Tom Masthay is director of real assets at Texas Municipal Retirement System. Prior to this, he was a principal investment analyst at NextEra Energy Inc., and a director of real assets at Kentucky Retirement Systems. He has an MMBA in Finance and a BBA in finance and economics from the University of Kentucky. He joint-published an article titled Considerations Around Placements Agents in the Journal of Private Equity (December 2012).
Tom was recently named on Trusted Insight’s ranked list of the Top 30 Future CIOs at Pension Funds. He graciously spoke to Trusted Insight on April 19, 2016. The following interview has been edited and condensed for clarity.
Trusted Insight: You are still a fairly new team at Texas Municipal Retirement System (TMRS). What is the team like, and how have the past 15 months been?
Tom Masthay: Our investment team culture is great. TJ Carlson is the chief investment officer, and I worked for him previously at Kentucky Retirement System. Another gentleman from Kentucky also joined, Chris Shelling, and he is now the director of private equity here. Roughly half of the team has been hired by TJ Carlson effectively in the last 15 months – a team expansion driven by the rolling out of programs in real assets, private equity, absolute return and non-core fixed income strategies. As a team we have similar mindsets, which is great culturally.
We've still got some administrative improvements to make in order to enable us to spend more front office time doing investment research. Prior to the recent expansion of the team the investments program was focused principally on public market investments, and therefore a lot of the necessary infrastructure to pursue real assets and other alternatives largely wasn’t in place. We’re evolving and growing, so that we can spend the majority of our time doing investment research. We are all on that same page and getting there together.
TI: What are your principal areas of focus within real assets for the TMRS portfolio?
TMRS was a very good professional opportunity because the portfolio was somewhat of a blank slate.
TM: We have two distinct allocations within real assets here: real estate and what we call real return. Real estate, for all intents and purposes, is private real estate – based on some changes we have made here in the last year. Real return is basically all other hard assets, related items and liquid strategies. Each of those allocations is 10% of the total portfolio.
TMRS was a very good professional opportunity because the portfolio was somewhat of a blank slate. Real estate was developed maybe 50% of the way at the time I joined, but I knew a lot of the portfolio. On the real return side, the portfolio was truly a blank slate; we had $1 billion in global inflation-linked bonds that used to be in a fixed-income portfolio, which had been relabeled as real assets. That was really the starting point.
Effectively, we had the same starting point at Kentucky Retirement Systems three or four years ago, where we also had an inflation-linked bond portfolio that was relabeled real assets and started rolling out a real assets portfolio. So we've been using a lot of the same playbook here. At TMRS we’ve focused a lot on regulatory trades; namely, structured equity and credit in sectors where there is less capital available to companies because of Basel III and all the other banking regulations flying around. We have invested across energy, agriculture, minerals and mines, and we will recommend our first big private infrastructure allocation here to our Board in the next couple weeks. We have also rolled out a more diversified liquids portfolio to get it fully funded as well.
TI: You mentioned overhauling the portfolio. What challenges did you face?
TM: I think the biggest challenge was to come up with answers to “how do we reinvent the investment process, document new policies and procedures? And then convince through the appropriate oversight channels (e.g. the Board of Trustees and Executive Director) that what we are doing is going to create better outcomes for member beneficiaries.” I think we were successful in communicating the evolving needs of a portfolio that includes alternative investments, and were able to implement a successful process.
TI: How does your relationship with the board of trustees work?
TM: Exceptionally well - TMRS’ Board of Trustees is generally composed of high-ranking city officials from a number of cities throughout the state. Currently, the board approves individual investment manager selections. While this has faced some bottleneck challenges, given the significant number of managers we’ve sought approval for, the organization as a whole has risen to the challenge. As an investment team, we’ve done our best in communicating with concision, highlighting in simple two-dimensional charts or one-dimensional concepts the things our board should really be considering from a fiduciary standpoint. For example, we may tell them in our meetings: "Here is our portfolio before the recommendations, here is the portfolio after the recommendations and here is why we think this is the appropriate thing to do and is within the investment policy statement guidelines.” TMRS has – by light-years – the most effective public board I’ve worked for.
A lot of the time, the challenge for government institutions is people like to rely on precedent. Fortunately, we came into an organization that was forward-thinking and were able to build a lot of trust by getting our work done, improving performance and really doing our best to meet all the objectives of the organization.
TI: How have you been building out the real estate portfolio?
2015 was a bizarre and frenzied summer because we ended up doing about $1 billion gross of deals in one board meeting.
TM: Within the real estate portfolio, 2015 was a bizarre and frenzied summer because we ended up doing about $1 billion gross of deals in one board meeting. It was a great opportunity because I was able to really present it in a portfolio context and tell people what was going on in a way that wasn’t fragmented by individual recommendations. We have done a couple of deals since then as well.
I would say there were three themes to this from a real estate perspective:
The first theme was to move up the capital structure in the U.S. and become more defensive. We had some debt managers and some other structures that we felt were defensive-oriented, and got those in place ahead of a slowing market now. We have been able to capture some of the CMBS dislocation activity here recently as a result of some of those decisions.
The second theme was to get more primary market orientation and to do it at price conscious points. Historically, our portfolio had been built on somewhat niche exposures and less liquid markets in general. Ideally, this could have been done in the exact opposite direction, but it is really a diversification story of “how do we get more primary market exposure without just blowing ourselves out of the water on a cost basis?” There are pros and cons to doing this now, but we have a more balanced portfolio today.
The third theme was getting access to European real estate beta. TMRS had launched an international portfolio the year before. Our perspective was “we aren't on the ground in Europe or anywhere internationally on a day-to-day basis, we understand it less well, so let’s find ways to get what looks more like statistical exposure to other areas of the globe.” This is particularly the case as we ramp up the portfolio; it doesn't make sense to be exclusively in niche, idiosyncratic things. We do need broader exposure.
TI: How are you looking to develop the real return portfolio strategy?
TM: We are continuing to build out the real return portfolio. The really big initiative is what the strategic allocation is going to look like longer term. I would say that the big themes here are to move more into private assets and define what strategically makes sense in terms of how much illiquidity we want to take on in this portfolio. Realistically, this particular plan doesn't have liquidity issues as it is well funded, which could enable us to dedicate close to all of our portfolio to privates. These decisions are yet to be made, however.
Breaking the portfolio down into two parts:
On the liquid side, the key for the short-term is to become more diversified and begin the trade out of global inflation-like bonds. I think we generally view GILBs as having an asymmetric risk profile given the long duration and current low interest rates – although we've actually gotten some gains from duration here in the past three months, so who knows how low the interest rates can go. I could be wrong on that front! As we move further along, we may try to pick individual managers to manage individual sleeves, such as global listed infrastructure and some other things like that.
On the private side, as I mentioned, we have built in some structured equity and credit thus far, a lot of which is contractual yield. We talked to the board about how real return investments are following along the spectrum of absolute return to inflation-beta. Absolute return is more tied to contractual cash flow yield and is probably more interest rate sensitive, whereas commodities and natural resource equities fall out more toward the inflation-beta end of the spectrum. I don't think there is a perfect answer to getting only a kinked positive exposure to upside inflation – but it would sure be nice if there was.
Early on in the portfolio, we think a little bit more structural protection makes sense. As we get more mature we can then take advantage of a group of assets that on an individual basis tend to be pretty heavily cyclical in the individual sectors we invest in, which I think is a key challenge for real assets.
We don't tend to look at real assets as an asset class within the portfolio. We look at it as a sector exposure. The rest of our portfolio is approximately a 70/30 equity/fixed income capital structure, and the preliminary plan is to pursue a similar capital structure within our real return portfolio during the implementation phase.
TI: To what extent has your portfolio been affected by the oil super-cycle?
It’s things which are unpredictable in their nature, like the OPEC and Non-OPEC meeting in Doha, that we are all relying on for a market price recovery or a disaster.
TM: Fortunately, we haven’t really had to steer through that, if only for luck of timing. Certainly, we have exposure in public markets, but looking at our real assets portfolio today outside of petro-currency exposure in our GILBs book any effect is somewhat indirect.
We have been able to watch the oil markets do what they do. The first private equity structured credit piece that we put in was an energy fund, which ideally would be able to capture some of the financing needs out there in the market. They haven’t deployed a lot of capital thus far. I think our general thesis on oil in the past six months has been to invest in a strategy where the investment decision is based on oil finding a bottom, but not relying on it coming back. In any case, we don’t owe our limited exposure to probably anything other than luck in this case; we were just on the path to getting implemented, and fortunately we weren't in the markets at that time.
We do talk a lot about oil internally. There are supply and demand numbers, and managers will come through and have their glittering representation of whatever supports their thesis on the market. We can sort through all those things and try to confirm or not confirm as much as we want. At the end of the day, energy markets trade on massive expectation swings. It’s things which are unpredictable in their nature, like the OPEC and Non-OPEC meeting in Doha [on April 17 2016], that we are all relying on for a market price recovery or a disaster. It’s hard to get managers to actually acknowledge that because everybody is “investing for the long term.”
It's an interesting market. I'm not sure how soon or if we’ll ever have an outright long exposure to oil within our real assets bucket, but who knows!
TI: What kind of investment opportunities are there the in areas affected by Basel III and a lack of credit?
TM: Mostly these are areas where mid-sized corporate lending that has gotten pushed out. The two areas adjacent to oil I alluded to earlier are mining and agriculture, both of which have also gone through cyclical lows.
We are backing a team in the agriculture space that might be considered an over-collateralized lending strategy. We can get 10-to-12 percent gross yields contractually, with some upside participation in an over-collateralized structure. There aren't a tremendous amount of firms out there doing these strategies, but there is an opportunity.
Pensions funds are hurdle-rate investors because of the accounting structures and the way they get handled politically – TMRS, to its credit, is among the leaders in employing lower discount rates. We are among the lowest in the country at 6.75%. From an investment approach perspective, anytime we can get an investment with contractual yield above 7% and participation to the upside, we like those type of structures. We have recently pursued commitments to Magnetar (energy), Orion (mining) and AMERRA (agriculture) with return profiles that can be described by these characteristics.
TI: Is that with a global outlook, or are you focused within specific markets?
TM: A real return portfolio is naturally going to be global because of the underlying assets we invest in and a lot of the dollar linkages, even ex-US. Ideally, if I can get the returns in the developed markets, then great, but I don't think we are shying away from emerging markets in the right instances. We are taking an approach in a “mini-sovereign wealth fund” concept. We want to own key marquee assets to the extent we can and then pursue higher returning assets around the fringes when appropriate. I say mini-SWF because we have to do it through asset managers, fund vehicles and smaller staff check sizes. This naturally limits our opportunity sets in comparison to the big global firms, but it allows us to focus our time and resources on our best ideas that will make a difference for our portfolio and beneficiaries.
TI: You made a point above about the importance of finding the right managers who can add diversification to your portfolio. How are you going about that process?
TM: Alignment and lifestage point are the key principles for us. I've got to credit Chris Schelling, who is far more the academic than me! He talks a lot about fluid and crystallized intelligence curves amongst investment managers, i.e. finding managers in the right stage of that career curve. Managers that are ideally aged between 40 and 45 we find to be kind of a sweet spot for us. People that are hungry – where this has to work for them this time around – but who have also found ways to build the infrastructure around them such that this is not a potential for a business proposition failure.
For instance, last year, we did TPG's real estate fund. It’s probably me being oversensitive in some way or another, but it feels like some have snickered at us doing that investment because there are longer established firms, and TPG is known principally as a private equity firm. However, the firm’s got the guy who was an underlying star for Westbrook Partners for many years. Now, in partnership with one of the founders of Colony Capital, they have built this platform that has a differentiated product offering. Is it fully proven out yet? No. Do they have a long track record? No. But they have all the pieces in place that suggest that they should do well as a group. We spent a lot of time on the people and the strength of their track records – at the end of the day, at our level of capital deployment we are buying people more so than assets.
From a process standpoint, it is examples like the above where I try to not get too entrenched in thinking any one thing is perfect. Generally, I try to start with the assumption that we aren't right. By starting with that assumption, I hope that it leads us to being cautious stewards of capital for our beneficiaries and that we’re capable of coming up with and implementing portfolios that are somewhat different than our peers. The goal, even if we have picked different managers, is to create a portfolio that is more institutional and is less exposed to business risk at the manager level.
TI: You were previously a principal investment analyst at NextEra Energy, which is a renewable energy firm. How does working for a corporation differ to working for a pension fund?
TM: From an investment standpoint – and I think this has helped inform the rest of my career – I had the opportunity to manage taxable and nontaxable nuclear decommissioning trust assets, ERISA (The Employee Retirement Income Security Act) assets and 401(k) portfolios. I would say the NextEra experience helped give me perspective on what the taxable world was really doing, and what quirks taxes and regulation in that world have on how they act and why fund structures ultimately exist the way they do. It also extended the breadth of the type of funds that I managed. I was focused on private equity, credit and hedge funds while I was there, but we were on the verge of getting into real estate and real assets at the time I left. I had a solid public markets interaction as well.
However, compared to the public institutions I have worked with, where asset management has really been a core function of the organization, trust fund management at NextEra is somewhat of an afterthought at the end of the day because the firm’s key competency is to make money in utility markets and its related business ventures. I would say that was the most interesting part. We found ourselves really bending over backward to operate within a framework that worked well for the accounting and tax infrastructure that was already in place.
TI: You mentioned that you have experience across real estate, real assets, private equity and hedge funds, as well as public market interactions as well. Would you describe yourself as a generalist?
TM: If there is any one theme to my career, it's probably breadth of experience and breadth of exposure to different asset classes and sectors. I've invested in hedge funds, private equity, real estate and real assets; I've traded our internal fixed income and bought portfolios; and I've interacted with private credit strategies throughout my career as well. That has been a strength, rather than necessarily focusing my expertise down one narrow path.
My time at Kentucky Retirement Systems was very informative because I wound up doing projects for legislative processes and the actuarial side. At TMRS, I’ve also had exposure to providing input for improvement in the governance infrastructure to enable us to better execute investments. I've had the opportunity to work in understaffed organizations and largely built the back office at Kentucky Retirement Systems. We have a much better jumping off point at TMRS, but we’re still working through the transition and hiring people to do more of the detailed operations work as we go along. From a career perspective, I've got a lot of administrative experience very early on in my career that probably a lot of other people in my position haven't. On the flip side, I would say that the cost of that is I'm probably less of an expert in any one specific area.
TI: What first attracted you to working in institutional investing?
TM: My first job out of school was a bank auditing job. Definitely not the most exciting job, but I had taken it in part because a professor said, "An audit job is a good place to start out of school." I started in September or August 2007, so I largely got to do credit review through the financial crisis. It wasn't a large bank, about $5 billion in assets. It was publicly traded, but it was a thinly traded NASDAQ stock. They had a lot of residential lot developments. I got a lot of experience in understanding the way regulators work and how corporate executives interact with other departments and regulators. I got to toy around with some theory, and I got to write down a lot of balance sheet capital very early on in my career, which was an interesting experience.
I think that experience informed me pretty quickly that commercial and retail banking is an industry I didn’t want to spend a long time in. I immediately started thinking that I would like to get an investment job, and began working toward that. I started taking the CFA program exams. I was commuting into Frankfort, Kentucky for the audit job, and Kentucky Retirement Systems also happened to be located in Frankfort and decided to launch an analyst program. Fortunately, I wound up getting that job, and it set me on the path that I am on now. When I started at Kentucky, I got dropped directly into real estate and private equity, which is how I initially got into working in alternatives – and here I am seven years later!
TI: What career advice would you give to someone who is looking to get an institutional investing role at a government pension fund?
I regard Wall Street as probably being less theory, more action, and academia is more theory, less action. Pension funds are really in the middle of that spectrum.
TM: I've worked in medium sized pension funds, ranging from $12 billion to $25 billion now. Even at that size, you have a big check to write. With that big check comes a lot of informational privileges, and a lot of access to marquee names in the industry. That type of access is invaluable. It depends on what institution you are at, some institutions are out there doing direct deals. You can get a look at markets from 60,000 foot view and actually take strategic viewpoints on the market rather than being caught up in day-to-day tactics.
That skill set is underappreciated. It is informative for how you manage your own personal assets at the end of the day, and public policy conversations that pertain to the retirement crisis we hear about all the time in the media. It's a great level in capital markets to work at from an intellectual standpoint, if you enjoy both theory and action at the same time. I regard Wall Street as probably being less theory, more action, and academia is more theory, less action. Pension funds are really in the middle of that spectrum.
TI: Who has been a key influence in your approach to institutional investing?
TM: TJ Carlson and Chris Shelling, my colleagues here at TMRS, have been by far the most important people in my career.
Realistically, I've learned the most on managing organizations and managing people from TJ. I’m in awe how much he is capable of doing without feeling the need to pat himself on the back for getting it done. He is a very humble guy and somehow everybody feels a part of what he has been able to accomplish. His roles at these public plans haven’t always been about investments, as being a CIO can get administrative, political and require the engagement of legislators at different points in time. How he balances it all I’m not quite sure – admittedly, particularly as it pertains to this particular list, if a CIO role is in my future I hope I can do it with as much grace as he does.
Chris Shelling is an awesome empiricist and investor. He has worked in a variety of different roles in the industry, but principally in hedge funds until now. I’m pretty convinced the guy is one of the top ten smartest guys in the pension industry. From the conversations we can have from a theoretical and data basis, I'm always amazed at what that guy knows. TJ got Chris to come on down to TMRS. Once Chris agreed to come, it didn’t take me a lot of convincing to come down – subject to a background check, naturally!
To learn more about top-tier institutional investors, check out Trusted Insight's Top 30 Future CIOs at Pensions.