Jonathan Grabel is the chief investment officer at Public Employees Retirement Association of New Mexico managing a pension fund with $14.5 billion assets under management. Previously, he was the chief investment officer at Montgomery County Public Schools. Grabel graduated from the University of Chicago, Booth School of Business with an MBA in Finance and graduated from the University of Pennsylvania, The Wharton School with a B.S. in Economics.
Mr. Grabel was recently named to Trusted Insight’s ranked list of the Top 30 Pension Chief Investment Officers. He graciously spoke with Trusted Insight on January 22, 2016. The following interview has been edited and condensed for clarity.
Trusted Insight: Tell me about your investment team's structure and team dynamic.
Jonathan Grabel: When I arrived at New Mexico, our team was very traditionally structured. We had people focused on traditional assets, hedge funds, private equity, real estate. We've changed the structure of the team here in a variety of ways.
Firstly, we are taking an orthogonal approach to looking at asset categories. I do not subscribe to the traditional versus alternatives view of investments. I think that there are three main asset categories: equities, fixed income and real assets. You can further divide those categories into liquid and illiquid structures, and there may be further wrinkles depending on whether a mandate is long-only or long-short.
Within that context, we changed the structure of the team here. For example, our head of equities used to be focused on traditional long-only equities, she now oversees our entire global equity portfolio -- long-only equities, hedged equity and private equity. We apply the same philosophy to fixed income and credit. Consequently, we focus on the predominant risk factor associated with the major asset categories, as opposed to the wrapper or vehicle in which an investment product resides. Fundamentally, the equity risk premium or equity beta is the main driver of equity returns. The underlying portfolio construct, be it low volatility, hedge or illiquid, is a second order determinant of returns.
We also apply this philosophy more generally by having an asset allocation portfolio manager who looks across all of our strategies, and makes sure we are not working at cross-purposes. For example, if one manager is overweight a position, another is short that same position and we are paying active manager fees for both, then we sub-optimize at the portfolio level. These are the type of pitfalls we look to avoid. In addition, our asset allocation portfolio manager helps facilitate knowledge sharing across asset categories. Our high-yield and direct-lending portfolios are relevant as we discuss private equity -- are there are connections between the strategies?
Secondly, we have also created a risk manager position, and beneath that we’re also building a team focused on risk. Rather than looking at the PERA fund as a pool of separate and distinct managers, we now view as more like a single consolidated pool. We have tightened guidelines for all of our managers. Our risk programs help us to make sure our managers stay within their mandate and do not stray. Toward this end, we focus on more granular data and have security-level view of the portfolio as well as a top-down view. As a former technology investor, I am a big believer in the ability to harness and analyze information. We have much better data than ever before and have a better hold on all our positions across the portfolio, managers and strategies.
In 2014, we did an asset allocation update and, as a result, we reduced our domestic equity exposure by 10%, separated credit from rates and increased some of our allocation in private assets. We subsequently reduced the portfolio beta from over one to under one. The best diversification and risk management is potentially at the asset category level; rather than having a core fixed income portfolio that had 30% in high yield or emerging market debt, that's now a separate portfolio that we manage and benchmark appropriately.
Our team is now much more forward-looking. We try to be proactive, as opposed to reactive. Everyone here has a “do-gooder” instinct, and so we are hyper focused on our mission to provide a pension benefit today and into the future.
Beneath the PM level, we are building out our analyst team. I think we have some great analysts. We have also tried to leverage the skills we have in our investment team and apply that to PERA Smart Save, the 457b plan we manage.
We are really trying to build a better team. We try to educate the team and encourage people to constantly increase their knowledge. We are also encouraging the team to work with each other. Investment knowledge and judgment does not reside in a vacuum. We work together and challenge each other continuously.
Trusted Insight: How do you go about attracting and retaining talent?
Jonathan Grabel: It is very easy to say, “it's hard for us to attract people, we don't pay enough.” That's a cop out. When you look at all-in compensation, including a pension benefit, then the compensation comes up significantly. People that help administer a defined benefit plan certainly understand the the significant value of that “long-term annuity” component.
I think that different careers attract different people. One of the aspects that attracts talented people to pensions is the quality of life. My hours are very different today compared to when I was working in New York in private equity. I think that there's a better work-life balance in an organization like ours. I get to spend more time with my family now than before.
There is also the tremendous sense of accomplishment in the social impact from our work. I feel great every day, because I am making a difference. In addition to helping our members, the team has direct exposure to some of the most prominent investors in the world. The team also has significant portfolio responsibilities. We commit about $1 billion a year to private assets. Last year, with our updated asset allocation, we moved about $6 billion to optimize the portfolio. We also changed custody banks as part of a comprehensive operational review. The learning curve here is incredibly steep. Rather than working your way up an arguably imbalanced career ladder on Wall Street, you have greater investment exposure in an environment like PERA. In conjunction with our board, we can be creative about how we implement our various portfolios all while serving in the best interests of our members.
Finally, I think one of the other things that attracts people to PERA of New Mexico is the geography; we are based in Santa Fe, and it is a pretty special place. I can drive 10 miles from my house and be up in the mountains. It's a recreation paradise here. In addition to the outdoors, there are great people, great food and great art. So, I would add geography as another element in that career choice equation.
Trusted Insight: You began your career in investment banking and private equity. What brought you to the realm of pension investing?
Jonathan Grabel: I spent a better part of 20 years or more working in New York, initially in public accounting, then investment banking, and finally in private equity. The most formative experience I had was the 13 years I spent at Baker Capital, which is a private equity firm focused on technology, media, telecom growth equity investing. Being at Baker during several market cycles and seeing the height of the internet bubble to the depths of the great financial crisis, was truly illustrative in terms of how to invest, what works in different environments and how to identify patterns. I learned that investing is the easiest business in the world, until you lose money. Hopefully you learn not to make the same mistakes over again, and then you truly have the opportunity to become a good investor.
I wanted to take the great experiences I had working in New York with some of the brightest, most successful people I ever come across, and apply that knowledge in a way that would have a bigger impact. Working in public pensions is potentially one of the most impactful ways that somebody can direct their career. At New Mexico, we effect the retirement of thousands of current and future retirees. I remind myself everyday of that responsibility. It is really easy to be a CIO in an up-market environment. It is in a down-market like this where I earn my keep, because our members need a steady hand at the tiller.
Trusted Insight: Pension funds are tasked with providing income for average Americans in retirement. Do you view this responsibility the same as strategically deploying any other large AUM or is there a deeper sense of purpose?
Jonathan Grabel: I think about our mission first. Our mission is to preserve, protect and administer the trust to meet its current and future obligations. That is pretty simple phrasing, but it means that you have to be both passionate and dispassionate, and balance current and future needs.
Unlike a perpetual pool of capital for a handful of individuals, such as a foundation or endowment, where the goal of the payout is in some ways a function of investment earnings. At New Mexico, our liability keeps accruing in a manner that is separate and distinct from our investment performance in any one period. This situation is top of mind. The global capital markets, as of today, are down by about 10% in 2016 while our liability increases at a steady rate.
Consequently, we take maintenance of liquidity very seriously. As a mature pension, we are cash flow negative; member and employer contributions are in the magnitude of $500 million a year, and our benefit payouts are $1 billion a year. We pay out over $80 million plus a month, and so we need to make sure that we have sufficient liquidity for that. We do not want to be in a position where we are forced seller of securities in order to pay benefits.
This forms the guiding principle of how we invest. A lot of other organizations, whether they are a pension, endowment or foundation, think of themselves as investors first. We think ourselves as public servants first, with a very important mission, and we invest in that context.
I think what keeps us focused on our mission is that we have a certain amount of humility and rigorous processes in terms of challenging every assumption, be it at the asset allocation level or within asset categories. This is opposed to arrogantly thinking we can beat any benchmark, or that tactically we know what's going to happen in the markets on any given day.
For example, there are some investors who say they knew that the market was about to go down, and moved all their assets to cash. Nonsense. Moving assets to cash does not mean that person knew what was going to happen in the markets. If someone was truly prescient, they would have gone short or come up with some vehicle that would not dampen losses, but would have gains in any given market environment. This kind of false sense of confidence leads to hindsight bias, where people perceive their investment decisions to be better than they actually are. They may not be necessarily focused on their mission. For us, the long view is what matters. We need to construct and monitor a portfolio that is resilient to meet our current obligations as well as grow in a prudent manner to decrease our long-term liabilities.
Trusted Insight: How have you positioned the portfolio to achieve your required annual return while still maintaining your long-term perspective?
Jonathan Grabel: We start with our mission.
Asset allocation is the biggest driver of how we achieve our mission. We looked at our asset allocation a couple years ago, and we improved diversification of our risks across asset categories. We did a good job. Given the current environment, we have launched a new asset allocation study to challenge, re-challenge and re-challenge again the long-term assumptions we have for different asset categories. First and foremost, we are focusing on the decisions that matter at the asset category level. For example, if you take any of those quilt charts that show the best-returning asset categories over extended periods, there is no pattern for which category is going to out- or under-perform in any given year. The notion that any investor can presage the future is silly. The financial press likes to cover the people that get it right -- what they do not cover is the orders of magnitude more who get it wrong.
The second factor is we want to make sure that our managers adhere to our guidelines. For instance, if a manager with a real estate mandate thinks that they are in a bad asset category and facing significant headwinds, we do not want them to start buying biotechs. We have done a tremendous job of tightening the guidelines and making sure that we allow diversification to work at the portfolio level, as opposed to each manager introducing unintentional tilts. We have reduced manager count, which I think really helps us avoid the portfolio biases and tilts. We have also reduced fees across the portfolio. While that's not the ultimate driver of returns, over the long term it certainly is a headwind, and every dollar counts. If we can get the same or better performance for a lower cost, why wouldn't we do that.
For instance, in our last asset allocation study, we flagged two outliers in terms of our implementation. One was in our core fixed-income portfolio. Specifically, about 30% of the assets were in high yield, emerging market debt and bank loans. We created a new asset category of more opportunistic credit such that our core fixed income truly was core fixed income.
Another example is domestic equity, where we had a small-cap growth bias. We got rid of that, and we are now more market neutral as we do not pretend we have any unique long-term insight into the global capital markets.
In private equity, a large component of our portfolio is private debt. In some sense private debt may be a higher sharp-ratio type of product, and that is good, but does it allow private equity to do what we want it to do at the total fund level? We probably want private debt to do something else. We are looking at the core components of our private assets portfolio, we may create a new bucket for all liquid and illiquid credit strategies. In the process, we will disaggregate our absolute return portfolio, and manage strategies in conjunction with the appropriate risk factor.
If you were doing this interview a year ago, a lot of people would have been talking about the Fed raising rates, and saying “long bonds and core fixed income are terrible, let's get out of it.” We have maintained our exposure to core fixed income. It's helped us in a variety ways. It dampens our drawdowns, but also prevents us to being forced sellers of our equities and our other assets that we think are a better proxy for long-term global growth.
Speaking of buying and selling, in an environment like this it is especially important for us to re-balance. We maintain our rigor and discipline with re-balancing. We try to remain unemotional and stick to our asset allocation. If the asset allocation chosen through modeling and judgment proves not to be the right one, then we can change it after a rigorous process and sufficient debate. Just to change portfolio weights on a whim, I think, creates a less diversified, potentially higher risk and lower sharp-ratio portfolio.
Trusted Insight: What trends have you identified in your time at public pensions?
Jonathan Grabel: Firstly, I think that we incorrectly tend to bifurcate the world between alternatives and traditional. The alternatives world is trillions of dollars and covers all asset categories. Additional risks may include illiquidity, leverage and shorts, but the exposure to various economic drivers are no different from those in more traditional assets. I think that the idea of alternative and traditional assets is an antiquated notion. We need to look at big asset category groups -- equities, credit, rates, real assets -- and then divide it between liquid and illiquid, physical and synthetic, long-only and long/short.
When I hear a lot of people saying that alternatives are our savior, I do not even know what that means. I think there are obviously lots of influences that drive that thinking. You pay more for alternative assets, and as a result you might try to justify it by virtue of attributing greater significance to the higher cost strategy. To some extent, this may be a function of creative marketing.
Secondly, we are also cognizant of the regime shift. We potentially are in an era of rising interest rates, although you are hearing more and more now about low rates for the foreseeable future. Should rates rise, what does that mean across asset categories? We may have money managers in certain asset categories that have never seen a rising interest rate environment. We need to be cognizant of the teams we back and in whom we have placed a tremendous responsibility.
Thirdly, it’s been seven or eight years since the great financial crisis, so there's a new generation of money managers now who may have never lost money. As I say, investing is the easiest business in the world until you lose money. I think there is a lot of bravado out there. A lot of that confidence comes from people that are highly compensated and who are very bright. However, you have to question whether their success is a function of having their compensation tied to a great beta, as opposed to truly delivering alpha.
I think that many institutional asset owners view their money managers as the star. I view the star as the PERA portfolio as a whole. I think we spend too much time trying to achieve alpha. I think alpha is an ephemeral -- it is a zero-sum game. If we are fortunate enough to have some alpha at certain points in time, that's great, but I would much rather have a portfolio where we have the best betas and focus on things limiting our downside. That may mean sacrificing some of the upside, but I think that really helps us position our portfolio for the long term. The worst thing in the world to do is take unnecessary risks in any given market environment.
Trusted Insight: What would you say is the biggest challenge of investing that's unique to public pensions?
Jonathan Grabel: When we look at public pensions, I think it has to be a combination of both the asset side and the liability side. We cannot just focus on investment returns, regardless of the risk. We have to combine looking at assets, looking at liability and balancing the need for short-term liquidity and safety with generating long-term investment returns. Unfortunately, these are often viewed as separate conversations, which is a challenge.
There is also a huge money management industry out there that generates a lot of fees from public pensions. I think we tend to focus too much on money managers and the “in” investment strategy. Failure to focus on the whole portfolio results in diversification in name only and poor asset allocation. I also think there is too much focus on returns, and not the quality of the returns through risk metrics. When we just talk about returns, it leads to a one-dimensional conversation about public pension funds.
Trusted Insight: Part of pension investing is helping out the constituency. To what degree do you tell them that it's not all about generating excess returns, it’s about mitigating risk?
Jonathan Grabel: We have a member-elected board, and we meet monthly to discuss the portfolio. I think like any good organization we're trying to continually evolve our process to focus on the issues that matter most. We're frequently asked by our legislature, which is an even larger representative group within the state here, to present information and answer questions. Our meetings here at PERA are streamed online so people can listen. I have started putting viewpoints on our website to be responsive to questions that come from our various stakeholders.
Something that I am really excited about is we are increasing our investment-related member outreach. New Mexico is a huge state in terms of geography, it's 120 thousand square miles. We’ve started having intimate town hall-type forums for our members to ask investment-related questions. This is in addition to the seminars held throughout the state by our outreach bureau that helps our members prepare for retirement. At the end of the day, there are a hundred thousand PERA members, and I have a duty to answer their questions.
Trusted Insight: What is PERA doing to foster the next generation of institutional investors?
Jonathan Grabel: We are working with the CFA Society here in New Mexico. We invited the Anderson School, which is the MBA program at the University of New Mexico, to PERA to have an open house for about 15 or so MBA students to shadow the PERA investment division for the day. We'll have meetings scheduled with prospective and current money managers, calls with custody bank, a focus on how we manage our cash and our liquidity programs and various risk analyses. We will have different sessions throughout the day to increase exposure to that next generation to what we are doing here. If this is successful, we will have days for other universities here in the state.
Trusted Insight: What is the number one lesson you have learned in your career as an institutional investor?
Jonathan Grabel: As I have mentioned, investing is very easy until you lose money. I think having a rigorous process is important. Before you make an investment, you will never know whether it will turn out to be good, bad or indifferent. The one thing you do know is whether you had a good process to identify it. When I was a private equity investor we started with various investment themes and would narrow it down to a sector, business model, stage of development, management team characteristics, geography, revenue, financing history, etc. In a public pension, the process has to be as rigorous. We start with asset allocation and move to a sub allocation to strategy types to a manager. We have to evaluate geography and currencies, active versus passive, liquid versus illiquid, long versus long/short and physical versus synthetic. We also have to evaluate the money management organization, its structure, operations, history, performance and breadth of products. This process, be it for a private equity investor or a public pension, can get better and better. As the investment process becomes more comprehensive, the ultimate chance of success increases. When you do not have a good outcome, a good process is useful tool to identify the causes that impaired performance. Otherwise it's hard to judge a manager and your organization if both are drifting and there are few constants.
To learn more about the the Top 30 Pension Fund Chief Investment Officers, click here.
Mr. Grabel was recently named to Trusted Insight’s ranked list of the Top 30 Pension Chief Investment Officers. He graciously spoke with Trusted Insight on January 22, 2016. The following interview has been edited and condensed for clarity.
Trusted Insight: Tell me about your investment team's structure and team dynamic.
Jonathan Grabel: When I arrived at New Mexico, our team was very traditionally structured. We had people focused on traditional assets, hedge funds, private equity, real estate. We've changed the structure of the team here in a variety of ways.
Firstly, we are taking an orthogonal approach to looking at asset categories. I do not subscribe to the traditional versus alternatives view of investments. I think that there are three main asset categories: equities, fixed income and real assets. You can further divide those categories into liquid and illiquid structures, and there may be further wrinkles depending on whether a mandate is long-only or long-short.
Within that context, we changed the structure of the team here. For example, our head of equities used to be focused on traditional long-only equities, she now oversees our entire global equity portfolio -- long-only equities, hedged equity and private equity. We apply the same philosophy to fixed income and credit. Consequently, we focus on the predominant risk factor associated with the major asset categories, as opposed to the wrapper or vehicle in which an investment product resides. Fundamentally, the equity risk premium or equity beta is the main driver of equity returns. The underlying portfolio construct, be it low volatility, hedge or illiquid, is a second order determinant of returns.
We also apply this philosophy more generally by having an asset allocation portfolio manager who looks across all of our strategies, and makes sure we are not working at cross-purposes. For example, if one manager is overweight a position, another is short that same position and we are paying active manager fees for both, then we sub-optimize at the portfolio level. These are the type of pitfalls we look to avoid. In addition, our asset allocation portfolio manager helps facilitate knowledge sharing across asset categories. Our high-yield and direct-lending portfolios are relevant as we discuss private equity -- are there are connections between the strategies?
Secondly, we have also created a risk manager position, and beneath that we’re also building a team focused on risk. Rather than looking at the PERA fund as a pool of separate and distinct managers, we now view as more like a single consolidated pool. We have tightened guidelines for all of our managers. Our risk programs help us to make sure our managers stay within their mandate and do not stray. Toward this end, we focus on more granular data and have security-level view of the portfolio as well as a top-down view. As a former technology investor, I am a big believer in the ability to harness and analyze information. We have much better data than ever before and have a better hold on all our positions across the portfolio, managers and strategies.
In 2014, we did an asset allocation update and, as a result, we reduced our domestic equity exposure by 10%, separated credit from rates and increased some of our allocation in private assets. We subsequently reduced the portfolio beta from over one to under one. The best diversification and risk management is potentially at the asset category level; rather than having a core fixed income portfolio that had 30% in high yield or emerging market debt, that's now a separate portfolio that we manage and benchmark appropriately.
Our team is now much more forward-looking. We try to be proactive, as opposed to reactive. Everyone here has a “do-gooder” instinct, and so we are hyper focused on our mission to provide a pension benefit today and into the future.
Beneath the PM level, we are building out our analyst team. I think we have some great analysts. We have also tried to leverage the skills we have in our investment team and apply that to PERA Smart Save, the 457b plan we manage.
We are really trying to build a better team. We try to educate the team and encourage people to constantly increase their knowledge. We are also encouraging the team to work with each other. Investment knowledge and judgment does not reside in a vacuum. We work together and challenge each other continuously.
Trusted Insight: How do you go about attracting and retaining talent?
Jonathan Grabel: It is very easy to say, “it's hard for us to attract people, we don't pay enough.” That's a cop out. When you look at all-in compensation, including a pension benefit, then the compensation comes up significantly. People that help administer a defined benefit plan certainly understand the the significant value of that “long-term annuity” component.
I think that different careers attract different people. One of the aspects that attracts talented people to pensions is the quality of life. My hours are very different today compared to when I was working in New York in private equity. I think that there's a better work-life balance in an organization like ours. I get to spend more time with my family now than before.
There is also the tremendous sense of accomplishment in the social impact from our work. I feel great every day, because I am making a difference. In addition to helping our members, the team has direct exposure to some of the most prominent investors in the world. The team also has significant portfolio responsibilities. We commit about $1 billion a year to private assets. Last year, with our updated asset allocation, we moved about $6 billion to optimize the portfolio. We also changed custody banks as part of a comprehensive operational review. The learning curve here is incredibly steep. Rather than working your way up an arguably imbalanced career ladder on Wall Street, you have greater investment exposure in an environment like PERA. In conjunction with our board, we can be creative about how we implement our various portfolios all while serving in the best interests of our members.
Finally, I think one of the other things that attracts people to PERA of New Mexico is the geography; we are based in Santa Fe, and it is a pretty special place. I can drive 10 miles from my house and be up in the mountains. It's a recreation paradise here. In addition to the outdoors, there are great people, great food and great art. So, I would add geography as another element in that career choice equation.
Trusted Insight: You began your career in investment banking and private equity. What brought you to the realm of pension investing?
Jonathan Grabel: I spent a better part of 20 years or more working in New York, initially in public accounting, then investment banking, and finally in private equity. The most formative experience I had was the 13 years I spent at Baker Capital, which is a private equity firm focused on technology, media, telecom growth equity investing. Being at Baker during several market cycles and seeing the height of the internet bubble to the depths of the great financial crisis, was truly illustrative in terms of how to invest, what works in different environments and how to identify patterns. I learned that investing is the easiest business in the world, until you lose money. Hopefully you learn not to make the same mistakes over again, and then you truly have the opportunity to become a good investor.
I wanted to take the great experiences I had working in New York with some of the brightest, most successful people I ever come across, and apply that knowledge in a way that would have a bigger impact. Working in public pensions is potentially one of the most impactful ways that somebody can direct their career. At New Mexico, we effect the retirement of thousands of current and future retirees. I remind myself everyday of that responsibility. It is really easy to be a CIO in an up-market environment. It is in a down-market like this where I earn my keep, because our members need a steady hand at the tiller.
Trusted Insight: Pension funds are tasked with providing income for average Americans in retirement. Do you view this responsibility the same as strategically deploying any other large AUM or is there a deeper sense of purpose?
Jonathan Grabel: I think about our mission first. Our mission is to preserve, protect and administer the trust to meet its current and future obligations. That is pretty simple phrasing, but it means that you have to be both passionate and dispassionate, and balance current and future needs.
Unlike a perpetual pool of capital for a handful of individuals, such as a foundation or endowment, where the goal of the payout is in some ways a function of investment earnings. At New Mexico, our liability keeps accruing in a manner that is separate and distinct from our investment performance in any one period. This situation is top of mind. The global capital markets, as of today, are down by about 10% in 2016 while our liability increases at a steady rate.
Consequently, we take maintenance of liquidity very seriously. As a mature pension, we are cash flow negative; member and employer contributions are in the magnitude of $500 million a year, and our benefit payouts are $1 billion a year. We pay out over $80 million plus a month, and so we need to make sure that we have sufficient liquidity for that. We do not want to be in a position where we are forced seller of securities in order to pay benefits.
This forms the guiding principle of how we invest. A lot of other organizations, whether they are a pension, endowment or foundation, think of themselves as investors first. We think ourselves as public servants first, with a very important mission, and we invest in that context.
I think what keeps us focused on our mission is that we have a certain amount of humility and rigorous processes in terms of challenging every assumption, be it at the asset allocation level or within asset categories. This is opposed to arrogantly thinking we can beat any benchmark, or that tactically we know what's going to happen in the markets on any given day.
For example, there are some investors who say they knew that the market was about to go down, and moved all their assets to cash. Nonsense. Moving assets to cash does not mean that person knew what was going to happen in the markets. If someone was truly prescient, they would have gone short or come up with some vehicle that would not dampen losses, but would have gains in any given market environment. This kind of false sense of confidence leads to hindsight bias, where people perceive their investment decisions to be better than they actually are. They may not be necessarily focused on their mission. For us, the long view is what matters. We need to construct and monitor a portfolio that is resilient to meet our current obligations as well as grow in a prudent manner to decrease our long-term liabilities.
Trusted Insight: How have you positioned the portfolio to achieve your required annual return while still maintaining your long-term perspective?
Jonathan Grabel: We start with our mission.
Asset allocation is the biggest driver of how we achieve our mission. We looked at our asset allocation a couple years ago, and we improved diversification of our risks across asset categories. We did a good job. Given the current environment, we have launched a new asset allocation study to challenge, re-challenge and re-challenge again the long-term assumptions we have for different asset categories. First and foremost, we are focusing on the decisions that matter at the asset category level. For example, if you take any of those quilt charts that show the best-returning asset categories over extended periods, there is no pattern for which category is going to out- or under-perform in any given year. The notion that any investor can presage the future is silly. The financial press likes to cover the people that get it right -- what they do not cover is the orders of magnitude more who get it wrong.
The second factor is we want to make sure that our managers adhere to our guidelines. For instance, if a manager with a real estate mandate thinks that they are in a bad asset category and facing significant headwinds, we do not want them to start buying biotechs. We have done a tremendous job of tightening the guidelines and making sure that we allow diversification to work at the portfolio level, as opposed to each manager introducing unintentional tilts. We have reduced manager count, which I think really helps us avoid the portfolio biases and tilts. We have also reduced fees across the portfolio. While that's not the ultimate driver of returns, over the long term it certainly is a headwind, and every dollar counts. If we can get the same or better performance for a lower cost, why wouldn't we do that.
For instance, in our last asset allocation study, we flagged two outliers in terms of our implementation. One was in our core fixed-income portfolio. Specifically, about 30% of the assets were in high yield, emerging market debt and bank loans. We created a new asset category of more opportunistic credit such that our core fixed income truly was core fixed income.
Another example is domestic equity, where we had a small-cap growth bias. We got rid of that, and we are now more market neutral as we do not pretend we have any unique long-term insight into the global capital markets.
In private equity, a large component of our portfolio is private debt. In some sense private debt may be a higher sharp-ratio type of product, and that is good, but does it allow private equity to do what we want it to do at the total fund level? We probably want private debt to do something else. We are looking at the core components of our private assets portfolio, we may create a new bucket for all liquid and illiquid credit strategies. In the process, we will disaggregate our absolute return portfolio, and manage strategies in conjunction with the appropriate risk factor.
If you were doing this interview a year ago, a lot of people would have been talking about the Fed raising rates, and saying “long bonds and core fixed income are terrible, let's get out of it.” We have maintained our exposure to core fixed income. It's helped us in a variety ways. It dampens our drawdowns, but also prevents us to being forced sellers of our equities and our other assets that we think are a better proxy for long-term global growth.
Speaking of buying and selling, in an environment like this it is especially important for us to re-balance. We maintain our rigor and discipline with re-balancing. We try to remain unemotional and stick to our asset allocation. If the asset allocation chosen through modeling and judgment proves not to be the right one, then we can change it after a rigorous process and sufficient debate. Just to change portfolio weights on a whim, I think, creates a less diversified, potentially higher risk and lower sharp-ratio portfolio.
Trusted Insight: What trends have you identified in your time at public pensions?
Jonathan Grabel: Firstly, I think that we incorrectly tend to bifurcate the world between alternatives and traditional. The alternatives world is trillions of dollars and covers all asset categories. Additional risks may include illiquidity, leverage and shorts, but the exposure to various economic drivers are no different from those in more traditional assets. I think that the idea of alternative and traditional assets is an antiquated notion. We need to look at big asset category groups -- equities, credit, rates, real assets -- and then divide it between liquid and illiquid, physical and synthetic, long-only and long/short.
When I hear a lot of people saying that alternatives are our savior, I do not even know what that means. I think there are obviously lots of influences that drive that thinking. You pay more for alternative assets, and as a result you might try to justify it by virtue of attributing greater significance to the higher cost strategy. To some extent, this may be a function of creative marketing.
Secondly, we are also cognizant of the regime shift. We potentially are in an era of rising interest rates, although you are hearing more and more now about low rates for the foreseeable future. Should rates rise, what does that mean across asset categories? We may have money managers in certain asset categories that have never seen a rising interest rate environment. We need to be cognizant of the teams we back and in whom we have placed a tremendous responsibility.
Thirdly, it’s been seven or eight years since the great financial crisis, so there's a new generation of money managers now who may have never lost money. As I say, investing is the easiest business in the world until you lose money. I think there is a lot of bravado out there. A lot of that confidence comes from people that are highly compensated and who are very bright. However, you have to question whether their success is a function of having their compensation tied to a great beta, as opposed to truly delivering alpha.
I think that many institutional asset owners view their money managers as the star. I view the star as the PERA portfolio as a whole. I think we spend too much time trying to achieve alpha. I think alpha is an ephemeral -- it is a zero-sum game. If we are fortunate enough to have some alpha at certain points in time, that's great, but I would much rather have a portfolio where we have the best betas and focus on things limiting our downside. That may mean sacrificing some of the upside, but I think that really helps us position our portfolio for the long term. The worst thing in the world to do is take unnecessary risks in any given market environment.
Trusted Insight: What would you say is the biggest challenge of investing that's unique to public pensions?
Jonathan Grabel: When we look at public pensions, I think it has to be a combination of both the asset side and the liability side. We cannot just focus on investment returns, regardless of the risk. We have to combine looking at assets, looking at liability and balancing the need for short-term liquidity and safety with generating long-term investment returns. Unfortunately, these are often viewed as separate conversations, which is a challenge.
There is also a huge money management industry out there that generates a lot of fees from public pensions. I think we tend to focus too much on money managers and the “in” investment strategy. Failure to focus on the whole portfolio results in diversification in name only and poor asset allocation. I also think there is too much focus on returns, and not the quality of the returns through risk metrics. When we just talk about returns, it leads to a one-dimensional conversation about public pension funds.
Trusted Insight: Part of pension investing is helping out the constituency. To what degree do you tell them that it's not all about generating excess returns, it’s about mitigating risk?
Jonathan Grabel: We have a member-elected board, and we meet monthly to discuss the portfolio. I think like any good organization we're trying to continually evolve our process to focus on the issues that matter most. We're frequently asked by our legislature, which is an even larger representative group within the state here, to present information and answer questions. Our meetings here at PERA are streamed online so people can listen. I have started putting viewpoints on our website to be responsive to questions that come from our various stakeholders.
Something that I am really excited about is we are increasing our investment-related member outreach. New Mexico is a huge state in terms of geography, it's 120 thousand square miles. We’ve started having intimate town hall-type forums for our members to ask investment-related questions. This is in addition to the seminars held throughout the state by our outreach bureau that helps our members prepare for retirement. At the end of the day, there are a hundred thousand PERA members, and I have a duty to answer their questions.
Trusted Insight: What is PERA doing to foster the next generation of institutional investors?
Jonathan Grabel: We are working with the CFA Society here in New Mexico. We invited the Anderson School, which is the MBA program at the University of New Mexico, to PERA to have an open house for about 15 or so MBA students to shadow the PERA investment division for the day. We'll have meetings scheduled with prospective and current money managers, calls with custody bank, a focus on how we manage our cash and our liquidity programs and various risk analyses. We will have different sessions throughout the day to increase exposure to that next generation to what we are doing here. If this is successful, we will have days for other universities here in the state.
Trusted Insight: What is the number one lesson you have learned in your career as an institutional investor?
Jonathan Grabel: As I have mentioned, investing is very easy until you lose money. I think having a rigorous process is important. Before you make an investment, you will never know whether it will turn out to be good, bad or indifferent. The one thing you do know is whether you had a good process to identify it. When I was a private equity investor we started with various investment themes and would narrow it down to a sector, business model, stage of development, management team characteristics, geography, revenue, financing history, etc. In a public pension, the process has to be as rigorous. We start with asset allocation and move to a sub allocation to strategy types to a manager. We have to evaluate geography and currencies, active versus passive, liquid versus illiquid, long versus long/short and physical versus synthetic. We also have to evaluate the money management organization, its structure, operations, history, performance and breadth of products. This process, be it for a private equity investor or a public pension, can get better and better. As the investment process becomes more comprehensive, the ultimate chance of success increases. When you do not have a good outcome, a good process is useful tool to identify the causes that impaired performance. Otherwise it's hard to judge a manager and your organization if both are drifting and there are few constants.
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