Tom Masthay is the director of real assets at Texas Municipal Retirement System since 2015. He manages the real assets portfolio of the pension’s $25-billion investments pool. Prior to this, Tom was a principal investment analyst at NextEra Energy Inc., and a director of real assets at Kentucky Retirement Systems. He has an MBA in Finance and a BBA in finance and economics from the University of Kentucky.

Tom was recently named on Trusted Insight’s Top 30 LPs Investing In Real Assets, Real Estate. He spoke with us on November 8. (He was previously named on Trusted Insight’s Top 30 Future CIOs at Pension Funds. Click here to read his first interview.)

In this interview, Tom discussed recent strategic developments at Texas Municipal Retirement System, his views on current real estate valuation and why he thinks the asset allocation model should be challenged during times of rapid portfolio diversification.

Tom will be speaking on  the state of the U.S. real estate market at the Trusted Insight Alpha Conference 2017 in San Francisco.

Trusted Insight: In your last interview, you mentioned that TMRS was expanding its alternative assets programs when you first joined. Specifically, within the real assets and the real return, the two things that you were working on, was there any notable changes happened in 2016?

Tom Masthay: Strategic clarification is probably the biggest thing that's taken place in our portfolio in the past six months. We clarified the objective of our real return portfolio, which is that in the long-term we are de-emphasizing inflation protection instead leaning portfolio focus to more return enhancing strategies.

We arrived at that conclusion at the end of our liquid real return search process. We inherited about $1 billion of inflation-like bonds from the real return portfolio, and then progressively started allocating to private capital, but aiming at getting the pension fully funded, we allocated new capital within the public markets as well. We came to conclude how to do that through a research process. We determined that the first step is inflation protection, which is especially important from a liability perspective. Secondly, the asset allocation influenced building up the assumption that higher-end inflation protection actually returns less in the short-term.

Basically it means we're going to be very active in the private real return and unlock the door in the next two or three years.
 

Trusted Insight: What areas within real assets do you see opportunities in?

Tom Masthay: We are trying to follow along the forefront of getting more natural resources capital deployed, particularly in the private markets, by continuing to find financing opportunities. Regulatory capital trades within real asset sectors such as energy, mining and agricultural have been a focus.

In general, within natural resources, I think we look at that as pretty big opportunity and anticipate being active in that area in the coming years. We're looking at private infrastructure as well – this seems to be more popular among institutions because people still feel jittery about natural resources investing.
 

Trusted Insight: Pension funds received a lot of criticism over investing in expensive alternative assets recently. Is management fee something that bothers you?

Tom Masthay: I think this question goes asset class by asset class. Certainly some asset classes are easier to criticize than others. The purveyors of the anti-alternative investing movement / those who question the legitimacy of investing in alternative assets, largely selectively choose a convenient time frame over which to draw public market data to make their case.  However, I will say yes. We're constantly seeking ways to lower our fees and challenging ourselves on what that asset allocation model should look like, because asset allocation model would largely dictate the fee levels. However, if you look at private equity and private real estate, you are getting higher fees, but you're also getting higher net returns than other alternative assets and public markets.  One thing to note here is that institutions can do a better job at rationalizing the economic models within which they invest.  It doesn’t pay to be an unsophisticated investor in alternative assets – unsophisticated investors pay more and get less in return. However, if institutions can increase their capital flexibility and resource themselves in a manner that is focusing on net performance over horizons commensurate with liability risk, success can follow through stronger negotiating positions with investment managers and better investment opportunity/manager selection outcomes.
 

Trusted Insight: Can you elaborate more on challenging the asset allocation model?

Tom Masthay: One thing we are taking a deep look at, in terms of challenging the asset allocation model, is international and domestic allocation. We are challenging the base case diversification benefit that international allocation has for a portfolio, particularly portfolios that are somewhat limited in size, like TMRS’, which is $25 billion.

My general comment is, and I borrow the general phrasing from a colleague, is that the average institutional investor is too willing to conventionally fail. And because of that, to a large extent public pension plans have very similar asset allocations and operate in bureaucratic molds that none of investment managers, endowments, family offices, sovereign wealth funds or other industry players seek to emulate.

I think that whole concept of Markowitz strategic asset allocation needs to be challenged. Obviously we have an institutional framework within which we operate, but we're thinking through these things on a daily basis. One way we try to do that is that we try to make fewer decisions, not more, and to simplify our thinking, not complicate. We have been in a period of rapid diversification compared with a just-bonds-only portfolio in 2009 so admittedly there is a bit of a juxtaposition in our approach. Institutional investors can probably do things simpler. Although I would say alternative asset classes play an important part in asset allocation going forward.

I would also argue that “private assets” and “alternative assets” are not necessarily the same thing. Private asset markets are something institutions can get involved in scales that normal investors can't. They do come with higher fees and higher costs, but I would caution industry participants, particularly your tangential industry participants or people looking to criticize “alternative assets”, of trying to distinguish between opportunities that are not otherwise available, like private market assets, versus various public market trading strategies. I think those are two different things. That's why the distinction doesn't always get drawn. In any case, we're one equity market sell-off away from a lot of the arguments against alternative assets from not being all that valid.
 

Trusted Insight: Let's switch to real estate for a minute. To what extent do you think are real estates overpriced right now?

Tom Masthay: My personal opinion is I don't think they're tremendously overpriced. Rather, I think asset values reflect something else. I had this discussion with a lot of people. It might in fact be somewhat unique because I manage the real estate portfolio at a very detailed level, but I also manage a broader pool of other assets because we invest a real return portfolio as well across public securities, private securities and various sectors in debt and equity.

As I think about real estate, lower rates means that higher asset prices makes sense – in the low rate environment we’re in, I don’t think it’s overpriced. When I ask people about their opinions on real estate, people have generally say they were being cautious, selling some of their portfolio here and there. But I have not gotten straight/consistent answers on how they were redeploying that capital, which is what I’m most interested in.

For an institution that has to stay deployed, I can live with my real estate exposure posting negative gains if it proved to be a better relative value than my alternatives. Can I get hurt in real estate? Yes. Do I think I'm going to get hurt in real estate in the same way I could get hurt in other asset classes? Probably not today. That's my general perspective.
 

Trusted Insight: How do you think the demographic change in the U.S. with affect the real estate demand?

Tom Masthay: People have been executing on these strategies for four or five years already. We've already seen multi-family markets run. We've seen urban revitalization. I think with those trends firm in place, and how managers recognize them, I think to some degree the rich get richer and the poor get poorer. Secondary markets will be more dislocated. Asset prices in the core markets should stay higher. These aren’t particularly novel conclusions to draw.




As I think about real estate, lower rates means that higher asset prices makes sense – in the low rate environment we’re in, I don’t think it’s overpriced.

I think demographics are constantly a conversation in real estate. Now, with pricier asset markets, it really is reduced to a supply and demand dynamic with increasing specificity on a market-by-market basis. The big trends have been moved in on the demographics, in my opinion. While people argue they should be developing more senior housing and more student housing, everybody that pitches their demographic stories tie to what they're doing for the most part – so it’s hard to get a good story absent independent research from the investment manager universe. I’d say 80 percent of real estate pitches have their pitch tied to demographics in some way.
 

Trusted Insight: In the near-term future, where do you see the opportunities in real estate and real asset investments?

Tom Masthay: I can't answer it without taking into account what I've already walked into. I would say that the themes we've pursued in investing in 2015 and early 2016 has been four-fold: One was that we wanted to move up the capital structure in the U.S.

Another theme was to get European beta.

The third one was to get more exposure to primary markets in the U.S. in a price conscious way.  Credit exposure was one way to do this. We inherited a portfolio that was largely secondary market-oriented and didn't have exposure to markets that recovered more poignantly in the most recent downturn.

The fourth theme is find structurally better investments where the inefficiency of the fund model isn't going to cause as large a drag on returns for us. We pursued that by being somewhat on the forefront of the new core-plus real estate space.

All of those things said, I would say those themes generally fit to real estate. I don’t have enough capital to say, I want to go invest in affordable housing or I want to invest in this sector or that. That wouldn't work for us and isn't particularly value additive because of the scale of capital we have and the government system we operate within.

 

To learn more about real assets/real estate investing, click here to view the complete list of Top 30 LPs Investing In Real Assets, Real Estate.