The Exchanges

Q So you have this big hole to climb out of. You've got these four forces you think of driving returns. How did you think about how to tackle this problem using the forces that you had in mind?

A I'd love to give you an elegant top-down story, but I'm going to give you a bottom-up story instead. I think probably with a public equity oriented portfolio, if markets are accommodating, I think maybe we can get eight. If markets aren't accommodating, we needed hedging. So I need two points of alpha. I guess alpha is all hope to some degree, but we need a real, real chance of two points of alpha per year. And that's not an easy thing to do. I mean, it's a pretty high target. What does the solution look like? I need two points of alpha. How am I going to get two points of alpha? Well, I'm going to go 30% privates. So I figure if we can go 30% privates, we can outperform Publix by four points on that. That's a 120 basis points at the overall plan level. That's part of it. In my mind, we saw this huge spending rate. If Delta does poorly, we've got a real challenge because of our spending rate. So that's about as illiquid as I thought we could be. Then portable alpha, second force. Let's go 40% market neutral hedge funds. If my 40% market neutral hedge funds can outperform my borrowing cost by three percent, that's another 120 basis points. So if I can get a 120 basis points out of the privates, if I can get a 120 basis points out of the hedge funds, that's going to give me 240 basis points. So that's 30% privates. That's 40% hedge funds. We got 10% cash. The other 20% of our cap…

AI assessment note: “if I can get a 120 basis points out of the privates”

Q How about turning to the private markets at 30%? How did you think about how you wanted to invest in that space?

A The private portfolio was very mature in 1999. By the time you get to 2014, it had become immature. And this is all professional credibility because I'm telling people leverage, derivatives, alpha, nine percent, 10%. We can do this. This is going to work. The last thing I want to do is show a bunch of negative time-weighted returns is we're firing up this private market portfolio. So private portfolio, It took a while to build into this. 15% private equity, nine percent private credit, six percent private real assets. Within that, for the private equity and the private real assets, 50% primaries, 30% secondaries, 20% co-invest. I want to put some wins on the board. I do not want J-curve. J-curve could derail my entire story, That was the blueprint for the private portfolios. And it's actually still where we are today. So it's been a decade and that structure served us well, but it's probably time to rethink some of those allocations.

AI assessment note: “15% private equity, nine percent private credit, six percent private real assets.”

Q How'd you think about some of the common levers of risk?

A It's all related to how much cash are you going to put behind the notional value of your portfolio? What is your derivative overlay look like? What is your net cash position look like? How much of a liquidity waterfall do you have? At some point you start cutting muscle as you go through that. That's really it. I mean, you've got investment risk and the liquidity risk and the liquidity risk really is what's your hedge portfolio look like and where are you going to go for cash if you can't get it from Delta and you've exhausted everything else. You've got to start looking at your risk parity portfolio, at your inflation hedging portfolio, at your emerging manager portfolio. You've got to start to look at where you're going to draw some of this.

AI assessment note: “you've got investment risk and the liquidity risk and the liquidity risk really is”

Q the market sells off, and as you said, you then tap that liquidity, you have to think about how do you reset it at some point in time? So you get through COVID, your portfolio looks totally different than it did three months ago. How did you think about recalibrating the program to where you started with this balance between the privates and the liquidity bucket and the hedge funds?

A The idea was from the outset, the 30% privates never changes. The 40% hedge funds never change. The only thing that changes is the nature of the derivative overlay and what we do with that other 20%. So we just reran all of the same calculations, and it's like, you know what, we don't need to reserve as much cash anymore. We don't really need equity hedges anymore. Our hedge ratio, 60%, 70%, something like that, so some exposure to a collapse in rates is still A good exposure for us. So we've been able to change some of what's in that other 20%. But that's it. It was designed that way from the outset. The derivative, the beta overlay, let that change. Let the hedge portfolio change. We don't do managed futures anymore. We don't do separate account macro, low cost, highly liquid stuff. We don't do that anymore. We just don't need to. We think we can get to a better overall risk adjusted return, liquidity adjusted return from there.

AI assessment note: “The only thing that changes is the nature of the derivative overlay”

Q How do you reflect back on the original four forces and the investment process that you saw as the potential driver of this?

A It's very much still the way I view the world. I mean, it's why we're still 30% privates. It's why we're still 40% hedge funds. It's why we're still a 140% is what our asset allocation adds up to. It doesn't matter what the problem is. Our problem now is we want to continue to grow our gap funded status to one oh five to one 10. To give Delta maximum flexibility. If they want to engage in pension risk transfer, they can do it without any additional cash. If they want to look at ways to use the excess funding in a way that's mutually beneficial to the company and to the company's employees, they'll be in a position to do that as well. There's all kinds of funky nonlinearities of pension management, and one that we're facing now is we're looking at mandatory contributions. I'll skip as to why it is, But yeah, we don't want gap funded status to go down. We want to grow it gradually, and we want to minimize what those mandatory contributions are. If you can start from a place of two points of alpha, everything else is so much easier. And if you can run a more balanced portfolio, if you can run a higher, sharp portfolio, it just makes it easier. It almost doesn't matter what the problem is. You start with your alpha, those first two forces, Private force. Your portable alpha force. You combine a more efficient asset allocation by going out on the capital market line a little bit. It…

AI assessment note: “It's very much still the way I view the world.”

Q Why don't you take me back to your path that ultimately led to this Cedar Delta?

A I grew up in a place called Newport News, Virginia. I grew up in a Navy family. My dad was a submariner. My mom really ran the house. My parents are the first heroes in this story. They didn't make a ton of money, but they always saved. I can recall that for a couple of birthdays, I would get stock certificates for utilities. He was a nuclear submariner. So Detroit, Edison, Central Illinois, public service. The stock certificates, they looked awesome. The dividends were nice, but didn't really pay that much attention to it at the time. That's where things started when it was time for me to go to college. I was pretty good at math. I was pretty good at science. I ended up taking a Navy ROTC scholarship to go to school and to help out around the house as well. So I was a mechanical engineer at Georgia Tech. Thermal systems really thought that I wanted to do alternative sources of energy. Now, of course, I knew exactly what I was going to do when I left Georgia Tech. I was going to be a naval officer. So I took a lot of very challenging mechanical engineering classes. They make you take one business class to graduate. The thrust of the business class that I took was time value of money. I'd never really thought about compounding at all, and the math is really simple, but it really opened my eyes. That was my senior year of college, and then, of course, I go straight in the Navy. I…

AI assessment note: “I grew up in a place called Newport News, Virginia. I grew up in”

Q How did you decide how to populate that hedge fund portfolio to drive at three percent alpha you're shooting for?

A This is portable alpha. We need to be super tight on our beta. I've been doing portable alpha with Matt since 2002, 2003. I've seen a bunch of stuff that can happen. And I understand you can calculate all of these parameters and all of these metrics, but it's not a hundred percent when you're talking about forward looking projections, but we wanted to be really tight on the portfolio. If we think about what that hedge fund portfolio looks like, we really kind of wanted to target a beta of around 0.1. So pot shops are well represented in our portfolio, and they have been since the early days. They make me a little bit nervous in terms of derivatives, but I think in terms of the risk management processes that they've got, their ability to attract talent, it's been a great investment for us. Relative value and fixed income relative value are points of particular focus for us. We've got a pretty substantial allocation of the multi-strats. We do have equity long short specialists. I know that's a bit of a dying industry. But I do think it's possible to develop deep expertise in pretty narrow parts of the market. I know that's what the pod shops suck up, but there's still some folks out there fighting it on their own. And then we've got quite a few macro traders in there as well. In the early days, we were like, no credit. No credit. Credit's got too much skew. It's got too much kurt…

AI assessment note: “we really kind of wanted to target a beta of around 0.1.”

Q When other folks come to you and look at what's happened and ask you for advice, what are the key things that you tell someone else that's in a similar position to where you were a decade ago?

A You need to have a governance that embraces this from the outset. Delta was willing to look a little bit different on the investment side because their investment needs were different. And Paul understood that. And Paul got promoted to CFO. He was the executive champion. And I met with Ed, of course, on a monthly basis. And Ed's had my back this whole time as well. My 13 years at Delta, Ed's always been there to have my back. And then just meet with your committee members one-on-one. Make sure they understand. You've got to be able to tell the story concisely and simply. You've got to be able to tell the story, and you've got to be able to give control to your governance. If the governance is not going to accept what you're trying to do, you can't do it. The governance has to buy into what the vision is.

AI assessment note: “You need to have a governance that embraces this from the outset.”

Q What's one fact that most people don't know about you?

A I used to be good at some stuff. I used to be a pretty good runner when I was a kid. I used to be a pretty good swimmer when I was a kid. I found that I've kind of slowed down and running just hurts. I'm 52. I know there's plenty of 52 year olds that are running ultra marathons and marathons. It just hurts. My knees are a mess. I still mess around with swimming. There's something soothing about just having your head in the water and either looking at the bottom of a pool, cause I'm not thinking about portable alpha. I'm not thinking about liquidity management. I'm thinking about efficiency of my strokes and trying to find pain and then trying to deal with pain and work through pain.

AI assessment note: “I used to be a pretty good runner when I was a kid.”

Q trading, compliance, and more. In the AI era, asset and wealth management firms moving to Ridgeline gain a decided advantage. That's why customers call it miraculous, game-changing, and an awakening. If that's not how you would describe your investment management tech, request a demo at ridgeline.ai And now, back to the show. There's a lot of Relatively complex strategies going on in that bucket. How did you go about implementing?

A My team's amazing. There's only six of us. I've got my deputy CIO, Amanda Kogar, my chief operating officer, Dmitry Vronkov, and my director of investments, Nick Aliff. The four of us have been together on this journey for over the past 10 years. We've been joined a little bit more recently by Mark Fong Wu and by Madison Woolley. We knew that we needed help from the outset. We're very engaged with hedge funds. We're very engaged with privates, but we've got consultants in both of those places because my team is not going to be able to monitor the entire universe, either on the hedge fund side or the private side. So we need help there. Two more names that were pretty instrumental as we went through this process is Jeff Scott and Omer Tureen. So Jeff spent some time at Dow and he was the CIO out at Alaska Permanent once upon a time. He worked in Microsoft's treasury department as well. Omer worked with Jeff in Microsoft's treasury department, and they got it. There's not a lot of people that are like, I understand. And even that first concept, I want to walk on the capital market line, not on the efficient frontier. We need to figure out a way to make that happen. You can try to help me do that, or you can be a believer and you can say, John, you're wrong on this, or you're wrong on that, or do you think about this? So we've always had quite a few consultants. I need other peopl…

AI assessment note: “trying to align external resources to help augment what we do on the inside.”

Q As you look back on this path, what do you think were the key drivers of your success in taking this from thirties to a 102% funded?

A Is Delta. We had a plan. I'd worked with a man at Wilmington trust as well. So we've been building this plan together. We talked a lot about what that plan should look like and how can we make it better? And we held it up to Paul Jacobson, Ken Moore, Ed Bastian, board of directors, Jeff Scott, Omer Terrain's phenomenal. Delta making eleven billion dollars of contributions into the plan from 2012 to 20 21. Now, we paid out thirteen billion in benefit payments during that same time frame, but they offset a majority of the cash outflows of the plan, which allowed the assets to really grow. Without hard working Delta employees in that disciplined capital allocation, We didn't have dividends in those days. We didn't do a lot of buybacks in those days until we got that investment grade credit rating back. Without Delta's steadfast support in this, it wouldn't have happened. And then I think without really trying to hold this plan up to scrutiny, another thing throughout my whole career. Cliff Asness, what do you think about this? I don't know Ray quite as well, but I know a lot of people at Bridgewater. What do you think about this? I've been influenced by you in making this plan. What do you think about this? Where are the weaknesses? It's an awesome thing about being a CIO. We get to talk to so many brilliant people. It's a tremendous honor and a responsibility to do what we do. I …

AI assessment note: “Delta making eleven billion dollars of contributions into the plan from 2012 to 20 21.”

Q Let's dive through each of those component pieces. Maybe start with the 10% cash. How do you think about cash in light of these needs for such high return objectives?

A Truthfully, the cash was a little bit higher back in those days, and the alpha projection was a little bit lower back in those days. The way we thought about it is, what does our beta overlay look like? Let's look at that beta overlay in isolation. We've got a pretty substantial hedge fund portfolio. We really paid a lot of attention to our 90 day VAR. So what is a two standard deviation 90 day VAR look like? What is a three standard deviation 90 day VAR look like? What's two standard deviation look like if all correlations go to one? I want to see three months of benefit payments. Benefit payments are not immaterial. So we pay out over a hundred million dollars a month. That's a high, high, high spending rate. You're thinking about that 90 day point because most of my hedge funds are something like quarterly 90. So if I can withstand 90 days, hopefully we'll have a couple of outs. We're going to have Delta. That's a possible out. Of course, I said we're equity centric. And something's bad for equities. It's probably bad for Delta two. And we know that going in, we've got the hedging portfolio. That's a possibility. And then we've got our hedge funds. That's another place that we can draw capital from. And so we figured that how much cash do you want to put behind your notional program? And we created our own language around all of this. And Amanda Kogar, particularly on my tea…

AI assessment note: “The way we thought about it is, what does our beta overlay look like?”

Q How about on the implementation of the strategies?

A I've known that Delta was going to be headcount constrained on this process. Again, we froze in oh six. These are legacy assets. If you want to do this, if you want to have 70 or 75% of your assets and alternatives, you need a large team of well-paid specialists. And it was clear that that just wasn't going to be able to happen. In a different place, that would have been my preference. That is a more aligned, less expensive way to do things. Couldn't do it there. So you really do need to have the right partners, and we've seen good partners, and we've seen partners that didn't quite fit. So I mean, people will say extension of staff a lot, but I mean it. I want to be able to talk to anyone. Amanda can talk to anyone. Dimitri can talk to anyone. Nick can talk to anyone. Why this manager? What's your process? We like them. Do you like them? You need to have the right partner, and that's a tough model. That's not a great scale model. It's not a great margin model because I am going to be needy in terms of resources and I'm going to be sensitive in terms of cost. And sometimes we've seen models like that, that work on our hedge fund side, everything continues to work great. It's harder to do on the private side. We've looked at is discretionary. The right model is quasi discretionary. The right model is some of the specialty consultants. Should they play a role? You've got to find …

AI assessment note: “Delta was going to be headcount constrained... you really do need to have the right partners”

Q Somewhere along the way, you've hit bumps in the roads. You could think of, 2011 was a tricky year for some of the hedge fund strategies, certainly in the early time period during COVID, March, 20 20. What happened in those interim periods when things probably weren't working along the smooth trajectory of generating returns?

A Yeah, so I joined in October of 11, so I missed the worst of the Euro crisis that was going on back then. 2015 was not a great year, so in terms of total return and alpha generation, and Paul was there, and Delta was there. All the hard work of the Delta employees and the thoughtful corporate capital allocation process, Delta did make it whole. And then 2018 was difficult, the fourth quarter was difficult, And we still had a little bit of smart beta, which did not work. It was great. It was phenomenal for a long time. And then it wasn't, but it wasn't really a challenge. All of the risk management systems that we had in place worked fine. So it never really got that uncomfortable. 20 20 is a different story.

AI assessment note: “2015 was not a great year... And then 2018 was difficult”

Q So this last, there's hedging risk parity, there's inflation, there's emerging managers. How did you think about what the goal is for that group together?

A I'll start with the hedging at the beginning because that is vital to the story. And this is surreal because I'm sitting there in 2013, sitting with Paul Jacobson and Ed Bastian in the conference room outside of Ed's office. So again, Ed is still the president at the time. And we are building hedging programs together. That gives you an idea of the extent of enterprise risk that continued to come from the pension funds in those days. So we had four or five components to our hedging program. We did some programmatic high-certainty stuff. So we did ninety-seventy-five put spreads. Dependent on what SKU was a little bit, we would tweak some of that. We would tweak the attachment points a little bit. We had, call it a LIBOR floor kind of strategy, where we were long-call options on the two-year part of the LIBOR curve. It was a make-money strategy, like in an upward-sloping yield curve, you can actually make money on that. But then if rates really collapse, you can make three times, four times, five times your money. Less certainty there. But a lot of convexity that you got for getting it, and maybe not quite as much bleed as you would see in a ninety-seventy-five put spread. Third component was long vol. Now, yes, this is wishing for a little bit of magic here. Can we work with volatility-oriented managers to say, we don't want this part to bleed that much. I don't want to lose mo…

AI assessment note: “I'll start with the hedging at the beginning because that is vital to the story.”

Q So within those strategy categories that fit your risk parameters and that goal for diversification to prevent the unknown unknowns, how do you go about deciding who, in your words, is the best of the best?

A This is something I've got better at through time is really drilling in on the people side. We're looking for a profile beta .1 or lower. There's some great 40 beta managers out there. If you're paying 20% incentive on 40 beta, you got to be damn good at manager selection. Some people can do it. I can't. That eliminates a lot of the universe. And we've known a lot of the universe for decades. So a lot of the long established players, and then a lot of the spin outs. Of the long established players. And then you're just looking for interesting stories as well. Who's out there that might be doing something a little bit different. Maybe something that you really haven't heard before. I still have a convert our manager. That's been phenomenal. I don't know how they've been so phenomenal for so long, but we still have some.

AI assessment note: “This is something I've got better at through time is really drilling in on the people side.”