Everything is bigger in Texas, so the saying goes. And the US state’s largest pension fund is certainly living up to the trope by conducting a major, multi-faceted revamp of how it invests globally.
The Teacher Retirement System of Texas (Texas TRS) could next almost double its internal investment team headcount, having overhauled its equity portfolio last year. The institution is also looking to set up an office in Asia to help manage its $22 billion of assets in the region. And like many other asset owners, it is moving to increase its private debt allocation.
Jerry Albright, chief investment officer of the $151 billion fund, outlined its thinking to AsianInvestor during a recent visit to its European base in London.
Like investors in Asia and worldwide, Texas TRS is responding to the prevailing low-yield environment and looking at how it can squeeze more performance out of increasingly challenging markets. Indeed, Albright said it is likely to reduce its assumed rate of return from 8% to 7.5% or 7.25%.
Albright, who has been with the pension fund for 25 years, has clear ideas on how its investment strategy should progress, evidenced by the transparent institution's detailed minutes of internal meetings.
At a board meeting in February he proposed adding 120 people to the investment team over five years to boost its headcount to almost 270. The aim is to do more direct deals and allocations, thereby cutting fees paid to external asset managers by at least $600 million.
That would reverse the fund’s traditional outsourcing approach. In 2007 only 6% of its then $85 billion assets were externally managed. Today, this figure stands at 60%, but under the fund’s new plan this amount will drop once more, though it declined to discuss by how much and over what time frame.
“During the past decade we’ve learned a lot; we’ve increased our resources in terms of quality and quantity,” Albright said. “We’re starting to pull more assets back internally, having watched how our partners have invested over time.”
The plan may be explored further at Texas TRS’s July 26/27 board meeting, but the outsourcing level is unlikely to fall as low as it was 11 years ago.
Albright suggested the scheme could more closely resemble the big Canadian public pension plans—which have very large internal teams and make a lot of direct investments—but he doesn’t expect the fund to become as big a direct investor as the likes of CPPIB or Ontario Teachers.
“I always say we’re going ‘halfway to Canada’,” Albright said. “We are going to make the best use of the resources we have; we don’t have unlimited resources like some other funds.” Former CIO Brit Harris, whom Albright replaced in July last year, dubbed this ‘the Texan model’.
Accordingly, Texas TRS does not have as large overseas offices as some asset owners, noted Albright. Its London branch—its only foreign outpost, set up in 2015 to focus on private investments in Europe—has four investment staff and one administrative executive.
The next stop looks likely to be Asia, where the fund is reportedly leaning towards setting up an office in Singapore in mid-summer 2019, though it has not confirmed if that is the case.
Like Texas TRS, big asset owners in Asia have in recent years sought to build up their in-house teams to reduce fees and do more direct investing. But even large institutions increasingly recognise the challenges and limitations of insourcing, as executives from Chinese insurer Ping An and Italy’s Generali pointed out at AsianInvestor’s Asian Investment Summit last month.
Turning to specific asset classes, Texas TRS is gradually raising its private credit exposure, reflecting the fund’s view of it as an opportunistic play.
The fund has a 3.5% allocation that it invests directly and through strategic partnerships with alternative asset managers Apollo and KKR. It wants to increase this to 5% over three to five years, Albright said.
This is part of the fund’s $41.7 billion private markets portfolio, which has grown from 6% of total AUM in 2007 to 27.6% as of end-2017 (see figure below). Private equity is the largest part of this, accounting for 12.5% of total AUM, while real assets take up 11.1% and 4% is in energy, natural resources and infrastructure.
Texas TRS has also reorganised its equity portfolio, a project that took 18 months and was completed late last year.
The pension fund has 58% of its AUM in listed stocks, hedge funds and private equity. It has divided these assets into US stocks (18.8% of total AUM), non-US developed markets (13.5%) and emerging markets (9.7%).
Previously, the fund structured its equity allocations around different asset management styles, which created some overlap, said Albright. Now the investment team will apply investment strategies across these portfolios, using a more top-down approach.
The aim of the overhaul was to better manage risk premia – that is, alternative weightings or factors other than traditional market capitalisation in indexes – and increase internal quantitative management.
SHIFT TO PASSIVE
As part of its equity portfolio changes, the fund has also stopped using external managers to invest into US stocks actively, deciding that it’s too difficult to find alpha in the highly efficient market. Instead, it does so via passive or internal quantitative equity strategies, reducing fees.
This reflects a shift into passive strategies among investors, particularly in respect of the most efficient developed markets. Western asset owners are seen to have led the way but Asian institutions, such as Australia’s Future Fund, New Zealand Superannuation Fund and Taiwan’s Bureau of Labor Funds have been ramping up their use of ‘quasi-passive’ factor-based investing in recent years.
As returns have steadily fallen, so the focus has grown on fees paid for active management and on the performance it has (or has not) delivered; investors have sought more transparency around performance attribution.
For instance, Japan’s Government Pension Investment Fund has said it would, from April 1 this year, offer performance-related fees to managers of its active equity and bond portfolios and, accordingly, cut the fees of those that underperform.