Concentrated power by monopolistic companies is a systemic problem in the US economy, according to Matt Stoller, director of research at the American Liberties Project, but investors have little power to change it.

Speaking at the Investment Magazine, Fiduciary Investors Symposium, he said these companies – such as Google, Facebook and Amazon – are producing stellar returns for investors, but they are not being matched with actual wealth creation.

“When financial returns are not being matched with wealth creation you have a serious accounting problem in society writ large,” he said. “What these firms are doing to get a 20 to 30 per cent annual return is just capturing market power, they are not creating wealth.”

This mismatch between what the financial systems indicate is happening in society and what is actually happening is dangerous, he said.

“We have a low interest rate environment and a lack of places to invest. It is really hard to start new firms which has implications for investments. If there is not new stuff, factories, innovative content and products then ultimately there won’t be places to invest money.”

Stoller believes that social corporate responsibility is a distraction in general. And while some corporate leaders were responding to employee demands, all the corporates really care about is regulation, tax, trade and anti-trust.

“I don’t think pension funds have that much power,” he told the audience.

Concentration is a systemic feature of the US economy, he says, and can be seen in various sectors from technology to peanut butter and portable toilets.

Historically Americans were very suspicious about monopolies and concentration of power, but a movement in the 1970s led by Milton Friedman and the Chicago University School of Business intellectualised concentration as a positive structure and good for efficiency.

“They argued that concentration of big business wasn’t a political problem, it wasn’t about anti competitiveness, but existed because they were efficient and good at things,” Stoller said. “They argued to policymakers they needed to unleash the concentrated capital to make the world more efficient and handle the inflationary environment of the 1970s.”

As a consequence there was consolidation in many sectors including retail, defence, energy and banking, all in the name of efficiency which was measured by low prices.

With that backdrop and the digital revolution in the 1990s and 2000s companies such as Amazon and Facebook were born native to monopolies, Stoller said.

“These firms are enormously powerful and consequential, and a result of the political economic revolution and tech revolution,” he said. “That has created this political crisis where a small group of people are setting terms over our markets and societies.”

Stoller says tech firms are the pace setters of the economy and are deeply embedded in the infrastructure of the economy.

“The power of these firms goes beyond the traditional, these firms are replacing government and public infrastructure with their own infrastructure and becoming somewhat sovereign in themselves.”

Stoller advocates for breaking up these monopolies, in part because he acknowledges how difficult they are to regulate due to their complexity.

“These firms are so complicated. They have soft influence which creates problems with democracy but they are impossible to regulate as is, because they are so complex and embedded,” he said.

At the American Liberties Project Stoller and the team are focused on the problem of private power including how to simplify these companies.

“We need to engage in structural separation, break them up. That conversation is starting to accelerate, to simplify these business models so we can regulate them.”

Stoller said the large tech firms such as Google and Facebook are not innovating and are holding back innovative.

“At first you could argue they were innovative and doing things people found useful. Now they are more a function of a series of mergers and probably they are holding back innovation all over the world,” he said.

The most obvious sign post for this he said is in media.

“Local news gathering and local newspapers are dying. We all have these super computers that are our phones that are vehicles for story telling but we don’t have financing models to build news in an innovative way that you would normally see. This is because of the ad models and these companies holding that back.”

Stoller said over history there have been many times that concentrated power has been reigned back in, and the post-1970s era of big is good is very uncommon in the US.

“There has been a fear and suspicion of monopolies back to the Civil War. What changes things in democracies is the public making different decisions about what they want,” he said. “How we structure markets is political, it doesn’t come out of nature. Out of the GFC we saw a tremendous dissatisfaction from the public in how we organise our markets. Now we are in the throes of the debate once again.”

He also warned that concentrated power is not just big tech firms, but pointed to China as an example of market power.

Stoller outlines in his book Goliath: The hundred year war between monopoly power and democracy, that what is being discussed now around these companies is a resurrection of these much older debates.

“There were a number of different ways the Chicago school instrumentalised their vision on to our economic order. One was relaxing how we approached anti-competitive behaviour, another way was restrictions on capital and who can borrow.”

Predatory pricing was illegal in the US before 1975 but is now commonplace. He said it empowers companies to borrow from Wall Street and price below cost, driving out people who can’t access the financial markets.

“The Chicago people would say that’s good for consumers. But what that ends up doing is privileging firms with closer access to capital, and int today’s environment of financialisation, the closer you are to central banks gives you enormous competitive advantages to wield power and influence how we interact with each other.”

Stoller said that the Ivy league universities in the US were a big part of the problem.

“This is fundamentally a battle of ideas. Economists have a mathematised language which makes them an agent of monopolies,” he said.

 

For more reading on monopolistic power see:  Finance mirrors tech monopoly behaviour

The CEO of CalPERS Marcie Frost has a big year ahead. Not only is the fund still searching for a CIO, but it will also conduct its four-yearly asset liability study this year. Frost speaks to Amanda White about the challenges of the top job at the largest fund in the US and how she works to make sure the “real story” of CalPERS gets told.

Marcie Frost is grounded in her own upbringing in the mission of CalPERS – to provide financial security for the fund’s two million members. She witnessed her grandparents’ retirement savings dwindle due to unexpected events and their struggle to live on social security.

“They were savers, they had no debt but they struggled. It was very difficult to watch. As ageing people they didn’t the have financial options to access medical and healthcare. The impact that had on them, seeing them stressed about finances was tough, and I think that is what pushed me into this retirement side and what can I do to make sure that people as they age have that dignity to pay bills. That is the most important part of the job,” she says.

She focuses on ensuring members trust the fund will provide financial security in retirement, adding that the average retirement balance at CalPERS is only just over $30,000.

“How do we do that transparently, and continue to have their trust that their benefit will be here when they need it? That’s the best part of the job,” she says.

“It’s a challenging environment, how do those two million members know and trust that the portfolio is being managed at an appropriate level of risk to reach the 7 per cent target? How do I continue to make sure we tell the real story of CalPERS is what motivates me,” she says.

Frost joined the fund in 2016 and has been working to build a culture that is inclusive. During the pandemic she says the team worked hard to protect the culture that had been created in those five years, primarily through increased communication and transparency with staff.

This included a weekly web chat with all 2800 employees where she made herself available to answer any question directly. The online forums were focused on providing updates on any issues that impacted employees jobs. They also drew on the fund’s health program experts with on staff physicians providing updates on the pandemic and the health implications for staff, members and the broader community.

“We also allowed live questions and people would email me on my phone and I’d answer them directly. To us it was increasing transparency and the trust and information we were providing,” she says, adding the online meetings are continuing every fortnight this year.

The fund started putting more information on its intranet including created a new DEI framework virtually.

“The other tone from the top was we need to be flexible with people. Our employees are trying to balance things they’ve never had to be before – do their job, and be school teachers and carers for the elderly. We allowed for flexibility in the way they do their work and how they arranged their days that best suited them.”

That flexibility will continue post pandemic and currently all business leaders are going through the 2800 positions to identify if they are eligible for remote work.

“But the challenge remains, CalPERS is a destination employer partly because people are able to work on teams with each other, and we provide training and invest in them. How you keep this secret sauce of the CalPERS family when people are working remotely? How does CalPERS keep that family culture as strong as it was prior to the pandemic? People are very proud of working here,” she says.

As Frost and her team work through the new flexible arrangements she says they are trying to avoid making significant decisions in the short term that may not be suitable in the long term.

“We want the flexibility going both ways, for employees and also for us in working it out.”

The 2021 ALM study

The $450 billion CalPERS has around $25 billion in liabilities it pays out each year. As such liquidity is an important part of the fund’s investment profile and risk management. The investment team has worked closely to develop a new dashboard to manage that liquidity profile which proved its worth during the pandemic when the fund was able to invest in some opportunistic strategies.

But Frost says the biggest advertisement for asset class improvement is in the private equity program.

“We did a look back at and attribution of performance and it’s not been strong. If our private equity performance was near that of our sister fund CalSTRS we would have hit our assumed rate of return last fiscal year,” she says. “In looking at it we had a concentration on buyout funds and we were not consistent in funding those over time. Now we have been working to repair relationships with GPs, ensuring communications and re-alignment of interest are happening. All our investments were in funds so the fee load on private equity was a real drag on the performance, and without co-investment to help that. It is very promising what we have done, but what we are putting into today we won’t know the outcome for many years.”

So unfortunately, she says, in the context of this year’s ALM project which will run from July to the end of the year, the private equity realignment is not going to be very helpful in the short term.

The fund faces a tough ask.

In the first part of the six-part asset liability modelling process, the fund defines its 10-year capital market assumptions. In the fund’s last study, four years ago, Frost says the fund’s determined a capital asset pricing model that would produce a return of 6.1 to 6.2 per cent for the same asset allocation. Frost says for the same asset allocation, that 10-year assumption has dropped to 5.6 per cent.

“We either have to increase risk to retain the 7 per cent target, or the growth target has to come down. They are the two choices, and neither are easy decisions,” she says. “There will be tradeoffs.”

Much of Frost’s task is to manage the fund’s various stakeholders, and she is very conscious of the board’s dilemma in this regard.

“It is difficult for people to think about adding cost to a system when CalPERS has already identified one of the key risks to the system is the affordability of public employers to continue to make contributions. The second key risk we have is being able to make that 7 per cent target and the markets. And the third risk is related to climate and human capital management and the disclosure of those metrics so we can appropriately manage those risks,” she says. “We are working through the board’s risk appetite, then we will bring forward to them various portfolios and asset class assumptions. We are trying to make sure our board understand that we are well aware of how difficult these decisions will be for them. It’s going to be a long year in ALM.”

CalPERS recorded a 12.4 per cent return for the 2020 calendar year, 8.4 per cent for three years and 9.7 per cent for five years ending December 31.

The year ahead at CalPERS: Marcie Frost on the ALM study and hiring a new CIO

A new CIO

The other big issue facing the CEO and board this year is securing a chief investment officer.

The fund has been without a CIO since Ben Meng’s resignation last year, and put its search for a new CIO on hold in April, citing a number of factors including the need for greater clarity regarding the position’s compensation and incentive structure.

The board has since voted to add a long-term incentive plan to the compensation package for the CIO. Now the base pay range is $424,500 to $707,500 and the CIO can earn an additional 100 to 150 per cent of pay if the fund earns its 7 per cent or higher compound annual growth rate over five years.

“One of the problems we have is the retention of that position. The long term incentive is intended to get people to think five years out,” Frost says.

An additional contributing factor to the fund deferring the appointment is the competitive environment in recruiting for this level position, Frost says. Many funds are currently recruiting for chief investment and chief strategy officers.

“When we compare to say the top Canadian funds our compensation is not that competitive,” she says. “We do think the long-term incentive plan will help, but in talking to candidates there is some caution, and a lot of questions about working in a very public, often characterised as a political, environment. Is the CIO able to focus on the portfolio and the people in the investment office or is the CIO more externally focused?

“Most of the candidates we were talking to are in the former. They are talented investors they want to work with a talented team and really want to have structure to keep the CIO focused there and not so much externally around stakeholders. They want to execute on the strategy.”

Frost says that potential candidates also expressed reluctance to move their families during the pandemic.

“It’s not a good time to ask people to relocate,” she says.

The board and the chief executive share the responsibility of hiring the CIO, a process that Frost says has been underway since she started but has now been formalised.

Dan Bienvenue, who was appointed deputy CIO by then CIO Meng and was formerly head of global equities, is acting CIO.

“He’s a natural interim candidate and was part of setting the investment strategy,” Frost says.

The fund has also hired Sterling Gunn, who has held senior positions in the past at GIC and CPP Investments, as its new managing investment director of the trust level portfolio management program. Yup Kim from Alaska Permament Fund was hired to work with Greg Ruiz in the private equity team.

“It’s been seamless for the team on the strategy side,” Frost says. “Through the pandemic and managing remotely has been easy and morale is high.”

 

The CEO of CalPERS Marcie Frost has a big year ahead. Not only is the fund still searching for a CIO, but it will also conduct its four-yearly asset liability study this year. In this Fiduciary Investors Series episode, Marcie Frost speaks to Amanda White about the challenges of the top job at the largest fund in the US and how she works to make sure the “real story” of CalPERS gets told.

About Marcie Frost

Marcie Frost joined CalPERS as chief executive officer (CEO) in October 2016. She is the ninth CEO and second woman to head America’s largest pension fund. As CEO, Marcie oversees an annual budget of $1.8 billion, an experienced team of 2,800 professionals, and three lines of business for the fund: pensions, health benefits, and investments.
CalPERS administers a defined benefit retirement system for more than 1.9 million California public sector workers and their families. It is the nation’s second-largest purchaser of health care benefits, covering more than 1.5 million lives. CalPERS’ global investment portfolios stand at roughly $400 billion.
Under Marcie’s leadership, CalPERS is focused on maximizing long-term investment returns to meet the fund’s fiduciary responsibility to members and leverage the fund’s global strength to drive sustainable markets. CalPERS is a founding member of Climate Action 100+, an initiative with 360 signatories and $34 trillion in assets under management, working cooperatively to ensure the world’s largest corporate greenhouse gas emitters take necessary action to address climate change. Marcie has also been appointed as a Guardian for the Council for Inclusive Capitalism at the Vatican and serves on the United Nations Global Investors for Sustainable Development Alliance.
Prior to joining CalPERS, Marcie spent 30 years as a public servant in Washington state. Her early leadership roles were in human resources with an emphasis on employee benefit programs and information technology. She later was named executive director of the Washington State Department of Retirement Systems, where she demonstrated strong leadership and innovation, an emphasis on customer satisfaction, and team collaboration.
In 2013 Marcie was named cabinet lead by Washington State Governor Jay Inslee for the Results Washington performance and accountability system, where she served as an early creator and architect for the platform that tracks goals and progress in education, the state’s economy, sustainable energy, healthy and safe communities, and efficient government.
Marcie served on the Washington State Investment Board as an ex-officio voting member for four years and served as its chair until she joined CalPERS. The board manages more than $120 billion in assets for 17 retirement plans.
Marcie has also served as chair of the Pension Funding Council, responsible for setting economic assumptions and pension contribution rates for the state’s pension plans; was a member of the Technology Services Board in Washington that oversees the state’s IT projects with a measurable focus on business alignment, security, open data, transparency, and mobility goals; and was a voting member of the Washington State Legislature’s Select Committee on Pension Policy.
Marcie represents the United States on the International Centre for Pension Management Board of Directors.

About Amanda White
Amanda White is responsible for the content across all Conexus Financial’s institutional media and events. In addition to being the editor of Top1000funds.com, she is responsible for directing the global bi-annual Fiduciary Investors Symposium which challenges global investors on investment best practice and aims to place the responsibilities of investors in wider societal, and political contexts.  She holds a Bachelor of Economics and a Masters of Art in Journalism and has been an investment journalist for more than 25 years. She is currently a fellow in the Finance Leaders Fellowship at the Aspen Institute. The two-year program seeks to develop the next generation of responsible, community-spirited leaders in the global finance industry.

What is the Fiduciary Investors series?
The COVID-19 global health and economic crisis has highlighted the need for leadership and capital to be urgently targeted towards the vulnerabilities in the global economy.
Through conversations with academics and asset owners, the Fiduciary Investors Podcast Series is a forward looking examination of the changing dynamics in the global economy, what a sustainable recovery looks like and how investors are positioning their portfolios.The much-loved events, the Fiduciary Investors Symposiums, act as an advocate for fiduciary capitalism and the power of asset owners to change the nature of the investment industry, including addressing principal/agent and fee problems, stabilising financial markets, and directing capital for the betterment of society and the environment. Like the event series, the podcast series, tackles the challenges long-term investors face in an environment of disruption,  and asks investors to think differently about how they make decisions and allocate capital.

This week marks the rather grim milestone of a year since the World Health Organisation declared the COVID-19 spread a global pandemic. But with vaccines being rolled out and lockdown easing, we might be glimpsing the light at the end of the tunnel. The big question remains: what will the world look like when lockdown is over?

Click here to read the full paper

The City of Austin Employees Retirement System has turned around its five-year performance with a focus on value in active management and deconstructing its bond portfolio. As it looks to the future CIO David Veal considers venture capital and crypto investments.

The City of Austin Employees Retirement System (COAERS) is at the tail end of five-year process, initiated by chief investment officer David Veal when he joined the fund, to improve governance and performance.

“We had a clear mandate to get out of the fourth quartile,” Veal tells Top1000funds.com. “We were concerned about that and what it meant for long term sustainability.”

The good news is that the fund’s five-year return is now first quartile against its peer group.

“We are very proud of that,” Veal says.

The path to achieve this turnaround in performance has involved a focus on where value can be added in active management. The fund moved to a predominantly passive strategy in its 30 per cent US equities allocation, paying particular attention to the nuance of indexing.

“How you index is interesting. Do we want to be all market cap? In the dot.com bubble the bear market was largely in tech stocks; if you had a more diversified portfolio you would have been better off. We have some equal-weighted portfolios and other diversified holdings, allowing us to lean against the concentration and that has done well for us. We want the ability to allocate to equal weight or proprietary methodologies.”

Veal and the team, which uses entirely external managers, looked at vanilla equal-weight as well as more nuanced approaches such as a factor-based approaches to equal weighting to get a more diversified portfolio.

In international equities the fund continues to employ active managers. One of its managers, the Scottish fund manager Walter Scott & Partners, has added 300 basis points annualised (net of fees) over the 30 years it has been managing money for the fund.

“That is a tremendous amount of value add. We think that is evidence of stock picking ability,” Veal says.

Other parts of the portfolio have also been re-organised, with the old core bond portfolio picked apart into its different constituents – mortgages, treasuries and corporate bonds.

“Taking it apart allows you to think about the economic drivers of returns of those assets, and then we can make a choice of active versus passive in each element,” he says, with both corporate bonds and mortgages being actively managed.

In  a June 2019 interview with Top1000funds.com, Veal said: “The treasury piece is big, and it’s got long duration on it, and by the way, it’s held in a separate account so we have access to it in a crisis. I think that’d be one of my takeaways for folks… is to think hard about how you hold things, because a commingled fund in the next crisis, there’s a risk, particularly with ETFs. Can you get to the underlying investment if you need it? Will you get liquidity? Because we know liquidity does tend to dry up.”

In our more recent interview in April 2021 he says the fund was so “thankful” to have taken those steps and the separate account proved to be efficient and effective.

“Even liquidity in treasuries got funny in March last year, if the treasury market dried up that would have been another story,” he says. “We also terminated our securities lending about 18 months ago. A lot of investors are reticent to give up the income stream, but we decided it wasn’t worth the pro-cyclical risk you take on.”

The fund’s treasury book was up 24 per cent in the lows of the market and did what it was supposed to do.

“The hedge book worked exactly how we wanted it to,” he says. “We were really well placed in terms of the crisis. Our one mission is to make reliable benefit payments and there was never a moment we thought we would have an issue we can’t access some income stream. We are 80 per cent daily-traded securities so we have excess liquidity if anything. We had comfort we had liquidity to spare even in this environment. That allowed the board to concentrate on other things like getting people home.”

Inflation

The COAERS board has delegated asset allocation and manager selection within an investment risk framework which tasks the staff with the day-to-day investment positioning. Veal says the fund continues to execute the long-term investment plan but has made some changes in the short term.

“One thing we have been discussing for a while is a regime change from deflationary to inflationary and we put a 1 per cent allocation to gold in place about a year ago,” he says.

The fund also has allocations to TIPS, infrastructure and real estate but is discussing whether to hold more in those investments because of an inflation expectation.

“We have enough in the portfolio to have some protection from inflation – but do we have more? The biggest question for institutional investments is will the traditional 60:40 go away for a while? I don’t have the answer but what might the scenarios look like and will you be prepared? Do you have the playbook to make decisions?”

Veal’s view is that investments being made today are not productive.

“We will get a short-term bounce but in six to 12 months there will be continued stagflation,” he says. “Inflation is here, is it transitory or something different? House prices are up by 20 per cent and houses in my neighbourhood are going for $200,000 over the asking price, and the price of lumber is going through the roof. Will it be sustained?

“We come down on the side this is a temporary bump with a few things to watch such as the flow through to wages, and a changing consumer mindset. One thing you saw in the 1970s is that inflation is as much a mindset as a state of the world. You have to look at consumer psychology.”

Veal has been saying for some time he is disenchanted with traditional mean variance optimisation-oriented asset allocation and it’s an area he continues to work on, with particular focus on the inputs into the process.

“Mean variance is still the go-to tool for constructing a portfolio but we are developing our own capital market assumptions. Most people rely on consultants but we pull ours down from capital markets ourselves, we look at what’s the implied correlations, volatility, and return,” he says. “The inputs are critical. Mean variance is sensitive to the inputs and we make great pains to get the inputs right.”

The next five years

So with the first five-year plan coming to an end the question moves to the future. Veal says the focus for the next five years is on maintaining performance and where to get alpha, including whether to hold more private and alternative assets, including crypto.

“Could we build out a top quartile venture capital program? Can we justify fees on the basis of the returns you’ll get from that? Is there something to do in digital assets?”

He notes the first mover advantage in private equity where funds that invested in the 1980s and 1990s experiencing different gains to those entering investments now.

“The same thing may play out in the digital assets world, it could be the same,” he says. “Tokenised stock trading started with shares of Tesla where you can buy for example a 100th of a share. This is a capital markets ecosystem distinct from the traditional markets. We continue to work on this to see if there is an opportunity for return.”

First and foremost he says there is a custody question around it.

“If you lose your keys to bitcoin you’re out of luck. Is there an ecosytem for situations around that to be ok. There is still a case around what the utility around these assets is, [and] does bitcoin have a purpose? Is there an economic rationale for that to exist in the first case? We are asking those fundamentals and looking at how it is a prudent investment. Are we trading sardines or eating sardines? That’s something we are asking, what’s the nature of these assets and do they have economic value long term?”

Farouki Majeed is worried about the future. His concerns are centred around the implications of the enormous federal debt in the US and borrowing from the future; the global competitiveness of the US economy in particular when it comes to its competitiveness with China; inflation; and the potential erosion of the value of the US dollar. He talks to Amanda White about what it means for his portfolio allocations.

“The economy is picking up,” says Farouki Majeed, chief investment officer of the Ohio School Employees Retirement System, citing travellers passing through the domestic US Transportation Security Administration returning to pre-pandemic numbers as an indicator.

“I expect the economy and markets to continue to head upwards for a while – even though they are at lofty levels – because they are supported by all this stimulus,” he says. “It’s a strange world.”

But like many CIOs around the world Majeed thinks the near-term outlook is pretty good, but he has many concerns about the medium to long term outlook for markets and the economy.

“The near term looks good. A year ago, I was looking at charts like the 1930s and looking at how long it takes to get back to normal, which historically has been a long time,” he explains. “We were worrying ourselves to death about how it might pan out. Who would have thought a year would change so much? We have had 21 per cent return so far this fiscal year. There is one more quarter to go and we are hoping to hold on to that.”

Majeed’s concerns in the medium to long term are centred around the growing debt burden and the implications of that on markets and on returns.

“There is huge stimulus in the US and it is all being borrowed from the future. The latest round of stimulus probably went a little too far. The new administration is trying to incorporate some of their other agendas into the COVID relief which is fine in the short term, but it’s a lot of money.”

Majeed points out the $27 trillion debt bill in the US has pushed the debt-to-GDP ratio to 130 per cent, up from 91 per cent a decade ago and 55 per cent 20 years ago. At the time of the market crash in 1929 the debt to GDP ratio was 16 per cent.

“We have that federal debt to GDP and have never seen such erratic prices at that level. That will be a drag on future economic growth,” he says.

Beyond the debt situation his lists of concerns go on, including the global competitiveness of the US economy in particular when it comes to its competitiveness with China, inflation, and the potential erosion of the value of the US dollar.

As an investor, Majeed’s job is to figure out how these concerns and opportunities can be reflected in the asset allocation, and he has taken an approach that is not rigid in the allocations by trying to fill asset class pots but looking at the overall portfolio and what is missing.

“We have not made any strategic decisions to say X per cent in inflation hedges or other hedges for these scenarios. But what we are trying to do is incorporate aspects in the portfolio we are not currently doing. Some funds have put allocations to [for example] gold in their strategic asset allocation in the last year. We have not done that, but we are reflecting that in our portfolio in small ways via strategies. It’s putting our toes in the water so we can ramp up those allocations as we need.”

Commodities and gold are two examples of this, where investments are not part of the SAA but they are in the portfolio and allocations can be increased as appropriate.

“Commodities will have a fairly big demand and leg up in the coming quarter. We don’t have a strategic allocation to commodities but I want to have a way to ramp it up.”

Defensive allocations

The other big question for the portfolio is the bond allocation.

“Owning US government bonds is a dead-end kind of game at this point,” Majeed says. “That is a concern so we are looking for alternative ways of hedging equities in the portfolio while trying to generate more income return.”

The fund now has up to 5 per cent in a private credit allocation that it didn’t have a few years ago. It followed the same path by dipping its toes and investing in private credit strategies and then graduating that into a new asset class.

“I haven’t quite figured out is what is a good substitute for a fixed income allocation. If we underweight fixed income I want to make sure we are doing it judiciously and incorporating other assets to fill that role such as TIPS, gold, ILBs,” he says. “For so long bonds have filled that defensive role and had decent returns. We have had a period of 30 plus years with a secular decline in interest rates and the 10-year treasury has gone from 15 per cent to 1.5 per cent. There are some that are saying the 10-year could be at 2 per cent by the end of the year. How rapidly it goes up depends on how inflation pans out. If the US Fed is forced to begin some kind of tightening regime, that would be a consternation in the markets.”

Federal Reserve chair Jerome Powell has said tightening will not begin until 2024 but Majeed is pondering whether he will be forced to act given all the stimulus and global growth picking up.

“If the economy is at 6 per cent over the next quarters the Fed might be forced to act” he says. “If that happens then it’s a potential risk to the market. The bond markets are already indicating they really don’t believe the Fed and it might happen sooner. We have to wait and see.”

At the end of 2019, Ohio SERS had been reducing its equities allocation with a view that markets were quite high, so it had some cash going into the crisis. This enabled it to deploy assets into some opportunistic investments including “a lot in credit”.

“Many companies were being squeezed and needed credit to get by. We invested quite a bit in credit strategies and high yield and this helped our return in this period.”

But while many investors would be pleased with the 21 per cent return so far this year, this adds to Majeed’s concerns.

“It means that forward returns will be quite dismal I think because we are borrowing from the future. Valuations are high. Equities and credit valuations, high yield, all are pretty high. Even real assets in certain areas are high.

“Valuations are very rich and likely to stay like that in the near term, because [of] all the liquidity and stimulus pumped into the economy. That is going to go somewhere, and I think it is going to elevate commodities and bring in some inflation.”

Majeed does concede there are opportunities in some real assets that have been quite badly impacted by COVID and could be some opportunities in the re-alignment in real estate for example.

He is looking to increase the fund’s infrastructure allocation which is currently around 3 per cent of the total fund from a standing start five years ago.

Hedge funds have been reduced to a zero-target allocation drawn down from 15 per cent when Majeed joined the organisation eight years ago. He does use hedge funds where there is confidence in the strategy, but they sit within other asset class allocations.

“I really think having a target allocation to hedge funds is ill-advised, we use hedge funds as an active management strategy within other asset classes depending on the underlying investments,” he says.

Some of that hedge fund allocation has gone into private credit and real assets.

“One of the goals was to improve income return. That is going to be crucial in coming years. If we have stable income return that will be a protection in this kind of market,” he says.

The fund is not looking to deploy any explicit hedges, but instead trying to incorporate implicit hedges within asset allocation and portfolio construction.

“We are exploring and thinking about it.”

Forward looking returns and the next crisis

With returns for the next 10 years destined to be well below those of the past 10 years, pension funds in the US may be forced to focus on matching liabilities rather than return targets.

“I think with the the 10-year yield is at 1 or 1.5 per cent what will happen is that matching liabilities as a conversation will feature more with boards, versus that of the return target of 7.5 per cent, ,” he says. “5 per cent above is a tough target. Our board has been trying to grapple with this issue and we have a conversation on pension fund sustainability on a pretty regular basis. Our hands are tied in the sense there is very little you can do. The solution is on the benefit side but cutting benefits is not a popular thing. Risk is also increasing. And we could potentially have people drawing benefits for longer periods. I wouldn’t want to be a CIO five or 10 years from now. It’s a tough equation.”

Majeed says while equities have returned excess of 10 per cent over 10 years for the fund, over the next 10 years he is expecting more like 5 to 6 per cent, with bonds likely to be 1 to 2 per cent.

“I have been in this business for 30 plus years. In the last 10 to 12 years we have had two major crises, who would have thought? In a way we are setting ourselves up for another – because of the debt and the stimulus. I don’t know what form it takes but you can see a lot of speculation. Look at Bitcoin, people are reaching out for these types of things. It will correct itself via some sort of crisis.”

As people around the world emerge from lockdown and communities get vaccinated there is talk of some return to normalcy. But Majeed’s view is that normal will be different to the past.

Some of the areas where change might be pervasive and impact the state of normal is how consumer behaviour might have been impacted and will play out in certain types of asset classes. Or the housing boom, or the impact of the COVID crisis on the young population and their sentiments and behaviours going forward.

“There is quite a bit of uncertainty I think. There will be some realignment and readjustment. Smart investors will have to catch on to them and hopefully we can do some of that.”