James Perry is the chief investment officer of the Dallas Police and Fire Pension System, a pension fund with $3 billion assets under management. Perry holds an MBA from the National University and a bachelor’s degree in Biochemical and Biophysical Sciences from the University of Houston. He also spent eight years as a pilot in the Navy.
James Perry was recently named to Trusted Insight’s ranked list of the Top 30 Pension Fund Chief Investment Officers. He graciously spoke with Trusted Insight on January 21, 2016. A “dynamic investor,” as he calls himself, Perry talks about his experience in pension investment, how a science background and his service in the Navy shaped his investment philosophy and his advice under difficult market conditions.
The following interview has been edited and condensed for clarity.
Trusted Insight: Describe your investment philosophy and how your background, in particular the biochemistry degree and your time in the Navy, helped form that?
James Perry: I think there's a huge value in taking a scientific approach when investing. With my background in biochemistry and biophysics, I was taught and trained in a scientific method to build an understanding of how things work: you start out with a hypothesis, but continue to question, challenge and refine the idea. What's the basis and foundation for how you do things? You're looking for proof and validity. I think it’s a good foundation for an investor. You learn a great deal about markets, fundamental rules and modeling in business school, but the study of science often teaches us to question what we think we know.
There's also a lot of real practical knowledge that comes from my experience in the military, like being able to look at things with a fresh set of eyes and adapting quickly. I think that is a skill set that came primarily from my experience as an officer in the Navy. That experience also gives me a broader set of views and experiences. I remember doing due diligence on a company once that invested in a helicopter operating company. As a pilot, my experience with aircraft maintenance schedules was helpful in understanding something even the manager had missed about the business and its operations.
Regarding my investment philosophy, a core belief for me is that price is a key determinant of risk. I know there are a lot of folks who take a more static view on asset allocation. I would be considered more of a dynamic investor. I adhere to the premises that an investor should always ask if they are being compensated for the risk of any investment and that relative value considerations can improve asset allocation decisions. In a paper that I co-authored with colleagues, Arun Muralidhar, Tim Barrett and Don Pierce, we discussed the SBCERA rebalancing model as an example of how you could enhance risk-adjusted returns with a dynamic asset allocation model based on relative value analysis and other fundamentals.
In addition to price, a focus on contractual returns is also a good way to manage risk. This is not new but often seems underappreciated. Just like in a traditional bond portfolio in normal market conditions, cash flowing contractual returns will provide a more stable return to a portfolio than just price change. It's a matter of deconstructing where you're actually getting returns. High levels of contractually driven cash flow can significantly reduce the volatility of a plan’s overall return stream. One problem today is that due to the low interest rate environment, a traditional bond portfolio has more duration risk and price volatility than cash flow, so an investor has to look to other assets such as senior loans to meet that need.
Trusted Insight: You've had experience with both endowments and pensions for a considerable amount of time. What's the biggest difference between the two types of institutions that came to be a surprise for you?
James Perry: I don't think it’s a surprise, but you have a different set of objectives. I think with a pension plan, the real mission is how to drive toward an expected actuarial rate of return with the highest probability of success. On an endowment plan, you typically have a cash flow requirement, but you also have a need to optimize the portfolio to drive the best risk adjusted returns for that plan. Endowment investing generally needs to be geared more opportunistically. You also have different compositions on the different types of boards, so initial familiarity with different types of strategies may vary.
Trusted Insight: Unlike most other types of institutional investing, pension funds are not tasked with perpetuating the wealth of a small handful of high-net worth individuals. Instead, you're managing a pool of money comprised of average American wage earners who are not particularly wealthy. For you, is that a burden to bare a righteous cause or just the same as strategically deploying any other large AUM?
James Perry: No. I think it's a privilege to be able to serve. At Dallas Police and Fire, we're serving those who serve. Actually, the motto on the back of our business card is "serving those who protect the Dallas community." That's really a key aspect of any public fund. You are in that position to provide benefits to those who are protecting and serving their community. So I think it’s a privilege, much like military service and being in a position where you can do a public good.
Trusted Insight: That's a great perspective. You are the first Chief Investment Officer for Dallas Police and Fire. Tell me about how you've constructued the investment team.
James Perry: This is a new position, but not a new plan. I started in September of last year with four dedicated investment staff members already with the plan. We are working diligently to find the best available opportunities in asset classes where we are currently investing or looking to expand our exposure. I coordinate those due diligence efforts but am also focused on where I can improve the portfolio, enhance reporting and transparency to the board and really communicating with the board on how we can drive the plan for the future. I think that transparency and communication are two key aspects for any CIO of a public plan.
As I mentioned earlier, there are some differences in the objectives of a public fund versus an endowment. I think the first thing you have to do on the job as a new CIO at any plan is to understand what the specific goals of that plan are. For a public fund, it's providing the cash flow for the pension and benefit payments. Then, you have to ask how do we design an investment program so that it has the best probability under various market conditions to meet that goal, and how do we best focus our team’s energy and resources to speed our progress in building and monitoring that program?
Trusted Insight: To what degree are you concerned about or are reacting to the near-term market volatility?
James Perry: The target allocation of the plan to public equity was fairly modest when I got here. We brought the plan to target allocations where possible and reduced public equity exposure from an overweight to target. I think the plan’s allocation now is actually pretty well positioned for a volatile market. I have been working with our plan consultant and board to come up with a new target asset allocation. In the new allocation, we want to focus on enhancing and improving cash flows to meet the requirements of the plan. We will seek to accomplish this through contractual returns and building a portfolio less impacted by market volatility.
Trusted Insight: Does that mean diversifying into alternatives and more uncorrelated assets that don't necessarily follow the ups and downs of the equity market?
James Perry: Yes. I think we will definitely consider those types of investments. The plan already had some significant exposure to private assets. We'll continue to have private asset exposure, but we are looking more into the credit space, specifically, high cash flow, high contractual returns and assets that would provide complimentary, low-correlation benefits to the existing portfolio. We're definitely exploring all of those. Hopefully we can talk to you next year and tell you about the successes we've had in building out that part of the portfolio.
We have a very dedicated board and executive director who are extremely focused on doing what is in the best interest for the plan and want to reposition the portfolio accordingly. A key objective to me has been how do we improve reporting and transparency to them so that they have all the information they need to make those decisions with regard to what's in the best interests of the plan.
Trusted Insight: What geographies or sectors are particularly intriguing to you in terms of sustained growth throughout 2016 and beyond?
James Perry: I think emerging markets is an area that offers some attractive valuations. On a relative basis, both EM debt and equity are looking interesting. I also think that the credit space should provide attractive returns relative to the risk over the long term due to regulations and less competition from the banks for institutional investors. The energy sector is another area that has certainly taken a pounding, but may be offering some value from these levels.
Trusted Insight: What trends have you identified in your time at public pensions?
James Perry: Hedge funds and other alternative investments have seen significant growth in general. Those types of strategies have more complex structures and strategies and also require higher reporting standards. As you add complexity to the plan, you need to improve reporting standards. The assets create great opportunities to drive towards more stable returns, but they also create challenges in monitoring and communicating.
Trusted Insight: Anecdotally, being successful at your job has to do with having a good governance structure, having good relationships with the board, then setting that governance structure and sticking to it when times are tough.
James Perry: I couldn't agree more. Again, that goes back to those key points. I think we have to be aware of the market opportunities, and we have to be able to communicate that information. We have to create reporting that our boards can point to and challenge us when something is getting out of line. Then, when you're having that discussion with your board, you can state here are the opportunity sets, here are the challenges and discuss how we should move forward. It creates a much more valuable dialogue once you've got transparency in reporting.
Trusted Insight: What would you say that the biggest challenge is to pension investing?
James Perry: Probably the biggest challenge is the current set of expected returns for assets that are available to us. I think you have very compressed returns on a forward looking basis. From a building block approach, you're starting with cash yields of zero. If you've got a seven or eight percent actuarial target that you're trying to reach, it’s a real challenge in a five percent type world. But, markets change. If you're not currently being compensated for risk, you may have to take a more cautious approach in the near term and wait for opportunities to develop.
Trusted Insight: If there was a number one rule or lesson that you've learned in your career as an institutional investor, what might that be?
James Perry: Everyone coming through business school or pursuing a CFA charter has been taught about asset allocation. Long term, it drives your portfolio’s returns and volatility. But understanding the assets that you hold and how they are valued is also critically important. Price paid for an asset is really the key determinant of whether an investor can get compensated for the risk of owning that asset. Buying good assets at the right price and focusing on contractual returns are fundamental parts of the job and will ultimately drive a lot of the returns.
In 2008, during the credit crisis, investors got another big lesson. The way leverage is structured is critical. A portfolio of non-stressed, performing bank loans or other debt instruments, held in the wrong structure could be devastating. Many investors who were using a TRS structure when the banks became stressed in 2008 experienced significant problems with those structures. When leverage makes sense, holding assets in term credit facilities with reduced mark to market risk can be much safer and well worth the additional cost.
Trusted Insight: What have I failed to ask that I should know about you, about Dallas Police and Fire or about pension investing in general?
James Perry: Globally, markets are challenging right now. If you are fortunate enough to have a portfolio that's positioned pretty conservatively, you probably feel pretty good. If it’s not, you may be a little bit more concerned right now. The nice thing about tough markets is that they usually lead to better opportunities. I think that this is one of those markets where an investor may appreciate the opportunities that are coming more than the ones that are currently at hand.
To learn more about the the Top 30 Pension Fund Chief Investment Officers, click here.
James Perry was recently named to Trusted Insight’s ranked list of the Top 30 Pension Fund Chief Investment Officers. He graciously spoke with Trusted Insight on January 21, 2016. A “dynamic investor,” as he calls himself, Perry talks about his experience in pension investment, how a science background and his service in the Navy shaped his investment philosophy and his advice under difficult market conditions.
The following interview has been edited and condensed for clarity.
Trusted Insight: Describe your investment philosophy and how your background, in particular the biochemistry degree and your time in the Navy, helped form that?
James Perry: I think there's a huge value in taking a scientific approach when investing. With my background in biochemistry and biophysics, I was taught and trained in a scientific method to build an understanding of how things work: you start out with a hypothesis, but continue to question, challenge and refine the idea. What's the basis and foundation for how you do things? You're looking for proof and validity. I think it’s a good foundation for an investor. You learn a great deal about markets, fundamental rules and modeling in business school, but the study of science often teaches us to question what we think we know.
There's also a lot of real practical knowledge that comes from my experience in the military, like being able to look at things with a fresh set of eyes and adapting quickly. I think that is a skill set that came primarily from my experience as an officer in the Navy. That experience also gives me a broader set of views and experiences. I remember doing due diligence on a company once that invested in a helicopter operating company. As a pilot, my experience with aircraft maintenance schedules was helpful in understanding something even the manager had missed about the business and its operations.
Regarding my investment philosophy, a core belief for me is that price is a key determinant of risk. I know there are a lot of folks who take a more static view on asset allocation. I would be considered more of a dynamic investor. I adhere to the premises that an investor should always ask if they are being compensated for the risk of any investment and that relative value considerations can improve asset allocation decisions. In a paper that I co-authored with colleagues, Arun Muralidhar, Tim Barrett and Don Pierce, we discussed the SBCERA rebalancing model as an example of how you could enhance risk-adjusted returns with a dynamic asset allocation model based on relative value analysis and other fundamentals.
In addition to price, a focus on contractual returns is also a good way to manage risk. This is not new but often seems underappreciated. Just like in a traditional bond portfolio in normal market conditions, cash flowing contractual returns will provide a more stable return to a portfolio than just price change. It's a matter of deconstructing where you're actually getting returns. High levels of contractually driven cash flow can significantly reduce the volatility of a plan’s overall return stream. One problem today is that due to the low interest rate environment, a traditional bond portfolio has more duration risk and price volatility than cash flow, so an investor has to look to other assets such as senior loans to meet that need.
Trusted Insight: You've had experience with both endowments and pensions for a considerable amount of time. What's the biggest difference between the two types of institutions that came to be a surprise for you?
James Perry: I don't think it’s a surprise, but you have a different set of objectives. I think with a pension plan, the real mission is how to drive toward an expected actuarial rate of return with the highest probability of success. On an endowment plan, you typically have a cash flow requirement, but you also have a need to optimize the portfolio to drive the best risk adjusted returns for that plan. Endowment investing generally needs to be geared more opportunistically. You also have different compositions on the different types of boards, so initial familiarity with different types of strategies may vary.
Trusted Insight: Unlike most other types of institutional investing, pension funds are not tasked with perpetuating the wealth of a small handful of high-net worth individuals. Instead, you're managing a pool of money comprised of average American wage earners who are not particularly wealthy. For you, is that a burden to bare a righteous cause or just the same as strategically deploying any other large AUM?
James Perry: No. I think it's a privilege to be able to serve. At Dallas Police and Fire, we're serving those who serve. Actually, the motto on the back of our business card is "serving those who protect the Dallas community." That's really a key aspect of any public fund. You are in that position to provide benefits to those who are protecting and serving their community. So I think it’s a privilege, much like military service and being in a position where you can do a public good.
Trusted Insight: That's a great perspective. You are the first Chief Investment Officer for Dallas Police and Fire. Tell me about how you've constructued the investment team.
James Perry: This is a new position, but not a new plan. I started in September of last year with four dedicated investment staff members already with the plan. We are working diligently to find the best available opportunities in asset classes where we are currently investing or looking to expand our exposure. I coordinate those due diligence efforts but am also focused on where I can improve the portfolio, enhance reporting and transparency to the board and really communicating with the board on how we can drive the plan for the future. I think that transparency and communication are two key aspects for any CIO of a public plan.
As I mentioned earlier, there are some differences in the objectives of a public fund versus an endowment. I think the first thing you have to do on the job as a new CIO at any plan is to understand what the specific goals of that plan are. For a public fund, it's providing the cash flow for the pension and benefit payments. Then, you have to ask how do we design an investment program so that it has the best probability under various market conditions to meet that goal, and how do we best focus our team’s energy and resources to speed our progress in building and monitoring that program?
Trusted Insight: To what degree are you concerned about or are reacting to the near-term market volatility?
James Perry: The target allocation of the plan to public equity was fairly modest when I got here. We brought the plan to target allocations where possible and reduced public equity exposure from an overweight to target. I think the plan’s allocation now is actually pretty well positioned for a volatile market. I have been working with our plan consultant and board to come up with a new target asset allocation. In the new allocation, we want to focus on enhancing and improving cash flows to meet the requirements of the plan. We will seek to accomplish this through contractual returns and building a portfolio less impacted by market volatility.
Trusted Insight: Does that mean diversifying into alternatives and more uncorrelated assets that don't necessarily follow the ups and downs of the equity market?
James Perry: Yes. I think we will definitely consider those types of investments. The plan already had some significant exposure to private assets. We'll continue to have private asset exposure, but we are looking more into the credit space, specifically, high cash flow, high contractual returns and assets that would provide complimentary, low-correlation benefits to the existing portfolio. We're definitely exploring all of those. Hopefully we can talk to you next year and tell you about the successes we've had in building out that part of the portfolio.
We have a very dedicated board and executive director who are extremely focused on doing what is in the best interest for the plan and want to reposition the portfolio accordingly. A key objective to me has been how do we improve reporting and transparency to them so that they have all the information they need to make those decisions with regard to what's in the best interests of the plan.
Trusted Insight: What geographies or sectors are particularly intriguing to you in terms of sustained growth throughout 2016 and beyond?
James Perry: I think emerging markets is an area that offers some attractive valuations. On a relative basis, both EM debt and equity are looking interesting. I also think that the credit space should provide attractive returns relative to the risk over the long term due to regulations and less competition from the banks for institutional investors. The energy sector is another area that has certainly taken a pounding, but may be offering some value from these levels.
Trusted Insight: What trends have you identified in your time at public pensions?
James Perry: Hedge funds and other alternative investments have seen significant growth in general. Those types of strategies have more complex structures and strategies and also require higher reporting standards. As you add complexity to the plan, you need to improve reporting standards. The assets create great opportunities to drive towards more stable returns, but they also create challenges in monitoring and communicating.
Trusted Insight: Anecdotally, being successful at your job has to do with having a good governance structure, having good relationships with the board, then setting that governance structure and sticking to it when times are tough.
James Perry: I couldn't agree more. Again, that goes back to those key points. I think we have to be aware of the market opportunities, and we have to be able to communicate that information. We have to create reporting that our boards can point to and challenge us when something is getting out of line. Then, when you're having that discussion with your board, you can state here are the opportunity sets, here are the challenges and discuss how we should move forward. It creates a much more valuable dialogue once you've got transparency in reporting.
Trusted Insight: What would you say that the biggest challenge is to pension investing?
James Perry: Probably the biggest challenge is the current set of expected returns for assets that are available to us. I think you have very compressed returns on a forward looking basis. From a building block approach, you're starting with cash yields of zero. If you've got a seven or eight percent actuarial target that you're trying to reach, it’s a real challenge in a five percent type world. But, markets change. If you're not currently being compensated for risk, you may have to take a more cautious approach in the near term and wait for opportunities to develop.
Trusted Insight: If there was a number one rule or lesson that you've learned in your career as an institutional investor, what might that be?
James Perry: Everyone coming through business school or pursuing a CFA charter has been taught about asset allocation. Long term, it drives your portfolio’s returns and volatility. But understanding the assets that you hold and how they are valued is also critically important. Price paid for an asset is really the key determinant of whether an investor can get compensated for the risk of owning that asset. Buying good assets at the right price and focusing on contractual returns are fundamental parts of the job and will ultimately drive a lot of the returns.
In 2008, during the credit crisis, investors got another big lesson. The way leverage is structured is critical. A portfolio of non-stressed, performing bank loans or other debt instruments, held in the wrong structure could be devastating. Many investors who were using a TRS structure when the banks became stressed in 2008 experienced significant problems with those structures. When leverage makes sense, holding assets in term credit facilities with reduced mark to market risk can be much safer and well worth the additional cost.
Trusted Insight: What have I failed to ask that I should know about you, about Dallas Police and Fire or about pension investing in general?
James Perry: Globally, markets are challenging right now. If you are fortunate enough to have a portfolio that's positioned pretty conservatively, you probably feel pretty good. If it’s not, you may be a little bit more concerned right now. The nice thing about tough markets is that they usually lead to better opportunities. I think that this is one of those markets where an investor may appreciate the opportunities that are coming more than the ones that are currently at hand.
To learn more about the the Top 30 Pension Fund Chief Investment Officers, click here.