(March 14, 2012) -- aiCIO recently asked Paul Matson, the animated and bubbly executive director of the approximately $28 billion Arizona State Retirement System (ASRS): What has been one of your biggest investment mistakes as the head of your fund?
His answer: "Continuing our strategic allocation to real estate before the financial crisis when too many signs were telling us not to."
The fund stopped its allocation to real estate during the latter part of the 2008 financial crisis, but prior to the crisis, still had a portion of its allocation to the asset class. "We should not have continued to commit strategically during 2006 and 2007," Matson admitted, noting that between 2007 and 2009, the fund was underweight to the asset class but should have been even more underweight, with greater confidence and conviction about their reasons for doing so. "There were too many signs that the asset class was fully valued and that there were not enough opportunities to suggest even more money in those areas," Matson said matter-of-factly.
Prior to the financial crisis, the Arizona fund had a strategic long-term real estate target of 6%, yet allocated a total of 3% to the asset class. "Since we had only half of what our long-term target was, we didn't want to lower it further, because it would take a lot more confidence to be lower," Matson said.
The lesson, according to Matson: If an asset class looks overvalued, it can continue to be overvalued for many years before fundamentals force a realignment of prices. Thus, investors should have a long-term strategy while paying close attention to valuations, deviating from the strategy when necessary. "In 2006 and 2007, it was hard to justify continuing with our real estate allocations. Yet, we continued to make commitments to the asset class," he said.
Matson -- who was previously a senior investment advisor with the Alberta Workers' Compensation Board (WCB) and an investment analyst at Alberta Treasury, now the Alberta Investment Management Corp. -- was brought on board the Arizona pension to internalize some management of assets. In 2003, Matson was promoted to executive director when he passed on the CIO reigns to Gary Dokes. "We started with 0% of our assets in-house and now have 40% of our $28 billion fund in-house," he said, alluding to that fact that the decision to hire him from the Canadian institutional investing world, traditionally much more apolitical with less utilization of consultants and more use of in-house staff, was thus a logical one.
In terms of investing opportunities, ASRS is focusing current research on investing in emerging market equities along with commodities, such as energy, agriculture, and precious and industrial metals. "We believe that in the medium- to long-term, as economies grow and there is relatively limited resources, we will have a reasonable level of commodities growth," Matson said. "We thought commodities were fully valued last year but now feel they are approximately fairly valued largely due to GDP growth.
Matson said the fund currently has five investment areas that they focus on:
1) An integrated asset allocation study, considering both economic expectations and risk in establishing an asset mix. "New ideas such as integrating securities lending into the efficient frontier analysis and determining investment target ranges that are risk/return normalized will likely be short-term outcomes of the current research," Matson asserted.
2) Ongoing liability/sustainability assessment. Starting in 2003, Matson said the pension took a 30-year look at its liabilities, making changes to those liabilities for both current and new employees. "In an effort to make our defined benefit pension more sustainable without using a defined contribution option, we changed the design of certain aspects of our DB plan so it was more sustainable," Matson said, reducing the June 30, 2011 present value of future liabilities by between $3.5 billion and $8.6 billion through decisions made from 2003 and 2011. "If we hadn't made those changes, we very well might not have the DB pension we have now."
3) Organization governance. "We make sure the right people -- trustees on our board and consultants and staff, for example -- are responsible with making the appropriate level of decisions," Matson said.
4) Internal global tactical asset allocation, or having a set of organizational perspectives -- called 'House Views' -- on the various markets so that the fund's internal staff makes prioritizes ongoing tactical changes to asset allocation as opposed to rebalancing.
5) Opportunistic public and private investment programs. "Even though we have a long-term allocation, we have opportunistic strategies when there's an out-of-favor market and reallocate to those markets quickly," he said.
During his tenure as the CIO and now executive director of Arizona's pension fund, Matson, like other investing heads, has been forced to make lemonade out of lemons, using the 2008 financial crisis to learn from mistakes and harness opportunities. "The terrible financial situation ended up providing much opportunity for funds like ours that had excess liquidity and the ability to stay in the market," he concluded.