CIO Roundtable (Part 1): How Top Asset Allocators are Dealing with Today’s Volatile Market

Ash Williams, CIO of the Florida State Board of Administration: I would just say there are going to be a million people coming to you with all kinds of ideas. People will always try to capitalize on a situation, perhaps thinking, “Never let a good crisis go to waste.”  The following thought may be, “Hey, I know, we could go raise money around ‘X.’”

You’ll get a lot of those calls and that doesn’t necessarily mean that the idea of capitalizing on “X” is a bad idea, but it does mean that you need to think about the best way to capitalize on “X.” Is it in liquid markets? Is it a private structure? Is it callable capital? What’s it really worth? Is it worth a high fee or a low fee? Should it have a hurdle?

And, by the way, who’s really good at this? The fact that there are a bunch of people calling you up saying, “We’re forming a fund to do ‘X’” doesn’t mean a thing other than they want your money.

You could get calls from 20 firms and maybe two of them actually are deeply qualified for the opportunity and have done it before. The other 18 may have some people who have kind of done it. They just lifted out a team from some institution that has hit hard times, and these guys needed to find other jobs so they landed somewhere else, and the way they talked themselves into the new job was to tell the new employer, “Hey we could go raise a fund around so and so. Isn’t that a great idea, and you’d make a lot of money, and you need us to do it.”

That’s how these things happen. So, you have to understand all these moving parts and really know what you’re doing before you pull the trigger.

Bill Coaker, CIO of the San Francisco Employees’ Retirement System: Remain fact-based, data-driven, analytically insightful, consider your plan’s unique characteristics—meaning their cash outflows, their constituency management—be disciplined, and consider your long-term objectives.

Williams: All of the points you just listed are excellent. The contextual point that binds them all together is the need to really understand your governance structure and its risk tolerances. Otherwise, even if you are fact-based, analytical, policy-driven, etc., doing smart, prudent work, the story may not be over.

If you report up to a board or some other collegial body that doesn’t understand the facts, isn’t long-term oriented because they’re focused on some time horizon that has nothing to do with a 15- or 30-year investment horizon (maybe an election), or just plain scared, they may not accept your recommendations or stay behind you if things get tough. One of the things about investing dislocated markets is that nobody really knows when you will get to the other side. Inflection points aren’t marked. You’re probably going to be in rough water for a while, and if somebody can’t take the sea conditions during that voyage, they could become mutinous; that’s not helpful.

It’s hard to maintain control when you’ve got people who say, “Never mind that I said I was with you on this. I don’t like the way this is going. Get out.” In many situations, “getting out” is an option available only at a steep loss, if available at all. So, understand your governance and make sure that the risk tolerances and the alignment between your long-term objectives, near-term investment policy execution, your team, and those you report to is really durable.

Coaker: That’s exactly what I meant by constituency management: What’s your governance and, really, what is its constitution for volatility, liquidity with respect to your overseers. Governance is exactly it.

We are long-term investors in the sense that we’re a pension plan that’s designed to live in perpetuity, but the short-term is also really vital to Ash’s point that if we don’t get a strategy or an approach to investing doesn’t survive in the short term, you’re not going to achieve your long-term objectives. So we need to take into account constituency management, brand volatility, and just really what our overseers and, for that matter, if we did experience a really large draw down, what the constitution of politicians that we ultimately report to, that ultimately are also funders of our plan benefits, and what the constitution and the criticism of the press would be.

Scott Chan, deputy CIO of the California State Teachers’ Retirement System: I would just say that it’s a time—even at CalSTRS, where I think we have great board governance—it’s the time to over-communicate, and our CIO Chris Ailman has done a fantastic job of communicating with them in this time.

Number two: stay calm, remain disciplined next to your strategy. For us, that would be maintaining our diversification and rebalancing to it. Again, we’re executing what we call the CalSTRS collaborative model, so in up markets and down markets, we’re trying to take more of our assets internal and thereby save costs and control the risk a bit more.

The third is that cash is king. During these times, we have to constantly ask ourselves, can we pay our obligations? The markets become illiquid so you don’t want to be selling now, but hopefully you’ve got enough cash to rebalance into equities and to essentially look at the private market opportunities that are going to be coming up.

Meanwhile, we’re all adjusting to being remote. When we started this remote access, it was funny at first, the people on mute, or the people trying to get onto the Zoom call, but it’s increasingly frustrating because every call you have, every Zoom meeting, every WebEx, there’s going to be some quirks. We all have to adjust and make sure that we can operate as a team and be compassionate during that time because I think there’s a lot of adjustment going on.

Jonathan Grabel, CIO of the Los Angeles County Employees’ Retirement Association: I wrote down several points and there is a lot of overlap.

The first one I wrote down is that in a situation like this, you need people to rely upon. You can’t get through a situation like this by yourself, you have to surround yourself with talented people and realize that the group is stronger than the individual. The primary focus of my job is putting in place a great team that’s dynamic.

The second is something that all three gentlemen raised: At moments like this, it is critical to have investment beliefs and stick to them. We’re all emotional beings and clear investment beliefs help counter emotional forces during a crisis. Do you want to minimize the risk of missing out or the risk of losing capital? Grounded and practiced principles provide the type of clarity necessary to position between these two poles. Revisit your performance and processes after the fact but stick to your investment beliefs.

The third Scott and Bill discussed: communicate, over-communicate, communicate once again. At a staff level, we have frequent video meetings. We communicate with our board leadership and the board as a whole in multiple formats. Communication is critical.

Grabel: I have a couple of thoughts. One is the speed at which the market draw-down has occurred and the autocorrelation across asset categories. There is also a human element that makes it that much more powerful and requires us to be more thoughtful as we approach our respective portfolios.

Going back a couple of years, LACERA put in place a new strategic asset allocation. In it, we reduced public equity exposure from close to 50% to 35%. We consolidated our asset categories to four—growth, credit, real assets and inflation hedges, and risk mitigating strategies—to hopefully perform better across multiple investment environments.

Chan: On the portfolio impact, you have to roll back a little bit first and say, “Well, how was your portfolio positioned before this crisis started to unfold?” You can’t predict the trigger of the next recession or the next crisis, the issues that are going to cause a bear market or a correction in the market, just as well as you can’t predict the bottom of that correction either.

From our perspective going into the crisis, we’re positioned a bit short on equities. We had developed an asset class category called Risk Mitigating Strategies, which is designed to do well during a correction like this, it holds long-duration bonds, CTAs, and global macro as an example. It’s been performing well, not surprisingly. And we obviously have fixed income as well, so we want to be diversified and we were diversified going in.

We’ve performed over 25 years at around 8.2%, well above our 7% hurdle. And over the long-term, we know that it’s the tried and true strategy, and we’re going to stick to that discipline even as the markets are where they are today.

What’s been unique in this environment is the extreme volatility because markets have been less liquid. This is likely as a result of some of the changes during the global financial crisis, there’s less balance sheet from the brokers/dealers, but I think another unique aspect is that we’re all trading remotely.

Coaker: We were as well-positioned as one could possibly reasonably be given the magnitude of what’s occurred. We were underweight public equity, target weight of 31%.  We never know what the trigger, the timing, the duration, or the depth of a bear market or a systemic shock might be, but we were well-positioned for that.

I’d say the most unique characteristic of this current crisis is the extreme plunge in economic activities that has taken place in such a short period of time. Goldman Sachs estimates that 2Q20 GDP will be a contraction of 24%. That’s the magnitude of 2.5x larger than any single quarterly contraction in history.

Some of the key variables to watch going forward are really how long does that plunge in economic activity take place, how deep it is, and whether or not we experience multiple waves of it over the next one to two years? 

Coaker: We expect to have on the margin a lot fewer distributions from private markets than we expect to. We think that that’s going to dry up quite a bit. History says that capital calls do not rise substantially in market weakness. That could be because LPs may be asking GPs not to call capital, but for whatever reason, extreme weakness doesn’t lead to a surge in capital calls.

Nevertheless, we have to be prepared that we are going to have a larger net cash outflow to fund uncalled commitments than our base case planned for. We went into this with multiple scenarios for uncalled net capital calls. We have a base case, we have a bad case, and we have a worst case. We had planned for that and where the source of that liquidity would come to provide for capital calls that are far below base case for three years, and we’re refreshing those plans right now and making certain that we have sources of capital lined up to provide for capital calls in a multi-year worst-case scenario. 

Grabel: One thing to add to what Bill is saying as it relates to capital calls is that this time may be a little different than when the tech bubble burst, 9/11, or the global financial crisis in that private equity firms have credit lines that they’ve been using much more regularly than during those prior periods.

They will likely call down on those credit lines now or they’ll make bigger capital calls to replenish those lines such that they have future availability. This makes for a different dynamic this time.

Over the last decade, most of our capital calls have been for what I’ll call positive capital calls. These capital calls have been used for growth purposes to help companies grow, make acquisitions, or invest in R&D, for example. If this crisis persists, some future capital calls could be defensive in nature. GPs may need the capital to help their portfolio companies survive and position themselves for the storm.

Chan: I think we started off positioning our portfolio, on the margin, defensively before the crisis:  short equities to our target allocation, developing an asset class like Risk Mitigating Strategies, shifting each of the asset classes in the way they manage their sub-asset classes and the opportunities that they’re thinking about, more toward defense, preparing for the end of a cycle, and taking more control of our assets internally.

Now we’re in that part of the cycle where we’re deciding when we should be taking some profits on the risk-mitigating strategies book and the fixed income book and starting to shift it to an overweight in global equities.

If you think about private equity, we might be doing a lot more co-investments and secondaries, if there are large discounts, because that will be a way for us to get in front and be able to invest at discounted NAVs the quickest. And we’ll be looking at things like distressed assets and be repositioning our asset classes from a late cycle, bear market look to one that might be the beginning of a newer cycle.