Pennsylvania PSERS Focused On Increasing Leverage To Reach 'Better-Balanced Portfolio' | Jim Grossman, Chief Investment Officer | Q&A
Jim Grossman is the chief investment officer at the Pennsylvania Public School Employees Retirement System (PA PSERS), where he oversees $59.1 billion of assets. He has been with PA PSERS since 1997. He has held various roles including managing director of external public markets, compliance, and as a risk manager. Previously, he was a senior manager at KPMG US for nearly 8 years. Grossman holds a B.S. in accounting from Elizabethtown College in Pennsylvania and is a CFA Charterholder and Certified Public Accountant.
In this interview, Jim discussed why PSERS prefers a more balanced and diversified portfolio allocation; why using leverage in the portfolio is evolutionary for them; and their measured approach to early-stage venture.
Trusted Insight: What is the Pennsylvania Public School Employees' Retirement System and what is your role there?
Jim Grossman: The Pennsylvania Public School Employees' Retirement System, also known as PSERS, was founded in 1917 with the passage of a state law. Two years later, PSERS opened with the merger of 13 school districts’ retirement plans and 37,503 individual members. So, we consider 1919 to be our 100th anniversary of operational services. In that century of service, PSERS’ investment duties, responsibilities and staff levels have increased. Today, we are a $59 billion system, serving more than 500,000 active and retired school employees and more than 700 employers.
The investment office I oversee has grown to 47 employees. That total includes operations and risk management professionals, as well as front-line investors who personally manage trades or work with outside consultants in traditional and non-traditional asset classes. One of the biggest strengths in the PSERS Investment Office is our stable team of accomplished and dedicated professionals.
"When I came on board, PSERS, like many institutional investors, was heavily weighted to equities. That portfolio design works well when the equity market is doing well since the portfolio is dominated by equity risk."
Most importantly, PSERS professionals do not work in silos. PSERS has an internal 5-member Allocation Implementation Committee that can take up to six months to vet and unanimously agree on a new investment before the matter is brought to the Board of Trustees for approval. That process builds a culture of teamwork throughout the agency while also serving as a checks-and-balance mechanism on our fiduciary duty to members.
We also would not be able to fulfill our fiduciary duties without the support of the plan sponsor, including the Pennsylvania General Assembly and Gov. Tom Wolf. For four years in a row, they have approved state budgets that provide full actuarial funding to the system. Full actuarial funding takes some of the pressure off the investment team, whose job it is to try to earn, over the long-term, the 7.25 percent assumed rate of return.
Trusted Insight: You’ve been with PA PSERS since 1997. How has the strategic asset allocation changed since you joined?
Jim Grossman: As I said earlier, the Pennsylvania Legislature over the years has passed laws, signed by governors, relaxing the statutory limits on investment vehicles the state’s two pension systems can use to meet our long-term return goals.
We’ve also made changes internally with the support of the Board of Trustees. The Board gradually lowered the assumed rate of return. It was 8.5% in 2007 and is now 7.25%. That reduction coincided with the Great Recession, which also forced PSERS to re-evaluate its portfolio.
When I came on board, PSERS, like many institutional investors, was heavily weighted to equities. That portfolio design works well when the equity market is doing well since the portfolio is dominated by equity risk. It doesn’t work so well when you are cash flow negative like we’ve been since the mid-1990s and the stock markets falls, which is what happened during the housing and credit crises of the late 2000s. At that time, we had nearly 70 percent of our assets invested in equities, causing the Fund to experience very large losses similar to other pension fund peers.
"We believe you will be seeing more pension plans use leverage in the U.S. and have, in recent weeks, seen a couple announce the use of leverage in their asset allocations."
After that experience, we began to study and implement a more diversified asset portfolio to significantly reduce equity exposure and increase exposure to more diversifying assets such as TIPS and commodities. Over the last decade, we’ve diversified our portfolio as we’ve decreased our public and private equity to roughly 30%. The rest of the portfolio is spread among fixed income, real assets, risk parity, and absolute return. That diversification reduces our exposure and risk in up-and-down markets we’ve experienced in recent months. We prefer a balanced portfolio allocation since we are humble about the future. The future is uncertain, so why concentrate all your risk in one asset class?
We are very pleased with the results. In August, the Board of Trustees voted to keep diversification as the central theme of our investment strategy by approving our asset allocation, effective Oct. 1, with only minor changes.
Trusted Insight: Is there anything unique about PA PSERS that separates it from its pension industry peers?
Jim Grossman: As our portfolio diversification shows, we are not afraid to think outside the box compared to some peers. PSERS also was one of the first pension funds to invest in risk parity and commodities as well as to use explicit leverage at the plan level.
I think our use of leverage to balance risk also is quite unique in the industry. Leverage doesn’t mean we are taking on more risk. Leverage allows you to decrease the risk for the same level or returns or increase returns for the same level of risk because it allows you to manage a more diversified portfolio of risk premiums. If we did not use leverage, we’d have to be more concentrated in equities to achieve our target returns. We believe you will be seeing more pension plans use leverage in the U.S. and have, in recent weeks, seen a couple announce the use of leverage in their asset allocations.
"PSERS is taking a measured approach as we pursue long-term, aligned relationships in the space with a renewed focus on the early-stage venture. Our goal is always to 'do things that make sense' without being limited to conventional wisdom and structures so innovation is welcome here."
The other thing we pride ourselves on is our transparency. We use our website to post information about assets, liabilities, and fees. In 2018 and again this year, we finished a months-long internal process to calculate and publicize carried interest we pay private equity managers. Our carried interest report was cited as an example of good governance by the Maryland General Assembly when it adopted a law in requiring that state’s pension fund issue a similar carried interest to report.
Trusted Insight: Many LPs agree that the next 10 years will continue to be a low-return environment. Are there any value-add strategies that you’ll be implementing in the next decade?
Jim Grossman: We are considering over the next decade increasing our allocation to emerging markets, specifically China. Allocating to these emerging markets will provide opportunities for incremental returns in both equities and fixed income. Given numerous uncertainties, including trade or escalating political rhetoric, we will be calculated in our pivot towards China and those regions, but if facts change, we will pivot and take a different view.
In the next decade, we believe the United States will probably come up with a larger infrastructure program where we think institutional money will be needed. We are hoping that the opportunities present themselves with us as they have in other parts of the world. Finally, we want to increase leverage to obtain a better-balanced portfolio than we have today. Using leverage in the portfolio is evolutionary for us. We learned a lot from our experiences managing risk parity internally. We can use a lot of what we learned there for total portfolio construction.
Trusted Insight: Does PA PSERS have a venture program, and if so, what are the next steps in that space?
Jim Grossman: We are in a somewhat unique position relative to other institutional investors in that we are actively seeking venture relationships but don’t have a longstanding, mature portfolio in the space.
PSERS is taking a measured approach as we pursue long-term, aligned relationships in the space with a renewed focus on the early-stage venture. Our goal is always to “do things that make sense” without being limited to conventional wisdom and structures so innovation is welcome here.
Trusted Insight: What markets outside of the U.S. are you focused on investing more in? Have you pushed back on certain countries?
Jim Grossman: Generally, we’ll go where opportunity exists. We’ve been focusing a lot of our time lately on markets in Asia, specifically China. This is a region of the world that has interesting growth prospects outside the United States. However, the private market activity is smaller and the institutional quality active management capacity is small relative to what you find in the U.S. and Europe. Our focus is on finding quality managers and building relationships with them early as many strategies are capacity constrained. Over the past 3 years, we have hired 7 different active managers in the public and private markets in this region.
Trusted Insight: Is there anything you’d like to add about yourself, the organization, or pension investing in general?
Jim Grossman: I am very happy to have supportive stakeholders, including the beneficiaries, the plan sponsor, and our dedicated Board of Trustees. I’m very grateful to have a hard-working, dedicated Board that works for the common interests of the members. I am thrilled and honored to lead a talented investment team at PSERS. I have been blessed with a stable and accomplished team of investment professionals. I can’t stress enough that it’s a fantastic group of dedicated professionals. We take our fiduciary duty to the 500,000 retired and active members very seriously. That doesn’t mean we don’t have free time, which in my case means spending time with my family and rooting feverishly for the Philadelphia Eagles, Phillies, Flyers and 76ers and Penn State Nittany Lions.
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