Risk and Return

CIO Perspectives: Capital at Risk

Risk and ReturnHere are more of my notes and photos from the Council of Institutional Investors Fall 2015 Conference in Boston. I added the subtitle to the name of this session, which mostly explored managing risk in low-return environment but touched on many additional topics. Feel free to post corrections, counterpoints and additional relevant material on topic, using the site’s comment feature. Find more posts from the conference on this site or Twitter by searching #CIIFall2015.

Scott Evans

Scott Evans

Evans addressed governance within the NYC Pension Funds. Corporate governance was handled by a separate organization but now they (Michael Garland and Scott Drazil) report to him. Diversity is fundamental because diverse boards and companies make better decisions. Heterogeneous groups avoid groupthink. They are now asking for investment teams that are also diverse. What is the diversity component of the compensation package?

According to Kevin SigRist, ESG, risk management initiatives, asset deployment with more focus on ESG value enhancement is also applied to portfolio management at NC Retirement. NC Asset liability study arrived at 7.25% benchmark. Decided not to reach for risk. 30% invested in long-term bonds. Hallmark is always funding (90% of funds more volatile).

Key for both funds is managing interim risk in low-return environment. NYC lowered benchmark from 8 to 7% and has 50% invested in public equities, 33% fixed income, 16% alternatives. New York state law constrains risky assets to 25%… counts some foreign investment as risky. Do we reach for risk or assume we will earn more further out? What is the risk appetite of the 58 members of the five separate boards? We educate them with the helpful advice of consultants.

Kevin SigRist

Kevin SigRist

Discipline around rebalancing. Hedge funds are speed boats. Pension funds more like ocean liners. Over time rebalancing in a disciplined way.

Passive investments about to overtake active investing. Represents long-term capital. Good thing if engaged. Tone from top important in seeking diversity and looking several levels down. Ask board members to mentor managers two or three levels down. [I really like this suggestion.] Directors get a better understanding of how companies tick and managers get new insights from directors. Capital allocation and role of board. Contest around business mix and drivers of those businesses. Risks.

What keeps you up at night? Garbage trucks in NYC. Stitching all the operations together. Robust risk management. Investment infrastructure, 100 staff. NC – fragility in the financial system. Policy makers having to get it right. The tension between long-term and unexpected events. Persistent slow growth, huge flows of capital and volatility. Return opportunity is evaporating. In NYC we think we are taking risk in an uncoordinated way, where one class will go up when the other goes down. Yet, we find they have a way of correlating. Delve into sources of difference in behavior and how to benefit from market movements. “Independent” sources of return in a financial world that isn’t very independent are hard to find. NC – Price of liquidity has changed and financial intermediaries retain cash for liquidity crises.

Models and tools. SC building risk model with SAS to do fully comprehensive modeling. Useful if actionable. Bringing in research services. Consultants helpful with risk models. NYC Comptroller decided initially to hire a chief risk officer very focused on operational issues. Building out more robust in-house strategies to parse the independent sources of risk. 

Transparency of private equity fees. Part of alignment is looking to have. Seeking disclosure. Would like to see more standardization. Mentioned Scott Stringer’s letter to SEC insisting on a standard. When invoices come into accounting, we can’t parse it out and serve up an accounting of gain sharing between General Partners, Limited Partners and asset classes. Numerous conversions required. Partners get it and are being proactive.

How do we as institutional investors avoid groupthink? We’re basically a herd. We move together. Someone has a good idea and people run with it. Comfortable to agree and go along. We all need to endeavor to challenge each other. It is OK to disagree. Diversity among our ranks would be a good thing. We need more of a culture of humility and more listening to the brick throwers. Look for the grain of truth in their complaints.

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