2020 Knowledge Brokers All Stars

Allan Martin

Partner/Senior Consultant
NEPC
Redwood City, California

Allan Martin had a sterling career at Bankers Trust, where he oversaw a large range of activities. For instance, he set up its index funds group and ran its $400 billion global retirement services business. Then he moved to RCM Global Investors and helped integrate it into acquirer Dresdner, the German bank, and repositioned the firm as a global asset manager.

Martin joined NEPC in 2000 and serves as partner/senior consultant. “Before I joined NEPC, I thought I’d retire and be on boards,” he said. But the allure of this new undertaking was strong. “You can never sit on your laurels,” he added. “Things are always changing.” He has been named to our Knowledge Brokers list before, in 2018, and that same year, at our Innovations Awards, was named consultant of the year.

CIO: What actionable thing have you learned over the course of your career that has proven itself this year?

Martin: In times of crisis, which seem more frequent recently, providing clear, thoughtful, and well-documented advice becomes even more important. That requires intelligence, integrity, and experience, or historic perspective. If you lack those elements, find them. During periods of extreme volatility, remember that you developed a long-term plan for a reason. Stay with it, even if it is uncomfortable…but simultaneously examine underlying assumptions to determine if there is any basis for modifications.

Perceived “market irrationality” is not a basis for modification. Describing market behavior as irrational only means you don’t understand it. Markets are composed of buyers and sellers. Understanding their motivations is critical. For example, in 2008/2009, banks and other providers of credit were forced to de-lever, which resulted in a self-reinforcing downward spiral in the pricing of underlying debt instruments. It was often the case, that the underlying loans themselves continued to pay, so you had good assets in the hands of weak sellers-that’s a condition to buy, not sell.

Decision Process

The process of deciding is as important as the result. If the ultimate decision-maker only acts due to faith in the advisor, the process failed. Adverse outcomes do not mean the decision was wrong. Well-researched and documented decisions sometimes don’t produce the expected result, but 1) you’ll have a basis for understanding what didn’t work that will improve decisions going forward, and 2) you’ll avoid the dysfunctional blame game.

Governance

Good decision-making and effective strategy can only be accomplished within the context of the governance process. Good governance requires an alignment of authority, responsibility, accountability, and competence. With Public Funds, ultimate authority is vested in a board, whose members are generally either elected or appointed. Most boards meet on a fixed calendar schedule. If the board has not delegated sufficient authority to staff, don’t invest in asset classes or sub-asset classes that operate on a cycle that requires entry/exit decisions more frequent than board meetings.

Private Markets/Public Markets

Generally, for larger public funds, I favor private markets (private equity, private debt, real assets, real estate) over public markets. In public markets, not only do the managers we hire have do better research than others, generally using the same information possessed by everyone else, but ultimately others need to recognize that value and bid prices up. In private markets, good managers have a greater opportunity to directly influence and create profitable outcomes.

Research bears out that there is some persistence in performance of good private market managers. This is especially true in private debt. If a manager purchases a loan which is selling at a discount to par, the asset will experience a capital gain (pull to par) as well as earning a higher yield…assuming the loan is repaid early or on-time. That’s where the manager skill is critical.

Liquidity

Liquidity, often ignored in more benign circumstances, has become even more important, particularly if the plan has chosen to invest in private markets. If you lack cash to meet pension contributions, rebalance back to targets and satisfy contractual obligations to private market GPs, you become a forced seller. It is critical to develop a liquidity plan which identifies specific sources of cash in stressed circumstances. On March 23, when even long Treasuries were difficult to sell, many plans, even those limited to public market assets, lacked sufficient liquidity to rebalance.

Expense Management

In a low expected return world, expenses matter even more. Always pick the best managers but negotiate fees aggressively. Take advantage of tools to add incremental returns (once you understand associated risks)—securities lending, timely filing of class actions, appropriate pursuit of foreign tax reclaims, etc. Use passive strategies where research demonstrates lack of active manager outperformance, recognizing that underlying market dynamics can change.

Volatility Management

Most public funds operate with significant cash outflows, which suggests avoiding extreme negative outcomes when negative cash flows may reduce plan assets enough to be insufficient to benefit from a recovery. In general, we cannot manage returns, but we can influence/manage volatility. Favoring strategies which include contractual income at a meaningful level may be helpful in managing volatility.

CIO: What investments (specific securities or sectors) look good to you now? And why?

Martin: While investors are accustomed to dealing with ambiguity in financial markets, COVID-19 has resulted in an unusually wide range of economic outcomes, which have amplified the range of possible market returns given the unprecedented monetary and fiscal responses being implemented. This wide spectrum of conceivable scenarios hampers the ability to develop a sound investment thesis and have conviction in near-term tactical actions.

Amid this uncertainty, the one thing we are sure of: the infallibility of the principles of strategic asset allocation. To that end, we encourage investors to maintain exposure to assets, especially risk assets such as equities, in line with strategic targets. In addition, we advocate discipline when determining adequate levels of portfolio liquidity and a dedicated commitment to Treasuries, which remain vital for balancing portfolio risk in an environment rife with uncertainties.

We anticipate that the unprecedented display of monetary and fiscal support will remain in place for an extended period. To that end, we encourage investors to adopt a strategic equity allocation that favors domestic and emerging market stocks. We propose a modest strategic overweight to US equities, despite elevated price-to-earnings levels, as we believe the current trend in valuation will likely persist.

We recommend a strategic bias to emerging markets, particularly Asia, to capture the higher long-term return expectations. Reinforcing a back-to-basics approach, we suggest investors set a dedicated strategic target to Treasuries to soften the potential impact of market drawdowns. Most importantly, in a world of uncertainty, maintaining adequate portfolio liquidity is critical as market dislocations can incite bouts of illiquidity even across publicly traded assets.

In addition, we are favorable to private equity. We are entering a period of rapid technological developments amid economic disruption and private markets will be the largest beneficiaries of these developments. We continue to favor private debt strategies as well, but with much more sector selectivity than following the GFC.

CIO: What ones don’t? And why?

Viewing certain assets as unattractive is generally a cyclical view, but there are three key items that one can look to. First, the asset does not provide a sufficient return to support the investment objective. Core bonds are such an example, as they offer historically low yields, and with corporate and mortgage bond exposure can suffer bouts of illiquidity. It should be noted however, that some assets such as Treasuries are required for prudent liquidity management.

Second, we view any investment that does not offer a proper alignment of interest among the investor, underlying assets, and the investment manager to be an unattractive investment opportunity.

Third, assets that look to deliver a return in certain market environments but require a premium to be paid or offer a negative carry over a full market cycle are investments we encourage investors to avoid.

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