TJ Carlson, who has been chief Investment officer at Texas Municipal Retirement System (TMRS) for six years, has completely renovated the fund from a basic, $22 billion, 60/40 indexed portfolio with six staff members to a team of 24. The enhanced team has specialized focus areas on each asset class, a compliance office, an operations department, and a four-person risk and analytics team that includes a proprietary internal data warehouse. The now $30 billion portfolio has been transformed to become a fully diversified modern institutional portfolio.
CIO: Can you describe your investment strategy?
Carlson: We believe being able to achieve our 6.75% discount rate is only going to be achievable by getting away from the traditional equity and fixed income beta markets as much as possible. Our investment strategy is to be highly diversified and non-siloed with a strong component of private market exposures. We also tend to shy away from the larger funds and fund raises and prefer smaller, more nimble investment products. To accomplish this, the TMRS investment team, in my opinion, casts a wider net than some of our peers and even some consultants to find good investment ideas. Across the portfolio, our team takes 1,400-1,500 manager meetings a year, which is a lot of work, but we think it has and will continue to pay off very well in the long run.
CIO: How does your investment strategy differentiate TMRS?
Carlson: While I don’t think our actual high-level strategy is that different than what many of our peers are trying to do, I do believe that our implementation process is a differentiator. We tend to have fewer barriers to entry for manager meetings, we do a meaningful amount of earlier-stage investments such as founding class and “Fund 1s or 2s.” We also like to use fund seeding, custom structures, side-cars and the like to create the best possible outcomes for TMRS. We have approximately 10% of our portfolio in managers/funds that qualify under some definition as an emerging manager.
CIO: What are some of your latest developments/investment moves at TMRS?
Carlson: TMRS has been working on improving investment agreement structures and alignment of interests by creating custom relationship/account structures similar to what others have implemented as “strategic partnerships,” but where we maintain decision-making control. We are basically trying to get closer to the assets anywhere we can. We also recently completed an asset liability study which resulted in the board approving a slight update to our asset allocation. We moved 5% from public equity to private equity and so now our allocations are 30% global equity, 10% IG core fixed income, 20% non-IG fixed income/credit, and 10% each to real estate, real return, private equity, and absolute return.
CIO: Your Investment Data Warehouse (IDW), which you developed internally, now drives all of your risk and analytics systems. Can you describe what it does, how you determine its effectiveness, what obstacles/challenges you faced in developing it, where it has strengthened your capabilities, and what you expect from it in the future?
Carlson: While we had rudimentary visions for an Investment Data Warehouse as early as 2014, development did not truly begin in earnest in early 2017. To start with, our risk team needed to feed data into a transaction-based performance attribution system. TMRS uses this type of analysis to perform market research and help us evaluate active manger skill in highly liquid markets like public equity and fixed income. The data demands are very high, requiring accurate daily security level transaction and performance data for each account across the entire portfolio. The inability of data vendors to efficiently and accurately provide timely data also helped push the program forward. The risk team had prior experience with using relational databases to solve data management problems and proposed developing an internal database to extract, transform, and store the data in a way that made it easy to extract the data set we needed for the performance attribution system.
From there, the growth of the database into a data warehouse has been “organic” in that we are constantly adding, adjusting, and adapting based on user feedback and operational needs. It currently has five principal functions:
- Managing data necessary for MSCI BarraOne risk and performance analytical systems
- Storing the granular level output from these systems for maximum flexibility in data visualization and reporting (i.e., risk reports, leverage, liquidity, geographic, rebalancing, etc.)
- Investment Account related descriptive and derived data
- A fund-by-fund level cash-flow projection model for all of our private market funds
- A model combining ORTEC dynamic capital market simulations, our private market cash flow financial model, and asset class rebalancing rules.
This last model, which is in beta testing phase, will allow us to explore questions like liquidity risk, cost of liquidity, and efficiency of different asset class rebalancing rules. It is important to point out that currently this is only for exploring rebalancing rules assuming no information advantage.
Determining effectiveness is actually quite simple given our development approach. Every revision or addition to the data warehouse is in response to a user need. We estimate the time demand on all stakeholders, confirm what success looks like, and, if all is acceptable, proceed with development and implementation. If the implementation satisfies the users’ needs and the development demands were in line with expectations, we consider it effective.
We are fortunate to have people with significant experience in the interface between technology and operations. This has, so far, allowed us to avoid the most typical challenges/problems. Some examples are being very clear on operational use cases prior to developing automated solutions, having strict control (procedures) for extracting/providing data throughout the operational lifecycle of an investment account (single source of truth), and having a technology platform that is secure, flexible, and easily expanded. Going forward, we expect the data warehouse and related capabilities to allow us to take advantage of rapidly evolving data and technology advancements. One example is increasing data availability for operating metrics of private market portfolio entities and also for similar companies in their markets. Another is the financial (cash flow) dynamic modeling we are doing in addition to the traditional performance models. This will allow us to get better insight into the distribution of possible cash flow, cost, and performance consequences of rebalancing and liquidity management programs.
CIO: You were able to convince two directors from your previous shop to come with you to TMRS and have been able to keep all of your asset class directors since you took the helm. What is key to recruiting top talent and keeping your team together?
Carlson: I feel very fortunate to have been able to hire and retain the team I have here at TMRS. The first thing you need to have in place is a governance structure that is committed to putting a top-tier team in place and retaining them. Our board and executive director at TMRS have been very supportive of building and retaining the right team.
Once that precondition is met, I believe the key to team building is to have a clear vision for the team from day one and then hiring smart people who have the same vision built into their DNA. The key is not just hiring the smartest people you can find, it’s finding the right smart people. Smart people who can’t work together will kill a team. In building this team, I was extremely fortunate to be able to lure two directors from my previous CIO role to TMRS, so I knew we had a shared vision. I was also able to recruit my FI/credit director, whom I’ve known for almost 20 years, but only after a first failed attempt. I retained one legacy director and personally recruited the last one after two failed search rounds and 300 applicants that were very smart, but not right for the team.
Finally, and most important in keeping talent, is to let them do their jobs. Building and having ownership of a slice of, or the responsibility for some aspect of, a $30 billion portfolio is extremely satisfying on many levels, so I delegate, question, monitor and hold people accountable, a lot.