CIO Roundtable: Improvements Made

This series talks with leading CIOs about improvements made to their funds that have made a difference.

From left: Abdiel Santiago, Holland Timmins, and David Villa

Each year at our CIO Summits and
Influential Investors’ forums, we watch as chief investment officers swap information about the kind of changes and innovations that made their funds strong. In that spirit, we thought we’d reach out to a few CIOs for some quick updates.

Abdiel Santiago
CEO & CIO, Fondo de Ahorro de Panamá

This year, Abdiel Santiago, CEO & CIO of Fondo de Ahorro de Panamá, made big progress at what could be the only sovereign wealth fund in the Americas south of the Rio Grande.

The fund was created in 2012 to be both a stabilization fund and a catastrophe fund, since Panama doesn’t have a central bank, and pay out for emergency response, clean up, and rescue.

The president selected an independent board of directors comprised of industry experts, bank execs, and economists who were knowledgeable about finance. The board hired Santiago in 2013 to manage the initial money from a series of privatizations that the government of Panama had garnered between 1996 and 2012—about $1.2 billion. It functions under an endowment type model with investments outside of Panama. The board of directors, Santiago, and his team have since generated about $250 million in net returns, around 50% of which have been divvied out to the government.

The challenge was the payout. For four or five years, Santiago and his team rallied to change the contribution formula, which was anything from the Panama Canal above 3.5% gross domestic product (GDP). (GDP in Panama is about $65 billion.) If the economy grew too fast, there would be no payout. This year, he and his board were somewhat successful, and the formula changed to 2.5%, effectively funneling about $38 million into the fund.

CIO: What did it take to change the government’s contribution formula?

Santiago: Four years ago, we quickly did the analysis about what we expected we would receive from the Panama Canal given the formula at the time, and we realized that was going to be zero. We wanted to grow to be there for the future, to help the government in a time of need. So we embarked on a dialogue with the ministry of finance, which is essentially our client, if you will, to convince them. We wrote articles in the press, we spoke with the legislature with the specific politicians, and had regular meetings with the ministry of finance to drive the point that if the law didn’t change, then you were going to see the value of the fund diminish relative to the economy.

CIO: What are some other challenges to the fund?

Santiago: If the economy keeps growing faster than the growth of the canal’s income, that’s going to be very difficult for us to receive anything in the future. If the Panama Canal is our golden goose, I guess, that’s great, but let’s not use everything that we produce. Let’s save something for the future. The exact number is I think it should probably be somewhere around 1.5% of GDP. There’s still a lot of work to be done to get that threshold down a little bit so we can really get some more funding.

CIO: How else might you be able to grow new capital?

Santiago: Putting aside the organic growth of the investment, if the government decides to liquidate their participation in state owned enterprises—there are about 10 of them—this could potentially bring anywhere from $2 billion-$3 billion, depending on valuation levels. From an asset allocation’s standpoint, we are trying to achieve some good returns relative to the risk and the diversification—we’re trying to get into private equity and see what formula is going to work for us to get some exposure to it.

CIO: How much exposure to private equity?

Santiago: We don’t need the whole fund to be 100% liquid. We can afford to have a portion of it in these semi-illiquid investments. It’s not going to be a huge number. It’s just going to be 5% of the fund, but as well, it’s going to provide by the virtue of their illiquidity some diversification benefits for us because the rest of the assets will be freely traded.

And one of the biggest challenges in investing in private equity right now at this point in time is we’re trying to fight this urge to time the market—and we can’t—because where the cycle is, and no one likes to arrive to the party when it is about to stop.

CIO: And what percentage are you in equities now?

Santiago: Right now, we’re at 15%. We used to be 23%, 24%. We brought that down. Our annual rebalancing and asset allocation project, we do that on a yearly basis. In September, we brought it down which turned out to be a smart move as we exited 2018. There were a lot of concerns at the time about the valuation levels for equity markets. We felt compelled to protect the portfolio, as our risk tolerance is in the neighborhood of a 5% drawdown; we went 25% cash/short-term from 5% so that was a pretty big move. We have zero incentive to be huge risk-takers.

CIO: What are you watching?

Santiago: We watch US markets, which are 90% of our fund. That’s pretty significant. So we’re watching the Fed’s independence. We, as investors, are concerned about whether the Fed still has that independence that we would expect because changes and levels of US rates have a wholesale impact on investment decisions. A lot of these central banks in other regions in Latin America model themselves after the Fed. It’s a little bit concerning to see the Fed pushed around, and then reacting to that pushback. It might cast some doubt about how independent they are. That’s my personal view, but it is something that we’re sort of watching.

CIO: Sure, if the Fed proves not to be independent then you can’t (and can) predict other things as well

Santiago: Right, not that you ignore the markets, the financial markets, but also might be showing some weakness against presidential tweets. If the US economy is not as strong as they believed and weakening, then by all means, get ahead of it and cut rates. Still, it’s a little bit troubling; I’ve never seen that before.

Holland Timmins
CIO and Executive Director, Texas Permanent School Fund:

The $44 billion Texas Permanent School Fund is a sovereign wealth fund which serves to provide revenues for the funding of public primary and secondary education, and functions as one of the largest educational endowments in the nation since its inception in 1854. It also functions as a financial backstop to the bond issues underwritten by the state’s public and charter schools. 

Holland Timmins, executive director and CIO of the $44 billion fund, steered August 2018 gross annual returns of 7.23% and has been strategically measuring when to bring investments in house.

CIO: What are some of the most significant plan improvements you’ve made?

Timmins: At the PSF, the most significant changes have been through using our strategic partners to work with internal staff to develop low-cost, high-performing internally managed portfolios. We have frequently hired a group of managers and then gone through an evolutionary process to broaden their role and responsibilities. During that process, the managers have become strategic partners in a consultative role in addition to managing the portfolios. We have followed that process for private equities, hedge funds, and commodities. The most recent example is the commodities program in which we initially hired Credit Suisse and PIMCO to manage portfolios. They both worked with our staff as we established an internal portfolio which began trading a year ago. It has worked well to utilize the strengths of our strategic partners with the cost efficiencies of internal staff.

CIO: You’ve also had a major accomplishment.

Timmins: Another major accomplishment of the past few years was the expansion and strengthening of the PSF Bond Guarantee Program. The Fund provides a AAA guarantee for about $82 billion in school district and charter debt within the Texas. We worked closely with the legislature and board to expand the utilization by charter schools and enhance the charter reserve fund.

 CIO: What were some of the challenges you overcame to make the changes happen?

Timmins: Managing any large investment portfolio is like steering a supertanker. Any adjustments need to be carefully analyzed and reviewed before implementation to ensure a prudent process and structure. 

David Villa
CIO, Executive Director, State of Wisconsin Investment Board (SWIB)

 The $118 billion State of Wisconsin Investment Board (SWIB) was one of the first plans in the United States that was designed to help ensure that the fund would remain fully funded, and CIO David Villa who has led the fund since 2006, is seen as a top strategist among his CIO peers. Villa also became the fund’s executive director in 2018 in order to continue to build the fund’s vision. Upon winning CIO’s 2016 Innovation Award for SWIB’s forays into risk parity, and the fund’s innovative risk-sharing structure (where bonus payouts for beneficiaries are linked directly to the fund’s annual return), Villa has continued to build out his in-house investment team, keep his plan fully funded, and manage risks. He is a member of the 300 Club, a group of global investors created to “raise uncomfortable and fundamental questions about the very foundations of the investment landscape.”

 CIO: Over the years, what changes to your plan have made a significant difference to your plan’s success?

Villa: We have implemented a robust and sophisticated investment strategy designed to meet the challenges of the financial market head on, while helping grow and protect the Wisconsin Retirement System (WRS) assets. Our strategy includes increasing internal management when possible and utilizing total fund leverage and alpha beta overlay strategies. Increasing internal management has lowered our costs and has saved $1.3 billion over the last 10 years. We continue to look for opportunities to strengthen our already award-winning staff to deal with the complexity of managing assets in a more challenging environment. In addition to optimizing costs, we are successfully using leverage and an alpha beta overlay strategy to benefit the trust funds. We have used leverage to construct a more efficiently allocated portfolio which results in greater return for the same level of risk. We are currently leveraged 10%. The total fund leverage strategy has been successful in generating a return of 10.6% gross of fees over the last 10 years. We have utilized the alpha beta overlay strategy to increase alpha or value added to the portfolio. The alpha pool consists of our internally managed alpha portfolio and our external hedge fund portfolio. The beta exposure is created by using derivatives. For approximately each $1 of alpha pool exposure, there is a corresponding $1 of beta exposure. Since its inception in November 2015, the strategy has generated a return of 6.4% gross of fees.

CIO: What needed to happen/challenges were overcome to do it?

Villa: In 2005, the SWIB trustees set out on a mission to transform the agency into a premier asset management firm by reinvigorating internal management and modernizing the investment organization. By building on past success with an eye toward continuous improvement, SWIB has become a recognized world-class investment manager. The Trustees hired me in 2006 as a change agent to help them meet their goals.  However, the key to SWIB’s success over the past 12 years has been the Board’s governance process and steady commitment to active internal management. They supported SWIB and our investment strategy, even through 2008 and 2009, when things were very difficult. That investment strategy includes a diverse asset allocation that is designed to meet the challenges of the current financial market while also keeping the WRS among the only fully funded public pension plans in the country.

CIO: CIOs really respect your ability to manage liabilities. Can you explain your philosophy and how you’re managing them currently?

Villa: The liability is a given and we have to build an investment solution that moves with the liability. The volatility of the liability is very low and economic growth drives the growth rate of the liability. The driver is basically wage growth. This makes it challenging to achieve the objective because the typical investment solution has high volatility while the liability has low volatility. A fund also needs to be fully funded. When a fully funded pension earns 7%, the effective rate of return is 7%. A pension that is 70% funded only earns an effective rate of return of 4.9% when the investments earn 7% because a significant portion of the assets needed to fund the liability are not available to earn returns.

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