Christopher M. Schelling Director, Private Equity, Texas Municipal Retirement System
Christopher M. Schelling
(Art by Victor Juhasz)

“Chris is one of the smartest investors that I know, period. He used to run Absolute Return Strategies for me, and now he runs Private Equity and Special Situations so he has incredible depth and breadth of knowledge across not only asset classes but vehicle structures and markets.  

He has the ability to easily blend his academic (he was a professor), technical (he was a researcher/writer) and the practical points of view and integrate them in almost any circumstance, and across the entire portfolio.”

— TJ Carlson, CIO Texas Municipal Retirement System


Always thinking and always putting new ideas together, Christopher Schelling is part-professor, part researcher, who is now the director of private equity of Texas Municipal Retirement System. Known for his ability to tackle a wide breadth of investments, Schelling built a PE portfolio from scratch during a time of lofty evaluations and is now working on a collaborative investment fund to lower fees and align interests. He is also acutely aware of the oncoming ramifications of baby boomer retirees.

To stay sharp and expand his thinking, Schelling reads a book per week, and it isn’t unusual for him to be combing through research, academic articles or subjects as varied as theology or science fiction, or writing thought leadership pieces on topics from shareholder activism to LDI for public pensions. He’s known to have given psych evaluations to his managers.

With experience ranging from buyside to sellside, consultant to allocator, front office to back office, Schelling has worked for firms such as Bear Stearns, Calamos Investments, and Thompson Reuters, and as a researcher for Mercer. While working as deputy CIO for Kentucky Retirement Systems, he taught finance at the University of Kentucky. Schelling has met with nearly 2,000 managers, invested $4 billion across roughly 100 accounts in public securities, hedge funds, real assets, and private equity, and generated roughly 2% excess returns per annum in the process.



CIO: What are the accomplishments you are most happy to have achieved recently, and why?



Schelling:
Well, I’m nothing if not perpetually unsatisfied, so I spend a lot more time thinking about what I could do better than what I’ve accomplished. If you put a gun to my head, I would say I’m proud of building the PE portfolio at TMRS from scratch in a period of high valuations and capital abundance with no J-Curve. We are $1.4 billion committed, and deploying only primary fund commitments – no secondaries or co-investment – are already annualizing in double digits less than two and a half years from our first capital call. There is still a lot of heavy lifting to do, and I maybe should have done a few things differently, but all in all we are off to a great start.


CIO:
 What would you be most excited to accomplish in the year ahead, and why?


Schelling: 
I would be most excited to get a collaborative investment fund off the ground, in partnership with several other asset owners. For the last two years, I’ve worked with a non-profit organization called FIRCAP—the Fiduciary Investors Roundtable for Collaboration and Partnerships—making significant progress towards establishing a limited partner-driven private equity fund. We now have a small working group of like-minded investors, sample term sheet, substantial capital available, and are moving towards interviewing teams in the near term. Such a structure could lower fees and better align interests between LPs and GPs, and I think it could have meaningful signaling power to the industry as well. I wrote an article on it about a year ago titled Private Equity’s Indisputable Problem which served as a bit of a call to arms and summarizes the thesis. If we could get that up and running, now that would be an accomplishment I would be proud of.



CIO: What’s the most rewarding aspect of being an asset owner?


Schelling: 
I’m going to cheat and name two highly rewarding aspects. The first would be the opportunity to be involved in large, significant investment decisions and meet with highly successful, world-class investors. As an allocator, I’m committing $500 million a year. The opportunity to do that—and hopefully do it well—is meaningful and engaging. Further, learning from some of the greatest investors ever is another benefit that comes with that scale. I simply would not have otherwise met with people like George Roberts, Paul Singer, David Rubinstein, Josh Harris, and Pete Briger were it not for the value of the seat itself.

Last but not least is the opportunity to be involved in mitigating a critical social challenge. I say mitigating, because I’m not sure we can “solve” the retirement crisis. Over the next two decades, 10,000 baby boomers will retire every day. Less than one in five has a DB plan, and on average, their DC balance is around $100,000. And Social Security will hit two  workers for every retiree by then. Public plans will certainly help that segment of the working population employed by government agencies, but with a collective $3 trillion funding deficit, we’ve got work to do to become sustainable. Trying to generate the best investment outcomes possible is more rewarding knowing it will go towards supporting someone’s life than just making a corporate margin fatter.



CIO: What’s the most challenging?


Schelling:
I will caveat my answer to this question by noting I am a US public pension. All asset allocators have some degree of challenge that arises from governance, resources, staffing, etc., but US publics tend to have a higher degree than others. My biggest challenge is simply our internal governance structures, which are sub-optimal relative to even other US publics. And I’ll leave it at that.


CIO: What are you most hopeful about in the future of the industry?


Schelling: 
(I came back to answer this question after reading number 7, so please keep the answers to both in mind together.)

What has me most hopeful is the pace at which new business models and technological innovations are disrupting exorbitantly profitable—often anticompetitive—misaligned incumbents. This could take the form of allocators bypassing certain asset managers by investing in some strategies directly or in collaboration with others. Or it could mean individual investors accessing fintech products for cheaper and more efficient financial services, whether it be online banking and lending platforms or robo-advisers. Instead of merely sticking with the status quo–although, there’s nothing wrong with doing so where the status quo is working–innovation permits the industry to do a better job of providing productive capital allocation to the economy in cheaper and more efficient ways.



CIO:
 What are you most cautious about?


Schelling: 
Valuations and the amount of capital available. Capital is abundant and there is no low hanging fruit anywhere. Within PE, we have $1.5 trillion of dry powder, and 2017 saw PE commitments near record highs. More investors than not are keeping their PE allocations the same or increasing them going forward, so it’s not stopping anytime soon. As a result, valuations are at all-time highs–11.0x EBITDA or so. Now, there are pockets of relatively less capital abundance, but this theme is playing out across asset classes globally. The real question is what happens if (when?) central bank stimulus are actively unwound— not merely rate increases, but actual disposition of assets into the market. It’s also worth noting that periods of US public equity volatility over the last decade have often coincided with pauses in Fed balance sheet expansion. What happens if there is actual selling? A severe credit correction could occur, which impacts leveraged balance sheets the most—PE debt levels are 5.5x EBITDA or so, also all-time highs. Regardless, debt-fueled growth everywhere has tended to end badly at some point. Understanding how that could work its way through capital markets and impact our portfolio is a big concern.



CIO:
 As a leader, what are the most important aspects of the industry you hope to change over your career?


Schelling: 
To me, the single-most important thing we must change about our industry is the increasingly parasitic nature of finance in general. In theory, finance represents a simple function. It facilitates the transfer of money between capital providers, savers, or investors, and capital consumers, for instance, borrowers or corporations, who allocate those resources into (hopefully) positive net-present-value projects. At its best, finance permits an economy to move capital from those with excess cash and little to do to those with lots of ideas but little money to implement them with. Theoretically, this allows society to maximize its collective utility function. That’s productive. In practice, multiple layers of intermediaries create a tangled pathway between saver and spender, resulting in a complex web of fees, expenses, and conflicts that are often opaque to all but the most informed. Sometimes these intermediaries enable the efficient transfer of capital between counterparties to the entity best able to take risk. But all too often the excess intermediation, and sometimes obfuscation, instead results in the transfer of risk to those least able to understand and price it, and one party simply profits at the expense of the other. That’s parasitic, and it’s why confidence in financial services ranks lower than most other industries.

Now, a market that is increasingly efficient is one where transaction costs, both implicit and explicit, go down as a percentage of transaction value. Finance as an industry has gone from 4.7% of US GDP to 7.5% over the last 20 years. We are moving in the wrong direction, and this has to change. Those of us in the financial sector should prepare for a future where our industry shrinks relative to the size of the broader economy. Margins and incomes will come under pressure for a great many institutions and individuals in the industry, and fewer and fewer jobs will be created. I believe finance needs to confront its fee structures, excessive margins—outside of entrepreneurs, more finance billionaires are added to the Forbes list every year than any other industry—and simply do a better and more equitable job of moving capital around at a fair price.


CIO: If you had one piece of advice for your peers, what would it be?


Schelling: 
I don’t know if I have any real valuable piece of advice for my peers, as by definition they know as much as I do. I’m still learning every day myself—maybe that’s trite, but perhaps that’s what I would go with. Take time to get out of the hustle and bustle of deadlines, emails, meetings, and multi-tasking, and spend time reading and thinking. Actually thinking. I try to block out whitespace weekly to think, read research reports, academic articles—many from outside of finance—and I also read one book every week, across fields as varied as theology, history, science fiction, and business.

I’ve found this helps provide much broader perspective and helps me prepare for a future that could be very different from the past.  


CIO: What are the biggest current trends you are seeing that have surprised you?​


Schelling:
Perhaps the biggest trend that I’ve been surprised by recently is the re-emergence of portable alpha. I know it has worked well for some institutions, but I didn’t get it the first time around and I’m not sure I do now. I mean, it’s just leverage. If you want to increase your notional exposure, you can always minimally fund something or substitute marginally riskier assets for collateral, but that still doesn’t turn it into alpha.