Scott Simon is chief investment officer at Fire & Police Pension Association of Colorado. He leads a team of 11 individuals to manage $3.4 billion in assets for the fully funded pension fund. Simon joined the pension fund in 2007, right before the financial crisis.
In this interview, Simon discusses the pension fund’s fully funded status, his “trial by fire” working through the recession and the logic behind the institution’s governance and team structures. Simon was recently named on Trusted Insight’s Top 30 Public Pension Chief Investment Officers.
Trusted Insight: Within the pension fund industry, a fully funded pension is a rarity these days. How did this come to be and, more importantly, how difficult is it to maintain that fully funded status?
Scott Simon: Well, I would love to say that I could take all the credit for that as far as it's a lot of solid investment returns over a long period of time. Certainly, we've produced solid investment returns during my tenure, about nine years, but certainly over a longer period of time. It has had a high nine percent since inception-type of performance, which has exceeded our actuarial rates of required return. It used to be eight, but now it's currently seven and a half.
Performance has certainly helped out, but I really have to give a lot of credit to the original structure of the plan. It's not a very old pension fund in terms of how old public plans can be. We're only 35 years old.
When it was created, there were a lot of structural safeguards of the plan to avoid getting into dire straits with the funded status. A lot of it can be focused around the benefits and primarily a cost of living increase mechanism. The pension fund does not have an obligation to maintain a certain cost of living increase per year per plan, and the board can be really flexible around what it grants every year, and they've just been prudent at doing that over long periods of time.
In good times, I think they were a bit more reserved in granting cost of living increases and granting benefit increases. That gave them a lot more flexibility when times were bad to potentially reduce that down. A fully funded status has a lot to due with the original structure and a really prudent board over many years. Certainly investment returns help.
Trusted Insight: You began at Colorado Police and Fire in 2007 right before the financial crisis. In 2008, the portfolio lost 29 percent. From the minute you walked in, through the crisis and beyond, how did you pivot the portfolio to achieve returns high enough to bounce back over the next few years? What were some of the key lessons that you took from that experience?
Scott Simon: It was certainly trial by fire. This was my first position as a chief investment officer. I had been focused in on a portfolio manager or specialist within the alternative space prior to that. So, it was my first chance to oversee an entire fund, and it was a unique time to come into that role. Again, I think there was a lot of circumstances that made us fortunate. We were over funded at the time, and so the funded status provided a lot of flexibility. Again, we have a very prudent board and the support of an executive director, who didn't panic.
When the crisis first started, no one was pounding on the table. They were certainly concerned, but there was no external pressure or politics to say that we needed to be reacting in a different manner than we did. With difficult times, you certainly learn how to focus and manage on liquidity a lot more than you might normally. You're certainly looking at rebalancing exposures during those time periods. We didn't have to sell anything that we didn't want to have to sell during that time period, which provided us with a lot of flexibility, and we didn't reduce risk and panic. When the recovery did occur in 2009, we were well positioned as that same portfolio to ride up the recovery and really rebound.
That being said, after the fact, I think it made everyone look at what were your true risks that you're taking within the portfolio, within your fixed income portfolio or equity portfolio, and it made us reassess. "Do you really want to be taking on that much equity risk on a go-forward, long-term basis?" The answer was no.
Our entity was really encouraged to start looking at, "How can you further increase the diversification with your portfolio, take on different classes, things that are going to be less correlated to the equity markets or provide a different return stream?" That was the beginning of what really led us to our significantly increased alternatives exposure that we have today, the liquid alternatives and also our hedge fund portfolio.
Trusted Insight: What challenges are you and your team facing right now?
Scott Simon: I would say hedge funds, broadly, are certainly a current topic of discussion. They've faced really a difficult environment since 2009. It's been such a gross market for the last seven-to-eight years in terms of returns and expectations, certainly if you were to compare hedge funds to just the equity market. This is a common mistake that the press, a lot of institutional investors and our board of directors are saying, "Well, you're not even coming close to the equity market returns. Why are we doing this for such high fees? Why are we doing these allocations?”
It's a current process to educate and get people comfortable with why they're in the portfolio, which is really to reduce risk and to provide a differentiated return relative to your public equity markets and your fixed income markets. Also, in particular, just the headline risk of seeing institution after institution want to just drop these programs and exit the business right now. It makes you wonder if you're missing something or at least if your trustees are missing something. Why aren't we exiting the business as well? It really is educating them on the nature of why they're in a portfolio, the benefit that they will provide if we do enter into a different market environment. That's certainly a current topic of discussion.
The other one is the low-return environment. Interest rates may have backed up a little bit and are starting to tick up a bit, but we're still obviously an extremely low interest rate environment, which is the building blocks for all the other asset class expectations of return. When you add all of your classes together, it's increasingly difficult to say that you can achieve that actuarial rate of return, whether it's eight percent or seven and a half percent. That obviously has implications.
You have to re-educate your board and trustees. You can only be so accurate with that number. It's also just to pinpoint your estimate of that number. There are certainly a lot of ranges of outcomes and possibilities that could happen with your portfolio. You try to refocus them in on, "Are you taking the most appropriate risk for what you want to make within the portfolio and making sure that that drives your allocation decisions?"
Trusted Insight: Where are you looking for alpha in this low-return environment? Niche strategies or undiscovered managers?
Scott Simon: You really hit on what we are trying to do. We're a pretty unique size of fund -- $4 billion is a sweet spot. We are large enough to participate in these strategies, meaning we can go out and invest into private equity and hedge funds and be a significant player into allocating to those funds, but we're not so big where we're having to write big checks that limits our ability to invest in certain types of managers. By that I mean, if you're too big you can't focus in on those niche strategies, smaller managers that may be younger and might have a greater ability to add value relative to larger players.
You certainly don't want to create an entire portfolio of those types of small fund niche strategies, but we really take as much as we can get, and 80 percent of our time is to try to find those managers. That's the strategy.
You're not incorrect. It seems like a lot of these classes are of full value. There's a lot of cash, a lot of commitments going into those classes. That just has to make you cautious. That won't make us stop. That might make us go slower a little bit in this type of environment, but we still remain committed to those types of strategies and those classes are better for us longer term.
Trusted Insight: What are some characteristics of a really good governance structure?
Scott Simon: It always starts with your highest level of authority, which is your board of directors, and recognizing what they're good at and what they should be doing to what they're less good at and not should be doing.
A high-level board should be focused in on being strategic in nature, setting appropriate policies and being very clear on the risks that they want to take and the guidelines that they want to set forth.
Then you delegate authority downward, whether it's as our model, to professional investment staff, or whether it's to highly thought-of consultants, or if you want to pay more for a fund of funds model. It really is trying to move your tactical and/or your day-to-day management operational decisions out of the board room and delegate downward to the experts where it belongs.
It takes trust, and that takes time. When I came onboard, it was a full-board discretion model where they would interview all the managers and make all the manager hire/fire decisions. They would meet for hours on end to get that done, but they really didn't have the expertise to be truly competent.
Now we're supported by consultants, and there's a much more efficient process that can be done on the governance front. I think we've moved to that over time to where we do use an investment committee, which helps give the board comfort that we're doing the job that we should be doing as an investment staff. An important piece to having a good governance model is to have that intermediary entity of an investment committee helping out the board. Making sure that they're comfortable with what they're doing, having appropriate information and maintaining that strategic role is critical in having a good governance structure.
Trusted Insight: What is the structure of the investment team itself? Are you more a generalist or specialist?
Scott Simon: I oversee the whole staff. We're mostly divided between two groups by the structure of the investment class that we're investing in. Primarily liquid strategies would be one group, and illiquid strategies is the other group.
Liquid strategies would obviously be focused in on strategies that are more liquid in nature, shorter dated. So that's your public equity markets, fixed income markets, hedge funds, which are not entirely daily liquid, depending on the vehicle, but more liquid than private equity. Then the illiquid group is focused in on private equity, real estate and real assets.
From that aspect, they are specialists, but they do have to cover what would be general categories, meaning everyone on each team should really be comfortable with equity-type strategies, fixed income-type strategies and debt strategies.
They're generalist in nature in that they've got to cover a lot of different ground, but are restricted by team to the liquidity nature of the strategy that they're looking at. We have three people on each side: three liquid strategies people and three illiquid strategies people. Then we have a total fund risk officer, that helps with overseeing all the exposures in aggregate and looking at it together. Then we have three operations people. That makes a staff of 11.
Trusted Insight: What's the most important lesson that you've learned in your career as it pertains to institutional investment?
Scott Simon: You have to be a good listener. Early on in my career, if you're focused in on a certain strategy and then become a specialist within private equity or real estate, you can take on being the expert in the room, with all the knowledge to be the expert in the room. But as you start to migrate toward a broader role, like a CIO role, you have to recognize that if you're managing all these different classes, strategies and exposures, you are not going to be the expert in the room. You really have to rely on your staff and/or a manager, as they're the experts in the field that you're really asking them to be experts on.
Being humble and not driving forward a view or a direction without consulting and being fully knowledgeable of what your experts are saying is an important lesson. You can't know everything and be an expert in every single class. You really have to rely upon the people that you trust and that you're placing trust with.
The other big lesson is just communication and being transparent about what you're doing. The boards of directors and executive directors are not investment people by training, and it really takes a lot to communicate what can be very complex things into something that they can understand and then fully entrust you with the execution. It takes a lot of time, personal one-on-one time with those people to really get them comfortable with what you're doing.
Trusted Insight: What else should readers know about you, Colorado Police and Fire Pension Fund or about pension fund investing in general?
Scott Simon: I think we're fortunate to have a lot of good people working for us who are all trying to do the right things. Sometimes we don't get recognized, but we have a lot of good people here who are very knowledgeable about the investment strategies that they're picking. Those staff need to be recognized more for that, as they are truly dedicated investment people, and they're trying to do the best thing for their beneficiaries and their members.
It really takes a lot of work, you need to have a lot of expertise and be thoughtful on how you do it. Sometimes you don’t get enough recognition of the challenge and difficulty that this job takes. That's what pension funds are trying to do.
To learn more about pension investing, click here to view the complete list of 2016 Top Public Pension Chief Investment Officers. You can view our full catalogue of interviews with institutional investors here.
In this interview, Simon discusses the pension fund’s fully funded status, his “trial by fire” working through the recession and the logic behind the institution’s governance and team structures. Simon was recently named on Trusted Insight’s Top 30 Public Pension Chief Investment Officers.
Trusted Insight: Within the pension fund industry, a fully funded pension is a rarity these days. How did this come to be and, more importantly, how difficult is it to maintain that fully funded status?
Scott Simon: Well, I would love to say that I could take all the credit for that as far as it's a lot of solid investment returns over a long period of time. Certainly, we've produced solid investment returns during my tenure, about nine years, but certainly over a longer period of time. It has had a high nine percent since inception-type of performance, which has exceeded our actuarial rates of required return. It used to be eight, but now it's currently seven and a half.
Performance has certainly helped out, but I really have to give a lot of credit to the original structure of the plan. It's not a very old pension fund in terms of how old public plans can be. We're only 35 years old.
When it was created, there were a lot of structural safeguards of the plan to avoid getting into dire straits with the funded status. A lot of it can be focused around the benefits and primarily a cost of living increase mechanism. The pension fund does not have an obligation to maintain a certain cost of living increase per year per plan, and the board can be really flexible around what it grants every year, and they've just been prudent at doing that over long periods of time.
In good times, I think they were a bit more reserved in granting cost of living increases and granting benefit increases. That gave them a lot more flexibility when times were bad to potentially reduce that down. A fully funded status has a lot to due with the original structure and a really prudent board over many years. Certainly investment returns help.
Trusted Insight: You began at Colorado Police and Fire in 2007 right before the financial crisis. In 2008, the portfolio lost 29 percent. From the minute you walked in, through the crisis and beyond, how did you pivot the portfolio to achieve returns high enough to bounce back over the next few years? What were some of the key lessons that you took from that experience?
Scott Simon: It was certainly trial by fire. This was my first position as a chief investment officer. I had been focused in on a portfolio manager or specialist within the alternative space prior to that. So, it was my first chance to oversee an entire fund, and it was a unique time to come into that role. Again, I think there was a lot of circumstances that made us fortunate. We were over funded at the time, and so the funded status provided a lot of flexibility. Again, we have a very prudent board and the support of an executive director, who didn't panic.
When the crisis first started, no one was pounding on the table. They were certainly concerned, but there was no external pressure or politics to say that we needed to be reacting in a different manner than we did. With difficult times, you certainly learn how to focus and manage on liquidity a lot more than you might normally. You're certainly looking at rebalancing exposures during those time periods. We didn't have to sell anything that we didn't want to have to sell during that time period, which provided us with a lot of flexibility, and we didn't reduce risk and panic. When the recovery did occur in 2009, we were well positioned as that same portfolio to ride up the recovery and really rebound.
That being said, after the fact, I think it made everyone look at what were your true risks that you're taking within the portfolio, within your fixed income portfolio or equity portfolio, and it made us reassess. "Do you really want to be taking on that much equity risk on a go-forward, long-term basis?" The answer was no.
Our entity was really encouraged to start looking at, "How can you further increase the diversification with your portfolio, take on different classes, things that are going to be less correlated to the equity markets or provide a different return stream?" That was the beginning of what really led us to our significantly increased alternatives exposure that we have today, the liquid alternatives and also our hedge fund portfolio.
Trusted Insight: What challenges are you and your team facing right now?
Scott Simon: I would say hedge funds, broadly, are certainly a current topic of discussion. They've faced really a difficult environment since 2009. It's been such a gross market for the last seven-to-eight years in terms of returns and expectations, certainly if you were to compare hedge funds to just the equity market. This is a common mistake that the press, a lot of institutional investors and our board of directors are saying, "Well, you're not even coming close to the equity market returns. Why are we doing this for such high fees? Why are we doing these allocations?”
It's a current process to educate and get people comfortable with why they're in the portfolio, which is really to reduce risk and to provide a differentiated return relative to your public equity markets and your fixed income markets. Also, in particular, just the headline risk of seeing institution after institution want to just drop these programs and exit the business right now. It makes you wonder if you're missing something or at least if your trustees are missing something. Why aren't we exiting the business as well? It really is educating them on the nature of why they're in a portfolio, the benefit that they will provide if we do enter into a different market environment. That's certainly a current topic of discussion.
The other one is the low-return environment. Interest rates may have backed up a little bit and are starting to tick up a bit, but we're still obviously an extremely low interest rate environment, which is the building blocks for all the other asset class expectations of return. When you add all of your classes together, it's increasingly difficult to say that you can achieve that actuarial rate of return, whether it's eight percent or seven and a half percent. That obviously has implications.
You have to re-educate your board and trustees. You can only be so accurate with that number. It's also just to pinpoint your estimate of that number. There are certainly a lot of ranges of outcomes and possibilities that could happen with your portfolio. You try to refocus them in on, "Are you taking the most appropriate risk for what you want to make within the portfolio and making sure that that drives your allocation decisions?"
Trusted Insight: Where are you looking for alpha in this low-return environment? Niche strategies or undiscovered managers?
Scott Simon: You really hit on what we are trying to do. We're a pretty unique size of fund -- $4 billion is a sweet spot. We are large enough to participate in these strategies, meaning we can go out and invest into private equity and hedge funds and be a significant player into allocating to those funds, but we're not so big where we're having to write big checks that limits our ability to invest in certain types of managers. By that I mean, if you're too big you can't focus in on those niche strategies, smaller managers that may be younger and might have a greater ability to add value relative to larger players.
You certainly don't want to create an entire portfolio of those types of small fund niche strategies, but we really take as much as we can get, and 80 percent of our time is to try to find those managers. That's the strategy.
You're not incorrect. It seems like a lot of these classes are of full value. There's a lot of cash, a lot of commitments going into those classes. That just has to make you cautious. That won't make us stop. That might make us go slower a little bit in this type of environment, but we still remain committed to those types of strategies and those classes are better for us longer term.
Trusted Insight: What are some characteristics of a really good governance structure?
Scott Simon: It always starts with your highest level of authority, which is your board of directors, and recognizing what they're good at and what they should be doing to what they're less good at and not should be doing.
A high-level board should be focused in on being strategic in nature, setting appropriate policies and being very clear on the risks that they want to take and the guidelines that they want to set forth.
Then you delegate authority downward, whether it's as our model, to professional investment staff, or whether it's to highly thought-of consultants, or if you want to pay more for a fund of funds model. It really is trying to move your tactical and/or your day-to-day management operational decisions out of the board room and delegate downward to the experts where it belongs.
It takes trust, and that takes time. When I came onboard, it was a full-board discretion model where they would interview all the managers and make all the manager hire/fire decisions. They would meet for hours on end to get that done, but they really didn't have the expertise to be truly competent.
Now we're supported by consultants, and there's a much more efficient process that can be done on the governance front. I think we've moved to that over time to where we do use an investment committee, which helps give the board comfort that we're doing the job that we should be doing as an investment staff. An important piece to having a good governance model is to have that intermediary entity of an investment committee helping out the board. Making sure that they're comfortable with what they're doing, having appropriate information and maintaining that strategic role is critical in having a good governance structure.
Trusted Insight: What is the structure of the investment team itself? Are you more a generalist or specialist?
Scott Simon: I oversee the whole staff. We're mostly divided between two groups by the structure of the investment class that we're investing in. Primarily liquid strategies would be one group, and illiquid strategies is the other group.
Liquid strategies would obviously be focused in on strategies that are more liquid in nature, shorter dated. So that's your public equity markets, fixed income markets, hedge funds, which are not entirely daily liquid, depending on the vehicle, but more liquid than private equity. Then the illiquid group is focused in on private equity, real estate and real assets.
From that aspect, they are specialists, but they do have to cover what would be general categories, meaning everyone on each team should really be comfortable with equity-type strategies, fixed income-type strategies and debt strategies.
They're generalist in nature in that they've got to cover a lot of different ground, but are restricted by team to the liquidity nature of the strategy that they're looking at. We have three people on each side: three liquid strategies people and three illiquid strategies people. Then we have a total fund risk officer, that helps with overseeing all the exposures in aggregate and looking at it together. Then we have three operations people. That makes a staff of 11.
Trusted Insight: What's the most important lesson that you've learned in your career as it pertains to institutional investment?
Scott Simon: You have to be a good listener. Early on in my career, if you're focused in on a certain strategy and then become a specialist within private equity or real estate, you can take on being the expert in the room, with all the knowledge to be the expert in the room. But as you start to migrate toward a broader role, like a CIO role, you have to recognize that if you're managing all these different classes, strategies and exposures, you are not going to be the expert in the room. You really have to rely on your staff and/or a manager, as they're the experts in the field that you're really asking them to be experts on.
Being humble and not driving forward a view or a direction without consulting and being fully knowledgeable of what your experts are saying is an important lesson. You can't know everything and be an expert in every single class. You really have to rely upon the people that you trust and that you're placing trust with.
The other big lesson is just communication and being transparent about what you're doing. The boards of directors and executive directors are not investment people by training, and it really takes a lot to communicate what can be very complex things into something that they can understand and then fully entrust you with the execution. It takes a lot of time, personal one-on-one time with those people to really get them comfortable with what you're doing.
Trusted Insight: What else should readers know about you, Colorado Police and Fire Pension Fund or about pension fund investing in general?
Scott Simon: I think we're fortunate to have a lot of good people working for us who are all trying to do the right things. Sometimes we don't get recognized, but we have a lot of good people here who are very knowledgeable about the investment strategies that they're picking. Those staff need to be recognized more for that, as they are truly dedicated investment people, and they're trying to do the best thing for their beneficiaries and their members.
It really takes a lot of work, you need to have a lot of expertise and be thoughtful on how you do it. Sometimes you don’t get enough recognition of the challenge and difficulty that this job takes. That's what pension funds are trying to do.
To learn more about pension investing, click here to view the complete list of 2016 Top Public Pension Chief Investment Officers. You can view our full catalogue of interviews with institutional investors here.