From Efficient Market Theory To A 100% Active Management Portfolio | Exclusive Q&A: Michael Odlum, CIO, Northwell Health
Since September 2011, Michael Odlum has headed the treasury group at Northwell Health. Odlum has served in various investment management leadership positions over a more than 30-year career. Odlum holds an MBA in finance from the University of Pennsylvania, an A.B. in history from Princeton University and is a chartered financial analyst.
Odlum was recently named to Trusted Insight’s Top 30 Hospital Investment Officers. He graciously spoke with Trusted Insight on January 13, 2017. In this interview, Odlum discusses the primary risk factors in the markets today, how his background as an asset manager helps him identify those risks and offers an outlook for the future of hospital investment offices as an industry. The following interview was edited and condensed for clarity.
Trusted Insight: How have your previous experiences as an asset manager informed your investment philosophy and your leadership style at Northwell?
Mike Odlum: They have had a profound influence in a number of different ways. Since a main objective is to provide an effective investment program at the health system for liquidity and capital income and growth over time, it's good to have perspectives from experience that allow a deeper analysis of the underlying drivers of the risks and returns in our investments.
Having experience in the investment management field allows a better sense of the investment process and perspective on assessing the skills of a manager. It helps, for example, in understanding what some of the risks may be in a manager’s execution of a strategy, or in the strategy itself. My experience has also been of great value in fostering an effective and collaborative working relationship with the Northwell investment committee, a group of engaged individuals with very deep and diverse investment backgrounds.
We utilize active managers for most of our portfolios other than in our defined contribution plans, where we include Vanguard index funds in the lineup of available investment options. The participants in the Northwell Health defined contribution plans have allocated about half their balances to index funds.
We continually challenge our active management approach by setting the objective to consider indexing if we feel we are not able to add value net of fees over time. However, over the last several years, the investment committee has been able to do just that, which is an extraordinary achievement. Looking over the last ten years, if you had asked me back then if that would be possible, I would have said that it's possible, but rare. I came into the investment industry back in the late 70s when the efficient-markets hypothesis was at the forefront of academic discourse; it still influences my thinking today.
I spent ten years of my career with Vanguard, and their philosophy is something that I’m in sync with. They suggest that indexing makes sense for the vast majority of investors, including institutional investors. There are rare chances where you can add some value through manager selection, and some managers out there have been able to add value. If you're able to find them, you can achieve excess returns. Although they are usually associated with indexing, even Vanguard engages active managers. The idea is that you want to identify the right managers and manage the process as efficiently and cost effectively as you can. This is our approach.
Trusted Insight: What distinguishes your investment strategy from peer institutions?
Mike Odlum: Well, as I mentioned earlier, we use active managers. I think probably many of our peers may use combinations of active and index or ETF-type investing.
As other institutional investors may also do, we set our strategic allocation targets and rebalance periodically. We allow the allocations to vary within reasonable ranges and try to keep the frequency of rebalancing to no more frequently than quarterly or semiannually. Although other institutions may employ tactical allocation, we don't. Even among professional managers there are very few who are good at tactical allocation over time. Even for those who are able to add value through tactical allocation, a realistic expectation would be for a success rate no better than 55 percent. We’d rather focus on strategic allocation positioning and manager selection.
Another factor that that I believe distinguishes us from our peers is the degree of engagement of our investment committee in the decision making process.
Trusted Insight: If Congress alters or replaces the Affordable Care Act, does that impact how approach investing?
Mike Odlum: As a general rule, the investment strategy for our corporate funds reflects the risk tolerance and liquidity needs of the organization and is based on a very diversified portfolio with a conservative balance of various asset class exposures. As a result, the portfolio is designed to provide an attractive return over time, but also to meet liquidity requirements as needed over a range of operating environments. We have also found that this approach has served as a good complement and diversifier for the organization as a whole.
Trusted Insight: What trends are occurring within the investment industry world that are impacting how you invest right now?
Mike Odlum: There are many risks out there that worry investors.
One issue relates to the impact of rising interest rates. If rates were to rise precipitously, the concern is what effect would this have on the value of portfolio? How should an institutional investor position the portfolio for this? It’s difficult to totally protect a fixed income portfolio, but an investor can make adjustments such as to reducing duration, adding to positions in floating rates, taking on measured credit exposures to provide a reasonable yield and employing other diversifying strategies. It is also important to maintain an appropriate long-term perspective and to remember the diversification value of having bonds as part of the portfolio.
The second is how to allocate globally given the geopolitical and currency risks. We maintain approximate strategic market weightings across global equity markets with a modest overweight to domestic equities. We do not employ currency overlay strategies and rely mostly on traditional diversification to help balance currency exposures, as well as allow managers some discretion to selectively hedge positions.
We are realists and know there are always risks and volatility in the markets. We positon the portfolio with reasonable diversification and shock test to protect the portfolio even in times of low probability market swings.
For a health system portfolio a key objective is to maintain a good level of liquidity, traditionally measured in terms of days cash on hand. We set the risk tolerance, test allocations against extraordinary volatility and position accordingly to protect liquidity of the portfolio.
We look at specific hedging tactics, but have generally found these to be expensive and potentially missing the mark in protecting against a broad set of scenarios, and in some cases potentially adding unintended risk. Relying on broad diversification is a traditional approach that may not sound very exciting, but over time it works pretty well. We like the idea of investing in equities and that if you can find the right managers who can add value by investing in the right businesses, we can generate capital growth in the portfolio over the long run. This approach has been a successful one for us over the years.
Trusted Insight: What role do you see hospital investment offices playing in the broader institutional investing universe over the next decade?
Mike Odlum: I believe we will become a bigger player as the industry continues to grow. Northwell Health has emerged as one of the largest health systems in the country, and as health systems continue to consolidate we will see these pools of invested assets also grow.
To learn more about health care investing, click here to view the complete list of 2017 Top 30 Hospital Investment Officers. You can view our full catalogue of interviews with institutional investors here.