“One of Dave’s many strengths is his experience in building multi-asset portfolios. He understands how the puzzle pieces fit together strategically and has helped put together a strong lineup of world-class managers to implement that vision. His intensity and focus also serve him well as the leader of our investment strategy efforts, while his good humor makes him a beloved member of our team.”
—David Veal, CIO, COAERS
David Stafford is the director of Investment Strategy at the City of Austin Employees’ Retirement System, where he focuses on the fund’s asset allocation framework and balancing its risk/reward scales.
Stafford joined the fund two years ago as a portfolio manager and oversaw the creation and implementation of a new manager selection process called the Premier List. This new process helped the fund more effectively select and allocate to managers across the entire portfolio. The approach focused on avoiding the typical “beauty contest” style manager search by building long-term relationships with high-quality managers and performing due diligence ahead of a mandate becoming available.
Through this process, Stafford oversaw a restructuring of almost 50% of the entire $2.9 billion pension’s portfolio in 2019, including a restructuring of the fixed income portfolio that equates to nearly 20% of the total fund. This restructuring unbundled the fund’s aggregate bond exposure into dedicated mandates for credit, mortgages, and Treasuries, which ultimately helped it to better withstand the 2020 coronavirus epidemic and the economic turmoil that came with it.
Additionally, in his current role, Stafford developed an investment risk framework for total fund asset allocation and risk management to help the fund manage and understand the material risks it faces while seeking returns. Stafford earns a ranking on this year’s NextGen list through consistent innovation in his position at Austin and helping the fund better meet its fiduciary obligations to provide benefits to its members and beneficiaries.
CIO: What did you think you understood before the COVID-19 crisis … and if, during the crisis you were proven wrong, what did you learn from it?
Stafford: The crisis continued to prove that there are things that I don’t know and helped to clarify areas where I should brush up. Concepts taken for granted like positive prices for assets (negative prices for oil?) or futures liquidity and arbitrage are tested in head-scratching ways. It was certainly interesting to see some of these dislocations, like the mismatches between cash markets, futures markets, and ETF NAVs in what I assumed to be one of the most straightforward assets of US Treasuries. The biggest lesson learned for me was that a willingness to question and change your assumptions is key in navigating these types of situations.
CIO: What took you by surprise? What worked?
Stafford: I think nearly everyone was surprised by the speed at which nearly all economic activity stopped. The changing regime quickly made traditional econometric modeling useless.
In talking with economists and other experts focusing on the impact to growth, many suggested that it was literally anyone’s guess as to the damage to GDP or return on equity. What became particularly interesting were unconventional data sets which were available much closer to real time such as internet search history or cell phone location data. These data sets gave a much better sense of the extent to which social distancing was taking place and how it was affecting economic activity.
In terms of portfolio positioning, long duration US Treasuries acted as the best hedge to equity volatility. Fortunately, we had recently undergone a fixed income restructuring in 2019 with a stated goal to increase its “hedginess” for just such an occasion as this by unbundling aggregate bond exposures into dedicated mandates for credit, MBS, and USTs. This allowed us to increase exposure to USTs while also significantly increasing duration. Similarly, strategies that incorporated modest amounts of leverage to a more highly diversified portfolio containing uncorrelated assets provided better risk-adjusted returns than an overconcentrated public equity index or actively managed equity strategy did.
CIO: How would you build the portfolio differently now that you have gone through this massive accelerated shift in the market?
Stafford: I believe the most important shift in the markets is not related to returns for equities, but rather it is the possibility that US Treasuries may be losing their effectiveness as a hedge against equity risk. In my view, there are real risks that USTs follow German Bunds to become a negative carry hedge, which would significantly decrease their efficacy in the portfolio. Similarly, it’s not out of the realm of possibility that a material increase in inflation occurs in the next couple of years wherein USTs lose their hedging appeal to real assets or cash. These questions and more are the strategic issues facing investors as the specter of a new market regime begins to set in.
In building a portfolio today, it’s more important than ever to think about the significant risks taken while seeking returns and the most effective ways to hedge these risks. A flexible approach that relies on common sense principles will be important in correctly positioning a portfolio for success in the 2020s. Realizing that underappreciated risks such as inflation are more possible than often suggested should cause an investor to want to increase optionality in their portfolio with the ability to make sizeable investments in real assets, cash, or options-based hedging strategies.
CIO: ESG has been a tidal wave force behind recent innovative investment framework in our industry. How do you see the ESG framework and effort be influenced by the recent event?
Stafford: In my view, recent events will help separate the wheat from the chaff when it comes to firms proving their commitment to these types of frameworks as part of their process. As is often the case in asset management, incorporating a new idea or framework can become a marketing exercise where firms will do their best to check the box so that their compliance can be included in pitch decks. Unfortunately, it seems that intelligently incorporating material concerns about a company’s viability or culture is now falling into this dynamic. In my experience, the asset managers who do ESG best (and typically are strong performers) have long considered these types of issues in their process and haven’t only begun including them now that the marketing machine is behind the idea.
CIO: What do you think will be the impact of COVID-19 on developing economies?
Stafford: Broadly, it would be fair to suggest developing countries will be more significantly impacted than developed countries due to a relative lack of health care infrastructure.
However, in discussing developing economies, the heterogeneity of different countries is a very important factor to consider. Countries like China, South Korea, Greece, and Saudi Arabia are often lumped alongside one another even though they have significantly different economies or governments. In measuring COVID-19 response efficacy, the results are seemingly as different as the countries themselves. As such, looking at the outcomes for individual countries will likely be a more effective way to understand the impact to economic activity.
CIO: What are the new creative/innovative strategies that you are researching right now?
Stafford: My work recently is focused on informing the most balanced portfolio under the prevailing market conditions. This framework informs efforts related to asset allocation, risk management, and manager selection in a way that is well-suited to the goals and position of the system. Recognizing the dynamic nature of risk factors and correlations means that the best mix of assets in the portfolio can change in different market regimes, and this framework helps inform these decisions. By combining these items into a holistic framework, we are more easily able to identify the purpose of fund investments and measure their efficacy in the total portfolio context. Flowing from these activities are ideas related to maintaining diversification as index concentration builds, thematic indexing opportunities to capture longer term market trends and choosing the appropriate hedge to equity beta.
CIO: With the shakeout of industries currently going on—where do you see the most exciting opportunities over the coming years?
Stafford: Hand in hand with the shakeout of smaller firms in many industries has been the overconcentration of mega cap stocks with a heavy technology focus. It’s important in times such as these to understand the risks to these companies and thematically identify market segments that may benefit from a dislocation from these mega cap stocks. In thinking about the next 10 years, trends in technology and consumer preference are likely to materially alter the landscape for education, health care, entertainment, and transportation. I’m excited to see the opportunities that arise from these changes and finding like-minded investors and firms to help capture them through new, customizable solutions.
CIO: And professionally, where do you see the most exciting areas to specialize further over the coming years?
Stafford: In the coming years, it will be very important to understand the way monetary and fiscal policies interact as government deficits explode and become an even more important consideration in the investment process. Often these relationships are oversimplified or poorly understood even though they can have lasting consequences for both the investment outlook and shape of governments going forward. As such, it will be important to understand these dynamics by studying both historical examples and the forward-looking prospects of these policies.
Additionally, the development of technologies that allow for easier access to traditionally illiquid assets could prove to be a game changer for portfolio construction. I’m interested in learning more about these technologies that could be influential over the next 5-10 years. I’m hopeful that these technologies will allow for new, customizable solutions to be available with partners who are willing to implement innovative ideas to meet the needs of asset owners.
CIO: How is the quarantine affecting the way you view teams and working environments, such as work from home, meetings, etc.?
Stafford: First and foremost, we’ve been very fortunate to have the ability to continue working remotely and I’m thankful to be a part of an organization that has prioritized enabling these capabilities. It’s certainly been an adjustment as my family and I balance childcare, school, work, and the various other responsibilities we have. While it initially takes some getting used to, I’m finding the joy of spending more time at home and integrating my workday with my family time.
Professionally, we’ve adjusted by using video chat and daily team check-ins to ensure that we are still able to coordinate and touch base as necessary. It’s been difficult to quantify the value of office small talk and the ability to pop your head into someone’s office to ask a question—something I certainly miss. While I don’t know what the new normal looks like, going forward I believe there will be a broad shift towards work environments that allow for and incorporate remote working.
CIO: What exercises have you found useful?
Stafford: The most useful exercises for me have been maintaining a schedule and routine for work and personal time. I’ve found that working from home can blur the lines between
parts of the day and that defining what your schedule looks like and sticking to it helps make parts of the day feel better defined. Thus, when the weekend rolls around it actually feels like a weekend and the time spent outside of work is more restful (though I can’t say I get too much rest with small children running around the house).
Additionally, physical exercise has been proven time and again to provide some of the most effective mental health benefits. Regular exercise can help relieve anxiety, stress, and negative moods that can come along with the difficult times many are experiencing. I’ve tried to incorporate as much physical activity as I can during my days to reap some of these benefits.
CIO: What asset class or investment troubles you most right now—and why?
Stafford: I think the return-chasing rush into private equity has created some concerning prospects for these investments. Record amounts of dry power and increased valuations for what can be a highly concentrated equity bet reduce the attractiveness of these investments in my opinion. There are also interesting dynamics where asset allocators have a dedicated target to private markets investments that they must meet.
As a result, allocators continue to make these investments despite a deteriorating outlook because it is written into policy somewhere. A better approach in my view would allow for the flexibility to choose how and when to allocate between public and private markets. This allows for allocations to global equities with a thoughtful approach to the best implementation of that exposure.
CIO: Describe the weirdest interaction you’ve had with an asset manager.
Stafford: I’ve had quite a few in my days. My weirdest (and probably worst) involved an asset manager who didn’t acknowledge or apologize for showing up an hour late. They then proceeded to suggest they only made the trip to Austin so that they could have a good time over the weekend. Not a good look.
CIO: What should be an investment trend, but isn’t (yet)?
Stafford: There is a real opportunity in the industry to create customizable solutions for asset owners. All too often, conversations around tailored solutions end with a recommendation for an off-the-shelf fund that is marketed to anyone and everyone. I think there is a real need for asset managers and index providers to truly partner with asset owners to help solve problems and provide solutions actually suited to their needs. Currently, as an asset owner begins to push out to the fringes of what asset managers or index providers typically do, there is often an unwillingness to create new solutions. The rise of technology has enabled ways to accomplish these types of solutions much more easily than would have been available just a few years ago.
