The $142 billion Teacher Retirement System of Texas (TRS) has overhauled its equities portfolio to improve integration of a $54 billion allocation that weaves together multiple managers and strategies.
Key changes include increasing risk premia and internal management, reducing active management in US equity and applying new strategies developed by the fund’s research arm to the main allocation.
It’s the culmination of an 18-month review during which TRS researched best practice in global public equities management, consulting with peers in North America and Europe, and the fund’s external asset managers and advisers.
At the heart of the strategy is the creation of a more top-down portfolio, says one of its chief architects, TRS’s new deputy chief investment officer Jase Auby.
Auby was promoted from chief risk officer in September in a reshuffle following former CIO Britt Harris’s departure to join the University of Texas/Texas A&M Investment Management Company (UTIMCO). Rather than focus on intense searches for the best managers in a bottom-up strategy to achieve alpha, TRS’s plan is to drive a single, integrated alpha stream from the top.
“Many allocators manage with a light touch at the total level and rely on the power of the individual strategy and manager selection to aggregate to a good result,” Auby explains. “This is not necessarily a bad choice, so long as risk exposures are managed, the alpha processes remain unconstrained and the focus is simply on choosing the best processes. However, we believed that we could improve on the light-touch model.”
In TRS’s old bottom-up strategy, the fund’s public equity portfolio was structured around internal and external management priorities and different asset management styles. Each portfolio was charged with delivering its own balanced return in a process that resulted in some duplication and cross-overs, says Auby, an Austin native who moved home to join TRS in 2004, after roles with Goldman Sachs and Lehman Brothers in New York.
Now, the fund’s public equities are divided into three vertical portfolios: US stocks (18 per cent of TRS’s total), non-US developed markets (13 per cent), and emerging markets (9 per cent). To this simplified frame, TRS then applies a range of horizontal strategies.
“It allows for more efficient answers to the internal/external, fundamental/quantitative and alpha/risk premia/passive questions,” Auby details, adding that the fund has also tipped its allocation away from US stocks in favour of non-US developed and emerging markets.
Directional hedge funds (4 per cent) and private equity (13 per cent) bring the total equity allocation to 57 per cent of assets under management.
TRS has favoured risk premia, particularly value and quality strategies, for a long time, but has tended to use these factors primarily in its dollar allocations. Now the fund will apply risk premia at the total equity portfolio level, with factor strategies targeting half of the 1 per cent excess return target for the total equity portfolio. In addition to the focus on funded beta, TRS has also introduced an internal alternative risk premium portfolio. This is a multi-asset class overlay portfolio for the total pension fund, in a non-funded form.
Although active equity management has added value at the fund – producing 29 basis points, on average, over the last five years, equating to $336 million – most of that has come from active strategies in non-US developed and emerging markets. Active management in the US has struggled with both internal fundamental, and external portfolios underperforming. The introduction of more factor strategies could be a big part of addressing this, Auby says.
Over recent decades, academia has honed in “on the concept of risk premia, and when we looked at concepts expressible across a $54 billion portfolio, these were the ideas that were timeless and universal,” he says. “We believe we can tilt on a long-term basis, and really move the needle. One of the reasons risk premia are appealing is because they offer both fundamental and behavioural explanations as to why they might persist.”
Factors in play
TRS has added a quality portfolio, a defensive portfolio and the multifactor portfolio; internal strategies will concentrate on low-volatility factors in US and developed markets, and fundamental factors in emerging markets and non-US developed markets. In addition, TRS now has three internally managed quant portfolios that go a step beyond traditional risk premia. But external management will still play an important role in the equity portfolio, with these managers targeting highly diversifying strategies not managed internally.
“Clearly, generic risk premia investing processes can come in-house,” Auby acknowledges. “However, many of our external managers rely on risk premia and are able to add alpha on top of that. To the extent that we are trying to aggregate risk premia exposures up to the total portfolio, these managers [add] to the overall process.”
Nevertheless, bringing more investment in-house has meant the loss of some external managers.
“We had a few external strategies with very high overlap with our internal strategies,” Auby says.
External management has been reduced by 8 percentage points – down from 52 per cent to 44 per cent of the portfolio. TRS estimates it saves about $100 million annually from internal active management. Building up the internal team hasn’t required mass hiring.
“We have added to the team in an evolutionary process over years,” he says. “While we don’t describe our exact tilts and the weights to those tilts, it is safe to say that our tilts align with academic thought over the past few decades; we review risk premia such as value, momentum, quality, size and liquidity for inclusion in the portfolio.”
He stresses that all factor allocations are for the long-term, rather than tactical.
“It is very difficult to time risk premia, and even if we did think we could, timing them on a portfolio as large as ours would be difficult.”
Research making an impact
Many of the new strategies have emerged from TRS’s research program. Further strategies under development in that pipeline include risk premium maximising, fundamental small-cap and mid-cap US, and trend following. As markets mature and it becomes increasingly difficult to achieve alpha in the US and other developed markets and ultimately in emerging markets, too, investors will depend on innovation, believes Auby, who says the department is one of Britt Harris’s many legacies at the fund.
“The ultimate test of a leader is how well an organisation does in the years after their departure. Alongside our board, Britt and Jerry built a strong organisation with a deep commitment to innovation and global leadership,” Auby says in reference to Jerry Albright, TRS’s new CIO. “People will have to re-commit to research and innovation. At the end of the day alpha is always elusive; it always has been and will continue to be so.”
TRS has no current plans to change its private markets allocation, which is now at 32 per cent of assets under management.
“Our next strategic asset allocation review, which the board typically conducts every five years, is scheduled for 2019,” says Auby, adding that one of the aspects of his new role he enjoys most is the opportunity it gives to think strategically about the entire portfolio; he’s no longer tucked away in the risk-management department.
“No one ever wanted to talk to the risk guy,” he jokes. “Moving from chief risk officer to deputy CIO adds significantly to the metaphorical line of people standing at your office door.”
He believes one of the keys to his success will lie in good communication with the 152-member investment team.
“My strongest focus is on our people and making sure they have all they need to manage their portfolios. My focus is on giving clear autonomy and authority but in exchange, I require excellent communication.”