Wisconsin remains confident in disciplined approach to active management

The Wisconsin Investment Board is not tweaking its asset allocation or adding inflation-linked assets to its line-up in reaction to the market turmoil, rather, it’s continuing to focus on generating alpha from active management. Chief investment officer, David Villa, spoke with Amanda White about the fund’s disciplined approach to hiring and firing.

The $66 billion State of Wisconsin Investment Board (SWIB) has had many discussions around its board table about what whether to tweak its asset allocation, but the status quo will remain until the markets ‘kind of return to normal’ according to chief investment officer, David Villa.

“It’s not in the cards for us now although we have been debating different ways to look at asset allocation,” he says.

The decision to wait until valuations return to more of an equilibrium is indeed a waiting game, with Villa claiming “we know things will get better but don’t know when”.

Similarly the fund has been looking at inflation hedges as it remains concerned with the effect of the stimulus withdrawal. But again inflated valuations dictate it will not invest right now.

“There has been a ground swell of TIPS and commodities investments and we don’t want to buy at the top,” Villa says.

The fund remains committed to equities as the cornerstone of a well diversified portfolio, which really means a faith in global GDP.

“We want to de-emphasise the comparison to the expected rate of return of 8 per cent and emphasise the relationship with GDP, that’s the real driver of growth,” he says. “It’s not that we’re confident or not in equities but we believe global growth is driving this so we have to measure against that.”

One of the prevailing trends of the fund, which only had got broad statutory authority in April 2008 changing its authority to a prudent investor concept, has been to increase the amount of assets managed in house.

Since December 2007 it has doubled the amount of capital managed in house from 21 to 40 per cent, and it will cap at around half the assets.

It now manages US large cap, US small cap, international equities, US government credit and global bonds in house, all on an active basis.

“We have had a good experience with active management so we tend to allocate more active capital to international equities and small cap than large cap US equities,” Villa says.

The externally managed emerging markets equities and debt are also 100 per cent active.

The fund actively looks to hire managers which have had poor performance and recently achieved good results allocating to a defensive international equities portfolio, a defensive US equities manager, a defensive emerging markets equities manager that were all recently poor performers.

“Now its going the other way, they’ve done well so we will take the money away,” he says. “We look at it as a marriage, it’s not opportunistic or temporal. We will move money around but we don’t terminate, very expensive to do that.

Villa believes managing costs in an aggressive manner is one way to do well in the business of money management, and while the fund will take money away from managers, it would take an organisational event to terminate a mandate.

“It is common to see a manager do well and for that to be thought of as skill, then the weight of the manager is allowed to increase exposing you twice as much if there’s a long tail event,” he says. “It’s expensive to move money from one strategy to another, you have to manage the costs. But one of the reasons why our experience with active management has been a good experience is because we move money away.”

Villa believes this discipline derives directly from managing money in house, with the SWIB employees numbering 120 , 75 of which are investment professionals and 35 of those are CFAs.

“It is easier to make that decision we do that every day,” he says.

Villa, who before joining SWIB was chief investment officer for the Florida State Board of Administration, believes the recent change in statute and established authority is important to align the fund to think about new strategies and implementation.

“Some of those thoughts have been stalled because of the crisis but in the next few years we will resume our thinking.”

One of the key drivers of pursuing the statue, and one key consideration will be the ability to short, and in the next three years the fund will be building a hedge fund stable. It has some allocation already in its multi-asset bucket where opportunistic and other investments that don’t fit in traditional buckets are allocated.

At the end of November the Core Trust Fund, the main fund, had an allocation to this asset class of 4 per cent. This fund had a return of 21.1 per cent at this time.

In addition Villa says he has campaigned for three years to emphasise the importance of allocating according to risk instead of dollars, and to ask of each investment what is the contribution to my risk?

“Risk is the same as loss. Many think of risk as volatility, the swing, but it’s the risk of really bad stuff happening. In Wisconsin we hunt deer from the age of 9, and from then until the age of 85 you could keep track of your hunting results, measure the distance of where you shot from and the hit rate. But the real risk is a bear coming into your tent in the middle of of the night and waking you up.”

Asset allocation 2009

Total Equities 55%

U.S. Equities 29%

International Equities 26%

Fixed Income   29%

Private Equity  6%

Real Estate 6%

Multi-Asset  4%