The investment market in Saudi Arabia has many challenges, driven by structural, economic and regulatory constraints. For insurers, regulatory restrictions exert much pressure to manage risks while optimising returns in a limited investment universe. In addition, the local bond and equity markets are shallow and volatile. Investors navigate these restrictions in various ways.

First, there are some good signs for insurance companies in Saudi Arabia, with the opening up of the market to foreign investors, albeit conditionally, and the potential inclusion in the MSCI Emerging Markets Index.

The challenges in the Saudi Arabian market are driven by structural, economic and regulatory constraints. Investment managers are often flummoxed while choosing investment products and asset classes, with asset quality continuing to be a key credit weakness for many insurers in the region.

Also, the bond/sukuk market needs to be strengthened, as it is the linchpin of investments by insurers. Allowing insurers to invest selectively in alternative assets would go a long way towards reducing the difficulty in imparting effective diversification to the book.

Shallow local bond market

Low levels of sovereign and corporate bond issuance limit insurers’ fixed income investment options, increasing their exposure to equity and real estate. This leads not only to volatile investment returns but also to severe tightening of solvency margins, which the finance managers of companies don’t cherish.

In addition, the local bond/sukuk market is narrow and shallow, with hardly any trade reported to the bourses for days or even weeks. There are only five bond or sukuk issuances registered on the exchange, with a total value of SR26.2 billion ($7.0 billion), in addition to about 48 privately placed issues, totalling SR32.7 billion. So the local fixed-income market is not big enough to facilitate investing and trading.

The equity market, in contrast, is arguably deep and wide, featuring 176 stocks with an average market cap of SR9 billion ($2.4 billion) or more. But there is considerable volatility.

As a result, both the fixed-income and equity markets pose challenging environments for insurers trying to achieve required investment return targets. In response, insurance companies manoeuvre using different products within regulatory and investment guidelines to achieve their objectives. Insurers also approach the regulator seeking permission to invest in otherwise prohibited classes, though the regulator more often than not says no.

A reasonably large number of products are in the money market space, with good size and liquidity and yields on a par with typical deposits or better. Structured products are also an alternative to medium- to long-term deposits, offering better returns.

Because the local bond/sukuk market is so inhibiting, particularly in terms of liquidity, insurers resort to Regulation-S or 144a issues (securities sold within the United States by non-US companies), consciously taking the currency exposure into consideration, including the fact the Saudi riyal is pegged to the US dollar. Insurers also have the option to invest through funds inside or outside of Saudi with a solvency margin of 5 per cent and 1 per cent, respectively, of total assets. This gives considerable leeway, avoiding the typical restrictions on asset classes.

Insurance companies (mostly branches of foreign entities) were registered in Saudi Arabia only with the enactment of Control of Cooperative Insurance Companies Regulation per Royal Decree No. M/32 of July 31, 2003.

The regulation was passed on November 20 that year and became effective on April 23, 2004, with the publication of Implementing Regulations by SAMA (now Saudi Arabian Monetary Authority, then Saudi Arabian Monetary Agency).

Regulations abound for insurers

Implementing regulations were followed by many other regulations – essentially drawing upon the parent regulation – such as risk-management regulation, outsourcing regulation and investment regulation. Most of these changes focused on mandating higher solvency margins with robust balance sheets, which an efficient and effective regulator ought to do in a fiduciary capacity.

As many as 34 companies have been licensed and listed over the years, most of them with paid-up capital of less than SR500 million ($133 million). It’s pertinent to mention here that minimum paid-up capital required for an insurance company is SR100 million and that, for a reinsurance company, the minimum is SR200 million – the majority of the companies have both insurance and reinsurance licences. There is only one company, Saudi Re, that has a licence only to transact reinsurance business.

Gross written premiums reached about SR37 billion at the end of 2016, posting a meagre accretion of less than 1 per cent over 2015. However, the profits, before zakat (alms) of insurance companies, reached about SR2.5 billion ($670 million), almost 30 per cent contributed by return on investments, compared with about SR1billion the previous year. Insurance penetration in Saudi Arabia is more or less on par with other Gulf Cooperation Council countries, at about 2 per cent.

At the end of 2016, the insurance sector, with a market cap of about SR43 billion ($11.5 billion), contributed only 2.55 per cent of the total market cap of SR1.68 trillion.

But when it comes to trading and volatility, the insurance sector makes up quite a significant part. Insurance companies contribute about a quarter of total trading transactions – including 20 per cent of transactions in listed companies – and one-seventh to total trading value and volume.

The economic environment is driven by low oil prices and they are a headwind for the Saudi insurance companies, as evident from growth of just half a per cent in the top line during 2016. The same may happen in the short to medium term, as economic growth is held back and weighing more on government spending.

Since insuring and investing are quite correlated and complementary, especially in terms of risk and capital allocation – as more risk in insuring has to be supported by less risk in investing and vice versa – a deceleration in the top line arguably results in lower net cash inflows and necessitates higher liquidity in investments, thus thwarting the achievement of optimised returns. In addition, regulatory requirements mandate that insurance companies invest at least 50 per cent in Saudi riyal and a minimum of 80 per cent in Saudi Arabia.

Regulations also prohibit investing in derivatives, option contracts, hedge funds, deposits with foreign banks, private equity investments and any off-balance sheet instrument, again unless specifically approved otherwise. The regulations essentially direct and encourage investing in bank deposits and highly rated bonds, particularly sovereigns.

The risk weights attached to assets depend on the size of balance sheet, rather than, ideally, on the quantity and quality of the asset itself. For example, investments under the “Shares-Saudi-listed” asset class are eligible for solvency margin up to 5 per cent of total assets (balance sheet size) irrespective of their own size and quality.

This means all investments in Saudi listed stocks up to 5 per cent of total assets are fully admissible for solvency margin – and anything above 5 per cent, fully inadmissible. Any other equity, be it developed market equity core/satellite or emerging market equity, attracts admissibility of only 1 per cent of total assets, leaving some of the asset classes even with zero per cent admissibility.

Mamraj Chahar is the chief investment officer of Saudi Re.

Evolution is the buzzword at the Local Pension Partnership (LPP), the collaboration between two of the United Kingdom’s local authority pension funds. The Lancashire County Pension Fund and the London Pension Fund Authority (LPFA), with combined assets of about £12 billion ($15.5 billion), set about joining forces to better access investment opportunities in private markets before the government decided to pool local authority schemes into fewer, bigger funds.

That trailblazing has earned the LPP real expertise as the wider pooling process is still gathering momentum. As the evolution continues, Chris Rule, LPP’s managing director and chief investment officer, is heading a quiet revolution as well.

“It’s all about making sure you get proper delegation of decision-making because, bluntly, if you come together and pool but actually all of your portfolios look very different to each other, you haven’t created much scale.

“I think the real challenge people are having, not only in the Local Government Pension Scheme (LGPS) but also in private-sector pension funds, where there is also talk of consolidation, is how you get people to give up their favourite manager, give up their authority to make decisions on minutiae, and focus on the real decisions that make a difference, namely asset allocation. They then need to replace the historical structure with a professional, scalable operation underneath that can report back to stakeholders.”

Rule is convinced that the key to successful pooling lies in getting the governance right. It’s what he refers to as “the governance premium” that will ultimately enable the fund to “maximise benefits of scale”.

LPFA and Lancashire have both maintained control of their strategic asset allocation, and how they deal with their employers and contribution rates. They also both still sign off on funding strategy.

A typical “sovereign decision” includes LPFA having a liability hedge in place using an overlay, whilst Lancashire doesn’t. However, in terms of sub-asset class strategies, manager selection and stock selection, control is fully delegated to the LPP.

“Once an asset allocation decision is made, LPP has full discretion,” Rule says.

Although the asset allocations between the two entities differ, he says the funds are on similar paths. Both already have low allocations to traditional equity (50 per cent at the LPFA, and about 40 per cent at Lancashire) compared with peers. And although there will be no dramatic shifts, both ultimately aim to expand investments outside fixed income and equity.

Not courting more local authority funds

Rule plays down the need to attract more local authority funds to the LPP pool to increase assets under management in line with the government’s £25 billion ($32 billion) target for each fund. He argues that the LPP is already big enough to negotiate the “lowest possible fees” with external managers “sitting significantly above the threshold below which fees start to escalate”.

He also says the LPP’s current size ensures it can be nimble. He says he is considering additional clients and pursuing a “number of avenues”, although he cautions that any considerations around taking on new investors have to be balanced against the fit with existing clients.

Besides, LPP is achieving greater scale in other ways, like collaborations in infrastructure. GLIL Infrastructure is an infrastructure partnership that began between the LPFA and Greater Manchester Pension Fund.

It has grown to a £1.3 billion pool that includes other local authority funds Merseyside and West Yorkshire. Now, Rule wants to make it available “to all investors”.

With this in mind, the joint-venture structure is being converted to a fund structure that will allow entry for passive, or smaller, investors.

“There are a number of investors out there who would like access, but don’t have the size of allocation that would warrant them coming into the structure we have today,” Rule explains. “A fund structure will allow limited partners to come in.”

So far, other local government pension funds have shown the most interest, but he believes smaller private asset owners “unable to join consortia” will join. He particularly likes UK infrastructure because of the advantage of local knowledge and the currency and inflation match.

“There will be a home bias, although we do look globally in all asset classes,” he says.

It is also a model he hopes to roll out to real estate, and possibly other real assets. Collaboration with other funds on infrastructure investment has developed a structure that has some parallels in real estate.

“The pooling at an asset class level, rather than on a multi-asset class level, does have some merit, especially in private markets,” Rule says. “We are at the early stages of thinking about how we might expand at this level. But the concept of sharing capital and sharing resources and underwriting capability is successful. We are able to do much more with much less; we are not operating with a huge cost base.”

Building up internal resources

Managing more assets internally is another stated aim at LPP, where the internal headcount is now 24, double what is was a year ago.

This effort has focused most on listed equity to date. About 40 per cent of LPP’s global equity allocation is now managed internally. Rule is reluctant to set a target for how much that should grow.

“We are very cautious about setting targets, because it is a false incentive to allocate internally if you don’t have the best ideas internally.”

Indeed, some of the internal capability will be invested in manager selection, in line with Rule’s belief that those choices are just as important as stock selection.

Along with building internal skills to allow more direct underwriting in infrastructure, he also wants to increase resources around underwriting credit investments. He’s looking to build expertise in total return as well, an asset class that catches more opportunistic and liquid investments at LPP, like re-insurance.

“We have done some underwriting in this space,” he says.

Although the rationale behind building internal teams is partly cost, Rule says it is also driven by a desire to invest in private markets in a way that’s different to how many investors do it.

“Our horizon is long term and private assets are often held by short-term investors,” he explains. “A traditional closed-end fund structure has a three- to four-year investment period, but we would rather own an asset for 30 years.”

That observation leads him to reflect on the beating heart of the pooling process.

“It’s about coming together to make more of one of the true competitive [edges] in the defined benefit pension world: being a genuine long-term investor.”

A company’s long-term success depends on how it operates today and, perhaps more importantly, how it allocates capital for future growth.

As a long-term investor, environmental, social and governance (ESG) issues are important factors in AustralianSuper’s investment philosophy on behalf of our more than 2 million members.

The building of our members’ A$110 billion ($81.5 billion) of savings into decent retirement outcomes requires strong investment returns over decades, not years. To achieve this, we need strong returns from companies we invest in over the long term.

ESG issues – including climate change, other environmental issues, health and safety, and labour rights in the supply chain – are determinants of the future operating environment. Other factors, such as technology and the regulatory environment, are also critical. Awareness of how these factors will unfold in the medium term will be critical to the success of capital allocation decisions.

As a long-term shareholder, we are acutely interested in how companies integrate ESG and other long-term factors into managing their business today and planning for the future. Specifically, we expect companies and their boards to incorporate this broader range of factors into their strategic and financial planning processes.

This is not always easy, especially as non-financial factors are more difficult to quantify than purely financial factors. However, this does not diminish their importance, particularly as the time horizon extends.

While there are encouraging signs that boards and management are realising that ESG issues are increasingly linked to long-term value, work remains to be done for these elements to be fully integrated into the capital allocation process.

In recent EY survey, 68 per cent of respondents said that in the past 12 months non-financial performance played a pivotal role in their investment decisions. While this was up from 58 per cent in 2015, it is still too low.

Only 60 per cent percent of institutional investors who responded to the survey said their clients were demanding ESG information, while, perhaps most alarming, 73 per cent said they conduct only informal assessments or no review at all.

There is clearly work to be done.

The key ESG areas for AustralianSuper are:

  • Encouraging companies to incorporate ESG factors into their analysis and reporting of current business conditions and future opportunities
  • Increasing direct engagement with company management and boards to better communicate our expectations as a long-term shareholder focused on long-term value creation
  • Ensuring remuneration frameworks deliver appropriate pay for performance outcomes, with reasonable pay levels and appropriate disclosures
  • Getting the right directors on boards to ensure the board operates effectively and that shareholder rights are appropriately protected.

We are finding that boards are increasingly willing to engage on ESG issues, as there is a greater understanding of our long-term view. More and more companies are coming to us as a sounding board throughout the year, which results in a much more productive relationship than waiting for an issue to come up to a vote.

In particular, forward-looking companies view ESG performance as an opportunity to better align the company’s long-term strategic goals and maximise opportunities by talking to their major shareholders.

This also benefits the companies, as directors and management are increasingly keen to engage directly with shareholders who have a long-term outlook and are, therefore, more valuable sources of long-term capital than investors with a more short-term focus. After all, our primary objective as a shareholder is the same as any director’s. We want the company to have sustained long-term success.

Remuneration still a sticking point

With regards to remuneration, we are still seeing far too many issues coming to the fore.

It’s an area that seems to be becoming more contentious and complicated, which means it can take up too much board and shareholder focus.

AustralianSuper is giving much thought to how we can communicate effectively to companies our expectations in relation to remuneration as a large, long-term shareholder. We are primarily interested in appropriate pay for performance outcomes, reasonable pay quantum, and clear disclosures that demonstrate how the company has performed on these issues.

Boards are increasingly willing to engage on these topics, as there is a greater understanding that we represent the interests of AustralianSuper members. The engagement process provides a valuable mechanism to express positions in relation to remuneration.

All of the above relies on having the right people with the right skills on boards. We need directors who can establish and clearly explain the links between strategy and ESG issues and demonstrate that the company is genuine in its approach to managing these issues and how this will create long-term value. This is what generates alignment with shareholders.

AustralianSuper seeks to assess the way a board operates in practice. To do this, we are developing a board evaluation framework.

Governance will always remain a high priority. The rights of shareholders and how they are treated in relation to stock issuance is a key issue, right alongside remuneration structures, getting the right directors on boards and effective board operation.

Sustainability reporting

We are seeing more companies using sustainability reporting frameworks than ever before, and it is increasing across the spectrum of companies in terms of size and sectors. Many companies are doing it well, especially in resources and financial services.

Of course, there is still room for improvement and we want to see more transparency, which we believe will ultimately benefit both companies and their shareholders.

ESG reporting has become an increasingly important forum for companies over recent years – to better explain their strategic intent. The firms that are doing it well have been able to show clearly how the strategic priorities of the company are directly linked to ESG issues.

AustralianSuper has seen many companies take a positive approach to engaging on these issues, and as we grow, it will be an increasing area of our focus, on behalf of our members.

Mark Delaney is deputy chief executive and chief investment officer of AustralianSuper.

Telstra Super’s internal investment team felt uncomfortable when it observed that a low volatility index did not line up with the fear and volatility that geopolitics was generating in global markets, so it asked its managers’ views. The process enabled the fund not only to be more comfortable with the anomaly, but also to find out which managers were prepared to be true partners.

In its weekly internal investment team meetings, the A$18 billion ($13.3 billion) corporate superannuation fund for telecommunications company Telstra had identified that the Chicago Board Options Exchange Volatility Index [VIX] was unusually low, but no one internally could fully explain how this was happening in a world of expensive assets, numerous geopolitical risks and mountains of global debt.

Telstra Super has a 27 per cent asset allocation to international shares in its default option and as the US equity market is the largest in the world, and arguably the most important, it desired to understand how the anomaly could affect its overseas holdings and asked its external fund managers what they thought.

“We saw that the VIX, which is meant to measure the amount of investor fear and uncertainty, was very, very low – lower than almost ever seen,” Telstra Super chief investment officer Graeme Miller says.

Typically, the higher the VIX – sometimes called the fear index – the more fearful and volatile the markets. However, the index is highly influenced by the actual level of short-term volatility in US equity markets. And in the 90-days to May 8, 2017, the S&P 500 had its most tranquil period in 22 years, with the actual, realised volatility for that time period falling to 6.7 per cent. The preceding months also had low levels of volatility, though not quite at record lows.

The historical high for the VIX was 80.26 points on November 20, 2008, at the height of the global financial crisis. On Monday, May 8, this year, the VIX closed at 9.77 points, indicating extreme market confidence – there have been only three days since the VIX’s inception in 1992 that it has been lower.

‘Swimming without bathers’

Telstra Super has embraced a partnership model with its 60 or so external managers, which handle around 70 per cent of the fund’s assets. It needs them to be more than just an arm’s length executor of a mandate. It wants access to the manager’s intellectual property, ideas, research and insights.

Before joining Telstra, Miller was the head of investment consulting for Australia at Willis Towers Watson, so he knows the breadth of insight that managers possess. For the purpose of uncovering the internal team’s perceived concern about volatility, or the lack of it, he approached a dozen fund managers and gave them a week to give their thoughts on the VIX issue. Some engaged with the question much more fully than others.

“It exposed, to some extent, those that were ‘swimming without bathers’ on the whole partnership thing,” Miller says. “It’s one thing to say, ‘We truly want to be a partner, we truly want to engage with you.’ But [only] some of them thought deeply about this, really brought the full weight of the organisation to the problem and came back to us with well-thought through answers.”

Miller won’t disclose the specific managers tapped for insights, but says they were selected from each of the super fund’s asset classes to garner a wide variety of views.

He adds that although there was a broad range of managers there was a surprising level of consistency in the responses.

Three of the key observations were:

  • While overall market volatility was low, intra-sector correlations were unusually high following US President Trump’s election. For example, the value of the US utilities sector had dropped, but the US defence sector had risen in value; this was masked by a low volatility in the overall market.
  • Because volatility was based on the spread between implied and realised volatility, it could be argued that the VIX was a lagging, not a leading, indicator.
  • No manager thought the US was on the precipice of a major market downturn, although there was a sense that there was some complacency about the systemic risks in the market.

Insights breed confidence that gets rewarded

Armed with the insights from the selection of managers, the super fund’s 16-person internal team was more confident about implementing actions in response to the disconnect between the short-term risks reflected in the ‘fear index’ and longer-term risks in global markets.

“The fact that markets, as a whole, do not think we are on the precipice of a major downturn gave us confidence to maintain a full exposure to growth assets over the past few months – and we’ve been rewarded for that,” Miller says. The fund’s allocation to growth asset is about 69 per cent for its balanced fund, across domestic and international equities, property and infrastructure.

He adds that the insights drove home to the internal team the point that the VIX is a blunt tool and was not an especially reliable indicator of investor sentiment or risk.

“This allowed us to more confidently position the portfolio towards a full weight to growth assets, coming from a position where our natural bias would have been to be a bit more cautious.”

The success of the approach has emboldened the Telstra Super investment team to reach out to fund managers for their views on market issues more often. And it’s worked both ways. One of the managers felt empowered to come to the super fund with a new idea.

“It has signalled to our fund managers [that we want insights]. It has given them a much deeper understanding of what we are interested in and what we are worried about,” Miller says.

 

 

What is sustainability? The Thinking Ahead Institute has a couple of working groups considering different aspects of the subject and one thing we have learned so far – Hold the front page! – is that a universally accepted definition of sustainability does not exist.

Each investment professional has their own legitimate take on the subject. For what it’s worth, my take is settling on the notion that sustainability is intrinsically linked to the rate of extraction of resources from a system relative to the rate at which they are replenished.

There are implications for investors here but first, let’s look closer at growth dynamics – meaning the shape of the growth rate over time – and sustainability.

I can think of three different types of growth, but there may be more.

  1. Sigmoidal, or S-curve, growth: growth starts slowly, then accelerates for a while before decelerating to a zero growth rate. This growth dynamic applies to most biological things, and explains why trees do not grow indefinitely into the sky.
  2. Exponential: the growth rate is consistently positive up until the point of collapse. An example would be the growth of a colony of bacteria in a petri dish. There is a technical wrinkle concerning whether the point of collapse occurs in finite time (a problem for us) or in infinite time (in which case, we could ignore it).
  3. Chaos: the classic example is the growth in the rabbit population on an island, with unpredictable booms and crashes.

In all three types, growth stops when resources can’t be extracted from the environment fast enough.

In the case of exponential growth, collapse comes when all available resources have been harvested. [Meaning Earth’s resources, I’d say. I doubt it will ever be economic to mine resources from passing asteroids and, further, I consider a human colony on Mars to represent failure rather than success – just think of the per capita resources required to sustain life there…]

We now need to tie these two ideas of sustainability and growth together. If the rate of replenishment of resources is zero – in other words, if we are gifted a one-off endowment of, say, fossil fuels – then we know we are dealing with exponential growth; eventually the resources will run out.

If the rate of replenishment is positive (and there is an existing stockpile), then we know two things:  the sustainable rate of extraction and that we can exceed that rate for a period, albeit with a future cost.

Humans are wired for growth

Whichever way you configure it, I am led to conclude that, over the very long term, the only sustainable growth rate is 0 per cent a year. However, we seem to be wired for growth. So how do we explain this mismatch? Two different strands of thought occur to me.

The first strand relates to history. For the vast majority of human history, global GDP growth is estimated to have been between 0 per cent a year and 0.05 per cent a year. Then, about 1750, it exploded exponentially. This pattern would fit either the sigmoidal or exponential dynamics reviewed above.

Arguably, the former is the more sustainable option – and it is possible to make the case that we could now be in the deceleration phase.

If global GDP is truly exponential, however, reasoning by analogy would suggest that positive growth could be sustained until the resources run out, at which point it collapses. In this case, we would need to define the time frame over which we were concerned about sustainability. If the collapse is likely to be beyond this, then it is outside our frame of reckoning.

The second strand of thought is inspired by Eric Beinhocker’s The Origin of Wealth.

This book makes the case that wealth is knowledge – so more knowledge equals more wealth. Assuming this to be true, wealth will increase indefinitely if knowledge increases indefinitely.

The indefinite increase of knowledge seems plausible, given that the more discoveries we make the more re-combinations of them can be made, to yield yet further discoveries.

There are two caveats in my mind. Again from history, the lesson from the destruction of Arab centres of learning shows that knowledge (and wealth) can be destroyed, even if that is harder to imagine now that knowledge exists in digital form.

Second, the problem of resource limits still needs to be solved. For knowledge and wealth to increase indefinitely, it seems to me that both have to be free of any resource constraints – and that is hard for me to imagine.

To conclude, I reiterate that I am settling on a belief that, over the very long run, the only sustainable growth rate is 0 per cent a year.

Given my belief in complex adaptive systems, a steady state seems remotely likely. More likely would be a chaotic pattern of positive and negative growth rates.

The lessons for investors

What does this mean in the real world of investing? With the caveat that there is seldom a simple and direct link between abstract thought and portfolio positions, there seem to be meaningful implications for portfolios.

First, equities are call options on growth, whereas bonds look more as though they extract resources at a rate more in line with replenishment – so asset allocation could be revisited. Second, there may be implications for risk management – in particular, being mindful of risk over longer horizons, and possibly having a more dynamic risk budget over time. Third, there are clear implications for security (and sector) selection.

We see the subject of sustainability as continuing to grow in importance – so we will continue to refine our thinking in this area.

Tim Hodgson is head of the Thinking Ahead Institute.

 

Brad Tillberg, chief investment officer of the $8.7 billion Oklahoma Public Employees Retirement System (OPERS) is only the second chief investment officer in the fund’s 45-year history. Perhaps even more remarkable, OPERS’ 13-member investment board, responsible for overseeing strategy and manager selection, has had only two chairs in more than 30 years.

This stability has brought a continuity and consistency to the fund’s leadership. Strategy continues to prioritise traditional investments, with passive strategies in equities and bonds, over private markets and active, skills-based investment.

In the latest rebalancing of the portfolio, assets have been split between US stocks (recently reduced to 40 per cent), international stocks (increased to 28 per cent) and domestic bonds (32 per cent). It’s a no-frills approach that Tillberg says still does exactly what it is meant to do.

The fund’s asset allocation is decided according to three main themes: asset allocation is the key determinant of risk and return of the overall fund; diversify by both asset class and within asset classes; and passive funds are suitable investment strategies.

No need for alternatives or private markets

“I don’t believe we are a conservative fund; we are a traditional fund,” Tillberg says in an interview from the fund’s Oklahoma City headquarters. “Conservative implies there is no risk in the portfolio and we do have risk, because we need this to reach our assumed rate of return. However, we are lucky because we have not been subject to the competing philosophies that come with leadership changes.

“You can have a portfolio that gets you to where you want to go without having to go into alternatives or private markets, and our board is extraordinarily sensitive to fees. We can do what we want to do with a traditional portfolio and the results speak for themselves.”

The fund has returned 9.41 per cent in the fiscal year to date, while the 10-year annualised return is 5.92 per cent as of the end of March 2017. Fees come in at 9-13 basis points, Tillberg says.

OPERS administers two defined benefit plans and two defined contribution plans. The largest defined benefit plan is the system’s namesake, the OPERS fund.

The system uses indexing for its domestic equity mandates (the Russell 1000, and Russell 2000 – the large OPERS fund doesn’t use the Russell 2000), its international equity mandates (MSCI All Country World Index ex-US and MSCI ACWI ex-US Growth), and its fixed-income mandates (US Treasury Inflation-Protected Security Index), with BlackRock now providing the four passive mandates for the OPERS fund.

The fund also has nine pure play long-only active managers in US small-cap equity and fixed income, plus three “in-the-hand” index managers, where Tillberg keeps a close eye on tracking errors.

“We emphasise beta exposure and diversification,” he explains. “We de-emphasise active management at the fund level, but we maintain selectivity in areas where we do employ active management. It’s a philosophy that allows us to control the things we can control.”

About 42 per cent of the US equity exposure, 68 per cent of the international equity allocation and 11 per cent of the fixed-income allocation is indexed.

Publicly traded markets mute risk

The manager roster comes to 16, while back in Oklahoma City, Tillberg is a one-man investment team, although he is quick to highlight the importance of the fund’s investment consultant and, of course, the board in decision-making.

“The level of sophistication on our board is strong,” he says. “Our investments are managed with a healthy dose of common sense and that goes a long way. We have the discipline to know what we can and can’t control, understand that the decisions we make have a big impact, and know the importance of maintaining discipline throughout market cycle.”

He also argues that keeping it simple reduces risk.

Like all large institutional investors, OPERS’ risk exposure runs the gamut from interest rate risk to currency and liquidity risk and geopolitical risk. Yet because the fund’s entire exposure is either to publicly traded markets or in vehicles where the underlying investment is publicly traded, risk is also muted.

“This transparency really serves as an additional risk-control function for us and I think this is probably unappreciated in the market,” Tillberg says. “Our portfolio is marked to market every day. By avoiding private markets, we [avoid having to] worry about operational issues like valuation methodologies and concentration in fund holdings, or structural fund risks or key man risk or cash drags or leverage usage. We are geared towards equity beta, no doubt about it, but also hold sizeable fixed income that dampens that volatility.”

OPERS’s success with such a straightforward approach has made Tillberg sceptical of more innovative investment styles.

“Buyers should approach innovative investment products with scepticism,” he argues. “One could have a highly effective portfolio with everything that exists today. One could also get into a lot of trouble with everything that exists today. It is our job as fiduciary investors to understand where a product fits within the portfolio and not just buy the latest product.”

Does he plan to introduce more active strategies, given today’s expensive equity markets and predicted low returns?

“We’re doing just fine at a fraction of the cost,” he concludes.