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The word “cloistered”—or perhaps “close-knit”—can easily be used to describe the community that surrounds liability-driven investing (LDI). And it’s unlikely that any company comes closer to the center of this group than NISA Investment Advisors, a firm that has largely tried to escape the watchful eye of the press. Based in St. Louis—a town known more for the 1904 World’s Fair and baseball’s Cardinals than for being a pillar in this specific investment strategy—NISA is an integral part of the LDI world. And its location in St. Louis speaks to this effort of avoiding the inquisitive eyes of New York City, where a conversation at the corner pub may turn up unexpectedly in a Twitter post, a Facebook picture, or in a headline splashed across a newspaper.
But they can’t keep the world out forever: In September, I took a day-trip to NISA’s office to find out what the fuss was all about.
When I arrived, I was brought to a large conference room, and I took out my notepad and pen, ready to begin a serious discussion about the firm and its approach to LDI as an investment strategy for their corporate pension fund clients. I was aware of the history of the firm, yet I was not yet keen to the firm’s corporate culture.
In walked David Eichhorn, wearing jeans and a light pink collared shirt. Eichhorn is a St. Louis native who joined NISA from JP Morgan Investment Management in 1999 and who directs investment strategies,. He was soon followed by Jess Yawitz, a Goldman alum and former Washington University finance professor, also in jeans along with a dark blue Polo. Yawitz sat at the head of the room, relaxed, with his feet (in sandals) up on the table. Eichhorn, slightly more conservative and equally friendly, sat across from me.
Within 10 minutes, I knew most of what I needed to know about NISA’s corporate culture, and the Eichhorn/Yawitz dynamic. “We can be casual and still have high standards,” Yawitz said, as if defending his jeans alongside my business casual attire. While both are Midwestern gentleman, there’s a sort of tension between the two that’s forever entertaining. Yawitz makes fun of himself for being “old.” He jokes around. He does most of the talking. Eichhorn pokes fun of Yawitz at well-timed moments—for being “old” by comparison, for example. Amid the banter, the two display a respect and gratitude for each other, each pushing the other to provide a realistic game plan for defined benefit (DB) pension plans amid low interest rates, an overall economic downturn, and declining stock prices, often labeled the “perfect storm” by many institutional investors.
A case study of success for NISA in navigating that perfect storm: Brown Shoe.
In the early 1980s, Brown Shoe, a now-$2.6 billion global footwear company known for brands such as Naturalizer, Dr. Scholl’s, and Via Spiga, was struggling—largely due to the impact of emerging globalization. Brown Shoe began feeling this reality when 35 US-based factories needed to close, and with profit at risk, the company’s pension plan became an increasing distraction—diverting attention for Brown Shoe’s executives, when they should have been focused on how to maintain profitability amid overseas competition. As with many funds now, the company’s scheme became a pestering agitation to its core business, already challenged.
That’s when a new pension strategy swooped in to save Brown Shoe’s scheme. While other corporate DB plans were satisfied with meeting their expected returns or foresaw increasing long-term rates—and were thus unwilling to buy long bonds— Brown Shoe embarked on LDI, a then ahead-of-the-curve strategy to limit the volatility and uncertainty of their plan.
I went to see Brown Shoe for myself, leaving Yawitz and Eichhorn for 8300 Maryland Ave in St. Louis, just a short drive away from NISA’s office. In front of the building stood an elegant ladies’ high-heel shoe, about 10-foot-tall, made of hundreds of normal-sized high-heeled shoes. There was no doubt I was at the right place.
Andy Rosen, who took early retirement in 2007 as Brown’s chief financial officer, and Mike Oberlander, Brown Shoe’s general counsel and corporate secretary, sat in a well-lit office room, surrounded by (can you guess?) framed pictures of women’s shoes. They reflected on the LDI strategy that helped them get out of their rut. “I came on board and was in an enviable position,” said Oberlander. “Rosen put us in a position where we had overfunding, and when I came on we were 40% overfunded. We knew who the LDI players were and we trusted NISA—we had built a partnership with them and they knew what derivatives were when others were uncomfortable with them,” Rosen added.
The approach by Brown Shoe reflected, at the time, a distinctive mind-set about pension risk management. As opposed to thinking in terms of total return, the goal for Brown Shoe’s pension fund was to match the liability, unconstrained by how the fund related to a conventional benchmark. LDI essentially freed Brown Shoe from the stress of competition and a groupthink mentality when it came to asset allocation and performance. “We were concerned about retaining our talent, and securing our pension became even more important,” Rosen asserted.
Rosen also reflected on failed attempts to limit the volatility of Brown Shoe’s portfolio. “We also advised with Leland O’Brian Rubinstein Associates (LOR)—they did portfolio insurance and failed at it, thinking they could protect equity structures by selling futures,” Rosen said. It’s a good thing he passed on that relationship, because when the stock market crashed in October 1987, LOR’s clients got hammered and the firm collapsed.
During Rosen’s early tenure at Brown Shoe, NISA—or rather the concept behind it—was just a vague idea. Perhaps it was luck, good timing, or both that led Brown Shoe to Yawitz and Bill Marshall of Goldman Sachs, along with Marty Liebowitz from Salomon Brothers, who were all toying with the idea of managing pension risk. The goal: duration-matching on fixed-income. During the mid to late 1980s, there were only a handful of early adopters of hedging strategies in addition to Brown Shoe—American Airlines and US West (now part of the CenturyLink empire), to name a couple, according to Yawitz. The potential reasons for the low number of LDI adopters? Firstly, strong conviction with equity returns ultimately overcame the focus on liabilities, and secondly, there was still a general discomfort with using derivatives. “Bottom-line: this was the period where the world started to shift from an asset-only mind-set to an asset and liability framework. Since this was a fairly seismic shift, it took some time to gain momentum,” NISA’s Eichhorn said.
Due to the low LDI traction, the provider universe was limited. The firms involved with LDI at the time were housed in investment banks, most notably the aforementioned Solomon Brothers and Goldman Sachs. For Yawitz, the seed for NISA had been planted when he came to the realization that the customized management of funded-status volatility among DB plans was surprisingly rare. But at this point, the relationship between Brown Shoe and NISA was still years off.
Fast-forward a decade. By 2000, Brown Shoe aimed to maintain its initial LDI program. (They had already been on an LDI path for about 10 years with JP Morgan as their provider.) The company was at a point in its LDI implementation where it needed more precise strategies that would better track its liability. While JP Morgan’s LDI strategy for Brown Shoe involved significant use of Treasury futures, Brown Shoe believed that there were better ways to track liability and eliminate risk. Rosen started scoping out his options. Yawitz, who was once Rosen’s professor in an executive MBA class at Washington University in St. Louis, was one of a few people at the top of his mind.
The rest is a reminder of the power and long-term value of networking. In the summer of 1988, while Yawitz was at Goldman, the firm formed Goldman Sachs Asset Management, with Yawitz becoming its first CIO. In the same year, Yawitz moved from New York back to St. Louis, opening a three-person GSAM office. A few years later, they were ready to make a change and rekindled a relationship with a Milwaukee-based bond manager called National Investment Services of America. In 1994, Yawitz and Marshall bought out the Milwaukee owners, and moved all of what was now NISA to St. Louis. “So when it came time for Brown Shoe’s pension head to look for an investment manager to implement LDI, I was right down the street,” Yawitz said.
Fast-forward again, to today: Brown Shoe is NISA’s longest-running LDI client that utilizes derivatives.
So LDI, and specifically NISA, helped to ensure the health of Brown Shoe’s scheme—but how?
“From the start, NISA had a free hand in constructing a portfolio we approved of,” said Rosen. That involved getting over a few hurdles.
Step one was extending duration. NISA currently actively manages against 45 long-duration benchmarks. The result: Brown Shoe’s pension now maintains an equity commitment of between 60% and 70%, which leaves 30% to 40% allocated to fixed-income. The initial LDI approach was done 25 years ago, and Brown Shoe hasn’t put additional money into the plan since then. Furthermore, while the scheme totaled around $200 million in 1987, it is roughly worth $330 million today. Through the entire period, overfunding has remained in the $40 million to $60 million range. “The one thing the strategy will do is preserve dollar overfunding,” Rosen said.
If a client is unable to get the duration needed with physical bonds, derivatives are the next option. From the beginning, while bond futures are generally Treasury-based, Brown Shoe needed some corporate bond exposure. The solution for NISA was to switch from Treasury derivatives to corporate ones while using interest-rate swaps. These investment vehicles, while more accepted among institutional investors, are still often perceived as a last resort, largely due to their complexity. Consultants have increasingly voiced their aims to up derivative use to hedge against interest-rate risk in the future. “We’ve seen a growing number of corporate pensions using derivatives as they pursue liability-driven investment,” Strategic Investment Solutions’ Managing Director John Meier told aiCIO. “If you’re trying to lower pension surplus interest rate risk, using derivatives is definitely effective in order to maintain a reasonable level of return.”
Another major step for NISA’s LDI implementation is equity protection. “We also put in place an equity protection program; we wanted to protect overfunding and secure the pension side. We did that by ensuring liability valuation was tracked by a dynamic fixed-income portfolio, which is now generally known as LDI. So if the liabilities moved up and down, the fixed-income moved up and down in the same way. What we did was put in a program to protect the equity valuation and we took the form of collared options,” Rosen explains, referring to a protective options strategy that is implemented after a long position in a stock has experienced sizeable gains. “Basically, we put a floor on equity losses,” he said.
Since the early days of LDI, the investing strategy has become a household name in the institutional investing world. According to a 2010 survey by Pyramis Global Advisors, a large percentage of US corporate plans (66%) are favorably disposed toward the concept of LDI strategies. Of those that have implemented LDI, 21% have done so successfully and may expand their LDI allocations, 23% are currently using or have used LDI and are monitoring results, and 22% are seriously considering or exploring LDI strategies. Few (11%) have not at least considered LDI and 23% have considered it and chosen not to pursue it. Brown Shoe, it seems, is increasingly not alone in its embrace of the strategy.
The relationship between NISA and Brown Shoe is a symbiotic one. NISA helped Brown Shoe turn its attention away from its pension and toward running a profitable company. Brown Shoe was a big step in highlighting NISA’s credibility as an LDI provider. NISA had less than 10 LDI clients in 2000. Today, with approximately $90 billion of institutional assets under management and more than $45 billion in derivative overlay, that number is about 100—all US corporate pension plans, ranging in funded status from well north of 120% to 60%. The average plan is about 80% funded. “With all of our clients there are a ton of variables —the nature of the liability, allocation to fixed-income, risk tolerances, and comfort with derivatives, to name a handful,” Eichhorn said, adding that to offer complete LDI solutions, customized glide paths are a must. “We have refined Brown Shoe’s strategy over the years and we do that with every LDI client we have. Brown Shoe really helped get us on the map.”
And in the same vein, amid a perfect storm for pension plans, the work of Yawitz and NISA helped at least one company—Brown Shoe—find the perfect solution.