Beyond asset classes: Active credit becomes the test case for Florida’s portfolio evolution

The build out of a new active credit portfolio at Florida State Board of Administration that combines public and private credit investments under one umbrella could mark the beginning of a new approach to asset allocation.

In conversation with Top1000funds.com, chief investment officer Lamar Taylor, who oversees the $308 billion portfolio that includes the $228 billion Florida Retirement System Pension Plan, said that the SBA will increasingly dip into a growing tool box that allows it to think of asset allocation in the context of return drivers and beta categories, as opposed to traditional asset class buckets.

“Historically, we have always been an asset class shop but in our credit exposure we are now thinking of return sources a little bit differently. It’s a first foray, but there is more to come regarding how we look at the world going forward, and maybe this is the first aspect of re-conceptualising investment buckets,” he says.

Taylor explains that the entire active credit asset class is a bit of an experiment in relative value whereby the team has combined liquid and illiquid credit exposures. Florida has specific target levels for each of these exposures, but allows itself the flexibility to deviate from those targets.

He says the idea is that the asset class team can tap into “good information value” in managing both liquid and illiquid credit exposure and it gives them the ability to weight one area over another over time, with the caveat that it will be harder to move in and out of illiquid credit.

“To apply this relative value concept even further down the asset class, in the liquid credit portion of the book, we have hired multi-asset credit managers who have the flexibility within their mandate to run the gamut of liquid and semi-liquid investments including bank loans, emerging market debt and high yield.”

capital repatriation

The changes in the credit allocation sit within a new strategy towards fixed income as a whole. In early 2024, Florida reduced its global equity by 8 per cent, putting it all into fixed income products to target yield from higher base rates and term premium. Fixed income was increased to 21 per cent and the new allocation to active credit assigned 7 per cent of total AUM.

The idea, he explains, was that the fund could achieve a more targeted rate of return from less volatile assets like fixed income at a time of high concentration risk in the major indices because of passive investing and growing retail investment.

Since then, other themes have also come into play. AI has highlighted the dynamism in American innovation and continued to pull global investment into the US that is visible in the capital markets and indices. But Taylor believes this might be about to change.

Gulf’s sovereign wealth funds may start pulling money back to rebuild following the war, for example. Elsewhere, governments in Europe and Japan are re-arming. Countries could begin to draw money home with fiscal policies; issue more debt and attract investors with higher interest rates that could mean more competition for capital.

“We haven’t made decisions yet around our level of conviction, or how to monitor and determine if our views are right. But the question is: should we lean into it and try and generate excess returns, or should we just allow the beta to generate while we wait?”

The reduced equity allocation isn’t risk free either. Another theme the team is exploring is how to effectively manage ballooning US passive exposures in equities alongside an internal policy that splits passive/active equity exposure 60:40, capping passive at 60 per cent.

Because US stocks have become such a large part of the global equity markets, the MSCI ACWI now has well over 60 per cent invested in the US.

“We tend to be passive in the US simply because it is an efficient market and overtime we haven’t been rewarded for being active. But the more the ACWI target pushes, the more pressure it puts on exceeding that 60 per cent cap.”

Taylor is reluctant to re-introduce a tactical allocation to help. Historically, the SBA has only ever had “a 50:50 success rate” at making tactical bets.

“Generally, our culture is not to make, certainly big, tactical bets because we put a lot of work into thinking about our asset allocation and diversification as a long term investor.”

Instead the team rebalances to make sure the fund isn’t over exposed to pockets of risk. The equity team is also integrating some enhanced passive strategies where it tries to mitigate pressure building on the passive cap. It will also re-initiate an asset allocation exercise this autumn to look at the problem in more depth.

It leads Taylor to reflect on recent steps to measure and underwrite another risk in the equity allocation: geopolitics, country competition and conflict.

Florida has removed all Chinese companies from its benchmark, but does allow its public equity managers to invest in Chinese companies as long as they are not state-owned entities. It is now incumbent on managers that want to include Chinese companies to make an off benchmark bet on that name.

“Managers can have Chinese companies in the portfolio, but they have to take tracking error relative to that benchmark,” he says.

selling in LP-led secondaries

Turning to private markets, Taylor expects returns in private equity to remain lower than what was underwritten previously in a process that will continue to weed out managers that perhaps “shouldn’t have been there” anyway.

But he reflects that comparisons with public markets in private equity are not always helpful.

“Public markets are dominated by a handful of very large, cash flow rich companies so when you compare on this basis, private equity returns lag. For the most part, a $200-300 million dollar EBITDA private equity company is not the multi-billion dollar EBITDA of a large cap.”

He suggest comparisons to a different market like the Russell 2000 would see a closer equivalent in terms of performance.

The SBA has been an active seller in the LP-led secondary space to manage portfolio exposures and manager concentrations. As for GP-led secondaries – one of the tools GPs used to generate liquidity – the SBA has sometimes taken the liquidity option and sometimes rolled into the new GP fund, often a continuation vehicle.

Although ideally he would continue to stay invested, he reflects the SBA hires its managers to make decisions, and is often “working to a time scale that requires selling” – although he clarifies that the SBA is not in the cohort of LPs selling into the secondary market to ensure they can re-up with our managers raising the next fund.

“We are not necessarily thrilled we are being thrust back into the sell or buy decision,” he says. “Generally, our view is to continue in the investment until the end of the economics, but we are often presented with a short time scale – by and large we would like to stay invested and roll, but sometimes the logistics don’t allow that.”

managing DC assets through a new trust structure

Beneficiaries in Florida’s $21.1 billion DC plan are beginning to tap into the investment team’s expertise. The SBA has just launched a novel group trust structure that allows DC participants to invest in portfolios managed by SBA pension plan staff.

Florida’s retirement plan options generally require new employees to choose between the DB or DC option. If they do not make a choice within the required period of time, special risk employees (mainly law enforcement and fire fighters) will default into the DB plan and everyone else will default into the DC plan. It means most new retirement system members default into the DC plan.

“Based on the rate of participant growth, it is fair to say that the future of the retirement system is the DC plan. As a result, our focus is on applying scale and experience of or DB investment team for the DC fund too,” says Taylor.

The group trust structure gives the investment team the flexibility to create specialised products that fit the needs of the DC participants, and allows DC plan members to benefit from expert manager selection, cost efficiencies and scale. The initiative has kicked off in fixed income and Taylor says public equity will follow.

“Fixed income products are the first and I would like to see us move into public equity products soon. The extent to which we bring private markets in is unconfirmed.”

Offering private markets to DC participants will be more complicated because of daily NAV requirements, but he’s prepared to go through pain points to understand what needs managing.

“We do have the ability to provide prudent private markets exposure to DC beneficiary, but it will be a crawl, walk, run, process.”