Craig Husting is the chief investment officer at the Public School and Education Employee Retirement Systems of Missouri, where he oversees the Systems' $42 billion investment portfolio. More specifically, he is responsible for strategically diversifying the asset allocation for the Systems including the development of real estate, private equity and hedge fund portfolios. He joined the retirement Systems as CIO in January 1999.
In this interview, he discusses the pension Systems' bucket approach and why 20 percent is allocated to safe assets; using back-office technology to remain as an innovative investment office; and how he's addressing the notable challenges in the public pension industry.
Trusted Insight: Given the low-interest rates; high valuations; crowded public and private markets; and stage in the macroeconomic cycle, do you have a thesis as to where the best returns will come from over the next decade?
Craig Husting: We believe that returns over the next 10 years will be lower than they have been for the last 10 years. We agree that public equity markets, private markets and even treasuries are overvalued. That makes it fairly difficult for an institutional investor. In this environment, we're trying to run a very balanced portfolio.
"The safe asset portfolio allows the Systems to pay benefits in any market scenario... Our goal, to feel comfortable, is an allocation of approximately 20 percent to safe assets."
We will likely have more cash than we had in the past, even though it is expensive to hold cash or treasuries due to such low yields. We are probably becoming a little more conservative because of the valuations. In terms of areas that we like longer term, emerging market equities are more attractive than U.S. or non-U.S. developed equities. We have a pretty healthy allocation to emerging market equities because of the longer-term growth prospects.
Trusted Insight: You adopted an asset allocation approach in 2009 that divides the portfolio into three buckets: safe assets, public risk and private risk. What caused this portfolio reconstruction and what impact has it had?
Craig Husting: Going into the financial crisis in '07-'08, we actually sold a significant amount of fixed income credit. We had a core fixed-income bucket in 2007, much like many institutional investors, which included mortgages, credit, and treasuries. We really thought a large portion of that index was tied too closely to risk assets or equities. We wanted to clean that up and ended up converting the entire portfolio to treasuries. That is when we started thinking about the bucket approach.
Ultimately, we made the switch to three buckets of safe assets, public risk assets and private risk assets for a couple of reasons. One, we liked the private assets for the illiquidity premium that we could accept as a long-term investor. At the time, we didn't have a lot of private assets. Today, the private risk allocation includes private equity, private real estate and private credit. We determined that 20-25 percent of our total portfolio could be allocated to private assets where we were expecting higher returns with some illiquidity risk.
"We utilize software packages to be much more efficient as a team, particularly on the private risk side... Technology has allowed us to grow more easily and be efficient and informed."
On the opposite end of the spectrum, we wanted a portion of our portfolio that offered full liquidity. We called this allocation, safe assets. The safe asset portfolio allows the Systems to pay benefits in any market scenario. We are currently in a negative cash flow situation of approximately a billion dollars a year (for example, the amount of money we collect in contributions each year is approximately a billion dollars less than the benefits we pay). As such, the safe assets portfolio ensures that we have liquidity for benefit payments. Additionally, the safe assets portfolio provides liquidity to redeploy as market changes dictate and also liquidity to meet capital calls for private real estate. The safe assets portfolio is a safe haven when equity markets drop significantly. Our goal, to feel comfortable, is an allocation of approximately 20 percent to safe assets.
The third bucket is an allocation where we are comfortable taking more liquid risk: public risk assets. This allocation includes primarily liquid assets that have any type of risk exposure, whether it's U.S equities, non-U.S. equities, corporate bonds, r high-yield bonds, currency or hedge funds. The allocation includes assets that have some risk associated with it but are reasonably liquid.
In summary, this is why we made the portfolio shift. One, we liked the separation of safe assets and risk assets. Second, the structure is conceptually relatively easy to understand in terms of safe assets or private risk or public risk. Finally, we like the new asset allocation because it is structured but flexible.
Trusted Insight: How does your new allocation approach hedge against the economic risk of an inevitable market downturn?
Craig Husting: We believe our allocation hedges against a downturn in three ways. One, we do have 20 percent of our assets in safe assets, which is primarily treasuries and cash. If there is a significant market correction, we like the safety of this allocation. We think that fixed income allocation will help us relative to having money in high yield or credit. Secondly, in the public risk bucket, we maintain a lower beta within our portfolios. We have a significant allocation to low-volatility strategies within our public equity portfolio. If the market corrects, we expect our portfolio to perform better than the index due to e lower beta, or lower volatility. Finally, we also have a decent allocation to hedge funds. About 12 percent of our total fund is in hedged assets, which is a category within public risk. This portfolio has a beta of about .35, so we think we'll get quite a bit of downside protection.
Trusted Insight: There's an increasing number of investment offices with a higher level of sophistication, in terms of technology and resources. How do you innovate as an investment office to remain competitive and produce strong returns?
Craig Husting: We do use several external advisors on the consultant side. They have the ability to spend more on technology than we do, so we leverage those relationships for support. We benefit from good partnerships with external consultants and managers. We also utilize several software packages to be much more efficient as a team particularly on the private risk side.
Ten years ago, we had just an investment staff. Today we have both the investment staff and an operations group of five people focused on investments. We spend a lot more time on the back-office end to make sure we limit mistakes and to ensure compliance from an operational standpoint. Technology has allowed us to grow more easily and be efficient and informed.
Trusted Insight: What are the most notable challenge(s) in the public pension industry or at your firm specifically?
Craig Husting: The assumed rate of return is the biggest challenge. Most public fund institutional investors have a relatively high assumed rate of return, whether it's 7 percent or 7.5 percent. I think the expected returns for the next 10 years will be lower than they have been in the past. As such, the ability for institutions to achieve target returns will be more difficult moving forward. We have to find other ways to achieve the returns, whether it's a more diversified portfolio or the pursuit of a higher level of alpha.The second challenge is the governance process with institutional funds. I believe that having a really strong governance process gives you an advantage or an edge in meeting your expected returns. Maintaining a good governance process is the key for any fund to reach meaningful returns longer term.
Trusted Insight: What advice would you give to an aspiring CIO that is starting out their investment career?
Craig Husting: Two of the most important issues are humility and understanding the governance process. The markets will humble you in a hurry if you are not pre-dispositioned in the regard. Having a strong governance process internally with both the people who report to you and with the board you report to makes all the difference. I also think you need to be comfortable hiring people that are smart and ambitious. If you can develop a diverse and ambitious staff, you have the opportunity to achieve strong returns and develop a top-tier system.
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