Tim Barrett is associate vice chancellor and chief investment officer at Texas Tech University (TTU), where he has served since 2013. In this interview, he talks about The Master Custody Account (MCA) structure, which is a concept that came to fruition for two primary reasons: the financial downturn of 2008, and the SBCERA investment team’s frustration in not being able to move fast enough on good credit strategies.
Barrett also discusses the substantial fees savings and better performance associated with this new investment structure; and why TTU is starting to model other programs after the MCA.
Tim Barrett was recently named on Trusted Insight's 2018 Top 30 Endowment Chief Investment Officers. The following interview has been edited and condensed.
Trusted Insight: Can you elaborate on the reasoning behind your portfolio construction?
Tim Barrett: We have a balanced portfolio construction. The idea is to achieve equity-like returns without the equity-like risks. We target 30 percent to public equities, which is lean in comparison to many of our peers. We have a 30 percent target to private assets that includes private diversifying, private debt and private equity. Debt strategies are targeted at 25 percent and these cover structured, asset-backed and stressed credit strategies. Moreover, we have a 15 percent target allocation to public diversifying assets, which is meant to perform regardless of the equity and credit markets.
While our exposure to public equities is comparatively low, we enhance the return and risk profile through a portable Alpha structure. Meaning, 25 percent of the Beta in the portfolios is achieved through derivatives. This derivative overlay utilizes stock options, swaps and futures, in order to have less downside risk and still capture the upside. The collateral is invested in an 80-20 split between absolute return strategies and cash. Our goal is to keep up in a bull market and outperform in a sideways and down market. In short, you can only outperform in two out of three markets – unless you are a phenomenal trader.
The main risk to a portable Alpha structure is a rapid and deep market downturn, think of 2008. To ensure we can tolerate such events, such as a 25 percent downturn, we implement left tail hedges. Michael Nichols, the senior investment officer, has been instrumental in assisting with both the derivatives program and the rebuild of the overall portfolio. In fact, he conducted all the research on our tail hedging program.
The last, but certainly not least, driver of returns for our portfolio is our Master Custody Accounts (MCA). An MCA is simply an account structure that achieves a number of objectives. It aligns interest between the manager and the investor by making the manager a fiduciary at the relationship level and allows for flexible deployment of capital with the manager in pooled funds or co-investments via a separate account. It aligns incentives as annually the net performance across all accounts is calculated at a relationship fee level which is lower than the individual fund level fees. This results in a rebate of fees back to the investor. More importantly, it aligns our risk and returns objectives with that of the manager.
We have implemented 12 MCAs over the years, resulting not only in substantial fees savings but also, and more importantly, with much better performance. Our separate accounts doubled the return when compared to the underlying funds by taking larger positions in a manager's best ideas. This idiosyncratic, concentrated risk is adding value. One last point in regard to MCA’s, the ability to increase exposure to a manager's best ideas allows a much deeper understanding of the manager and investments. This works from the manager’s perspective as well as they have a better understanding of the types of risk in which we have interest.
Trusted Insight: You are one of the first investors to implement the MCA structure, both at San Bernardino County Employees’ Retirement Association and at Texas Tech University. What led you to implement this new structure?
Tim Barrett: When I was in San Bernardino, we had lots of ideas that we wanted to do and we wanted to execute them much quicker than the governance structure allowed.
In a public fund, there is typically committee and board meetings, and it is a long process to get decisions approved. It takes time which has a cost. The MCA structure addresses this issue by allowing staff discretion within specific parameters.
To give credit where it is due, while I recognized the problem, the San Bernardino staff and Tom Hickey at Foley and Lardner are the ones who built the solution.
The downside of the MCA is that most boards do not want to give up authority. If you have a board that views their responsibility as making the day to day investment decisions, they are not likely to give an MCA structure their approval. In order to implement this structure, the board must be comfortable at the asset allocation level. To be fair, with a strong, professional staff, Boards should focus their management on the higher asset allocation level and let professional staff implement the lower level decisions.
Trusted Insight: Other than a board willing to give part of their mandate to the staff, you need to have a robust reporting structure?
Tim Barrett: If you want the board to give you the authority needed, you have to be able to report back to them and show them your success or failure.We use Maples to reconcile our separate accounts as well as calculate the complex fee arrangements. This is imperative in order to show the board the fee savings from the structures.
In addition, Maples produces a report that calculates the performance of our separate accounts versus the underlying funds. This is important because it verifies how our “best ideas” portfolios with a manager are indeed performing versus the managers' funds within the MCA structure. In short, it is our report card on the MCA program.
Trusted Insight: How much money have you saved on fees using the MCA structure?
Tim Barrett: Our last report showed savings of nearly four million dollars. You do save money, but the alignment of interest and depth of understanding we get regarding the managers’ best ideas is more valuable.
One of the problems for people in my shoes, i.e. institutional investors, is that we get a lot of deal flow. And frankly, the people on the other side are better than we are. They live in that space day in and day out. The MCA structure allows for co-investing in a manager’s best ideas through a trust relationship. It is as close as we can get to a direct program without the burden of a large professional staff. For us, the alignment of interest with our manager is critical.
Trusted Insight: You have been with Texas Tech University for almost five years now. With respect to your long-term perspective, in what nuanced ways has your approach to the portfolio changed over that period?
Tim Barrett: It was a rebuild from the ground up. When I came in we were in the 100 percentile in the NACUBO universe on a 3-year basis. We are now 47th, so we have made a lot of progress. The overarching changes would not have been possible without a supportive Board of Regents, and an active Investment Advisory Committee that was willing to change to a staff directed investment model. Investment program changes of this magnitude truly require that all stakeholders are engaged and supportive.
The use of a portable Alpha structure and the MCA program are by far the biggest structural changes. The asset allocation itself is more conservative, but that is more a function of the length of the bull market and will change when the business cycle turns.
As to strategies, we have added a direct real estate program that is modeled after the MCA structure where we look at real estate transactions, either debt or equity, through a preferred manager. By being able to access debt or equity, we can manage the risk profile in a timelier manner. Public diversifying assets has become a meaningful allocation at 15 percent which includes strategies we seeded, such as Trade Finance, as well as risk premia swaps, and other uncorrelated strategies. This portfolio has been challenging, but we are excited about the outlook going forward.
Dan Parker, Deputy CIO, is doing a great job on the venture side as well as assisting across the portfolio. The venture program will become a major driver in time, and we are excited about the program that Dan is implementing.
Trusted Insight: What is one highlight of your career that you are the proudest of?
Tim Barrett: Successfully transitioning between three different genres of the buy-side has been gratifying. However, I am most proud of the individuals that have worked for me over the years, five of which became CIOs themselves. I have always been blessed with good teams. My success would not have been possible without them.
You can view our full catalog of interviews with institutional investors here.
Click here to view the complete list of Top 30 Endowment Chief Investment Officers.
Barrett also discusses the substantial fees savings and better performance associated with this new investment structure; and why TTU is starting to model other programs after the MCA.
Tim Barrett was recently named on Trusted Insight's 2018 Top 30 Endowment Chief Investment Officers. The following interview has been edited and condensed.
Trusted Insight: Can you elaborate on the reasoning behind your portfolio construction?
Tim Barrett: We have a balanced portfolio construction. The idea is to achieve equity-like returns without the equity-like risks. We target 30 percent to public equities, which is lean in comparison to many of our peers. We have a 30 percent target to private assets that includes private diversifying, private debt and private equity. Debt strategies are targeted at 25 percent and these cover structured, asset-backed and stressed credit strategies. Moreover, we have a 15 percent target allocation to public diversifying assets, which is meant to perform regardless of the equity and credit markets.
While our exposure to public equities is comparatively low, we enhance the return and risk profile through a portable Alpha structure. Meaning, 25 percent of the Beta in the portfolios is achieved through derivatives. This derivative overlay utilizes stock options, swaps and futures, in order to have less downside risk and still capture the upside. The collateral is invested in an 80-20 split between absolute return strategies and cash. Our goal is to keep up in a bull market and outperform in a sideways and down market. In short, you can only outperform in two out of three markets – unless you are a phenomenal trader.
The main risk to a portable Alpha structure is a rapid and deep market downturn, think of 2008. To ensure we can tolerate such events, such as a 25 percent downturn, we implement left tail hedges. Michael Nichols, the senior investment officer, has been instrumental in assisting with both the derivatives program and the rebuild of the overall portfolio. In fact, he conducted all the research on our tail hedging program.
"Our separate accounts doubled the return when compared to the underlying funds by taking larger positions in a manager's best ideas. This idiosyncratic, concentrated risk is adding value."
The last, but certainly not least, driver of returns for our portfolio is our Master Custody Accounts (MCA). An MCA is simply an account structure that achieves a number of objectives. It aligns interest between the manager and the investor by making the manager a fiduciary at the relationship level and allows for flexible deployment of capital with the manager in pooled funds or co-investments via a separate account. It aligns incentives as annually the net performance across all accounts is calculated at a relationship fee level which is lower than the individual fund level fees. This results in a rebate of fees back to the investor. More importantly, it aligns our risk and returns objectives with that of the manager.
We have implemented 12 MCAs over the years, resulting not only in substantial fees savings but also, and more importantly, with much better performance. Our separate accounts doubled the return when compared to the underlying funds by taking larger positions in a manager's best ideas. This idiosyncratic, concentrated risk is adding value. One last point in regard to MCA’s, the ability to increase exposure to a manager's best ideas allows a much deeper understanding of the manager and investments. This works from the manager’s perspective as well as they have a better understanding of the types of risk in which we have interest.
Trusted Insight: You are one of the first investors to implement the MCA structure, both at San Bernardino County Employees’ Retirement Association and at Texas Tech University. What led you to implement this new structure?
Tim Barrett: When I was in San Bernardino, we had lots of ideas that we wanted to do and we wanted to execute them much quicker than the governance structure allowed.
In a public fund, there is typically committee and board meetings, and it is a long process to get decisions approved. It takes time which has a cost. The MCA structure addresses this issue by allowing staff discretion within specific parameters.
To give credit where it is due, while I recognized the problem, the San Bernardino staff and Tom Hickey at Foley and Lardner are the ones who built the solution.
The downside of the MCA is that most boards do not want to give up authority. If you have a board that views their responsibility as making the day to day investment decisions, they are not likely to give an MCA structure their approval. In order to implement this structure, the board must be comfortable at the asset allocation level. To be fair, with a strong, professional staff, Boards should focus their management on the higher asset allocation level and let professional staff implement the lower level decisions.
Trusted Insight: Other than a board willing to give part of their mandate to the staff, you need to have a robust reporting structure?
Tim Barrett: If you want the board to give you the authority needed, you have to be able to report back to them and show them your success or failure.We use Maples to reconcile our separate accounts as well as calculate the complex fee arrangements. This is imperative in order to show the board the fee savings from the structures.
"One of the problems for people in my shoes, i.e. institutional investors, is that we get a lot of deal flow. And frankly, the people on the other side are better than we are."
In addition, Maples produces a report that calculates the performance of our separate accounts versus the underlying funds. This is important because it verifies how our “best ideas” portfolios with a manager are indeed performing versus the managers' funds within the MCA structure. In short, it is our report card on the MCA program.
Trusted Insight: How much money have you saved on fees using the MCA structure?
Tim Barrett: Our last report showed savings of nearly four million dollars. You do save money, but the alignment of interest and depth of understanding we get regarding the managers’ best ideas is more valuable.
One of the problems for people in my shoes, i.e. institutional investors, is that we get a lot of deal flow. And frankly, the people on the other side are better than we are. They live in that space day in and day out. The MCA structure allows for co-investing in a manager’s best ideas through a trust relationship. It is as close as we can get to a direct program without the burden of a large professional staff. For us, the alignment of interest with our manager is critical.
Trusted Insight: You have been with Texas Tech University for almost five years now. With respect to your long-term perspective, in what nuanced ways has your approach to the portfolio changed over that period?
Tim Barrett: It was a rebuild from the ground up. When I came in we were in the 100 percentile in the NACUBO universe on a 3-year basis. We are now 47th, so we have made a lot of progress. The overarching changes would not have been possible without a supportive Board of Regents, and an active Investment Advisory Committee that was willing to change to a staff directed investment model. Investment program changes of this magnitude truly require that all stakeholders are engaged and supportive.
The use of a portable Alpha structure and the MCA program are by far the biggest structural changes. The asset allocation itself is more conservative, but that is more a function of the length of the bull market and will change when the business cycle turns.
As to strategies, we have added a direct real estate program that is modeled after the MCA structure where we look at real estate transactions, either debt or equity, through a preferred manager. By being able to access debt or equity, we can manage the risk profile in a timelier manner. Public diversifying assets has become a meaningful allocation at 15 percent which includes strategies we seeded, such as Trade Finance, as well as risk premia swaps, and other uncorrelated strategies. This portfolio has been challenging, but we are excited about the outlook going forward.
Dan Parker, Deputy CIO, is doing a great job on the venture side as well as assisting across the portfolio. The venture program will become a major driver in time, and we are excited about the program that Dan is implementing.
Trusted Insight: What is one highlight of your career that you are the proudest of?
Tim Barrett: Successfully transitioning between three different genres of the buy-side has been gratifying. However, I am most proud of the individuals that have worked for me over the years, five of which became CIOs themselves. I have always been blessed with good teams. My success would not have been possible without them.
You can view our full catalog of interviews with institutional investors here.
Click here to view the complete list of Top 30 Endowment Chief Investment Officers.