“Within the hedge fund allocator community, Josh has grown to be a leader in his field. Working with him on a daily basis, his dedication, investment expertise and ‘can-do’ attitude bring a positive impact to the RTX Pension Investments organization. We’re proud to have him as a valued member of our team.”
—Robin Diamonte, CIO, Raytheon Technologies
The CIO Editorial Team shared a dozen questions with all our NextGen nominees and asked them each to pick six to answer. Their answers informed our decision to include them as a NextGen. Below are the answers from Joshua Adler.
CIO: How are you dealing with rising interest rates and economic uncertainty?
Adler: For the overall portfolio, the current rising interest rate environment has caused us to move higher up in credit quality and capital structure, as the portfolios are higher yielding. This has pushed the overall portfolio down the risk curve while still meeting our target return.
We are aware that rising interest rates may create increased volatility in markets, which is why, within the hedge fund portfolio, we are more focused on managers who can capitalize on dispersion and potential dislocations in asset prices. We target hedge fund managers who have the sophistication, proven process, infrastructure and skill set to identify and monetize undervalued and overvalued assets, which in turn create more alpha.
Finally, and maybe most importantly, we are being patient. Since the Fed Funds Rate is yielding 5 to 6%, we are getting paid to wait. The hurdle to invest has increased; therefore we will only invest if we have a strong conviction in the strategy, manager and opportunity set. In the meantime, we are improving the liquidity profile of the portfolios and have been scanning areas of opportunity for when prices look more attractive.
CIO: What is the best way to bring more diversity to the financial industry?
Adler: Diversity is at the forefront of our minds and a pillar of our due diligence process. Although as ERISA fiduciaries, we do not invest in managers solely based on diversity, we view diversity as a key element to having a sound investment process.
Allocators must believe that diversity within their managers and their own organizations will help build a better process and remove crowded trades and other biases. We need to encourage current and prospective managers to improve the diversity within their firms.
At Raytheon, we are committed to fostering a DE&I culture by partnering with such organizations as [the Robert] Toigo [Foundation], where an MBA intern joins our team to learn about our corporate pension program to include investment strategies while applying skills they have acquired at their respective university. Also, we invest in diverse private equity managers through a partnership we have with GCM Grosvenor. Finally, we monitor the diversity within the firms we invest with through questionnaires in which we ask for data regarding demographics of ownership, decisionmakers and talent. DE&I is one of our core values, and our manager questionnaires ensure that the organizations we engage with align with our values.
CIO: What asset classes offer the best options for avoiding or mitigating drawdown risk in an institutional portfolio?
Adler: Market-neutral active management strategies such as hedge funds offer the best options for avoiding or mitigating drawdown risk in institutional portfolios. It’s crucial that these managers are truly market neutral and have a low correlation to other investments in the institutional portfolio. If these managers are not market neutral, then there could be a scenario similar to 2022, in which expensive equity long/short hedge fund managers provided little diversification during a time when equity and fixed-income markets declined by 20%. There are three major downsides to this asset class:
1) These managers have higher fees;
2) Potential lower liquidity; and
3) Deployment of higher levels of leverage than other passive strategies.
However, when done well, this asset class can produce 5 to 10% above T-bills consistently, regardless of market performance.
When building a market-neutral hedge fund portfolio, the institutional investor should add satellite positions to strategies that tend to have a long volatility profile. Whether these are tail risk funds or other macro strategies, these positions will help further reduce potential drawdowns during times of market dislocations. The combination of uncorrelated returns and managers with a longer volatility profile will create a portfolio of consistent returns with lower drawdowns.
CIO: What roles do AI and large language models have in the future of institutional investing?
Adler: AI and large language models will have a profound impact on the way institutional investing is done. Today, AI is a convenient tool. However it will change the way we invest going forward from how data is synthesized and analyzed to creating efficiencies within the due diligence process and developing a sound investment thesis. It will take time before we trust AI with decisions regarding strategy and market insight. However, skillsets that are more objective, such as programming and low- to mid-level analysis, which is typically done at the analyst level, can be done through AI. AI will not eliminate the analyst role but change how analysts operate and think. Analysts will need to become proficient in AI querying while improving their strategic investment decisionmaking. It’s critical that institutional investors educate themselves on AI and how to manage AI, because if they don’t, then their competitors who are already ahead of the AI curve will be frontrunners with innovation and allocation with urgency and precision.
CIO: What asset class or investment troubles you most right now, and why?
Adler: The most concerning element of the market is the amount of low fixed-rate debt that will be maturing for the remainder of this year ($107 billion), 2024 ($248 billion) and 2025 ($389 billion) while the Fed will be reducing its balance sheet from $8.4 trillion to $5 trillion by 2025 through quantitative tightening. If rates are kept at current levels, then the market could have a wave of defaults and zombie companies. These companies have been propped up by cheap financing and the colossal amount of capital that poured into private markets. Today, cost of financing is higher, capital raising is difficult and capital owners are prioritizing liquidity, which could be a recipe for disaster. What is countering this gloomy scenario is that demand remains strong, unemployment is low and the consumer is in good shape. There has been a slowdown in growth, and the Fed still walks a fine line between hard and soft landing. If unemployment increases and demand slows, then companies will have difficulty servicing the higher interest rate debt. There are very few working individuals who have seen a rising rate environment, and we may not fully appreciate all the repercussions.
CIO: What new skills do you think allocators need to be leaders in the field in the coming decade?
Adler: We are currently entering a pivotal moment in the financial markets where interest rates are rising, technology such as AI is moving at a rapid pace and the United States’ top position is being challenged by China, drastically changing the world order that has been in place for the last 100 years. The combination of these major changes to the market and global economies will require more strategic thinking, due diligence and risk management.
Allocators will have to understand how to leverage new technologies to continually recalibrate their investment strategies at a faster pace, while improving processes and risk management practices. The new norm will require institutional investors to navigate global markets with heightened levels of uncertainty, supported by high-performance, agile teams who can innovate and solve problems at a faster pace than the competition. Data will be crucial, and large language models will be the conduit for strategic decisionmaking. Leaders and their teams will have to be proficient in managing large and unique data, as well as new methods in analyzing the data.
