Kim Walker Thinks It's Time to Get Real | Chief Investment Officer

From aiCIO Magazine's Winter 2011 Issue: Washington University’s $5 billion endowment chief investment officer Walker spoke with aiCIO about 2008, investment risk, and real assets.

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“At our endowment—at most endowments—what we’re trying to do is this: Generate a real return of at least 5% to maintain or increase the purchasing power of the endowment. Today’s challenge is to do this in an environment of very low interest rates that sets a floor from which all risk assets are valued. In a simple framework where the value of the endowment equals the starting value plus investment gains and contributions, less spending, if we can’t earn our required return, we either need to rely on increased gifts or decreased spending. If all of the focus is on return, then we are forced to look at assuming additional risk. With the financial crisis still top of mind, however, we need to realistically assess our risk profile and ask the question ‘Can we endure another 2008?’ Another outcome of 2008 is that we, and others, are getting away from traditional asset allocation models. We now focus more on risk factors. You’re seeing a lot of that across the industry—and not just with endowments and foundations. It’s part of a larger move to look inwards. Endowments in general think about risk more than they use to. We understand risk better, and we look at the entire enterprise’s risk more. You can’t just look at the portfolio—you have to look at how that portfolio will do when the university needs capital. We look at correlations between risks, so in a downturn, the university will likely need to give out more financial aid, while at the same time contributions to the endowment will fall. With those factors in mind, we need to balance our long-term time horizon with shorter-term liquidity. All the same, investors should be rewarded for taking on risk over the long term, or else the capital markets would not function. The endowment model is supposed to be one in which we are the early investors in an asset class. For us, right now, that has manifested itself in an increasing emphasis on real assets. It’s not new—but it is an area garnering increased attention and allocations. There’s no consensus around the definition, of course. We’re asking ourselves, “What do real assets actually mean? What’s the purpose? Is it an inflation hedge, a return source, or a diversifier?” We have a lot of equity-related beta, so we’re looking to diversify that. With real assets, we start by dividing them into liquid and non-liquid categories. We then look at sector—natural resources are something we really like. Energy investments, metals, and mining—this is where we want to be. We’re new to some of these, so we’re putting a lot of effort into learning about them. In terms of other diversifiers, we’re gradually moving more of our equities offshore. Our emerging market allocation (10%) almost matches our US equity allocation (12.5%) and our developed non-US allocation (11.5%). The private equity allocation is still dominated by US-based investments—but that’s not a statement about opposition to overseas private equity. There is just a higher hurdle there. And while we take a long-term view, we also seek to position the endowment opportunistically. The elephant in the financial market room, so to speak, is the recent volatility related to geopolitical turmoil and related market dislocations. As a result, we are looking at opportunities created by the European banking crisis and the provision of credit more broadly.”

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From aiCIO Magazine's Winter 2011 Issue: Kunz, head of the Chicago Policeman's Annuity and Benefit Plan, spoke with aiCIO about international pension differences, mushroom hunting, and overconfidence.

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

“I’m originally from Geneva, and started at the roughly $3 billion Policemen’s Annuity and Benefit Plan in Chicago in 2008. The investment process at the scheme is different from the structures I was accustomed to. In Switzerland, we would have an idea in the morning and would act on it in the afternoon, so we made more errors but didn’t miss as many opportunities. In the US, we make fewer mistakes, but we don’t take as much advantage of shorter-term trends. When I talk about asset allocation with trustees, there’s a tension between the optimal allocation—what we should be doing—and the appropriate allocation—what we can do. For example, we feel there are opportunities in opportunistic real estate and private equity, but we’re forced to the status quo because of our funding ratio. Alternative investments have been a great area of interest as well. But you first need to ask yourself: ‘Is the market trending or ranging?’ The direction of the trend is not as important as defining whether you’re in a range expansion or contraction. In a directional market, the best one can do is buy and hold or sell and hold—you don’t need to buy a product that charges 2 and 20, you can just hold the S&P passively and ride the wave. But when the market is ranging, alternatives become much more attractive, as they’re more nimble and thus better equipped at catching tops and bottoms. I don’t like to make predictions—it’s not my area of expertise. I try to stay very humble in this area, because I believe that overconfidence is a bias that plagues the industry. People should note their level of confidence each time they make a prediction. It’s rare to find people that use this approach in finance. Maybe that’s because making predictions is more glamorous. Active management: In Switzerland, mushroom hunting is very popular. In the fall, there is a high probability there will be mushrooms when the sun is shining just after rain. But perfect conditions don’t guarantee you will be successful in finding any. The same holds true for active management. One interesting point of view is Andrew Lo’s Adaptive Market Hypothesis, which asserts that alpha is unstable, moving from one segment of the markets to another. At any given point of time, there are inefficiencies somewhere available to someone, but it doesn’t mean that investors are able to capitalize on them. In other words, markets might not be efficient, but the trick is to be able to take advantage of that inefficiency despite its versatility. Therefore, the budget for active management should be spent very wisely because our ability to consistently capture these opportunities is low.On a personal level, working at the fund is an amazing platform to meet and have discussions with very smart people. When I started in the finance industry, access to information was much more of a challenge. Now, the difficulty is determining what’s really important. There is also a lot of leakage and, unfortunately, many good ideas are never implemented. There is a need for variance and a need for closure in every process, and finance is no exception. You need to gather as much information as possible and then isolate what is critical to find the adequate answer to a given problem. I try to be very organized with the news and research I receive because my goal is to combine different viewpoints and extract innovative ideas in order to generate the best possible solutions.”

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