Eight top pension, endowment and foundation officials
assembled in New York City on the morning of May 15 to share
their thoughts on how complex and challenging their jobs have
become. The previous evening these experts, who hail from Los
Angeles, Washington and a number of points in between, had been
honored for investment excellence at Institutional
Investors annual U.S. Investment Management Awards
dinner. Although they work within institutions of varying sizes
and missions, the winning eight recognize that, no matter how
hard they grapple with difficult investment questions, there
will always be unknown factors thrown in their paths.
The longer youre in this business and the more
you learn, the more you realize what you dont know,
says Donald Lindsey, CIO at George Washington University in the
District of Columbia.
The executives discussed their risk management concerns,
compared their very different fund governance structures and
debated whether there will be a resurgence of economic growth
in the U.S. and other developed countries or if emerging
markets will take over the world. Weighing in on the side of
U.S. strength, Lawrence Schloss, CIO of the New York City
Employees Retirement System, declared, I think the
technological impact on everything is grossly underestimated,
particularly productivity and capital formation and
growth. Joining Lindsey and Schloss were Douglas Brown,
CIO of Chicago-based Exelon Corp.; Conrad Freund, COO of the
LA84 Foundation in Los Angeles; Sean Gissal, CIO of
Milwaukees Marquette University; Joshua Gotbaum, director
of the Washington-based Pension Benefit Guaranty Corp.; Robert
Manilla, CIO of the Kresge Foundation in Troy, Michigan; and
Lee Partridge, CIO of Houstons Salient Partners, which
manages $8.5 billion in assets for the San Diego County
Employees Retirement Association.
Institutional Investor Editor Michael Peltz and
Senior Writer Frances Denmark moderated the discussion,
excerpts from which follow.
Institutional Investor: There are
many forces today challenging the quest for investment
Greece is facing the real possibility of an exit
from the euro; Italy and Spain arent far behind. The U.S.
has its own credit problems, job growth is tepid at best, and a
contentious election season is under way.
Add to that the unrest in the Middle East and
slowing growth in China. With so much negative news, is a 5
percent real return an achievable target?
Donald Lindsey: Im actually very
optimistic. In spite of the overriding macroeconomic problems
that were experiencing, particularly in the developed
world, corporate profitability is at an all-time high.
Productivity is extremely strong. If you look at the very
long-term return on global equity, its around 10 percent.
Now, thats not delivered evenly year after year, as we
all have found out. In fact, you can go for rolling 15-year
periods and longer where the real rate of return has been
negative. But we are undergoing a third industrial revolution,
involving digital technology, that is in the early stages;
these productivity gains are going to be a fantastic tailwind
Douglas Brown: I would agree. Im
optimistic in the long run. I think, however, the next couple
of years its going to be pretty challenging to meet
investment targets, whether its a 5 percent real return
or an 8 percent pension return target, given the situation
around the world, whether its the sovereign situation in
Europe, the slower growth in China, the fiscal situation in the
U.S. or incredibly low rates. At some point, rates have to
return to a more normalized level, which will be disrupted from
where they are today.
Robert Manilla: I agree with both of those
comments. Its a question of duration. If we look at our
ten-, 15-, 20-year returns, weve met our 5 percent real
rate of return. I think thats an achievable target.
First, there are a lot of risks out there that are still tied
to global growth, so you should be spending some of your energy
looking for things that are uncorrelated to that global growth.
Second, find assets that provide and have a structure that
allows you to recapture some liquidity. We look around the
world and, with the retrenchment of banking, we think
theres actually a vacuum out there to fill some of the
roles that banks used to play. Being a secured lender against
hard assets is an interesting spot. Those are really important
lessons we took away from what happened in
Lawrence Schloss: I think you all are
right. What makes it really interesting for us is, we have a
large pool of assets. So portfolio changes are made around the
edges; you expand your edges from 10 percent to 20 percent to
25 percent. Then you come back when you think things are not
doing very well. But I totally agree that, long run, there is
nothing but growth, because theres no looking back. I
think the technological impact on everything is grossly
underestimated, particularly productivity and capital formation
and growth. People tend very much to live in the moment, and
the moment everyone is looking back to is
0809, and that didnt feel very good.
Much the same way, were talking about risk, risk, risk.
Well, you know, risk has been around for thousands of years.
Its just when it goes wrong, then you focus back on
You have government regulation pushing banks around,
correctly, and theres not as much regular lending as
there ought to be, and theres not as much illiquidity
theres actually too high an illiquidity premium.
So for people like us to think long term, theres a great
opportunity for what Ill call easy stuff, like senior
loans, private placements, secured lending in Europe. Things
that used to trade at basis points are now 100 to 150 basis
points over because everyone has to let go of what is the
easiest stuff to own. We can get some very, very fat premiums
for not a lot of risk.
To get a 5 percent real return, will investors have
to take on greater risk than in the past?
Schloss: One of the problems for large
funds is theyre told, Once you have your asset
allocation, stick to it and revisit it every three years.
Thats forever. I think one of the things our boards in
particular learned is we dont need to do that again. If
you can avoid the losses, everything kind of takes care of
itself. One of the things about avoiding the losses is to get
out of the way. If you see something bad happening, its
referred to now as risk on/risk off. I wouldnt quite put
it that dramatically; its not a switch. But if
youre worried about the euro in Europe, you might cut
back. If you get the bigger things right and avoid the things
that could crush you, youre going to be close to making
the return you need.
Once you allocate the money, youre dependent on the
manager. One of the frustrations Ive had was when I asked
all of our managers to manage up to 10 or 15 percent cash.
Virtually every manager said, We dont want to do
that. We only know how to be long only, if were equity
managers. Thats your job. Youre supposed to figure
that out. Youre supposed to call us up and say,
Take the money back. I thought that
was a terrible answer, but thats what everyone said. So I
also think theres a certain amount of responsibility
thats not quite aligned with the actual owners of the
Manilla: We set up our governance structure
so we could do things internally. Because, generally speaking,
our managers are relatively illiquid. Even if we didnt
like something, it might take us a quarter to get the capital
back, and that could be too late. So we were very cognizant of
the fact that most of the hedging and adjusting were
doing in our portfolio is around our manager allocations,
without having to actually take capital back.
Lindsey: I think theres a
misperception of liquidity. A lot of people think they have to
have cash on hand. Cash is helpful, but I see liquidity as the
amount of time it takes for an asset to come back to intrinsic
value after it goes well below intrinsic value because of a
huge sell-off in the market. So if I own shares of IBM or Intel
and the market is down 20 percent and the fundamentals
havent changed on IBM or Intel, that stock is not going
to stay down 20 percent for multiple quarters. But if I own an
illiquid mortgage-backed security with embedded derivatives,
maybe that market does disappear for several quarters and
getting an actual bid close to intrinsic value will be very
difficult. I think in todays environment you really have
to think about liquidity not in the sense of how much something
will go down but how long it will take to recover to intrinsic