’t find anything that meets our hurdle,” he said. “We have board members with alternative investment experience that have been instrumental in helping us set the direction of the portfolio. But it’s always going to be hard to figure out who to work with and the right structure— that never changes.”
EY survey
Continuing a multiyear trend, the vast majority of investors expect to keep their allocations to hedge funds flat, according to the EY survey. By a ratio of three to one, investors that indicated they expect changes to their hedge fund allocations forecast decreases rather than increases, the report stated. The hedge fund industry’s continued lackluster performance relative to perceived high costs, combined with hedge funds already comprising a large percentage of investors’ existing portfolios is a leading concern for many, the report continued. The largest HF managers, those with more than $10 billion in assets under management, were attracting the most capital as they leveraged their broad and diverse product offerings to raise funds, the report noted. “Many midsize and smaller
INVESTMENT STRATEGY
managers are playing a zero-sum game among senior consultant at Verus told IA. “It’s rare to see each other, resulting in some managers winning more than a 10% allocation to hedge funds,” she added. “There was a time when public funds, en at the expense of others,” the report concluded. masse, threw a lot of money to hedge funds, investing Consultants weigh in without understanding the true risk exposures. While there are smart, skilled hedge fund When they exited during the global financial crisis, managers out there, they are hard to find; various hedge fund shops shut down.” additionally, the hedge fund industry has been Verus has partnered with boutique hedge fund historically burdened by a high-cost basis—often, consultant Aksia to provide its institutional clients a alpha is overridden by fees, said Todor Todorov, a robust resource to identify the top HFs, Neill noted. member of the manager research team focusing An institution’s interest in hedge funds could vary on diversifying strategies at Willis Towers Watson. considerably, based on whether it is an opened “Long-term, hedge funds falling behind is not an or closed pension fund and its funded status, or issue; we encourage our clients to think more whether it is an endowment or foundation, which about portfolio diversification.” typically has an infinite life. Each institution has a Public funds typically employ modest allocations to unique risk tolerance and the size of the allocation hedge funds, Eileen Neill, managing director and to hedge funds, the types of strategies employed,
and individual funds chosen should be customized to the institution’s needs, according to Cambridge Associates’ Marenda. “For instance, a well-funded pension plan or a closed pension plan is particularly sensitive to drawdown risk, which likely drives its total allocation to hedge funds and the types of strategies and managers chosen,” he said
“Hedge funds were the only asset class where, in the previous three years, more money had stayed with the manager in the form of fees and expenses than had been returned to the fund as performance.”
Anthony Chiu, director of alternative investments, KRS; Christopher White, portfolio manager at Teacher Retirement System of Texas; Craig Husting, CIO of the the Public School and Education Employee Retirement Systems of Missouri; Eileen Neill, managing director and senior consultant at Verus; Joe Marenda, managing director at Cambridge Associates; Susan Slocum, CIO of Children’s Hospitals and Clinics of Minnesota; Todor Todorov, senior investment consultant at Towers Watson
VOLUME 2, ISSUE 1
35
ESG: IMPACT INVESTING
IDB LAUNCHES LAC GENDER-FOCUSED FUND; REGION RIPE FOR IMPACT CAPITAL BY MARK FORTUNE
I
DB Invest, the private-sector arm of the Inter-American Development Bank Group (IDB) and the Overseas Private Investment Corporate ( OPIC) have partnered to launch Fund Mujer, the first gender-focused fund for Latin America and the Caribbean (LAC), to invest in female entrepreneurs, companies with a significant share of women leaders, and firms that generate jobs or consumer products for women. The fund has a $200 million target and is expected to comprise 70% equity and 30% debt, according to Pablo Verra, head of equity and mezzanine investments at IDB Invest. The LAC region has relatively underdeveloped private equity markets compared to the developed markets and other emerging regions. That condition applies to impact investments too. But, according to Verra, the region is of growing importance to the world economy, with a plethora of sustainable development goals (SDGs), some of which may represent attractive impact investment opportunities for institutions. IDB is seeking investors that have an interest in coimpact investing within the region. “We are often approached by and are seeking other like-minded investors who want to co-invest with us, utilizing our development standards, or who would like us to establish a trust for IDB Invest to manage their
36
INSTITUTIONAL ALLOCATOR
investments under its criteria,” he said.
Impact investing means different things in different emerging markets Impact investments are private-sector projects that combine financial and social returns to contribute to poverty reduction and promote sustainable economic development. For perspective, the United Nation’s Sustainable Development Goals 2015, which were agreed to by 135 countries, commits to ending poverty, protecting the planet and ensuring prosperity for all by 2030. The goals imply a $2.5 trillion annual investment gap, globally. Though IA could find no source of investment return metrics specific to LAC impact investing, a research collaboration beginning in 2015 between Cambridge Associates and Global Impact Investing Network (GIIN), a New York-based advocacy organization dedicated to increasing the scale of impact investing, now boasts an underlying dataset for the benchmark that includes 71 funds, all seeking market rates of return while targeting social impact objectives. Classified by vintage year, 8% of the funds began investing between 1998 and 2001, approximately 32% between 2002 and 2007, 27% between 2008 and 2010,
Pablo Verra, head of equity and mezzanine investments, IDB Invest
and the remaining 32% between 2011 and 2015. Classified geographically, 39% of aggregate fund capitalization focused on Africa, 37% on the U.S., 17% on a mix of emerging markets, and the rest on a mix of developed markets. According to Seeking Alpha, the 2015 study made the following points: §§ Since inception, the 71 funds have generated aggregate net returns of 5.8% on average, with 4.6% showing up as the median. §§ The fund level internal rate of return can vary a
ESG: IMPACT INVESTING
good deal. The top 5% of funds get 22.1% or ambitions of mobilizing more than $1 billion higher and the bottom 5% lose 15.4% or more. for investments in sustainable infrastructure, agribusiness, education, healthcare and access §§ That range itself is “similar to what is seen to finance, had its first close of $100 million in in conventional investing and illustrates September. The fund has integrated the UN’s that fund manager selection is key to strong sustainable development goals (SDGs) into performance.” due diligence, impact target-setting for each Also, 48 investor exits from impact investments in investment, and impact monitoring throughout India (2010 -2015) produced a USD internal rate the duration of each loan. of return of 10%, and the top one-third yielded “Impact investing means different things in USD IRR of 34%, according to GIIN. different emerging markets, even in regions so “There is an increasing degree of awareness about close as the different LatAm countries,” according impact investments in LAC, both from the to Eduardo Grytz, a managing partner at Sao perspective of investors and companies,” Verra Paulo-based Performa Investimentos, a socialsays. “Multilaterals like us, IFC [International environmental impact investment firm in Brazil Finance Corporation], CAF [Development Bank with in excess of $75 million in assets under of Latin America] and other players have been management, that focuses on the growth capital gradually pushing a dual financial/developmental stage. The firm’s third fund, which has a $120 approach towards private equity. In addition, million target first close in March and a final close there is an emergence of dedicated private impact by the end of 2019, plans to invest up to 30% in funds,” he said, pointing as an example to Blue LAC, in companies that plan to come to Brazil one like an Orange Sustainable Capital Latin America year after the investment, Grytz said. The fund will Fund I, a mezzanine impact fund with a sole focus focus growth capital investments in industries such on Latin America, with which IDB Invest has as healthcare, education, clean tech, renewable partnered to maximize its mobilization capacity. energy and FinTech, among others sectors. The fund, which targets financing for small- and Brazil and Mexico are the LAC markets that mid-size businesses in Latin America and has Performa Investimentos considers the most
attractive for ESG/impact investments, with U.S. institutional investors in mind, due to the size of those markets, their existing large infrastructure, and sizable funding needs, coupled with their active local capital markets and regulating agencies and institutions. Grytz added that other attractive destinations are “Chile, Peru and Colombia for the growth of the economies, coupled with increased business-friendly institutions and capital markets, and Argentina for the quality of the entrepreneurial ecosystem.”
Eduardo Grytz, managing partner, Performa Investimentos
Regional sustainable development goals
According to a presentation delivered last month
by Verra at the Wharton School of Business at the University of Pennsylvania, short-term SDGs in the region include tackling environmental challenges, such as reducing waste, combating climate change and marine conservation, as well as reducing slums, population and violent death. There are now approximately $23 trillion of assets under management in responsible investment strategies globally, representing an increase of 25% since 2014 and a 135% increase since 2012, according to Verra. A survey this year by GIIN, found that invested capital in impact investments globally increased by 32% and the number of deals grew by 27% from 2013 to 2017—$6.1 billion and 4,140 deals, respectively, in 2013 to $8.1 billion and 5,263 deals in 2017. Roughly one-quarter of the survey’s respondents said they invest primarily through private equity (26%) and private debt (24%). Approximately 16% of impact investments are allocated to LAC, according to GIIN survey respondents. A majority of respondents indicated that their investments have met their expectations for both impact (82%) and financial (76%) performance, since inception. Another 15% reported outperformance across each of these dimensions. The report’s findings are based on survey responses from 229 of the world’s leading impact investing organizations, including: fund managers, banks, foundations, development finance institutions, pension funds, insurance companies, and family offices. In total, respondents collectively manage more than $228 billion in impact investing assets, a figure that serves as the latest best-available ‘floor’ for the size of the impact investing market, the report claims. Regarding the sectors in which investors target for LAC impact investments, Verra points to the graph below from the GIIN survey:
GROWTH IN REGIONAL ASSET AMONG REPEAT RESPONDENTS (2013-2017) 5 YEAR TREND
Among 81 five-year repeat respondents, the fastest growth in allocations were reported in Ocenia (45%), East and SE Asia (28%), and MENA (26%). South Asia and EECA also experienced growth, but at rates lower than the overall average.
Note: East and SE Asia were disaggregated as regions in 2017. To ensure comparability with 2013 responses, they have ben recombined for this analysis. Source: GIIN
GEOGRAPHY
2013
2017
CAGR
Oceania
37
164
45%
East and SE Asia
2,721
7,258
28%
MENA
481
1,224
26%
LAC
4,761
8,226
15%
SSA
4,961
8,394
14%
US & Canada
6,698
10,436
12%
WNE Europe
3,258
4,865
11%
South Asia
3,343
4,229
6%
EECA
3,496
4,058
4%
Other
1,034
1,922
17%
Total
30,790
50,777
13%
VOLUME 2, ISSUE 1
37
ESG: IMPACT INVESTING
DISTANCE FROM GENDER PARITY 2017 BY REGION
Western Europe
75%
North America
72%
Eastern Europe and Central Asia
71%
Latin America and the Caribbean
70%
East Asia and the Pacific
68%
Global Weighted Average
68%
Sub-Saharan Africa
68%
South Asia
66%
Middle East and North Africa
60%
Source: Global Gender Gap Index 2017
PERCENT OF RESPONDENTS TARGETING EACH IMPACT THEME (MULTIPLE ANSWERS)
60%
Decent work and economic growth 44%
Good health and well-being 39%
Quality education
39%
Afforable and clean energy 31%
No poverty
31%
Sustainable cities and communities 27%
Industry, innovation and infrastructure
26%
Responsible consumption and production 23%
Reduced inequalities
23%
Clean water and sanitation
22%
Climate action 19%
Gender equality 13%
Zero hunger 11%
Life on land 8%
Partnership for suistanable development
7%
Peace, justice and strong institutions 4%
Life below water Other
2%
Source: GIIN, The State of Impact Measurement & Management Practice; n=124. Other includes affordable housing, sustainable agriculture and financial inclusion.
38
INSTITUTIONAL ALLOCATOR
VOLUME 2, ISSUE 1
38
ESG: IMPACT INVESTING
Total assets under management allocated to impact investing in LAC in 2017 stood at $4.7 billion (there was a 49% increase in the number of deals and a 93% increase in the amount of capital invested), according to the LAVCA-ANDE 2018 The Impact Investing Landscape in Latin America report, released this month. The report, which is based on a survey of 67 investors conducted in February and May, also notes that the largest sectors for investment were microfinance (US$782m, 369 deals) and agriculture (US$300m, 276 deals), together representing 75% of the total capital deployed in the region. The report noted that the tech sector was a key area of focus, with information and communication technology capturing $146 million in the 2016 -2017 period. Survey respondents said they expect to increase capital available for impact in the region by US$1 billion each year in 2018 and 2019, both through new capital raised for fund structures and increased allocations to the region, and 64% of respondents said they expect to invest in more deals in the region in that time frame. LAVCA is the Association for Private Capital Investment in Latin America, a not-forprofit membership organization dedicated to supporting the growth of private capital in Latin America and the Caribbean. The Aspen Network of Development Entrepreneurs (ANDE) is a global network of 290-plus organizations that propel entrepreneurship in emerging markets.
Verra said: “I would like my audience to dismiss the myth that by prioritizing impact projects they are leaving money on the table. Social impact is a profitable business and firms that ignore environmental and social matters will have a hard The objective of Fund Mujer is to narrow the time attracting investors in the future. Furthermore, gender financing gap in Latin America and the there is significant evidence indicating that impact Caribbean by supporting investment strategies investments largely meet investors’ expectations and focused on female entrepreneurs, companies usually surpass them, and that impact indices like with a significant share of women leaders, and FTSE4Goodin the U.K. or the KLD400 in the firms that generate jobs or consumer products for U.S. have outperformed the FTSE and the S&P women, Verra said. over similar time periods during the last decade.” “Women-owned micro-, small- and mediumThe IDB was established in 1959. It is the largest sized enterprises worldwide face a $1.7 trillion and leading source of financing for economic, shortfall in access to finance. In Latin America social, and institutional development in Latin and the Caribbean, the region with best gender America and the Caribbean (LAC) parity in early-stage entrepreneurship, the business opportunity could reach more than $98 billion,” stated Gema Sacristan, chief investment officer at IDB Invest, in a press release announcing the fund’s launch. “With Fund Mujer, we are not only investing in women-owned and led enterprises. We are also investing in enterprises that provide quality employment and access to products and services that address critical barriers, so that we may enhance women’s economic participation and success…We are moving beyond merely counting women; we are also valuing women,” Kathryn Kaufman, managing director for Global Women’s Issues at OPIC, added in the release. IDB Invest CEO, whom Verra quotes in his presentation. “The gender gap is present in all areas from junior to management positions,” Scriven said.
When asked what key point he would like the audience to take away from a panel discussion Challenges in which he participated in at Markets Group’s Though environmental, social and governance Private Equity Latin American Forum in Sao Paulo, (ESG) investing is slowly building momentum in December 3-4, Latin America, there are still a number of challenges to its growth. “Local knowledge and expertise and partners are very important,” according to Grytz. He explained that “each emerging market is different in terms of local gaps and necessities to be addressed by impact investments. Also, regulatory and business environments may be complex, and local industry connections count as well to assess the best investment opportunities and understand the more attractive themes and theses.”
Gender Parity
“One of the most pressing challenges for Latin America and the Caribbean continues to be how to close the workforce gender gap,” according to James Scriven,
VOLUME 2, ISSUE 1
39
ESG: IMPACT INVESTING
FORD FOUNDATION EMBRACES AFFORDABLE HOUSING, FINANCIAL SERVICES BY LESLIE KRAMER
T
he Mission Related Investment (MRI) fund at the $13 billion Ford Foundation is seeking investments that support the preservation of affordable housing in the U.S. and expanded access to vital financial services to low-income households in the Global South. According to Christine Looney, deputy director of mission investments, investments in these sectors will be administered through the Foundation’s $1 billion MRI fund, which is part of its Mission Investments program. The goal of the fund, which was launched in April 2017, is to generate positive social returns along with attractive financial returns, Looney said. “We are also seeking to advance issues of diversity, equity and inclusion, paying attention to the composition of the fund team as well as where they invest and with what values,” she said. The team has made $75 million in aggregate commitments so far to funds that support affordable housing projects in the U.S., as part of its national strategy, and to funds that advance financial inclusion in the Global South, including Latin America, Africa and developing countries in Asia.
outstrip supply, given demographic trends and homeownership is continuing to decline. Supply The MRI fund currently has commitments with is expected to remain constrained, due to land six impact managers: Jonathan Rose Companies, prices, labor issues, strict zoning and long regulatory Avanath Capital Management, Capital Impact approval processes.” Partners, LeapFrog Elevar Equity and L+M At the same time, billions of families around the Development Partners. world remain underserved or unserved by the traditional financial markets, Looney emphasized. As Housing preservation strategy Within Mission Investment’s affordable housing a way to help remedy the situation, under MRI fund’s preservation strategy, the Ford Foundation is financial inclusion strategy, the team is investing in working with managers that are targeting returns of private equity and venture capital funds that invest approximately 9%, with annual distributable cash in companies that provide responsible financial flow of 5-7% once properties are stabilized. “The products and services to low-income households investment does provide some liquidity—which in underserved markets in the Global South. The is positive—but many factors come into play in companies offering these financial products “are the strategy, such as our long history in affordable often leveraging technology-enabled distribution housing and the need for preservation,” Looney channels to reduce costs and serve a more expanded noted. customer base,” she said When choosing managers for the fund, the MRI team looks for managers with track records of delivering financial returns as well as impact. “The team is currently reviewing mangers with valueadd strategies, where they can make operational improvements to the properties—including green building initiatives and that include social services for residents and preserve affordability of housing for low-income residents,” Looney said. “Several of the managers leverage tax incentives and federal and state subsidies to ensure the affordability of the property or units,” she noted. Ford’s total endowment, based on the current endowment value.
Mission Investments also expects to commit another $75 million to $100 million in 2019. No financial target has been set for the fund, but Mission Related Investments expects the fund, on a portfolio basis, to generate sufficient risk-adjusted returns to contribute to the foundation’s payout requirements, adjusted for inflation. The MRI fund’s $1 billion investment, The financial downturn in 2007 exacerbated the which will be invested over a 10-year period, once lack of available affordable housing in the U.S., fully allocated, would represent around 7.5% of said Looney. “Demand is expected to continue to 40
INSTITUTIONAL ALLOCATOR
Christine Looney, deputy director of mission investments, Ford Foundation
PEOPLE MOVING
PLAN SPONSOR PEOPLE MOVES BY MARK FORTUNE
In this column, IA lists senior executive personnel moves at institutional asset-owner organizations in the calendar quarter preceding the magazine’s press deadline. The accuracy of the information in this column, which is aggregated from many sources, is deemed reliable but cannot be guaranteed. attorney is now SWIB’s deputy executive previously the highway patrol system’s finance §§ Elizabeth Burton was lured away from her position as managing director in the director will continue in that role. director/chief administrative officer. quantitative strategies group at the Maryland §§ Arizona’s Public Safety Personnel Retirement §§ Gillian Brown was named senior managing State Retirement and Pension System (MSRA) director, capital markets, at the Ontario System (PSPRS) has promoted Mark Steed to to become Chief Investment Officer (CIO) of Teachers’ Pension Plan. She replaces Ziad CIO after conducting a national search for the the Employees’ Retirement System of the State Hindo, who was named CIO at OTPP in job. Steed has served as PSPRS interim CIO of Hawaii (ERS). She replaces Vijoy Chattergy June. Brown will report directly to Hindo. since Ryan Parham retired on June 30. who parted ways with the fund last winter. Previoulsy, Brown was managing director, §§ A Southern California police officer Corona §§ Courier company UPS has selected Ernie credit, insurance-linked securities and equity police officer, Jason Perez, unseated the Caballero, the former Chief Financial Officer products. Danilo Simonelli was named president of the California Public Employees’ (CFO) for the company’s European region, as managing director, alternative investments, Retirement System (CalPERS) in a local its new CIO. He replaces Geoff Kelley who overseeing Ontario Teachers’ hedge fund government election. Perez defeated 15-year within months of the job was promoted to a investments. Simonelli will report to Brown. CalPERS Board of Administration member senior role at subsidiary Coyote Logistics. Previously, he was director, developed-markets Priya Mathur. fixed income and currencies. §§ Global pension fund manager Colin Kerwin retired from ExxonMobil after 34 years at the §§ Clint Rhoden was named executive director §§ Kirsty Jenkinson joined the California State of the Arkansas Teacher Retirement System company. Corporate Finance Executive Phil Teachers’ Retirement System (CalSTRS) as (ATRS). He replaces George Hopkins, Newman took over the global defined benefit director of corporate governance, replacing who will retire after ten years at the System. portfolio. Anne Sheehan, who retired in March. Previously, Rhoden served as associate director Previously, Jenkinson was a managing director, §§ Director of Private Market Investments Kevin of operations at ATRS. sustainable investment strategies, at Wespath Dalmut left his position at the University Investment Management, a division of System of Maryland after having spent over §§ The board of the Colorado County Officials & Employees Retirement Association (CCOERA) Wespath Benefits and Investments, an agency ten years at the endowment. has named Elizabeth Price as the Association’s of The United Methodist Church. Sheehan is §§ The State of Wisconsin Investment Board new executive director, replacing director, Jacob joining PJT Camberview, a business group of (SWIB) has doubled the duties of CIO David Kuijper. Marvin Tuttle had been serving as the PJT Partners as a senior adviser. Villa, naming him as executive director in role of interim executive director. §§ The former head of the North Carolina what will now be a dual role. SWIB oversees Retirement Systems, Kevin SigRist, has taken the Wisconsin Retirement System. Villa has §§ Mike Press, general counsel of the Ohio Highway Patrol Retirement System was named a job as CIO of a new asset management unit led SWIB’s investment strategy since 2006. He the system’s CIO. He replaces Dennis Smith, created by Saudi Arabian Oil Co. SigRist takes up the new role from interim Executive who, during the summer resigned to join the will oversee billions of dollars in pension and Director Rochelle Klaskin, who took on the Ohio Public Employees’ Retirement System, corporate funds for Saudi Aramco, the state oil job in July following the departure of Rick company, through its Wisayah unit. SigRist as associate counsel–benefits. Smith also was Smirl, after just six months, to become COO resigned from the North Carolina’s state at Russell Investments. Klaskin, SWIB’s lead general counsel of the pension fund. Press, VOLUME 2, ISSUE 1
41
PEOPLE MOVING
Investment Management as vice chairman of §§ Carrie Green was named director of equities for the Tennessee Department of Treasury. investment management and head of strategic partnerships, based in New York. §§ Green will oversee the equities portfolio of the Tennessee Consolidated Retirement System, §§ Michigan Gov. Rick Snyder named three §§ Nicole Musicco was named senior managing along with equities in other state portfolios. appointees to the new State of Michigan director, private markets, at the Investment Green, previously, was senior portfolio manager Investment Board: Dina Richard, senior vice Management Corp. of Ontario. The position of private equity assets. president of treasury and CIO for Trinity is a new one. Musicco will report to CIO Jean Health; James Nicholson, chairman of PVS Michel. Previously, Musicco served as senior §§ Sergio Arvizu will step down as CEO and Chemicals; and Reginald Sanders, director of managing director, public equities, at the secretary to the pension board of the United investments for the W.K. Kellogg Foundation. Ontario Teachers’ Pension Plan. Nations Joins Staff Pension Fund (UNJSPF). All three previously were on the state’s Arvizu’s duties are currently being overseen by investment advisory committee, which the new §§ The Los Angeles County Employees Retirement his deputy, Paul Dooley, who took them on Association (LACERA) has named Lou Lazatin investment board replaces. when his superior undertook a leave of absence as its new Chief Executive Officer (CEO) after in August 2017 ahead of an internal audit into §§ Kentucky Retirement Systems is searching searching for a replacement for more than a the pension. Earlier this year, the pension board for a new CIO. The system has issued an year. Lazatin joins from the Shriners Hospitals recommended Dooley maintain those duties RFP for a personal services contract for a for Children of Southern California, a nonuntil December 31 and has recommended permanent replacement for David Peden, who profit hospital system, where she was also Thibaud Beroud be appointed deputy CEO left the system in January 2017. Rich Robben, the CEO. Lazatin also served as the CEO of and deputy secretary of the board for a fivepreviously KRS’ deputy CIO and director of Saint John’s Health Center in Santa Monica. year term. fixed income, has been serving as interim CIO LACERA spent more than a year searching for since Mr. Peden’s departure. a new CEO to replace Gregg Rademacher, who §§ John Pomeroy II, CIO of the Penn State University endowment since 2001 is retiring §§ Ben Meng took over as CIO of the California stepped down from the post in October 2017. at the end of this year. Public Employees’ Retirement System, While LACERA conducted a national search, replacing Ted Eliopoulos, who stepped down. Assistant Executive Officer Robert Hill handled §§ Katharine Wyatt departed Abbott Laboratories Eric Baggesen, managing investment director after 11 years to become CIO of the endowment CEO duties. Hill now returns to his old role for the pension system, who oversees asset at Loyola University Chicago. and will assist with Lazatin’s transition. allocation, had been serving on an interim basis § § Tire manufacturer Michelin’s deputy CIO until Meng joined the System. Most recently, §§ Sanjeev Daga took the role of chief operating Justin Pinckney left to become a principal on officer (COO) at the Harvard Management Meng was the deputy CIO of China’s State Mercer’s real estate team. Co. (HMC) endowment. Daga replaces retiring Administration of Foreign Exchange, which COO Bob Ettl, who will remain as an advisor §§ Wei Huang joined the auto repair and regulates the country’s foreign exchange market to HMC for a year following his retirement. insurance company Auto Club Group as its and manages its $3.1 trillion foreign exchange CFO Kevin Shannon plans to retire at the end CIO, after leaving his CIO position at the St. reserve. Eliopoulos spent five years as CIO Paul Foundation of 2019, after a decade at the endowment. before stepping down to join Morgan Stanley pension system more than a year ago after a new state treasurer overruled some decisions made by the fund’s investment executives.
42
INSTITUTIONAL ALLOCATOR
120 YEARS OF INNOVATION
1
*Assets under management as of 30 Sept 2018 658613-INV-O-11/19
988
$
BILLION IN AUM*
TRUSTED PARTNER
nuveen.com VOLUME 2, ISSUE 1
43
MARKETS GROUP 44 E 32nd St Floor 4 New York, NY 10016 www.marketsgroup.org