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Exclusive Q&A: David Villa, Chief Investment Officer, State of Wisconsin Investment Board

by trusted insight posted 1year ago 2611 views

David Villa joined the State of Wisconsin Investment Board (SWIB) as the chief investment officer in 2006. He oversees the state pension's $99 billion in assets. Prior to this, he was the chief investment officer for the Florida State Board of Administration and worked for UBS Global Asset Management/Brinson Partners as an executive director and client relationship manager. Villa has a B.A. in economics from Princeton University, an M.A. in Latin American Studies from Stanford University and an MBA from Northwestern University. He is a chartered financial analyst.

Mr. Villa was recently named on Trusted Insight’s Top 30 Public Pension Chief Investment Officers. He graciously spoke with us on November 11.


Trusted Insight: You started out with B.A. in economics from Princeton and a Master’s in Latin American studies from Stanford. How has your academic background helped you in your career?

David Villa: Well, I started out at Princeton studying economics and the financial markets of Peru. Stanford was an extension of that, but focusing on Latin America and the financial markets in Colombia. Then I went off to business school.
 

Trusted Insight: Right now for areas like real estate, Latin America has captured a lot of attention from institutional investors. Has your studies given you a perspective into investing in that area?

David Villa: It's given me a point of view, and my point of view is the financial system should not be used as a policy arm of a government, especially in financial systems that are not deep and highly diversified. I'm in favor of central bank independence and market forces.
 

Trusted Insight: Does that impact your approach to investments globally? Do you steer clear of those kind of markets for those very reasons?

David Villa: No, but I do take that into consideration when assessing risk. It’s fine if you get compensated for taking the risk, but if you're not getting compensated for the risk, you shouldn't take the risk. It's more of a matter of understanding the question: What is the risk? And then asking yourself: Am I getting compensated for that risk? It's too narrow or myopic to say: I don't like this, so I won't invest in it. It always comes down to the price I'm getting paid to take this risk and if that compensation is sufficient.

 

Trusted Insight: Within risk management, what are other factors that you are looking for while making investment decisions?

David Villa: Risk tends to be evaluated based on what is easy to measure, so I think the first thing to consider is: What is risk? Just because volatility of return is easy to measure, is that really risk? Is risk more akin to camping outside in a tent and having a bear coming and waking you up at two o'clock in the morning? I think it's really hard to measure the risk of a bear waking you up, but that's probably a better manifestation of risk than the volatility.

The war for talent is not just about attracting, it’s about developing and retaining. I don't want to be a training ground for Wall Street. We have to create an environment where people enjoy working with other talented and skilled investors.

It's important to think about risk from the perspective of shocks, permanent loss of capital, and things that are really hard to think about and measure. If the only tool you have is a hammer, everything looks like a nail, so I think risk measurement and risk management can be subject to the same problem of having just a hammer. Risk is bad things happening that are unacceptable. That's hard to measure.


Trusted Insight: You mentioned earlier that you felt like the current climate was a bit like being in the depths of winter, do you think that that situation has improved?

David Villa: I still see a lot of risk today. I see an investment playing field that doesn't compensate investors fairly for taking risk. I think you have to be cautiously optimistic at this point. The themes that policymakers are discussing are encouraging because we seem to be moving away from sequestration, the fiscal cliff and austerity with extremely accommodating monetary policy towards normalization of monetary policy in the future and maybe acceptance that fiscal policy is also a tool that should be used.

The 10-year treasury is about 2 percent today, and it was recently as low as 1.6 percent. If inflation is 2 percent, you have to ask yourself: Do you really want to lend money to the U.S. government for 10 years below the cost of inflation? I don't think that's fair compensation for taking 10 years of rate risk. Since the return has gone from 1.6 percent to above 2 percent in a relatively short period of time, I think one can be a little more optimistic that we're going to be on the path to normalization.

Higher interest rates may choke off economic growth and that could make things worse than they are today, so there's no easy path to normalization. In spite of a general feeling that investors aren't being compensated for the risk that is required to hold risky assets, my prospects for the next few years are optimistic.

 

Trusted Insight: How would you describe your investment philosophy?

David Villa: Imagine a foundation whose mission is to eliminate poverty. The foundation is trying to figure out how to create an asset allocation that is in harmony with the mission. It starts with an asset allocation of 60 percent equities and 40 percent fixed income. If it builds that portfolio, almost all of its risk comes from equities. Furthermore, equities do well when the economy does well, and when the economy does well, poverty is declining.

The opposite happens when the economy does poorly. When the economy does poorly, equities do poorly, and poverty is increasing. By tying your future to equities and giving grants based on the size of your endowment fund, you are decreasing your grant making when poverty is increasing, and increasing your grant making when poverty is decreasing. You're not really in phase with your mission.

I like to think that SWIB is trying to solve the same problem, except that we are not trying to eliminate poverty. What we are trying to do is allow our retirees to retire in dignity, which isn't the same thing, but it has some of the same dynamic. When our retirees live through a recession, an economic correction or a crisis, their wealth is decreasing, and because of our risk sharing, their benefits would also be decreasing at the same time. We need to have an asset allocation solution which provides a more robust investment outcome when the economy isn't doing well. That's very hard to do in an environment where the compensation for taking risk is lower than it probably should be. The goal is to create an investment solution that is more in harmony with our mission.
 

Trusted Insight: You've made the decision to bring your asset management in house. How are you looking to achieve that mission?

David Villa: We believe that you have to take risk in order to be compensated at a level that is required to be able to keep the promise we've made to the beneficiaries. We also believe that it is possible to outperform benchmarks and that active management has a positive expected return, provided that you have skilled investors. We also believe that the market is efficient and that the compensation for the skill that flows to the creator of the active return leaves the investor with almost no net-of-fee active return, especially for long-only strategies.

The creator of the active return earns fees that are equal to the benefit that's created on average. If you have many external managers, on average their fees offset the value added. Because we want to capture the active return, we bring the asset management in house, doing that at one-fifth the cost of external management. Therefore we get to keep four-fifths of the active return for the beneficiaries.

It's important to start with a core belief that active management adds value. It is further believed that most of the value added goes to the external manager. If we can attract and retain talent, if we can win the war for talent, we get to keep four-fifths of the value added that's created.
 

Trusted Insight: Is the “war for talent” the biggest challenge that you've faced in bringing in the asset management in house?

David Villa: The war for talent is probably the biggest challenge. The talent comes into the office early in the morning and it leaves in the evening. I worry about it coming back every morning. My talent is mobile and highly skilled. The war for talent is not just about attracting, it’s about developing and retaining. I don't want to be a training ground for Wall Street. We have to create an environment where people enjoy working with other talented and skilled investors. It’s also important to have the right infrastructure, support and culture. There are probably a handful of things that are part of the secret sauce, and if you exclude any one of those ingredients, you don't get a good outcome.
 

Trusted Insight: What have you tried to implement to develop the talent and create a good culture?

David Villa: I think one thing is that investment professionals need to feel like they have a direct measurable contribution to the investment outcome. A typical complaint that you would hear from an analyst working in another organization other than SWIB might be that the portfolio managers never listen or put their ideas into the portfolio. We work very hard at creating a process where the analysts’ ideas are expressed in real-money terms, not paper-money or paper-portfolios, and hold the analysts accountable for those investment outcomes.

There is a real sense of ownership of the investment decisions and a real sense of fairness with regard to the compensation. We delegate a lot of the decision making process, and then tie the compensation directly to the investment outcomes. We make it clear that the cultural values are very important. There is just a very high premium put on the team behavior and collaboration. Our culture is that one bad apple can spoil the barrel, and there is no tolerance for a bad apple.

There's also a pinch of entrepreneurism in our culture. We embrace innovation, incubation, experimentation, research and development. I'm not trying to move the industry, but our own knowledge to new frontiers. Being able to have an investment culture environment in a state agency is really a big part of our secret sauce, and we celebrate that.
 

Trusted Insight: You put a huge emphasis on developing analysts. How does that process work?

David Villa: Since we are keeping four-fifths of the value added for the beneficiaries and not for the investment professionals, we've built an organization and a culture that is analyst-driven and not portfolio-manager-driven. Our culture is not a star-driven culture. It's a process-driven culture, and in order to have a process-driven culture and win the war for talent, we need to have a career path for an analyst that is a career, not a stepping stone to being a portfolio manager.

One of the first changes that I made when I arrived in 2006 was the creation of a longer career path for analysts. Previously, we called the analysts "analysts," and there were three levels, junior, intermediate and senior. In 2007 or 2008, we introduced the “managing analyst” category. Somebody might be hired as a junior, intermediate or senior analyst, and then he would be promoted to be a managing analyst, and then to junior, intermediate or senior managing analyst. Those managing analysts have direct responsibilities for developing investment ideas and getting those ideas into the portfolios.

Creating that career analyst position has allowed us to move from retaining analysts for five to six years to retaining analysts for 18 to 20 years. We're trying to develop deep knowledge and expertise in specific areas. It might be covering sovereign credits, investment grade credits, global industrials or currencies, but these areas of expertise are where we try to develop analysts who have deep knowledge and are able to generate ideas that outperform their measuring sticks through time.

For the junior, intermediate and senior analysts, we make it a requirement that they have to produce timeless research projects as part of the body of work or body of evidence that they are ready for a promotion. This idea of creating research and coming up with insights is part of the body of work that needs to be evidenced before someone could be considered for a promotion.

Again, culturally there is also this commitment to a life of learning, and that's part of writing research papers as well. We're competing in an industry with a million other really talented analysts, and we have to move our knowledge frontier out continuously and not just get anchored in the past. What we've done in the past is never going to be good enough for the future because we're competing against other investment professionals. This idea of research and continuous improvement is part of what is required to be considered a good analyst and merit promotion into these higher levels of the analyst career ladder. It may sound really simple, but it's a very challenging strategy to execute.
 

Trusted Insight: How have you also utilized technology and support to realize this?

David Villa: We are taking data and information and we are creating knowledge. It’s not easy because you're competing against millions of other investors, trying to find an insight. For every investment professional, there is more than one investment service professional who is involved in not just processing the activity, but also in managing the infrastructure, which includes managing a lot of data that is required to support the investment function.

The secret formula is not only to have good investors, but also to have an infrastructure and a support organization that allow you to create the knowledge out of this raw research. The dimensions are really the same as they would be in an asset management firm: an investment organization, an investment services organization and a relationship management organization. For our organization, the investment management organization is focused on just a few clients, and that's the responsibility of the executive director, communications and the general council to manage.

Our relationship management function is much smaller than it might be in a large asset management firm with $100 billion in assets, but it's no less important in our organization. It's not just the investment organization that creates the outcome, it's the broader organization that allows you to accomplish the mission.


To learn more about public pension investing, click here to view the complete list of Top 30 Public Pension Chief Investment Officers.