David Villa, chief investment officer at the State of Wisconsin Investment Board (SWIB) likens the current investment climate to the depths of winter: something to be endured and survived until spring arrives, of which there is little sight yet.
“The current environment is heavily influenced by monetary policy and slowing growth in emerging markets and China: nothing works in this environment. Assets that are valued on their growth, and the growth of their cash flow, are not doing well and there is a high level of financial stress in credit markets. The prospects for growth are modest to negative.”
Villa’s answer is to “not try and be too clever” or stretch for a return, but hold tight until things improve.
And even what opportunities do exist are difficult to tap because of SWIB’s $106.2 billion size and limited ability to be fleet of foot.
“There was a brief opportunity to buy investment grade credit in February. We have to move our capital quickly to take advantage of these opportunities and our strategies are more long term than this,” he says.
Founded in 1951, SWIB is responsible for managing the combined assets of the Wisconsin Retirement System, the State Investment Fund and various other state funds.
As winter continues to bite, Wisconsin is working on two longer-term strategies.
The fund is building a portfolio of hedge funds that will provide “a higher quality source of alpha” on top of existing market beta exposures.
“We only have 3.5 per cent of the fund in this strategy and it is growing slowly because the low volatility hedge funds we like are rare. It takes a lot of due diligence to identify the right hedge funds that fit into our program.”
The strategy aims for a policy return of between 5 and 6 per cent plus an alpha of 2 to 3 per cent, he says.
The other strategy at the fund is to continue building an internally managed, multi-asset division to provide a diversified source of return generation.
Here the idea is to “take the best ideas” across the whole portfolio and express them within a single portfolio able to take advantage of opportunities that other allocations can’t because they are tied to their particular asset class or industry.
“Some portfolios are one-trick ponies. In this case we are trying to create a circus,” says Villa.
SWIB has $1.5 billion in multi-asset strategies and $3.6 billion in the alpha beta overlay that includes hedge funds, making a total of $5.1 billion in these two new strategies.
Villa finds himself in unprecedented territory in that for the first time in SWIB’s history, half of the fund’s assets are in passive strategies.
“The fund is configured around the lowest active risk profile in its history,” he says.
The reason is simple: today’s markets don’t offer any reward for risk, and for this reason Villa explains SWIB’s passive allocations are a sign of the times, rather than any broad rejection of active management.
“The prospects for active management are not good at the moment but that doesn’t mean you give up on active management. It just means it isn’t good today and when the environment changes, we will take on more risk.”
Villa describes a market best suited to active management as one that has different time horizons, points of view and opinions; a sensitivity to multiple factors, rather than one that clusters around a single theme with a diminished opportunity set.
“When a market tends to herd, and I’m talking lemmings here, the prospect of active management breaks down.”
He is also quick to articulate that SWIB’s current passive allocation is not a particular nod to cutting costs, something SWIB has done successfully in recent years.
“Costs are important and we do think in terms of the return we get from active management and if it’s not attractive then we’ll index. However if there is a prospect of a return net of costs, then we are happy to incur costs.”
The fund has added $1.17 billion above the policy benchmark over the past five years and is considered a low-cost manager, managing more assets internally and passively than its peers, translating to $63 million in savings according to an independent review.
Another ongoing strategy at the fund is to build and maintain its 75-strong internal team.
Villa describes attracting and retaining the best investment professionals as a “war” where fierce competition merits SWIB’s compensation structure benchmarked against private sector banks and asset managers.
However, he qualifies that “a significant part of compensation” for the team is discretionary incentives.
“These have to be earned. We are not paid for showing up.”
It is a risk-sharing culture at the fund that is rooted throughout its structure, right down to beneficiary payouts also being connected to the fund’s returns.
“Schemes that have been structured with professional governance and staff, and are willing to invest in asset management to the extent that they are almost indistinguishable from private asset management firms, these are the ones we admire and aspire to be like,” he concludes.