The Exchanges

Q You saw that both at Australia and then later back home, New Zealand super fund. What are some of the subtle differences in two different sovereign wealth funds applying the total portfolio approach?

A You've got to understand the objectives of each of the organizations. One thing that I spent quite a lot of time thinking about when I arrived at New Zealand Super was why Future Fund and New Zealand Super did things quite differently. Future Fund was set up in 2006, started operating in 2007, so it was later than New Zealand Super, which got going around 2003. They had a lot of similarities, sovereign wealth funds, both in Australasia. New Zealand Super had larger risk appetite than Future Fund. The reason being, it had a longer horizon. It was getting small contributions over a long period of time. The distributions from New Zealand super were going to be some way off in the distance. Future fund had a startup with a lot of money to begin with. Sixty billion Australian dollars. The last thing you want to do when you've got a big money to start off with is to lose a chunk of it. You're going to be conservative. They also started at a time when assets were cheap. They had a lot of liquidity and were able to benefit from those high prospective returns because of those cheap assets. That worked pretty well for a while. Future Fund was discretionary, active, a shorter horizon because the expectation was that they would have to make distributions to the budget come twenty-twenty. It turned out not to be the case, and those distributions have been put off further and further. The te…

AI assessment note: “New Zealand Super had larger risk appetite than Future Fund. The reason being, it had a longer horizon.”

Q There's a lot of steps there. In your time at Wall Street, what were some of the different roles that led you to understand how you thought about markets?

A It's an interesting question because you learn something in each role. When I was at Chase before the merger with JP Morgan, I got to, to sit in the dealing room and to combine different products. I got to sit with the swaps traders, the floating, floating traders, the option traders, and I would structure transactions. Seeing things from different perspectives was very helpful. I still think about going through the pricing on a floating, floating swap. That was insightful. Then moving to the FX options desk, it was quite a revelation because when you come from an academic background, you think it's all about the formula. And you don't really understand how people derive or how they trade implied vol. That was another lesson. There are lots of incidents like that. Those are two early ones that stand out.

AI assessment note: “When I was at Chase before the merger with JP Morgan, I got to”

Q So geographically, it fit. How did you end up professionally deciding to make this move?

A I've been at New Zealand Super for five years. It's a great place, and it's nice being home. I got a call from a recruiter. They mentioned the co-oper's role. Frankly, I wasn't that interested. It's a tough gig. But the call prompted me to think about it some more, to do some due diligence. I thought, there's so much potential there. When the recruiter called back, I was more open, and the recruiter immediately got Marcy on the phone. She's very persuasive and very engaging. Not long after that call, at the same day, the recruiter called me and said, we want you to interview with the board subcommittee. Shortly thereafter, I interviewed with the board subcommittee, and great questions, and I really enjoyed the interaction. That's what I wanted to roll.

AI assessment note: “I interviewed with the board subcommittee, and great questions, and I really enjoyed the interaction.”

Q How do you think about how to measure appropriate diversification in a TPA approach?

A Scenario analysis is important. Let's take a simple example. Equities and bonds. Do they diversify? Is a bond exposure going to diversify an equity exposure? Well, it may. It depends on what's happening. Take the example of an inflation shock. If inflation goes up, nominal bonds are going to be hit. Equities are probably going to be hit as well. If you have a growth shock, it's going to be the opposite. Equity is going to benefit. Bonds are probably going to be hit, so bonds are diversifying there. You need to look at what's driving the event. Rather than simply looking at historical correlations, one needs to be thinking about multi-dimensional scenarios and to think about how the portfolio behaves given those scenarios.

AI assessment note: “one needs to be thinking about multi-dimensional scenarios”

Q When you came into CalPERS with this thought from your experience, you'd like to shift the portfolio to total portfolio approach. What did you find in the portfolio in the process of trying to figure out this is the right TPA model for CalPERS?

A When I first came in, my focus wasn't on rapidly moving to a total portfolio approach. My intention was to spend three to six months listening, learning. We're about to start an asset liability management review, which occurs every four years. The question for me was, do I want to push to go down this route of a total portfolio approach now, or do I wait four years? And I didn't really want to wait. We really did this in a Stepwise fashion. One of the first things we did was to show the board how a risk equivalent portfolio had done compared with Kelpa's portfolio. It was revealing for people because you can take a simple combination of equities and bonds, and it will track the actual portfolio very closely. And that'll be the case for most pension funds. Once I saw that reaction, I thought we should go further and take people on this total portfolio journey. I saw a few other things which made the process easier. You want to get the right alignment, and you want everyone to be investing the portfolio as a whole. Some years earlier, Marcy had changed the compensation structure so that everyone got rewarded on the basis of the whole portfolio, not their asset class. That was quite important. The team had done a lot of work on liquidity, had invested a lot of time, a lot of efforts, and really good work was done on that That was a particular advantage for looking at the whole por…

AI assessment note: “show the board how a risk equivalent portfolio had done compared with Kelpa's portfolio.”

Q What common language have you come across those asset classes as you described to start to understand how to compare the real estate asset to the public equity, to the private equity?

A You should think about funding all the investments out of the reference portfolio. Funding them out of some combination of equities and fixed income. In our case, it's US treasuries. You want to risk match the investment you're making with some combination of equities and bonds. In reality, it's going to be the equity risk that dominates. You're obviously looking at things like equity beta as one of the considerations. You've also got to be thinking about how you charge for illiquidity, because if you are investing in a liquid asset, you've given up some optionality, and that's of some value. How much, of course, will depend a bit on the institution, depending on how much liquidity you have. It also can be a function of base currency and currency hedging and so on. Those are some of the considerations.

AI assessment note: “You should think about funding all the investments out of the reference portfolio.”

Q In a strategic asset allocation model, that incremental investment is probably someone's assessment of better alpha. If it's a new manager in public equities, we think that manager's better than the manager we have, maybe in the construct of what we're trying to find. What might the similarities and differences be in that incremental investment in a TPA approach?

A With an SAA, the asset class is probably thinking about how additive that investment is. Given the asset allocation. Let's say it's an asset class with a 10% allocation. They'll fill the bucket up to that 10%. Now it could be that it's sub-optimal. It could be that the return from the marginal investment in an asset class is less than it could be in another asset class. Or possibly it could be that it's a lot better and the team should be doing a lot more. You could be under-invested or over-invested depending on the relative attractiveness. If you've got a 10% allocation, you're probably going to look to diversify that portfolio. You don't want to have a too concentrated an asset class portfolio. But when you're thinking about its contribution to the whole portfolio, you should be much more comfortable in having a more concentrated asset class portfolio because it gets diversified away at the whole portfolio level. Those are some of the differences. It's also one of the reasons why it's hard to hold An asset class as accountable in a total portfolio approach because the asset class may have been asked to do something for whole of portfolio considerations. The assessment of the contribution is really the contribution to the whole portfolio rather than just looking at the asset class on a standalone basis.

AI assessment note: “The assessment of the contribution is really the contribution to the whole portfolio”

Q Among the tried and true principles that have worked for a long time for some of the strategic asset allocation models, rebalancing and private market exposure always comes up. How does the concept of mean reverting rebalancing work within a TPA approach?

A I don't see any difference. Future fund, New Zealand super would be rebalancing. Typically what you would do with the forms of total portfolio approach that I'm familiar with is you would have a target portfolio anyway. You would be aiming for something where you've got a reference portfolio. You're rebalancing the risk back the reference portfolio level. If you're the future fund and you don't have A reference portfolio, you'll still want to think about equity equivalent exposure, and they'll want to rebalance back to that. It will be similar. In terms of the privates, that's an interesting one, because with private market exposure, you can't move that anytime you want, because they're illiquid, and the relationships involved, the investing teams will need to have clarity over a multi-year runway. In the organizations I've been in, there's usually some sort of runway or plan over multiple years. The target portfolio has to take that into account so that the teams have decent planning horizon and so they can manage relationships.

AI assessment note: “I don't see any difference. Future fund, New Zealand super would be rebalancing.”

Q Thema. For all the private equity managers out there, Thema uses AI to help map the landscape and source private businesses. It's incredible what a well-designed AI tool can do to accelerate the discovery of businesses in private markets. There's a link in the show notes so you can learn more. And here are those closing questions. What was your first paid job, and what did you learn from it?

A My first paid job was a student job. I was a laborer doing all sorts of manual work. That job brings back memories, because I remember my first day on the job. A group of us started that day. We were given tools like crowbar, pick, shovel, and we were asked to dig up a road. It was a metal road, It was hard work because we only had these tools. At the end of the day, I went home. I had seven blisters on my two hands. My father looked at me and thought I needed toughening up. He got some denaturalized alcohol and just poured it on my hands because that toughens up the skin. It stung. From that time, I wasn't sure whether they were testing us as new joiners, but it got easier after that. I enjoy doing that manual work.

AI assessment note: “My first paid job was a student job. I was a laborer doing all sorts of manual work.”

Q The governance boards, guardians, New Zealand, Australia, are thought of as very sophisticated investment pools of capital. And in the public pensions in the US, typically the people serving on the boards do not come from finance backgrounds. How has that changed how you thought about approaching the portfolio?

A It's true. The nature of the boards are different. The boards in Australia and New Zealand, the ones I dealt with, comprise investors. There's a different type of conversation, but kelp as the board is the ultimate governance body. Um, Move to a total portfolio approach pays attention to that. It's a management team that has the investment experience. We should be accountable for it. It becomes clearer. The board has the overall oversight. The asset liability management model remains the same. We've just moved to a reference portfolio, and we define the active risk a little differently. Ultimately, there's more clarity around who is accountable. It's the management team that has the investment experience. The board has the governance experience.

AI assessment note: “Move to a total portfolio approach pays attention to that.”

Q How have you tried to bring that culturally from what you've seen to operate in that type of collaborative way?

A One of the things we've done at the level of the leadership team is to call out collaboration. When people are assessed for performance, collaboration is one of the key leadership competencies. We've heightened that in terms of how much focus We give to it. There's focus on communication, outreach. We've had lots of questions and answers and discussions. When you do that in the big forum, people don't feel that comfortable speaking up. There's been a lot of outreach at the team by team level. Early on, there was some discomfort in the private markets because people were thinking New Zealand doesn't have much exposure to private markets. The reality is Future fund does. And if you look at the TPA adherence, they tend to have a bigger exposure to private markets. So there were a lot of misunderstandings because you've got to look at the organization and where it's relevant. When thinking about the asset allocation, there's been an education process, Q and a listening discussion, and it's ongoing.

AI assessment note: “One of the things we've done at the level of the leadership team is to call out collaboration.”

Q As you're looking at making these trade-offs, and particularly making these shifts over time, what does the data and information that you need to aggregate look like on a dashboard on your desk so that you can make an informed decision?

A The data and analytics are hugely important. One of the things we have been doing at Kelpa's is embarking on an effort to simplify some of the Systems we're using to get that better whole of portfolio view. That's a multi-year exercise. You essentially want to be able to aggregate in a common language. Historically, we've tended to have best of breed, you know, applications by asset class. That can be great for a single asset class, but it's not so good when you want to combine everything. So you've got to be thinking about the right trade-off between that asset class functionality and the whole of portfolio. Um, bias is to try and have a better view at whole of portfolio.

AI assessment note: “simplify some of the Systems we're using to get that better whole of portfolio view”

Q So when it comes to brass tacks on Position size. You have an organization that is very different. In some ways you could say unique, the way they approach the world, the way they invest. You can't really fill a bucket of Bridgewaters. So how do you think about how big is appropriate for that one manager in your portfolio?

A That's a great question. It's a great question because the size is going to be a function of how confident we are. In their ability to deliver alpha. And it's also going to be a function of all the other investment opportunities that we have. So I can't give you a straight answer apart from saying that those are the considerations. I would also say that it's typically quite hard to find skill, and if you can find it, sometimes it's difficult to access, and sometimes it's difficult to scale. So we think about all those things when thinking about the sizing. Sometimes we just can't get the size that we'd like, or we can't get the access that we'd like.

AI assessment note: “the size is going to be a function of how confident we are”

Q As you're getting ready to figure out how you're going to make these comparisons, love to hear in your time at New Zealand or in your time in Australia, what was an example of comparing that common illiquidity premium that you would want from a private equity or venture capital asset to a public equity beta?

A In both of those countries in New Zealand and Australia, a lot of the investing was offshore. Because they've got relatively small domestic capital markets. One of the biggest considerations related to foreign currency and the hedging of those foreign currencies, and of course for comparing assets, you would want to look at things on a hedged basis so you can compare across countries. That has implications for liquidity because in both Australia and New Zealand and Canada, for that matter, When there's a negative shock, equities are going to fall, but those currencies will also weaken, so there's a liquidity consideration. That's different if you happen to be a US-based investor, or it has historically been different. That's one consideration. You've got to look at the big factor, which is equities, and you're normally looking at regression analysis, but then again, you've got to think about what is the market value at a point in time, and these things are infrequently marked. There can be a lot of discussion and debate. In the end, you want to get something that's reasonable.

AI assessment note: “One of the biggest considerations related to foreign currency and the hedging of those foreign currencies”