6/13/2011 09:12:30 AM

Alaska!

On the day that CIO Jeff Scott has announced his resignation from the Alaska Permanent Fund, aiCIO magazine offers a sneak peak at how the oil-rich state is leading the way toward a new method of asset allocation – and how it has brought in some of the world’s most powerful money managers to do its bidding. Joe Flood reports.

To see this article in digital magazine format, click here.

In May of 2009, Cliff Asness, the former Goldman Sachs quant-guru and Founder of AQR Capital Management, flew to Juneau, Alaska. The following May, it was Bridgewater Associates Chief Investment Officer Robert Prince who made the trip, along with PIMCO's Mohamed El-Erian. A few months after that, it was Asness again, back in Juneau with his AQR team.  

So, what brought some of the biggest names in investing this far north? A fashionable hunting reserve for the rich and famous? Salmon fishing under the Midnight Sun? A fundraiser for one of the state's prominent politicians? Actually, it was a much more important feature of state politics than Sarah Palin or Lisa Murkowski: the annual dividend checks given to every Alaska resident and, more specifically, board meetings of the Alaska Permanent Fund (APF), charged with investing a portion of the state's oil and gas proceeds and distributing the profits every year via those checks. 

Hedge fund honchos and asset management mavens flying around the world to meet investors isn't unheard of but, in the case of the APF, these high financiers are doing more than recruiting investment dollars or paying a friendly visit to a big client. Along with GMO and Goldman Sachs Asset Management, PIMCO, AQR, and Bridgewater all serve as “external CIOs” to the fund, a new program started by Chief Investment Officer Jeff Scott over the last two years. Of course, the external CIOs manage assets, but their role also includes educating the APF and its board of trustees about why they're investing that way. This includes giving lengthy presentations on everything from big-picture economics to the esoterica of risk management; lending their impressive research departments to the APF when they've got a theory to test; or just serving as an external sounding board and informal think tank. It’s the price these funds pay for accessing the cash of America’s largest state.  

“The key thing when it came to picking external CIOs wasn't just their past returns,” says Scott. “We wanted people who really were committed to working with us: who would fly up to Alaska for board meetings, really answer our questions, get into conversations about what they see happening in the market.”  

Not content with just one major innovation, in his two years on the job, Scott also has pushed for a new way of valuing risk and thinking about the fund's portfolio. The idea is to focus less on the rigid categories of asset allocation, and look more deeply at the kinds of risk factors—corporate exposure, counterparty risk, currency fluctuations, inflation and deflation—that so often cut across asset classes indiscriminately. Like Jesus said about the poor, unstable oil prices and variable investment results will always be with us. Yet, Scott hopes this new way of looking at risk might moderate the ups, and particularly the downs that roil the oil and stock markets. 

This new way of looking at risk may seem isolated and distinct from the external CIO program, but Scott says that overhauling the fund's approach to risk—or any major project like it—wouldn't work nearly as well without the input and education the external CIOs offer. A new idea is only as good as its implementation and, to put his plans into place, Scott needs to educate not only his board of trustees, but also the state legislature and public.  

“Usually, change is seen as risky,” says Prince. “The irony is that [Jeff's] going to a less risky, more diversified portfolio, but we have to get across the message that the portfolio we have now is risky, the change isn't risky. That's the challenge in communication.” The ability to communicate with the board of trustees, says Scott, has been the key to getting everyone at the Permanent Fund thinking more deeply about risk. “It's amazing the communication we're getting now because of the education [from the external CIOs],” Scott says. “The board members are able to look at things and ask good questions and really understand.”  

From attacks on the orthodoxies of portfolio theory and asset-allocation strategies, to tail-risk hedges, to the scrapping of old risk metrics and the development of new ones, risk management has been the topic in post-crisis institutional investment. However, Jeff Scott and the APF are changing more than just their tactics for dealing with risk. They are fundamentally changing the way they think about it and, perhaps more importantly, the external CIO program has helped create a space for the fund's board to study, understand, and help implement these changes, instead of just entrusting their new CIO to create some risk-management black box that's beyond their comprehension. It's a dual-reform well worth studying for anyone looking to change their approach to risk, or get more from their money managers in return for those hefty fees. It’s also an idea whose seeds were planted well before Jeff Scott ever got to Juneau.