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Exclusive Q&A: Michael Trotsky, CIO & Executive Director Of Massachusetts Pension Reserves Investment Management Board

by trusted insight posted 2years ago 3759 views
Michael Trotsky, CFA, is the executive director and chief investment officer of the Massachusetts Pension Reserves Investment Management (PRIM) Board, a pension fund with $62 billion assets under management. Trotsky's work at PRIM was preceded by a 25-year career in the private sector, most recently as SVP and portfolio manager at PAR Capital Management. Trotsky received a BS in electrical engineering from the University of Pennsylvania and an MBA from the University of Pennsylvania, Wharton School.

Mr. Trotsky 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 Jan. 21, 2016. The following interview has been edited and condensed for clarity.

Trusted Insight: Let’s begin by talking about your educational history. You hold a BS in electrical engineering and an MBA from the University of Pennsylvania. I'm sure your MBA has greatly informed your investment philosophy, but I'm always interested to understand how other areas of study factor into your overall investment thesis. Can you describe your investment philosophy, and how your educational background, particularly the electrical engineering degree, has come to inform that?

Michael Trotsky: There's a number of ways that it affects what we do here. I was an electrical engineer. I worked for Intel Corporation for more than six years. I'm very comfortable with quantitative analysis and math in general. Then I went back for an MBA basically to learn things I didn't learn in undergraduate school such as finance and accounting and marketing and all the business-related things that I never had a formal education in. Of course, that's very helpful. Then on top of that, I'd say pursuing the CFA designation after the MBA was icing on the cake, because I'd added fixed income in particular and then reinforced a lot of the same curriculum and filled in the gaps from my MBA studies. 

How it affects our process and philosophy? I'd say the one thing people have remarked about PRIM since I've been here for the last five years is that we're bringing on to our staff more experienced money managers and people who have actually sat on the other side and run money as I have. I've also been very comfortable in bringing in more quantitative skills. The hallmark of that is when I first got here we brought in the Barra One Risk Management System, which I think is unique in the country in terms of how we use it. We're really on the forefront of doing that and hired people who were quantitative in nature. Number one, it allows us to model what the portfolio looks like, and how it might behave. Number two, it's a spyglass into how our managers, in particular, behave. Number three, it helps us identify skillful managers. 
    
That kind of highlights my background educationally. As a money manager, I worked for both quantitative and fundamental firms, and I try to bring the best of both to bear. I want to be careful to make sure that you don't think that we're 100% quantitative, because in my career I've also noticed the dangers of being too bound by models, and we're not that way. We use risk modeling in our quantitative techniques to inform our investment decisions, not drive them. 

TI: You alluded to this, but you've had a variety of work experiences in the past. What brought you to the realm of pension investing as opposed to any other type of institutional investing?

MT:  I was always very focused on finance. I love the investment business. In fact, I often joke that even in my undergraduate application to Penn in which I applied to the Engineering School, I wrote that I wanted to get an MBA after that. That particular background, working for Intel, made it possible for me to become a very effective equity analyst covering technology industries. I did that when I first started in the investment business. I went up the ranks and became a portfolio manager and eventually a partner. Then I helped found a hedge fund in partnership with Summit Partners, a local venture capital firm.  So I have hedge fund experience. I have long-only equity experience. I have trading experience. I have experience running my own sleeve of assets. 
    
Moving into the pension world was intellectually very challenging. It was attractive to me because it has given me the ability to learn a lot about other asset classes I didn't have exposure to. PRIM has $60 billion AUM, and we're in just about everything. We're in private equity, direct real estate, timberland, private debt, distressed debt; we're in all sorts of different kinds of fixed income, which I really didn't have huge exposure to prior to coming to PRIM.

So number one, intellectually, it's been very, very stimulating. Number two, it's given me the chance to manage people. I've never run an organization this large before. I always thought I'd be good at it. It's one of the things when I tell my friends and other colleagues, it's one of my favorite parts of the job.  Many people don’t like managing people, but I really like it.    

I entered this job in the aftermath of the world financial crisis. The hedge fund where I was working – it still exists and is one of the most successful hedge funds in the world – had a bad year. We were down about 30%. My particular portfolio was down about 25%. I was looking at a multi-year comeback in order to make money again at that hedge fund. You know how those work – you have to earn back everything you lose before you start making money again.  At about the same time, the state of Massachusetts approached me. At first I said, “No, I'm not interested yet.” Then as the world financial crisis grew into more of a crisis, I became interested in trying to give something back. Massachusetts needed help. I thought I could offer help. 

We have to kind of turn the clock back. It seems like a long time ago, but at that point, we had just elected a new president, Barack Obama, and financial services were really not trusted -- they still aren't trusted very much. Frankly, I got wrapped up in that, and I thought it would be an interesting opportunity to expand my career and at the same time try to give something back. That's how I got into this.

TI: That segues nicely into my next question. Unlike most other types of institutional investing, pension funds aren't tasked with perpetuating the wealth of a small handful of high-network individuals. Instead you're managing a huge pool of money comprised of, let's say, average American's wages, who are more than likely not particularly wealthy. Is that a burden to bear, is that a righteous cause, or is it the same as managing any other large AUM that needs to be deployed strategically?

MT: I think it's a dynamic that makes this job even more interesting and more important. PRIM is unique in this regard in that we have two captive clients, the State employees and the State teachers. Then each municipality in Massachusetts, and there are more than 300 of them, can decide to invest in PRIM or not invest in PRIM. I actually do a lot of client-facing work where I'm on the road, probably once a week on average, meeting local municipal retirement boards and agencies. Many of these are composed of just the type of employee or retiree you mentioned. 

I love it. I really thrive on it. I think it's important. I try to do a good job for them. It makes one aspect of the job very fulfilling. That's very different in Massachusetts than in other states. I think that with 351 towns and cities in Massachusetts, there's plenty of opportunity to meet the people whose lives I affect. That makes it fulfilling, honestly.

TI: Tell me about your investment team? What's the structure, what's the team dynamic and how might your team differ from peer institutions?

MT: During the past five years we've been really successful in rebuilding the investment team, which in the aftermath of the world financial crisis, was really decimated. It was down 11 employees, nine key employees, and it was the result of a compensation philosophy and plan that was constantly in flux and not well supported.
 
For the first few years of my tenure here we addressed that. The board passed a plan, which allowed me to recruit some really incredible people. Not unlike other plans, we're divided by asset class. I have a head of public markets; a head of private equity; a head of real estate and timberland; a hedge fund director, I call him hedge fund and low volatility strategies director; and a director of risk management. Those are my direct reports on the investment side. 

The kinds of people that I've been able to attract I think are very differentiated from what I've seen around the country. Many of them have direct money management experience. One of them is a PhD in Finance from Harvard. He's also a professor at Brandeis business school, and he ran money for large firms here in Boston. 

How am I able to attract them? Well, I can't pay them Wall Street rates, but the work here is very, very interesting. There's a lot of responsibility. I give my direct reports a lot of autonomy. They can learn other asset classes. That's been a thrust for us for the past year is to allow people in any one silo to contribute to other silos. 
    
Just last year we implemented a professional development program where very high-performing employees can rotate to other investment teams. Sarah Samuels, the deputy CIO here who runs public markets, has been spending the past five months on the private equity team. This is the kind of thing that I hope, and so far so good, makes the job more interesting to people, even though I may not be able to pay them what the private sector pays. 

TI: Great, you answered my next question, “How do you retain and attract new talent?”

MT: There's more on that, too. With regard to the director of hedge funds that I alluded to, I'm flexible. He's a professor and, if he needs to leave at three o'clock to go teach his class, I've allowed him to do that.
 
Regarding our efforts to recruit women, we recently expanded our parental leave program substantially. It was four weeks. It's now 12 weeks paid parental leave. We're trying to think of everything to make PRIM a good lifestyle choice as well.

TI: Let's change gears. Right now is a particularly tough time to be an investor both on the public and private side. To what degree are you concerned and/or reacting to near-term market volatility?

MT: That’s an important issue, this is a good week to be talking about this, because we just had our investment committee meeting on Tuesday [January 19, 2016] in preparation for the Board meeting in two weeks [February 2, 2016].
 
Obviously, we're concerned about the global slowdown, and we feel fortunate and timely in that for the past four years we've been preparing for this slowdown. We feel that we have been ahead of the curve. There are really three major things we've done to prepare for this equity downturn. 

Number one, we brought our global equity exposure to 40% from 49%. That's helped us through this. 

Number two, we've added long-duration Treasuries to our core fixed-income portfolio. We were 100% Barclay's Agg. We moved in December 2013, so for all of 2014, we moved to 100% long-duration Treasury STRIPS in that portfolio, away from the Barclay's Agg. That was the single-best performing asset class in 2014. Now we're 50% Barclay's Agg and 50% long-duration Treasuries. The long-duration Treasuries, we believe, are the best insurance policy against a declining equity market, and we arrived at that decision through a long study where we looked at very sophisticated tail risk hedging strategies using options and derivatives and other things. We landed on long-duration Treasuries as the most liquid, the efficient and the most cost effective to deploy, and in most times, Treasuries are negatively correlated to equities. That's number two: long-duration Treasury exposure.
    
Number three, Eric Nierenberg on the hedge fund team is also in charge of low-volatility strategies. We created a 4% position in a new strategic bucket that we call portfolio completion strategies. The mission of that strategy is to identify investment strategies uncorrelated to equities. We've identified and started to fund two strategies in that regard. The first is an alternative beta strategy. We have $1.5B deployed in it already. It's been doing well, and it’s behaving well through this downturn. The second that we're beginning to talk about is agriculture. It's not dissimilar to timberland, which has held up well through this downturn, but we're expanding into a specific type of agriculture, mainly permanent crops. 
    
TI: What geographies and sectors are you looking for sustained growth in 2016 and beyond?

MT: I'd rather not comment on any particular geographies. We’re exposed to the U.S. economy, we're exposed to developed international markets, and we're still exposed to emerging markets. 

There was a lot of discussion at the investment committee meeting this week about emerging markets. We have a 6% equity position in emerging markets. We're aware and concerned that the dollar-denominated debt levels in emerging markets has risen through this cycle. We view it as a potential problem that we're paying close attention to. Like I said, we've been preparing for this downturn for quite some time. In fact, we did reduce our emerging markets equity exposure. 

The comforting part of this otherwise difficult week for the markets is that we feel we've been ahead of the curve as much as we can be, at least for now, and the decision we’ve made is we're standing pat. We have decided that we're not making any strategic allocation changes because we've already done what we think we need to do. 

TI: What trends have you identified in your time at public pensions?

MT: The number one trend that is very interesting, and a lot has been written on this: there has been a resurgence of what the industry has called fiduciary capitalism. I think we're a great example of it. The asset owners like pension funds and endowments are beginning to develop staffs and investment capabilities that are impressive. You're starting to see more and more investment decisions being driven within pension funds rather than marching to the recommendations of outside agents and consultants. 

Pension funds are starting to attract talent, and be innovative as an industry. I think that's a major change in the last five years. I think it's really exciting to be on this side. 

TI: What's the catalyst for that change?

MT: I'm not sure. The media reports very often on the fee structure of the agents in this industry. A lot of people make a lot of money. I think that is one potential reason why it's changing.

We launched Project SAVE [Strategic Analysis for Value Enhancement] two-and-a-half years ago, which was a systematic approach to look at our cost structure and also to try to identify value-enhancing activities. We identified and implemented more than $120 million in annual enhancements and cost reductions, which is not insignificant. It's on a total budget of $350 million.
    
For example, the largest component of that was transitioning away from a hedge fund of funds model, where there are two layers of fees, to a direct model. This eliminates one layer of fees, which run around 85 basis points. In order to do that, you need to hire talent within, and that's when we hired internal talent to develop our direct hedge fund program. Fees are one aspect of it. 

TI: What’s been your biggest challenge at PRIM so far?

MT: My biggest challenge has been to change the culture here at PRIM by not only attracting intellectually curious and talented people, but really trying to shake up the culture and look at new ways of doing things. Project SAVE was a good example, adding risk management was another. That's just the tip of the iceberg. We rely far less on consultants to drive our investment decisions here now than we used to, and we're developing our own tools, our own screening, trying to hire people with analytical skills to determine for ourselves what and who we want to hire. 
    
You know, that's not an easy thing to accomplish in any organization, and it's particularly so in government, where it really requires a wholesale change in culture. To be honest with you, it's taken a lot of time. I think we're finally there with a staff who behaves this way, and the cross pollination of ideas and everything that I've mentioned so far today doesn't come easy. Some people feel threatened by it. Some people don't thrive in that environment, but that's a management thing. That's very difficult and extremely important. I'm proud of that, and I think we're marching in right direction. It makes people want to come here.

TI: What makes PRIM unique?

MI: There's actually two things unique to PRIM. Number one, unlike many PPF’s, we're focused solely on investments. We don't do any of the benefit administration side of things. That's a great luxury to me. I don't want to touch the benefits side. It's so often a distraction to investment organizations and can be very political. 

Number two, a key aspect aside from everything we just went through is our governance is very different from what I've seen from other states. It's different in how broad and diverse it is. There are nine people on our board. The Treasurer, who is an elected official, is the chair, and she has one appointment. The Governor has three appointments, and the remaining four are actually members of the beneficiaries – state retirees and state teachers. They care deeply about running a professional organization. It's a very balanced board with no one entity controlling the agenda; any Board Member with a good idea has to get 4 other votes.  It makes for a very stable and productive organization. It doesn't change on any one election.

TI: One of Trusted Insight’s goals is to help foster the next generation of CIOs. What is the number one lesson you’ve learned in your career that you would like to impart on these up-and-coming institutional investors? 

MT: I've been in the investment business for over 25 years, and as I said at the investment committee meeting recently, I've seen many careers truncated when people try to time the markets. That's especially pertinent this week and this month. Pretending to know which way the market is going on a near-term basis is not an exercise worth spending your time on. We try to think longer term, and I think very many people on both sides, both the asset owners, and on the supplier side, focus way too much on trying to time the market. 

TI: That's actually all the questions that I have for you today. What have I failed to ask that I should know about you about pension, or about pension investing in general?

MT: I can't emphasize enough how supportive the board and our committees have been to everything we're doing here. That also requires a lot of work and you can't do it without their support. I'm very thankful that they've allowed us to do what we've done here. I'm not just saying that either. I mean, without their support, some of this stuff wouldn't happen. I've seen some of my colleagues across the country dealing with some really very significant governance issues, and I'm very thankful that I have the board structures – and the board and committee members – that I have.

To learn more about the the Top 30 Pension Fund Chief Investment Officers, click here.