David Erickson is chief investment officer at Ascension Investment Management, where he oversees the management of $37.8 billion in assets. In this interview, he discusses the changes that have taken place in the post-financial-crisis market, the impact of artificial intelligence on future investment management and the areas of the market that he finds most interesting.
David Erickson was recently named on Trusted Insight's 2018 Top 30 Health Care System Chief Investment Officers. The following interview has been edited and condensed.
Trusted Insight: Given ultra-low interest rates, high valuations and monetary and regulatory policy since the financial crisis, there is a little historical context for the markets. Do you recognize the markets today? Is recognizing the markets important for your long-term strategy?
David Erickson: Some areas of the market are different, because they are still influenced by the financial crisis. Some changes are just new developments that naturally occur.
In my mind, interest rates are still artificially low due to the crisis and global central banks’ responses to it. Therefore, the idea that you can achieve the desired return with a meaningful allocation to bonds is just different today than it has been in the past. In 1995, you could hit a 5 percent spending rate with a full bond portfolio. In 2005, bonds could have been roughly half the portfolio. And today, the models might allow you to have 5 percent or less in bonds.
Therefore, the role that bonds play in hitting a typical spending type rate is very different today. This means you must be very creative and careful in how you structure downside risk when building portfolios that can achieve your spending targets. Additionally, cash earns you very little. And the penalty of holding cash is that much greater if markets do well. That has been a real difference maker over the time that I have been investing.
"Areas such as artificial intelligence, big data and robotics are all technological developments that will change the institutional investment world."
Regarding regulatory policy, I feel we have been a constant wave of change. For the most part, if we invest based on regulatory changes, it would only be at the margin. However, it has influenced how we perform due diligence on certain investments or what types of questions that we ask of our managers. And today, with the new administration, regulatory changes are occurring again and we are trying to determine if we need to adjust course in any way.
The speed of technology and its impact on the market is something that we spend a lot of time thinking about. Areas such as artificial intelligence, big data and robotics are all technological developments that will change the institutional investment world. The speed of tech advances is a constant question for us. Is it going to be an exponential change with regards to jobs or the way we spend our time or money? Take self-driving cars as an example. There are some who think that the technology is already upon us and others that think that combustible engines will be around for a long time. Does this mean that truck drivers will be unemployed within a year or two? Or does the infrastructure need more time to change and consequently the timeline is much longer? These are really tough questions that we are trying to answer.
Overall, at this point after the Great Financial Crisis, we agree with the common belief that returns going forward should be less than what we have experienced in the recent past. It seems to be a given considering the level of cash yields, bond yields and the valuations of stocks. As a result, we believe that spending rates will need to be lower to coincide with lower returns.
However, I have been saying this over the last few years and every year we’ve experienced great returns. Perhaps there will be enough growth in new emerging market economies and new technologies to keep things higher than expected. There are no easy answers, so we hold on to the idea that we should be careful about how we spend and perhaps spend less aggressively based on our interpretation of markets today.
Trusted Insight: What areas of the markets interest you the most right now?
David Erickson: We try to determine areas that are both historically expensive and historically cheap. Unfortunately, there are a lot of expensive assets in the market, particular sectors within fixed income. Valuations for public equities across the board seem to be on the expensive end as well. Normally, expensive assets are areas we shy away from, but it’s hard to find anything cheap at the moment. Today, we are not looking to be heroic and call the next cycle. Our current thought process is: "Look, the next six to twelve months looks pretty good from a growth perspective, yet prices are high," so we are fairly neutral in over- and under-weighing our portfolio to specific asset classes. We are trying to focus more on niche opportunities.
"We focus on investments designed to improve access to social goods and services that may not be available to the poor and vulnerable, such as health care, housing, nutrition and financial services."
Some of those areas have been certain energy sub-sectors where oil prices are recovering yet related assets have not recovered as quickly as some may have thought. We also recognize that private equity and private credit funds are paying higher prices for companies or securities than in the recent past. However, we think there are niche strategies that are still very interesting based on the general partner, fund size and area of focus.
One area we are spending a lot of time on is impact investing. Impact investing focuses on investment opportunities across the world that AIM believes will generate a beneficial social and/or environmental impact. We focus on investments designed to improve access to social goods and services that may not be available to the poor and vulnerable, such as health care, housing, nutrition and financial services. We also look at areas like clean energy and clean water. We don’t disregard the potential for return, just because these investments “do good.” We evaluate these opportunities similarly to any of our other private equity investments. There are some really interesting projects and funds that we are seeing in these areas. We believe the demand for those types of funds will only grow, as millennials get older and as people see how these types of funds perform.
Trusted Insight: Do you think artificial intelligence and machine learning will have an impact on what the future of investment management will look like?
David Erickson: Overall, I tend to think that artificial intelligence and machine learning will create disruption faster than most people expect. Within investment management, there are certain areas of our business that could be replaced by AI. However, the trust factor that comes with human interaction will be difficult to overcome.
"If A.I. can figure out games such as chess and Go so quickly and master them, I suppose there is no guessing what it can accomplish in the future."
Could A.I. create an appropriate asset allocation based on an investor’s risk? Could that replace what we do on a regular basis? It is very possible. However, at least in the very near future, I believe investors will need to have someone they trust that can explain the investment process and decisions made as opposed to executing orders from a black box.
Sometimes you need someone to say "Look, you should not take as much risk as you think you should.” I believe there is an element of art as well as science in our jobs. Even though A.I. might not change the industry tomorrow, I do think that everything is potentially an A.I. victim at some point down the road. If A.I. can figure out games such as chess and Go so quickly and master them, I suppose there is no guessing what it can accomplish in the future.
Trusted Insight: In your last interview with us, you spoke about the increasing number and sophistication of health care investment offices. Is that an existential crisis for you and others in positions like you?
David Erickson: I think whenever there are more people searching for alpha it is a harder ecosystem to compete in. And yes, there are a lot of great healthcare chief investment officers and teams out there, as good as anywhere else in the institutional universe.
However, the increased number of good investors tends to increase demand for good deals. This can make fund sizes larger or make it harder to get the allocation sizes that you might be used to getting. This makes it more difficult at the margin. Overall, I am more than happy to see this development within healthcare take place. I think we should all want our health care investment institutions to do well. At some point, all of us will need hospitals and we want them to be as financially strong as possible.
Trusted Insight: What distinguishes your investment office from your peer institutions in your opinion?
David Erickson: One of our challenges is that we have a large portfolio to allocate. It makes us work a little harder, but it does allow us to negotiate terms and potentially structure funds or separate accounts specifically to meet our needs. One of those things is our Catholic-based socially responsible investment guidelines – something that we take very seriously. With every manager and every investment we make, we look through our SRI lens and make investment decisions based on our mission and values.
Secondly, we are a very relationship driven group. We see our managers and service providers as partners with whom we want to have a long-term relationship. These strong relationships have been very beneficial whether it is getting the first call on an opportunity or asking for additional work we might be looking for. Having that strong culture and genuine group of likable people have been very valuable to our work.
Trusted Insight: How has your investment philosophy evolved over your career?
David Erickson: I have always believed in diversification and I have always felt that it has been important to protect portfolios in risk-off markets, even if they give up some performance in risk-on markets. I have always been a fan of Howard Marks’ memos. In one of those memos, he said something very simple, "You really have a choice between two ways of positioning your portfolio. You can outperform in the really positive risk markets, but that means you are going to underperform in really bad markets." The vice versa would be, you can protect in down markets, but that probably means you underperform in very positive markets. My philosophy continues to be the latter approach and consequently, we have been more defensive than some over the last couple of years.
Yet I still believe a portfolio should be diversified across different economic regimes (growth, inflation and deflation/anti-growth) and invested in assets that do well across all regimes. Whenever you go through long stretches of very good stock market growth, your diversification views are tested. It is easy to lose patience. But I think if you change your long-term philosophy due to the most recent behavior of the markets, you can easily get whipsawed and end up getting hurt. Therefore, my philosophy has not changed too much since I started.
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