Interrogation: Harshal Chaudhari

Reflections on his first year, de-risking, and how IBM got to the enviable position of having a fully funded plan.

Art by Tim Bower

Art by Tim Bower

Harshal Chaudhari became IBM’s new CIO barely a year ago, in 2016, upon being tapped internally from his CFO post. It followed a gradual ladder climb, which he began as a senior consultant to IBM in 2002. The former software engineer and PwC consultant appears to come to the position with a multi-faceted understanding of both technology and investments.

IBM’s liability-driven investing (LDI) strategies are the major reason it is fully funded today. It began its LDI strategies in the 1990s, originally with a small part of its portfolio. Chaudhari inherited his position from Ray Kanner, who had taken the CIO post right before the financial crisis. Kanner quickly boosted the liability hedge and de-risked it further by reducing equities by 10 percentage points in the second part of 2007, which provided IBM’s pension fund with more shelter than most funds had during the crisis. Then, in the middle of the crisis, IBM almost completely increased the hedge, shielding the pension fund from the impact of the crashing rates.

When Chaudhari took over the $50 billion fund, it was 98.4% funded and fully hedged. When we last checked, it was up to 102%. He recently reviewed his first year with CIO.

CIO: How has your first year been? Have there been any developments, or changes to your plan? New asset allocations? New philosophies? New analytics?

Chaudhari: The first year has gone by fast. I had a strong financial markets background coming into the role, but I had little familiarity with our external managers. So, I spent the initial months meeting and getting to know our managers. It was important for me to take the time to learn about the existing portfolio, understand the plan designs and the liability characteristics. I am fortunate to have a great team, and there is a lot of historical data and documentation, which made it easy to get up to speed quickly.

Since then, we have taken a number of actions on the portfolio. We executed another de-risk earlier this year as strong markets continued to improve the funded status of the plan. I have initiated an effort to redesign our absolute return portfolio with a view towards better diversification. We have also been busy on the manager search front with roughly half a dozen new mandates. We also undertook a broad portfolio review of our worldwide plans last year that resulted in significant asset allocation actions for several international plans. On the systems side, we are in the process of deploying a new set of analytical tools, including a multi-asset risk system.

CIO: Your plan has been described as a “de-risking machine.” What was put in place over time to make it fully funded?

Chaudhari: To quote Peter Bernstein, “risk is a choice, not fate.” As a mature plan with a relatively stable liability profile, our asset allocation strategy is naturally driven by a liability-aware approach. This philosophy has existed for a long time. When we were underfunded, the focus was on closing the funding gap. Now that we are fully funded, the focus has naturally shifted to preserving and growing the funded status. Aligned with that strategy, we have undertaken a methodical approach to shift our asset allocation over the years to gradually reduce the equity risk and increase the hedge ratio. We have taken three actions in the past four years as the funded status has continued to improve. We also have a laser-like focus in ensuring our active program is risk-controlled and delivers a high-quality alpha stream.

CIO: You had a trajectory plan, where you took only the amount of risk you needed to take (hedging, etc.) to protect your downside and accumulate and lock down gains. Can you go into detail on it?

Chaudhari: We prefer a thoughtful dialog before we make meaningful changes than having a formal trajectory plan, which is often simplified and mechanical. We have a very good sense of where we are going, though, and our governance and operational processes are very strong. This allows us to act swiftly and deliberately to alter our asset allocation as opportunities arise.

CIO: Now that your plan is 102% fully funded (congrats!), what level of risk taking is the right level for you?

Chaudhari: We are in a good position and would like to build up a more comfortable cushion. However, we can be patient and do not need to chase returns. The risk has been reduced by roughly a third since the beginning of last year, and our return expectations going forward are modest, but sufficient to grow surplus at a measured pace. The lower risk profile is intended to withstand substantial market drawdowns.

CIO: If the risk taking is a lot less, the asset liability risk management is more important. How are you structuring and hedging your liability risk so there’s not a lot of drawdown in the future?

Chaudhari: Spending time in IBM’s treasury department has ingrained in me a deep risk management perspective. Coincidentally, one of my jobs there was to analyze and mitigate asset liability risk, focused on managing net interest margin of IBM’s financing business. That experience extends naturally to a liability-driven investment approach. As we have de-risked, we have moved a quarter of our portfolio into fixed-income in the past year and half. This has enabled us to focus on fine-tuning the hedging portfolio. We have reduced the reliance on derivatives, and STRIPS have become a key ingredient in our toolkit. Yield curve match has been improved, and we have been focused on improving the macro factor balance to increase the resiliency to shocks from changing economic regimes.

CIO: This is truly an open-ended question, not necessarily about LDI. As an investor, what do you find exciting or innovative?

Chaudhari: One of the exciting aspects for me is the constant learning. As an allocator, one needs to develop a tremendous amount of breadth and it is incredibly intellectually stimulating. This industry attracts a lot of smart, opinionated people that have strong viewpoints—active vs. passive, fundamental vs. quantitative, rational vs. behavioral are all riveting topics. I view the truth as usually somewhere in the middle, but it is fascinating to get a glimpse into how different people think and the variety of investment approaches. Cryptocurrencies is one of those topics that brings out some very strong reactions from both sides. It is still too volatile as an investment vehicle, but I am paying attention to this area as I believe the blockchain technology promises to be a game-changing innovation for investing, for finance, and for applications much broader than that. While all of this is very exciting, as an investor, staying grounded and translating the exhilaration of the markets into a portfolio that delivers steady, consistent returns is an exciting challenge, in my view. —CIO

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