Harshal Chaudhari recently sidestepped from his role as company-wide CIO at IBM where he has overseen strategy for the $150 billion defined benefit and defined contribution retirement pools since 2016, to a new role as the tech giant’s chief analytics officer. He spoke to Top1000funds.com on the strategy he ran at the pension fund, his wider thoughts on the global economy and the impact of technology on the investment world. The assets of IBM’s US and non-US DB pension plan’s are $48 billion and $37 billion respectively.
Sarah Rundell: Could you detail how investment strategy at the IBM pension fund has changed under your leadership and your motivation for those decisions? Where do you think your impact on the portfolio has been most significant during your tenure?
Harshal Chaudhari: The portfolio underwent substantial changes during my tenure. First and foremost we took significant de-risk actions which really followed logically from the strong returns we have achieved over the last three years. As the funded status increased by 7 percentage points we were able to reduce the surplus volatility by about half. We improved our liability hedge – both quantitatively by increasing the hedge ratio and qualitatively by designing a better curve match. We have gone through some sizable moves in interest rates and credit spreads since then and the hedge has performed extremely well. So, I am very happy with that outcome.
We also took the opportunity to simplify our asset allocation strategy. Simplification and reduction in the granularity of our asset class buckets now allows for a lot more flexibility for the investment team to add strategies and respond to market opportunities quickly while continuing to have appropriate governance control over aspects of risks that really matter.
We have also heavily restructured the growth portfolio. While it is smaller in relative terms it is still large in absolute terms and needs to work efficiently to deliver a large contribution to our total return objective. I inherited a strong developed markets active equities book and so it was an easy decision to reduce the passive allocation of 40 per cent to almost a fully active portfolio.
We also moved away from a mechanical rebalancing to index weights. One of our strengths is our in-house trading capabilities and so we have been able to manage beta overlays with ease allowing us to harvest alpha potential from our strongest managers without taking unintentional size or country bets. Emerging markets on the other hand was a different story. We had to start from scratch and revamp the entire portfolio. We took advantage of the fresh start to structure a great alignment of interest. Every new mandate now has performance-based fees supported by hurdles and clawback mechanisms. This did prove more difficult than I anticipated but in the end I am happy that we achieved fair structures for both parties in all cases.
Some of the most impactful things we have done are in the alternatives space. We meaningfully increased the allocation and have engineered a turnover of more than half of our hedge fund portfolio to focus on truly diversifying strategies. We have added about half a dozen new strategies and nearly doubled the number of managers in this portfolio while cutting correlation to equities by two thirds. On the private side, the de-risk has resulted in a reduced allocation for the US fund but we have taken the opportunity to leverage some of our best relationships and established programs with our non-US plan that still have a need to build up their funded status and therefore require higher returns. This has also allowed us to increase concentration and reduce the number of managers.
Returns are expected much lower in the coming years. What are your thoughts on the key issues facing financial markets today and the resulting challenges for institutional investors? What strategies should they put in place to prepare for low returns and a market drawdown, and where is the opportunity?
It feels like we have all been crying wolf about lower returns for many years now. I do hope the complacency does not set in as the downturn will eventually come – we just don’t know when. Markets and the global economy have proven very resilient despite numerous risks we can all enumerate, and it is hard to pinpoint what could be the eventual catalyst. I think it is prudent to be prepared. Knowing the risks inherent in the portfolio and focusing on true diversification is critical. As our fixed income allocation and exposure to corporate credit has grown as a result of our derisking actions we have been focused on reducing concentration risks and taking steps towards diversifying our sources of spread income. On the other hand, volatility is still reasonably priced and so adding high convexity strategies could be an opportunity for investors to continue to maintain equity allocations with some downside protection.
What are your thoughts on the impact of more rate cuts by the Fed for long-term investors, particularly fixed income investors/LDI?
A lower rate regime has been extended into the foreseeable future. Combine the low rates with compressed credit spreads and it does present a challenge to fixed income investors in terms of the absolute return potential. However, I would argue that you still want a fixed income allocation in a general portfolio as the diversification purpose of the asset class is still intact regardless of your view on expected returns. And then, specifically for pension funds, a fixed income portfolio duration matched to the liability is the risk-free asset for a pension fund. So, if a fund has a hedging objective, I would advocate maintaining the course. In a holistic risk budgeting approach, mitigating unrewarded interest rate risk frees up budget to reallocate risk in areas with better risk reward trade-offs with arguably a higher probability of success than attempting to time interest rate moves.
What did you find most exciting and stimulating during your tenure as a CIO?
The learning, the relationships and an objective report card at the end of every period. I have always been interested in investing and been seeking out investing books, research papers and blogs even before I assumed the role of the CIO. However, the focus was very limited. Being in the institutional investor seat opened the flood gates and exposed me to strategies I wasn’t even aware of before and led to a vast variety of learning in a short period of time. The more I dug into a topic and learned about something the more I realized how little I know and how much more there is to learn. This opportunity for endless learning is extremely intellectually stimulating.
Next is the people. Given our scale at IBM, we get access to the best minds in the industry. Ability to discuss, debate and bounce off ideas with the forefront experts, researchers, authors in the field has been a fantastic experience not only in terms of improving portfolio outcomes but also in forging strong partnerships between IBM and the respective firms. And then the opportunity that I did not appreciate enough prior to being in this role is the relationships I have developed with the broader institutional investment community and my fellow investors. I have found this community super friendly and delightful to engage with. Rarely did I find somebody not willing to share experiences and engage in learning together. These interactions have led to some very good friendships that I hope to continue to cherish for years to come.
Lastly, as a pension investor I enjoyed the balance between a) using the long-term focus to make decisions with a multi-year horizon and b) at the same time having the ability to periodically get objective feedback on how the decisions are panning out and if you need to course correct. It is a double-edged sword but using it to your advantage requires instilling a certain discipline to believe in your process when things are not going your way and at the same time constantly questioning where you may be wrong. This introspection is a stimulating exercise to sharpen the thinking and improving the process.
Could you talk a little about your new role? What will you be doing?
As the chief analytics officer, I lead a team of data scientists and strategy consultants focused on driving the adoption of advanced capabilities like big data and artificial intelligence to accelerate IBM’s reinvention as a cognitive enterprise. We have a broad mandate to pursue IBM’s most complex strategic issues to improve the business outcomes and achieve financial goals. We are looking at every functional area across the company, creating new AI-based solutions by leveraging diverse data sets – both internal and external -bringing our significant capabilities to bear across initiatives like sales productivity, pricing, marketing insights, skill development, fraud detection, to name a few. The solutions range anywhere from Robotic Process Automation (RPA) making existing processes faster and efficient, to deep learning techniques delivering cognitive business advisor assistance to senior executive decision makers.
Drawing on your expertise of both technology and investment, could you give a sense of how technology is going to change investment in the years ahead and the opportunities and challenges therein?
Just like any other industry, technology will profoundly change the way investment management will function in the future. AI will transform all aspects of investments from core alpha generation activities to risk management to back office operations. Ability to ingest high variety, velocity, veracity data, finding patterns indecipherable by humans and removing bias is immensely valuable. Bringing it all together to create a well-reasoned and relevant knowledge representation will become an integral part of the investment process and skills requirements.
At the same time, companies need to reimagine their teams and find the right mix of skills. While technology will certainly replace some tasks, more importantly it presents an opportunity to reimagine the way everyone works.
You can already sense the change that is coming. If you scan the careers website of investment firms today, do not be surprised to find the highest frequency keywords to be data science, Python, R, etc. Finding and retaining high-level AI skills around machine and deep learning, and at the same time investing and reskilling of the existing employee base is critical to forming high functioning T-shaped teams. Teams that can embrace technology, look beyond the inevitable short-term implementation hurdles to focus on long-term value and leverage the fundamental analysis skills, along with deep domain knowledge to ask the right questions of the data, will be best suited to thrive in the changing landscape.