After three years, the strategic partnership that Teacher Retirement System of Texas (TRS) initiated with four of the world’s biggest asset managers is bearing fruit, both in terms of returns and improvements in the fund’s investment processes.
TRS’ chief investment officer, Britt Harris (pictured), says the “Strategic Partnership Network” (SPN) has been a top-quartile performer over the three-year period and in the top five per cent over two years.
The four managers – BlackRock, JP Morgan Asset Management, Morgan Stanley and Neuberger Berman – have earned strong returns and added value in all three periods (see table below), says Harris.
The fund recently added a fifth manager, Barclays Capital, to the program, and gave it $500 million to invest.
Harris explains that when TRS first started the program in July 2008, with a $1 billion allocation to the four managers, the fund was dipping its toe into external management.
It was only about three or four years ago that TRS was restricted by legislation from hiring external managers.
It now has $50 billion of its $110 billion in assets managed in-house and Harris says they are 80 per cent of the way towards reaching their external mandate targets.
When it comes to the latest member of the SPN, Harris says Barclays was chosen both for its global reach and its contrasting investment strategy.
“Barclays brings in a different approach. They are a firm that is solely focused on the separation of alpha and beta and use primarily a beta approach to global asset allocation,” Harris says.
“They also bring in a different process than any of the other four strategic partners, so their returns have historically been very lowly correlated with the strategic partners that we already have.”
Along with an investment objective to generate 2 per cent alpha over market returns over long-term investment periods, the partnership also aims to provide research that is tailored to provide practical improvements to the fund’s investment processes.
This has resulted in 20 proprietary research projects in the past three years, covering a broad range of investment areas including asset allocation, risk management, regime forecasting and liquidity management.
“The research that has been conducted has been much more focused and practical than many of the research [projects] that might have been done otherwise,” Harris says.
“Because they have a client that is a practitioner, therefore, the research has been much more useful and had a much better pay-back ratio.”
The strategic partnership has also more closely integrated the firms with TRS, allowing for greater efficiencies and better knowledge of each other’s needs and processes, says Harris.
“Three years is a decent amount of time, but these things are meant to last for decades and a solid foundation has been established between us and them with a common language and committed people,” he says.
TRS manages its diversification process by constructing three separate portfolios of varying sizes.
Its central strategy is comprised of a 60 per cent allocation to global equity markets with structurally high allocations to both emerging markets and private equity.
The remaining 40 per cent is split relatively evenly between two additional strategies designed specifically to effectively diversify the total fund when either a deflationary or inflationary regime arises.
The percentage allocations to the three strategies reflect the likelihood of each of three scenarios occurring, based on history.
The scenarios are each defined by GDP growth, inflation, earnings growth, productivity, political stability, and valuation.
At its most recent board meeting, the TRS investment division reported that for the year to June 30, TRS generated a return of 22.2 per cent, which equates to 1 per cent value added.
This put the fund in the second quartile in terms of its performance relative to its peers for the year.
Over a two-year period the fund achieved a total return of 18.9 per cent and over a three-year period 3.4 per cent.
At this September board meeting the TRS outlined several new strategic priorities.
These include increasing the global equity portfolio to 62 per cent, from 60 per cent, by raising the allocation to private equity from 10 per cent to 12 per cent.
Within the global equity portfolio both large and small cap US equities will be reduced by a total of 5 per cent, to be replaced by a directional hedge fund strategy.
Hedge funds currently have a 4 per cent allocation of trust capital and the Texas legislature recently approved an increase in the allocation from 5 per cent to 10 per cent.
Under the new strategy, TRS plans to expand its allocation to hedge funds to 9 per cent of trust capital.
An annual review of external public markets handed down to the investment management committee in September stated the new hedge fund strategy would be “more directional and market sensitive”.
“Directional hedge funds add alpha opportunities for the trust that are currently untapped,” the report to the committee states.
It goes on to say that the expanded allocation “increases the trust’s expected return and reduces its volatility”.
The original hedge fund strategy adopts an absolute return approach and forms part of the stable value portfolio.
Its core strategies have a low to negative market sensitivity, and are expected to have positive returns when markets are down.
In contrast, the directional portfolio has moderate market sensitivity and lower volatility to equities. It is expected to outperform when markets are down but will underperform in a strong market environment, the report says.
Both strategies are expected to outperform US treasuries over the long term.
The investment team has outlined strategy allocation targets for both of its hedge fund strategies.
Out of its total directional hedge fund allocation it has set a target of 40 per cent to long-short equity strategies, 30 per cent to event driven (includes distressed), and 20 per cent to fixed income (includes convertible arbitrage). The remaining 10 per cent target will go to risk parity strategies.
In absolute returns the investment team has targeted a 20 per cent strategy allocation to commodities and trends, 35 per cent to equity market neutral, 20 per cent to fixed income (includes convertible arbitrage) and 25 per cent to macro and volatility strategies.
Harris, who came to TRS from a hedge fund background at Bridgewater Associates and prior to that Verizon Investment Management, says the risk reporting and monitoring that the fund has developed concentrates on the key risks of leverage, liquidity and concentration.
“We believe that risk management is essential to the entire investment process, so we put it right at the heart of the company,” Harris says.
TRS has well-developed risk monitoring reports but is now moving quickly to a higher level, specifically risk management, says Harris.
This includes the creation of two new groups: a risk team within the trust and a risk committee of the board.
TRS states its risk monitoring systems include many of the current best practices such as value at risk (VaR), diversification impact, scenario analysis, leverage, liquidity, asset exposures and reputational risk.
Harris says there has been a recent expansion into measuring and targeting the risk impact of specific asset classes on total risk, and a series of risk and return “alarms”.
The investment division works closely with the TRS board to establish, monitor, and report its various risk metrics and has the required authority to efficiently and effectively implement associated actions, Harris says.
In addition, the fund operates a risk bar system where the investment team aims to reduce the risk contribution of equities to the fund’s overall risk exposure.