What This Corporate DB Plan Invests In To Hit Funding And Return Goals | Exclusive Q&A With Erik Carleton Of Textron
Erik Carleton is a director of pension investments at Textron Inc., a $13.4 billion-revenue industrial conglomerate. Carleton manages the global fixed income and public equity investments of the Textron Defined Benefit Plan. He is in charge of the manager selection within public equities, fixed income, currencies and derivatives. His former roles include investment consulting for NEPC and Fiduciary Investment Advisors. He holds an MBA and a Master's in Finance, both from Bentley University. He is also a CFA charterholder.
Like many institutional portfolios, Textron’s defined benefit plan underwent a transition from investing heavily in index equities and fixed income to investing in actively-managed funds. In this interview, Carleton discusses Textron’s shift in its investing strategy, how he selects fund managers and the challenges facing corporate pension investors currently.
Mr. Carleton was recently named on Trusted Insight’s 2017 Top 30 Corporate Investment Office Rising Stars. He graciously spoke with us on March 22, 2017.
Trusted Insight: What’s the makeup of your investment team and asset pool?
Erik Carleton: We have roughly $10 billion of assets under management. That is currently $6 billion in the defined benefit plan and $4 billion in the defined contribution plan. We have a team of five within Treasury. This includes two investment professionals reporting to our Chief Investment Officer, operations/compliance, and support from our team coordinator. I run the publicly traded part of the defined benefit plan, including global equities, fixed income, currencies, and liquid derivatives. This portion comprises 80 percent of the plan. My colleague runs the alternative investments in the defined benefit plan and the defined contribution plan.
Trusted Insight: Your pension plan has an 87 percent funding ratio, which is considered very healthy compared with industry average. How does that affect your investment strategy?
Erik Carleton: Yes, it is a well-funded pension plan. As investors, we run the assets with a total return profile. We are aware of our funding status, and we manage our hedge ratio as part of the overall risk position, but that is not guiding the investment philosophy.
Trusted Insight: How did your portfolio perform in 2016 relative to the target rate of return?
Erik Carleton: In 2016, we returned 9.8 percent on a net basis. We outperformed the policy benchmark by 100 basis points. At a high level, it took some tactical shifts from our CIO during the year to not only make the return, but also to keep it.
Trusted Insight: How is your portfolio structured?
Erik Carleton: On the public side, we run the portfolio by asset class, each built with a core/satellite design. All of the selected strategies are actively managed, although for each asset class we also have a liquidity sleeve for beta. Those are indexed vehicles such as futures, ETFs, even mutual funds. They are typically used to make shifts in our tactical allocations, which also helps to protect our active managers from flows.
Trusted Insight: Since your chief investment officer Charles Van Vleet took over the pension fund in 2013, he has significantly transitioned the portfolio from passive to active management-driven today. From the perspective of an investor on his team, what was that transition like?
Erik Carleton: Sure, it has to do with a shift in the philosophy at the Chief Investor desk. It also helps to explain the liquidity sleeves for beta. The previous Assistant Treasurer was much more of a buy-and-hold-type allocator. She would hire good managers with the goal of trusting the assigned investment decisions to them, often both alpha and beta at some level. For a good long time that model was successful and appropriate for the way this team wanted to invest the money.
Charles is different in that he actually came with direct asset management experience himself, a former portfolio manager in fixed income and FX. Compared to many allocators I’ve seen on this side, he forms a more complete macro view of the market as he reads charts, and typically prefers direct market data as the source of insight. At Textron, he wanted to retain more control of the overall portfolio beta in house, and try to focus outsourcing more towards alpha and unique opportunities. That took a rearranging of structure so that we ended up with a lineup that feels more like partners than products. Also, liquidity vehicles became more important, too.
Trusted Insight: How many managers do you work with? How long is the average relationship term?
Erik Carleton: We have about 20 manager relationships throughout the public book.
One of the things we've actually gotten great results out of over recent years is seed-funding new strategies. That ends up working great in the spirit of partnership, where the asset manager gains a client, gains assets and gets live track record for the idea. And in return, we gain founder’s fee agreements.It's now a little bit of a mix where we have some very long-term relationships, some from 1985, 1993, 1996, for example. Investors like these have a long history of adding value for the plan and play core roles in the current profile. And yet, we also try to introduce some different things into the mix. We've got things like 130/30 in U.S. equity, where we can net 100 percent exposure but enhance conviction by shorting 30 percent of things you don't like and using that cash to emphasize the things that you do like. Closed end fund trading is offering a varied return profile within our international exposure. On the fixed income side, strategies like convertibles have been new additions. We also have some newer structural approaches to investing, including things like ETFs and factor investing.
Trusted Insight: What is your criteria for manager selection?
Erik Carleton: There are no characteristics that are universal except integrity and partnership. We hire managers that are designed to do well in varying environments. Last year is a good example. Some of our best investors had a really tough year, but it was a really tough year to be an investor. But it was a great year to be a trader.
Trusted Insight: Do you have a preference between managers with a solid track record and those with innovative, niche expertise?Erik Carleton: The nature of running a portfolio like we do is that it gives us the ability to have both. Also, because we're doing our own work independently, we don't necessarily need to wait for a track record or for asset levels to confirm commercial viability of a strategy. One of the things we've actually gotten great results out of over recent years is seed-funding new strategies. That ends up working great in the spirit of partnership, where the asset manager gains a client, gains assets and gets live track record for the idea. And in return, we gain founder’s fee agreements. Also, the dialogue stays strong because you rarely feel like the next marginal customer.
Trusted Insight: How did you transition from consulting to corporate pension funds?
Erik Carleton: I knew the Textron team because they were originally a client of the consulting firm that I worked for. When they decided to turn their investment capabilities in house, they concluded their relationship with the consultant, which was too bad because I really liked the portfolio. I actually liked what I knew of the new CIO as well. I could see why he did it, because when you have your own market views, you have less need for many of the services that a consultant provides and does best. A couple months later, when his internal staff member wanted to take a different role within Textron’s operating division, somebody suggested that I should consider competing for this job.
Trusted Insight: How has your consulting experience informed your investment philosophy?
Erik Carleton: I really liked investment consulting. I had exposure to many different types of portfolios, pools of capital, investors and committees. It was a terrific experience to continue to gain understanding of how many different ways there are to attack a risk or return hurdle. There would be two things about it that I have learned in retrospect: One was the difference between advising an asset and owning an asset. On the plan sponsor side, I'm glad to be able to think of something, run it by the superiors and then actually implement it, so you can get from advice to action.
Trusted Insight: Overall, is it common for consultants to switch field to pension funds or institutional investment offices?
Erik Carleton: I am not sure how common it is to move from consulting directly into the plan sponsor side. Sometimes, I think I more often hear about people going the other way, from a plan sponsor to a consulting role. Consultants and outsourced chief investment officers end up operating in between companies and asset managers. So you could see people going from the middle into either side. I think it might be more common to find the next step on the asset manager side as opposed to the asset owner side. That might just be supply and demand, because I think there are ultimately fewer positions.
Trusted Insight: Currently, what are the challenges that investors face in corporate defined benefit plans?Erik Carleton: I think the greatest challenge is the constant tension between short-term and long-term outlooks and investment opportunities, particularly given growth prospects and valuations going forward. It feels more likely that beta or index expectations could be lower than they were seven years ago, particularly if you can’t avoid at least part of a drawdown. That just means that you have to spend the portfolio risk a little differently than simply looking like the benchmark.
Also, that takes a risk tolerance because you're going to have tracking error to the benchmark and you may have some short-term underperformance or delay of long-term returns. I think that, ultimately, governance of the capital pool is either the competitive advantage or the hurdle that a lot of corporate pension plans face. That will affect an investor's willingness and ability to spend risk.
Trusted Insight: Can you tell me about your governance structure?Erik Carleton: Yes, that's actually one of the things I like most about our plan. Governance has gone a long way to help us generate good returns with thoughtful levels of risk. Ideas can get into the portfolio if they're approved by the Treasurer and the CIO together. We don't have to take manager ideas or strategy ideas up to the committee level.
The Investment Committee, which is chaired by the C-suite and consists of five company executives, owns portfolio targets and ranges for asset classes. They own the strategic policy. Investment Management, which is us, is responsible for populating those asset classes, or spending the risk within those categories.
We're able to operate within the prescribed ranges without too much friction, for the most part. There's a balance between control and oversight, and also flexibility and creativity. We all maintain good communication throughout the year with quarterly meetings and monthly updates.
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