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CIO Roundtable: Active, Passive, and the Future of Investment Strategies

The nation’s leading institutional investors discuss how each style fits into their massive portfolios.

Art by Pete Ryan

Despite being at the tail end of the longest bull market in history, the great financial crisis a decade ago left investors all too wise and cautious about unexpected market fluctuations, and everyone’s on their toes at this point in economic cycle.

Now is the time that investors are deciding whether they should continue a passive-heavy approach and ride the market indices, or prepare for what will be a potentially substantial market correction in due time, navigated primarily through active investment strategies.

From left and top: Chris Ailman, Gary Bruebaker, Marcus Frampton, Angela May, Amy McGarrity, Michael Viteri, and Ash Williams


Marcus Frampton, the Alaska Permanent Fund Corporation’s newly-minted chief investment officer, concurs that the current market is bearish, citing abnormally high public equity valuations, which, when measured by the Shiller P/E/ ratio, have only been this high in 1929 and 2000-2001. However, only institutional investors who are truly prepared for active investment strategies should partake in the endeavor, he said. “If you have the resources to select very talented managers, they can navigate a bear market better than an index investment.  Even if you get into the world of active managers, there’s a ton of defensive strategies you could employ.”

“There’s no right answer, and beating the market is not an easy game,” Frampton said. “If you’re not set up to do it, you should go passive.”

He and his team have been working on finding and recruiting active managers during the past few months, recently pushing past their target allocation for hedge funds in particular within the past year. “In the short term, we’re really shooting for hedge funds and market neutral funds—those are strategies with zero correlation in the market,” Frampton said.

CIO Jonathan Grabel of the Los Angeles County Employees’ Retirement Association (LACERA) noted that “active investing is a way to complement a traditional portfolio with additional sources of return that cannot be accessed through passive products. These additional sources of return benefit total fund diversification and risk-adjusted returns in the long term,” he said.

Ash Williams, CIO of the Florida State Board of Administration (SBA), added to Frampton’s point, citing that just active investments in general won’t save you in a market cycle—it’s “the quality of the investment that will separate winners from losers in times of stress.”

Part of that quality is the timeliness of an investment, Williams illustrated, “if you look at relative value and if you look at everything that’s investable, and ask what’s relatively cheap, I can’t help but look to emerging markets, Asia in particular. If you look at population growth, middle-class growth, and the natural commercial history of these markets, and study their valuations, you’d have to say I want to be there.”

“If we see the US equity market soften or decline, it would be even more important for active managers to add value by performing better than the index,” Christopher Ailman, CIO for the California State Teachers’ Retirement System (CalSTRS) said. “We have a mix of passive and active strategies and target exposure ranges around both. We are more passive in the US. than in non-US markets. We don’t see us changing the active/passive ranges much for US and non-US developed. We are looking into whether to add some passive to emerging managers.”

Gary Bruebaker, CIO of the Washington State Investment Board, concurred with Williams’ sentiment regarding market location and investment strategy. “Passive will be most suitable for highly efficient markets like US public equity, although we will always reserve the ability to invest in an active manager where we have high conviction in the manager and see a strong fit with our overall strategy,” he said. “Outside of the US, in less efficient markets, we are more apt to rely on active managers for their insights, strategies, and performance.”

Colorado Public Employees’ Retirement Association CIO Amy McGarrity and her team are choosing to stay put with her current equity strategy. “As long-term equity investors, we do not believe in shifting between equity strategies as we consider this to be market timing, where it is very difficult to be successful after transition costs. We are satisfied with our current active/passive mix,” McGarrity said.

Grabel, too, is sticking with the team’s current plans as the economic cycle evolves. “The best approach for LACERA at this time is to adhere to our strategic asset allocation and not attempt to selectively time markets,” he said. “While considering future return expectations that are lower than recent realized results, we strive to improve the portfolio at a macro level without chasing the ‘hot’ niche strategy.”

The Oregon Public Employees’ Retirement System also is sticking with its current investment plans as the market cycle moves forward. Michael Viteri, senior investment officer for public equities, said his portfolio “allocated less than 15% to capitalization weighted passive strategies [while] 85% of the portfolio is invested in active systematic or active fundamental strategies. We don’t expect the portfolio to evolve significantly from this active/passive allocation.”

On Lucrative Active Investment Strategies

However, what if an investor is looking to add active investment strategies to their portfolio? CIO asked these highly talented and experienced senior investment professionals what has worked best for them in the past.

“Private equity has been one of the Chicago Teachers’ Pension Fund’s top-performing asset classes,” said CIO Angela Miller-May, outperforming public markets by 330 bps net of fees annualized since inception. “We continue to build and implement a more direct approach versus a fund of fund approach to investing with private equity managers and will continue to explore innovative strategies and emerging markets that can provide growth and risk-adjusted returns.”

“We have been working to increase active management in both our equities and fixed income portfolio while maintaining a passive approach in the large cap equities space. Long term, we will continue to be 100% active in the International Equity asset class while Domestic Equity will have a mix of passive and active,” Miller-May said. “We are moving to an 80%/20% active/passive model in the Fixed Income asset class. Overall, all mid-small cap strategies will remain active strategies.”

“The Washington State Investment Board will continue to employ active strategies in the less-efficient markets such as global public equity, emerging markets equity, and debt,” Bruebaker said.  “Active investments provide insights that can translate into alpha, particularly in less-efficient markets, but are challenging to identify and may be capacity-constrained, which can be an issue for a fund the size of WSIB.”

Frampton added, “one thing we’re doing with active strategies is we’re moving as many managers as possible to very low bps, anywhere from 0-15 bps, then adding an incentive fee. We’re paying a manager for a base fee, and an option on their outperformance. We’ll pay them to the extent that they add alpha.”

Colorado PERA’s McGarrity added that “[co-investments] can be an appropriate strategy to lower overall fees. While many institutional investors are exploring this form of investing, time will tell if it becomes mainstream for all types and sizes of funds.”

“I’m not advocating for a particular strategy,” said Williams. “Emerging markets are more suitable for active than passive investments,” citing the regions’ assets potential to appreciate over time. “And I think that the buyers for goods, services, and commodities in those regions will continue to grow. As middle classes grow there will be more intra-regional trade where they’ll consume their own output and become less dependent on developed nations to be their consumers. China and India are good examples of those.”

“We do a little bit of just about everything [in active investments],” Williams continued. “Every asset class has a specific role in the performance of our total portfolio. What we’re trying to do is take that holistic approach that collectively gives us the best risk-adjusted returns that we can capture, and bring us as close as possible to our target returns.”

Despite the benefits in capturing return premia as a function of complexity, illiquidity, regulatory pressures, and/or capital flows, Grabel said a key clause to note is their inconsistency. “Expensive fee structures can fully absorb any index outperformance. LACERA is a discerning investor who selectively invests in active strategies when we expect to be well-compensated for risks and uncertainties.”

Taking Things In-House

A number of institutional investors have been seeking cost savings by opting for internally run investment management teams, however, different CIOs are selecting different asset classes to pursue.

“Active management is more expensive and may make sense net of fees if the asset owner hires the right managers,” said McGarrity. “Colorado PERA emphasizes internal management which makes active management much more appealing due to the low-cost nature of internal management.”

The Florida SBA’s growth in recent years provides Williams with the necessary resources to carry out in-house investment strategies, he explained. “Over the past 10 years, headcount grew by about 25 people. The main thing about depth of staff, it positions us to manage a substantial amount of assets in-house, giving us a major cost advantage,” said Williams. “Generally speaking, the cost of external management will be a multiple of internal management. CEM Benchmarking, a firm based in Toronto that tracks the cost of pensions, consistently ranks the SBA as one of the lowest-cost providers among our peer group.”

However, some investors are not looking to take investments in-house currently, such as Chicago Teachers. “CTPF currently has a stable group of diversified and complementary investment managers that manage CTPF’s total assets. At this time, we are not considering hiring the resources that would be needed for the management of in-house active investment strategies,” Miller-May said.

Alaska has been doing in-house investments for almost three decades. “The longest-standing area of internal active management [in the APFC] is fixed income, we’ve done that going back to the ’90s,” Frampton said.

He added that the sovereign wealth fund likely won’t pick up public equity-managed strategies in-house in the near term. “With public equity, we would need six or seven people to cover each sector. It’s hard to cover global equities, and it makes me less ambitious in taking things in house,” Frampton said.

Washington State, too, delves into fixed income strategies through an internally managed staff. “We have done exactly that with our team that covers fixed income globally,” said Bruebaker. “We have a highly skilled internal team of nine, many of whom have been with us for 10+ years. For all other asset classes, we employ outside managers or partners. Periodically, we do take a closer look at the pros and cons of internal management for our public equity assets. To date, including very recent analysis, our studies have readily convinced our board to stay on course with external managers. Costs are comparatively low; performance has been strong; diversification is rich; relationships have been deep and valuable.”

“Oregon manages active systematic public equity strategies and active fundamental fixed income strategies internally,” added Viteri.

“Colorado PERA has emphasized internal management for decades. For example, we have 14 equity investment professionals,” McGarrity said. “All have the CFA charter and most have advanced degrees. PERA has been able to recruit investment talent from all over the country as people want to live in Colorado while also enjoying the stability of assets under management.”

All things aside, many institutional investors generally agree on the benefits and drawbacks of active and passive strategies. “Passive is a very low-cost way to capture market beta, the broad benefit of exposure to markets we want to be in. Active strategies capture the beta and then also add a layer of alpha, that reflects the quality of your securities selection and portfolio structure.”

“Passive investments have low costs, virtually unlimited capacity, market-level diversification, and performance often exceeds most active managers in highly efficient markets,” Washington State’s Bruebaker said. “Active investments provide insights that can translate into alpha, particularly in less-efficient markets, but are challenging to identify and may be capacity-constrained, which can be an issue for a fund the size of WSIB.”

McGarrity added, “passive management is inexpensive. Additionally, there are no surprises in terms of relative performance. Active management is more expensive and may make sense net of fees if the asset owner hires the right managers.”

Bringing the Best Managers from Both Sides

Institutional investors have a responsibility to provide suitable conditions to attract the highest-performing fund managers to their portfolios. Doing such could add a tremendous amount of value through exposure to some of the best returns in the asset class, and different investors take different approaches to achieve this.

“Colorado PERA is a patient investor. We do not hire/fire based on short-term relative performance,” said McGarrity. “In addition, we share industry and company insights with our managers ,which adds to the potential for alpha.”

Florida SBA embraces its scale—nearly $200 billion in assets under management—to sustain meaningful relationships with successful GPs. “We’re a thoughtful investor, we’re long-term oriented, meaning we’re sticky money,” said Williams. “We can scale capital to levels that can make our relationship meaningful to any size partner. I was in the private sector for a dozen years, and managed client relationships. Those three characteristics are platinum, any GP puts value in them. If you consistently operate with those three characteristics, everyone wants to be your partner.”

“The Washington State Investment Board has a strong reputation for setting and adhering to long-term, clearly defined strategies, large fund allocations, all backed by a stable and skilled internal investment team and a very engaged and fair-minded board,” Bruebaker said.

Among the many benefits of attracting talented managers is capitalizing on their opportunistic investments. Through co-investments, where each investor lays claim to a stake in the particular asset, the limited partners gain direct access to gross returns generated from the investment.

“Co-investments can be an appropriate strategy to lower overall fees. While many institutional investors are exploring this form of investing, time will tell if it becomes mainstream for all types and sizes of funds,” said McGarrity.

“Co-investing is something we’re really emphasizing across private equity, infrastructure, and private credit,” Frampton said. CIO recently interviewed Frampton on his co-investment strategies, which have generated returns upwards of 60%. “The benefits of active investments—we’re all fiduciaries trying to reduce risk a maximize return, and if you’re only passive you can’t deviate from things you’ll find concerning.”

“We are likely to see co-investments become a larger portion of investors’ investment dollars,” Grabel added. “The most compelling deals may only be offered to select investors who have true strategic partnerships with investment management firms. Investors need to avoid adverse selection and avoid making co-investments solely to reduce fees.”

“In private equity, the WSIB employs an external manager to seek out co-investment opportunities. In other private markets, the WSIB makes direct co-investments. Growth of this practice of co-investing will depend on the risk tolerance, skill sets and the stability of various investment programs,” said Bruebaker.

Infrastructure’s a great place for co-investments for institutional investors. The asset provides long-term, stable, forecasted revenues with little risk in brownfield deals. Many different institutional investors are taking a close look at the sometimes-lucrative investment.

Miller-May touched on the subject, noting that “infrastructure as an income producing strategy/asset class will continue to have a place in the portfolios of institutional investors and/or pensions plans as appreciation being a part of total returns seems to be shrinking.

“Income and liquidity become increasingly important to investors and infrastructure can provide steady cash flows and capital,” she said. “The need for infrastructure improvements also presents significant opportunities in the space for investments.”

“The keys to success in infrastructure include disciplined asset selection on the front end, coupled with the ability to do well on the operating side during the time you’re holding the investment,” she added.

LACERA just picked up infrastructure recently with a 3% target allocation. “Infrastructure has the potential to provide income, enhance diversification and hedge against inflation,” Grabel said. The allocation is expected to evolve, subject to a structure review, from listed infrastructure investments to fund core private commitments, and potentially over time, new co-investments.

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