Ronald Schmitz is the chief investment officer at Virginia Retirement System, where he oversees $68 billion of assets under management. Prior to this, he was the chief investment officer at Oregon Public Employees Retirement Fund and Illinois State Board of Investment. Schmitz began his career with Kraft Foods Inc., before gaining pension management experience at Sears, Roebuck & Co. He has also served as the director of investments for Blue Cross & Blue Shield Association. Schmitz has a bachelor's degree in finance from Western Illinois University and an MBA from Northwestern University.
Schmitz was recently named on Trusted Insight’s Top 30 Public Pension Chief Investment Officers. He graciously spoke with Trusted Insight on December 1, 2016. The following interview has been condensed and edited for clarity.
Trusted Insight: You started out your career at Kraft Foods Inc. before joining a pension fund. How does working for a public pension fund differ from working for a corporation?
Ronald Schmitz: It's a lot different. The governance structure is quite different. After leaving Kraft, I worked at Blue Cross Blue Shield for about ten years. Some corporations may have a board or a committee that's the decision-making authority, but the ones that I'm familiar with are typically just the investment director and a senior management committee, and very often it's just the treasurer, or the chief financial officer. So, it's much more of a one-on-one or one-on-two-or-three kind of group discussion process, whereas public funds tend to be a much larger group and a can be a bit of a dog-and-pony show.
I've worked for three different public funds and the governance structure for each is a little bit different. At Illinois and Oregon, we needed to condense two or three years of work and research into a 20- to 30-minute recommendation, followed by a presentation by a manager. I've been fortunate enough to find most of the boards I've worked with have a lot of faith in the staff and more often than not go along with the recommendations, but sometimes there’s a debate between the board and staff, and sometimes a debate within the board in which staff often interjects a little bit and try to get to a resolution. It's much more of a give-and-take consensus. You end up playing a lot of it by ear. At Virginia, the board sets basic policy parameters and delegates manager selection to staff. Very different.
Trusted Insight: You joined Virginia Retirement System about four years ago. How has the plan and your portfolio evolved since then?
Ronald Schmitz: We've maintained the same risk profile over the years in an absolute risk sense. Within the portfolio, there's been some subtle shifts -- we've increased our private market exposure, and we will continue to do that over the next few years. The money largely moved away from traditional public stocks.
Trusted Insight: Do you think it's a trend for other pension investors as well? Will pensions allocate more in private markets?
Ronald Schmitz: Yes, that's generally a trend that would continue. I think at some point the growth of private markets might, in theory, hit a maximum point where you have too much money chasing too few deals. But at this point we still see a favorable arbitrage in terms of pricing that's being paid for the multiple of earnings that you're buying in private companies versus public companies. So, we're still comfortable with the return prospects. I do think most large funds will continue to become more and more private asset-oriented.
Trusted Insight: Are there any assets within private markets that you particularly favor at the moment?
Ronald Schmitz: We really like credit -- private credit, in particular. We've made a fairly significant move into direct lending and growing exposure into some areas like mezzanine investments.
We also like real estate and real assets, even though real estate cap rates are quite low by historical standards, indicating that prices are expensive. It's like the difference between private and public markets. It's still a very favorable arbitrage versus the 10-year Treasuries. So, we feel pretty good about traditional real estate as well as other real assets such as infrastructure and natural resources.
Trusted Insight: Can you tell me a little bit about your team culture and structure?
Ronald Schmitz: About a third of our portfolio is managed internally. That's 100% of our investment-grade fixed income and about 40 percent or so of our public equity. The primary external relationships that we have are in private markets and a little bit in complementary public equity strategies and credit.
The team is divided up into teams who deal with external managers versus those who handle internal portfolio management. Generally speaking, the culture, or at least my philosophy, is that I expect the teams to be very solid and each person to be very knowledgeable about what they do. I'm the guy who knows enough to be dangerous, but they're the ones who actually have to know their markets inside out. So, I look for ideas to bubble up from the bottom as opposed to me being more authoritarian and driving things from the top down.
Trusted Insight: In a 2012 interview, you mentioned that when you started out in this role, one of the big differences between Virginia and Oregon (where you previously worked) was how they handled the recession. What was it like at Oregon in 2007?
Ronald Schmitz: In 2007, the board understood that while the decline in price hurt, it also meant it was a buying opportunity. The worst time to get conservative is right after a big downturn, because you could sell everything at a low price and lock in your losses. However, if you buy, you have a chance to add value and catch the upside. That's kind of the mindset Oregon had.
So we expanded and rebalanced our portfolio into equities. We also ended up taking about 6 or 7 percent of the portfolio into credit, which we believed was technically underpriced given the fundamentals, and those two bets ended up paying off nicely for the portfolio.
If we had a board that was really skittish, we wouldn't have been able to do that, and the fund would've been worse off.
It always sounds like it's easy to be rational, but in the middle of the stock market declining 50 percent, it's harder to actually be rational.
Trusted Insight: What is your approach toward handling potential financial shocks now?
Ronald Schmitz: I hope that all of these discussions and warnings that we've had with the board tell them that a shock is possible. We do a lot of scenario analysis, such as -- what if growth or inflation tick up or down a little bit? What impact that might have on the portfolio?
We try to continually remind the board that an equity-oriented pension portfolio always has the chance of being down by 25 percent in a given year. They have to realize that such an event is a short-term situation and in the long run we expect to get the returns that we assume, which is 7 percent in our case. We hope that they don't panic in the short term and realize that it's normal; it's probabilistic that something like that will happen.
Trusted Insight: Speaking of shocks, how do you think the U.S. election could affect your investments?
Ronald Schmitz: We're trying to assess it. I can't say that we have any answers at this point. Before the election, we were looking at various market analyses, and the consensus seemed to be -- if Hillary Clinton wins, it would be a known quantity and a mildly positive market reaction. A lot of experts were saying that Donald Trump’s policies were negative, debt would increase with some of the policies -- tax cuts, for example -- and would not be paid for by spending cuts. We were seeing projections of a double-digit decline in the equity markets.
What's interesting to us is that since the election, it's actually been a pretty positive market reaction. We are trying to figure out why. It's too early to make any judgements, but I think the President-elect’s initial tone in both the acceptance speech and the weeks after the election has been less wild and crazy than some people had thought it would be. As long as there's an adult behind the wheel, it seems like the markets will continue reacting pretty positively.
Trusted Insight: What’s your outlook in emerging markets?
Ronald Schmitz: We have a very small overweight in emerging markets. Even though growth has been impacted by China’s slowdown in particular, broadly speaking, emerging market growth is still more attractive than the developed world. We're actually a little more concerned now than we were a year ago, because the markets seem to be a pointing to strong dollar and that would hurt U.S. returns in general and at least certain emerging markets. We are looking at that pretty closely right now.
Trusted Insight: Is there a particular long-term investment that you look back on now and think that was a really good decision?
Ronald Schmitz: The move into credit in 2008 when I was at Oregon was an example of a great move. We looked at the downside and felt that if the world continued to implode like it was in 2008 and early 2009, some of the investments we made would be attractive relative to traditional stocks and bonds. Then if we were right about the recovery, it was going to do much better. So we had a skewed upside versus downside outcome matrix. I think it's a good way to frame most investment decisions. I think being leery of what you don't know leads to more decisions not to make certain investments than it leads to proactively making investments.
Trusted Insight: What are some of the big projects that you're looking to accomplish going forward?
Ronald Schmitz: Historically, we have been relatively passive with respect to making adjustments to the policy portfolio. We tend to stick fairly close to our Board-approved policy and not make tactical or strategic shifts of any particular significance.
One initiative we are undertaking is that we are trying to be more proactive, and I've set an informal goal of adding as much value from tactical and strategic shifts as we do from security selection. That's something that we've started last year. We're going slow and building up our comfort with the idea and prove that we can do it before we actually jump into it in a big way.
And like many other firms, we're trying to assess risk a little differently than the traditional mean-variance analysis. We're doing a lot of research on factor investing and some of those alternative data approaches.
Trusted Insight: If there is a piece of advice that has served you well over the years in successfully managing your portfolios, what would it be?
Ronald Schmitz: The number one piece of advice is to truly be a long-term investor. Don't just say it, but live it. The second thing is that there's an awful lot you don't know, and to acknowledge that there is a lot you don't know. As soon as you get overconfident or cocky that you've got all the answers, that's usually when you get blindsided.
To learn more about Trusted Insight's Top 30 Pension Chief Investment Officers, click here. You can view our complete library of interviews here.
Schmitz was recently named on Trusted Insight’s Top 30 Public Pension Chief Investment Officers. He graciously spoke with Trusted Insight on December 1, 2016. The following interview has been condensed and edited for clarity.
Trusted Insight: You started out your career at Kraft Foods Inc. before joining a pension fund. How does working for a public pension fund differ from working for a corporation?
Ronald Schmitz: It's a lot different. The governance structure is quite different. After leaving Kraft, I worked at Blue Cross Blue Shield for about ten years. Some corporations may have a board or a committee that's the decision-making authority, but the ones that I'm familiar with are typically just the investment director and a senior management committee, and very often it's just the treasurer, or the chief financial officer. So, it's much more of a one-on-one or one-on-two-or-three kind of group discussion process, whereas public funds tend to be a much larger group and a can be a bit of a dog-and-pony show.
I've worked for three different public funds and the governance structure for each is a little bit different. At Illinois and Oregon, we needed to condense two or three years of work and research into a 20- to 30-minute recommendation, followed by a presentation by a manager. I've been fortunate enough to find most of the boards I've worked with have a lot of faith in the staff and more often than not go along with the recommendations, but sometimes there’s a debate between the board and staff, and sometimes a debate within the board in which staff often interjects a little bit and try to get to a resolution. It's much more of a give-and-take consensus. You end up playing a lot of it by ear. At Virginia, the board sets basic policy parameters and delegates manager selection to staff. Very different.
Trusted Insight: You joined Virginia Retirement System about four years ago. How has the plan and your portfolio evolved since then?
Ronald Schmitz: We've maintained the same risk profile over the years in an absolute risk sense. Within the portfolio, there's been some subtle shifts -- we've increased our private market exposure, and we will continue to do that over the next few years. The money largely moved away from traditional public stocks.
Trusted Insight: Do you think it's a trend for other pension investors as well? Will pensions allocate more in private markets?
Ronald Schmitz: Yes, that's generally a trend that would continue. I think at some point the growth of private markets might, in theory, hit a maximum point where you have too much money chasing too few deals. But at this point we still see a favorable arbitrage in terms of pricing that's being paid for the multiple of earnings that you're buying in private companies versus public companies. So, we're still comfortable with the return prospects. I do think most large funds will continue to become more and more private asset-oriented.
Trusted Insight: Are there any assets within private markets that you particularly favor at the moment?
Ronald Schmitz: We really like credit -- private credit, in particular. We've made a fairly significant move into direct lending and growing exposure into some areas like mezzanine investments.
We also like real estate and real assets, even though real estate cap rates are quite low by historical standards, indicating that prices are expensive. It's like the difference between private and public markets. It's still a very favorable arbitrage versus the 10-year Treasuries. So, we feel pretty good about traditional real estate as well as other real assets such as infrastructure and natural resources.
Trusted Insight: Can you tell me a little bit about your team culture and structure?
Ronald Schmitz: About a third of our portfolio is managed internally. That's 100% of our investment-grade fixed income and about 40 percent or so of our public equity. The primary external relationships that we have are in private markets and a little bit in complementary public equity strategies and credit.
The team is divided up into teams who deal with external managers versus those who handle internal portfolio management. Generally speaking, the culture, or at least my philosophy, is that I expect the teams to be very solid and each person to be very knowledgeable about what they do. I'm the guy who knows enough to be dangerous, but they're the ones who actually have to know their markets inside out. So, I look for ideas to bubble up from the bottom as opposed to me being more authoritarian and driving things from the top down.
Trusted Insight: In a 2012 interview, you mentioned that when you started out in this role, one of the big differences between Virginia and Oregon (where you previously worked) was how they handled the recession. What was it like at Oregon in 2007?
Ronald Schmitz: In 2007, the board understood that while the decline in price hurt, it also meant it was a buying opportunity. The worst time to get conservative is right after a big downturn, because you could sell everything at a low price and lock in your losses. However, if you buy, you have a chance to add value and catch the upside. That's kind of the mindset Oregon had.
So we expanded and rebalanced our portfolio into equities. We also ended up taking about 6 or 7 percent of the portfolio into credit, which we believed was technically underpriced given the fundamentals, and those two bets ended up paying off nicely for the portfolio.
If we had a board that was really skittish, we wouldn't have been able to do that, and the fund would've been worse off.
It always sounds like it's easy to be rational, but in the middle of the stock market declining 50 percent, it's harder to actually be rational.
Trusted Insight: What is your approach toward handling potential financial shocks now?
Ronald Schmitz: I hope that all of these discussions and warnings that we've had with the board tell them that a shock is possible. We do a lot of scenario analysis, such as -- what if growth or inflation tick up or down a little bit? What impact that might have on the portfolio?
We try to continually remind the board that an equity-oriented pension portfolio always has the chance of being down by 25 percent in a given year. They have to realize that such an event is a short-term situation and in the long run we expect to get the returns that we assume, which is 7 percent in our case. We hope that they don't panic in the short term and realize that it's normal; it's probabilistic that something like that will happen.
Trusted Insight: Speaking of shocks, how do you think the U.S. election could affect your investments?
Ronald Schmitz: We're trying to assess it. I can't say that we have any answers at this point. Before the election, we were looking at various market analyses, and the consensus seemed to be -- if Hillary Clinton wins, it would be a known quantity and a mildly positive market reaction. A lot of experts were saying that Donald Trump’s policies were negative, debt would increase with some of the policies -- tax cuts, for example -- and would not be paid for by spending cuts. We were seeing projections of a double-digit decline in the equity markets.
What's interesting to us is that since the election, it's actually been a pretty positive market reaction. We are trying to figure out why. It's too early to make any judgements, but I think the President-elect’s initial tone in both the acceptance speech and the weeks after the election has been less wild and crazy than some people had thought it would be. As long as there's an adult behind the wheel, it seems like the markets will continue reacting pretty positively.
Trusted Insight: What’s your outlook in emerging markets?
Ronald Schmitz: We have a very small overweight in emerging markets. Even though growth has been impacted by China’s slowdown in particular, broadly speaking, emerging market growth is still more attractive than the developed world. We're actually a little more concerned now than we were a year ago, because the markets seem to be a pointing to strong dollar and that would hurt U.S. returns in general and at least certain emerging markets. We are looking at that pretty closely right now.
Trusted Insight: Is there a particular long-term investment that you look back on now and think that was a really good decision?
Ronald Schmitz: The move into credit in 2008 when I was at Oregon was an example of a great move. We looked at the downside and felt that if the world continued to implode like it was in 2008 and early 2009, some of the investments we made would be attractive relative to traditional stocks and bonds. Then if we were right about the recovery, it was going to do much better. So we had a skewed upside versus downside outcome matrix. I think it's a good way to frame most investment decisions. I think being leery of what you don't know leads to more decisions not to make certain investments than it leads to proactively making investments.
Trusted Insight: What are some of the big projects that you're looking to accomplish going forward?
Ronald Schmitz: Historically, we have been relatively passive with respect to making adjustments to the policy portfolio. We tend to stick fairly close to our Board-approved policy and not make tactical or strategic shifts of any particular significance.
One initiative we are undertaking is that we are trying to be more proactive, and I've set an informal goal of adding as much value from tactical and strategic shifts as we do from security selection. That's something that we've started last year. We're going slow and building up our comfort with the idea and prove that we can do it before we actually jump into it in a big way.
And like many other firms, we're trying to assess risk a little differently than the traditional mean-variance analysis. We're doing a lot of research on factor investing and some of those alternative data approaches.
Trusted Insight: If there is a piece of advice that has served you well over the years in successfully managing your portfolios, what would it be?
Ronald Schmitz: The number one piece of advice is to truly be a long-term investor. Don't just say it, but live it. The second thing is that there's an awful lot you don't know, and to acknowledge that there is a lot you don't know. As soon as you get overconfident or cocky that you've got all the answers, that's usually when you get blindsided.
To learn more about Trusted Insight's Top 30 Pension Chief Investment Officers, click here. You can view our complete library of interviews here.