OCIO Roundtable (Part 2): Surprises and Best Practices Through COVID-19

Jon Pliner, Senior Director, Investments – Head of Delegated Portfolio Management, US, Willis Towers Watson: Our process is done by committees. We have a global investment committee which I sit on, which comes up with our views at a point in time, so that’s portfolio management on the OCIO side as well as our manager research (from the bottom-up perspective) and our capital markets research (from a top-down perspective.)

We have meetings to come up with our broad, high-level asset allocation and positioning that we like. We then have regional committees. I chair the US committee, which we adapt for our marketplace, our specific client types, and client needs and expectations, which then goes to portfolio managers for individual OCIO clients who will implement based upon that.

That worked quite well throughout 2018, 2019, and trying to create efficiencies for how we’re managing the portfolios. This year and from mid-February through to now, in particular, that became even more important to ensure that we did have consistency. Those meetings became very, very frequent, multiple times a week, to make sure that we are understanding and taking in the information that’s changing so frequently. [We’re] coming up with decisions, but also not acting rashly across portfolios, and have a consistent process that we can continue to implement that’s been successful for us in the past.

Sona Menon, Head of the North American Pension Practice, Cambridge Associates: We have several investment teams. I run my investment team, and then we have other OCIOs and the decisions we make are made inside of the team. So, there’s no committee structure or larger governing body that determines the asset allocation, because we tie the investment strategy of each portfolio to whatever the institution’s needs are. And so we have the ability to make the decisions inside of our team with the subject matter expertise that we have.

Our team essentially consists of everything that you would have in a typical investment office: a CIO, head of public markets, head of private markets, several analysts, a deputy, etc. It effectively replicates an investment office, and then we have obviously larger guardrails around what we can or cannot do that are informed through compliance. But we essentially leverage the same research platform of the organization. All the investment teams leverage the research and the manager ideas, but we make our own distinct decisions based on our clients’ needs.

Biagio Manieri, Managing Director and Global Chief Investment Strategist, PFM Asset Management: We have an investment committee, which I chair. We meet on a regular basis. If the markets are volatile, as they are from time to time, we meet on an ad hoc basis. I set the agenda, present the analysis to the other members of the committee in terms of what’s important, where I do want to make changes to the portfolio. We discuss it, make a decision, and then I work with the traders to implement those decisions across the different clients.

Heather Myers, Partner, Nonprofit Practice Leader, Aon: Our OCIO implementation follows a systematic process which is both top down and bottom up. We have a US Investment Committee, which I chair (we also have a UK and Canadian Investment Committee). The US Investment Committee is the oversight body for investment beliefs, recommended strategies, and policies (such as rebalancing) for both our advisory and our OCIO businesses. This USIC approves our model portfolios, which exist for different investor types (for example, endowments and foundations, defined benefit plans, health care operating, etc.). These portfolios provide guidance as to allocations, but aren’t expected to be rigidly followed. In addition, we have a separate oversight committee for our OCIO clients. That committee, of which I am also a member, monitors allocations and portfolio implementation for discretionary mandates. Every OCIO client is assigned a dedicated client team. Clients may be invested in our multi-manager fund vehicles or directly with investment managers or a combination of the two. The solution for each client is customized to their needs and objectives. There are other aspects of the process that provide guidance and oversight such as managers in discretionary mandates are on Aon’s Buy List and reviewed by the operational due diligence team. We have portfolio managers who manage the multi-manager funds and a team in charge of trading and oversight of portfolios. Finally, there is a regular review of the portfolios and drivers of performance.

Stan Mavromates, Partner and Americas CIO, Mercer: We have $300 billion globally, we have three regions around the world. I run the one in the US and Canada. There’s one in Europe, one in Australia. We have a pretty significant internal governance structure and the tone is set at the global level. The dynamic asset allocation was set at the global level on a quarterly basis in 2019. That is pushed down to the regions, and then, within each region we have our own regional committees that are particular to the types of clients we have. So, there are committees for: defined benefit, defined contribution, not-for-profit, and health and insurance. I run most of those committees. We meet monthly. And then to give you an idea, I have a portfolio management team and operations and all sorts of infrastructure that allows us to implement things.

So normally, those committees meet monthly and the dynamic asset allocation quarterly. In this particular crisis, we meet daily. As a portfolio management team and operations, we normally issue one dynamic asset allocation view per quarter. We issued about six in the last, and those are our guiding principles.

And then, what surrounds all of that, is our manager research footprint globally, where we have over 200 research analysts specializing in private equity, hedge funds, fixed income, equities, and real estate. That’s how decisions are made, but there’s a lot of discretion at the regional level in a governance framework.

Mavromates: Core and core plus fixed income surprised me in some of the plus sectors, the speed with which it deteriorated especially CNBS, ABS, those types of instruments overwhelmingly swamped the relative performance on the negative side. So, the plus sectors were down drafting. When you go into this market, most people were overweighting to some extent. They were underweighting treasuries coming out of ’19. That reversed itself in the blink of an eye. It’s recouped somewhat. I mean you can look up mutual funds, core or core plus, and you can see where it was in 2019, where was it the end of March, where it is now. You can see it’s improved a little bit now. I would say that was the biggest surprise for me.

Manieri: Clients hire us to outperform, and we used the same process last year as we used this year, which is to say ‘look to see what’s happening in the economy and capital markets and based on those views, how do you want to be positioned?’ The way we were positioned in the second half of last year, (because we did make a number of tactical decisions), we became more constructive as the year progressed. If you look at the data, the second derivative was turning less negative, turning positive, and you were beginning to see an improvement in the data. So, we added risk to the portfolio in August of last year and then again in September. So the quarter was strong. We outperformed.

We came into the year with a portfolio that was overweight equities but then, as we started getting data on the virus, we started de-risking, and so we took risk out of the portfolio and we outperformed in the first quarter as well, relative to the benchmark because we de-risked meaningfully. ‘How are you performing?’ is an important question because if you only do well in up markets, that just means you’re taking a lot of risk. If you only do well in down markets, it means you’re not taking a lot of risk in general. And we’re expected to do well whether markets go up or down, so no excuses. You have a benchmark, try to beat the benchmark, and don’t make excuses that the market went up or the market went down. That’s why clients hire us, and everybody else on the panel: to add value regardless of market conditions.

Pliner: What should be added to the question is: ‘What have you done over the entirety of the period?’ Because at the end of the day, yes, we’re trying to beat the benchmark in shorter term periods, but really, at the end of the day, we’re trying to compound capital at the highest rate that we can. And so, understanding how the portfolio has performed throughout those periods in a cumulative fashion, and managing through the volatility that we’ve seen, both on the downside and the end of 2018: The large rally in equities and credit during 2019, accompanied by the fall in Treasury yields, and then all of the volatility that we’ve seen year to date thus far. And so making sure that at a total portfolio level, we are making decisions that, over the longer term, will help our clients achieve their objectives, whether that’s reducing a funding deficit, whether that’s keeping up with your 5% spending needs and inflation for a nonprofit, or what have you. So, I think that the added piece to what have you done over those three periods is what have you done over the entirety of those periods?

Menon: I would agree with those comments. I would also say that the question about performance is such a broad one. Are you looking at absolute performance or are you looking at relative performance to benchmarks? You end up in very different places depending on the institution and whatever objectives we had set forth. So, I’ll leave that aside and say, what was surprising to me, was actually that markets have done through 2019 or rather early this year as well as they have done. The length of the strength of the market has been very surprising. I think that last year was a unique year in that equities did really well and fixed income did really well. That doesn’t happen very often in a given year. So that part was a surprise.

The fact that markets sold off sharply on the back of a crisis this year was actually not a surprise. They were ripe and ready for a sell off and a correction. And so, I think then, the question really becomes how do you navigate tactically within this? I don’t think anybody expected the type of returns that we’ve been seeing through 2019 to last. So, I think if we end up negative on this year, that won’t be a surprise. I think what’ll be interesting is how we position the portfolio and the new normal. 

Mavromates: I think it depends on the particular circumstance and objective of that particular organization. And so, for defined benefit, it’s value and risk and funding ratio. For not-for-profit it’s are they going to be able to meet the needs of their operation? Are their contributions going to go down? What’s their liquidity like? And so, it’s much broader. Defined contribution is obviously the younger demographic that has time on their side. The older demographic doesn’t, so measure how some of the later dated target-date funds did, or the ones more close to retirement.

What did we learn? I think this crisis is different and speed matters, and you have to have a really good, robust, well-organized decision-making process so you can move quickly when you do see a signal. So, examples would be the balance between treasuries and credit. There’s some good opportunities there.

On the learning side, I would say, you could have entered a little early on the credit side and taken a big haircut, but if you didn’t move quickly enough, you missed the 6% run up when the spreads came in. It’s about quality, speed, execution, and making sure you don’t make a mistake. And if it slows you down by a little bit, that’s OK. It’s a little bit of a whirlwind, but that’s sort of a quick tour of a view into our world.

Myers: I think that the learnings are obviously happening on a daily basis right now. The markets are so incredibly dynamic, and often the advice of a week ago may shift, based on where spreads are. I mean, look at the way the credit spreads blew out and then already have come back so significantly; or what you saw with equities and how they fell and then they came back so quickly. It’s just such a dynamic market and there’s so many more things that are driving the world we’re living in today, compared to what drove us in the financial crisis.

One of the benefits we have (because we have much more than just investments at Aon,) we have this huge health care team and they’re spending a heck of a lot of time thinking of all aspects of what’s going on with COVID. Our IC meetings are usually monthly. We’re now meeting (as others have said) multiple times a week, and in yesterday’s IC meeting, I had one of our Ph.D. specialists in this area in health care speak to the IC and he just talked about what’s really happening with this pandemic and how is it going to play out within the world? How do we see the world economy coming back? What’s the impact of the vaccine? What’s the impact mentally, the behavioral impact, all of that. And after he spoke, we pivoted to our chief economist and how he’s seeing the markets. Taking that information is helping us think about the portfolio construction and whether we are missing something.

I think that you have to take a mosaic approach to today’s portfolio construction. Our health care clients are under such different stress than our other clients: How are we thinking about their liquidity portfolios or their operating portfolios? Do we do something differently there just because of the metrics and the needs that they have? That’s a significant different approach than you may have with some other pool.

The lessons are daily. We’ve just got to keep moving forward. We need to make decisions. Every decision we make is not going to be correct, but you can’t just stand there and not be aware of what’s going on and think about the impact of these portfolios. You’ve got to make decisions. And you hope that most of those decisions move you in the right direction, but there are absolutely going to be missteps along the way and we have to learn from those and regroup and then make the right decision the next time. So I would say it’s not for the new investor. All of us have obviously lived through a lot. That really matters too: That we have the tenacity and the insights from previous experiences to approach this holistically and really think about it from many angles.

Menon: We think of four factors. The first is immediate liquidity needs, that’s been said. Two is: which risks are we going to get compensated for? That involves a constant analysis of valuations, and the magnitude of the draw downs, so that we’re doing the cost benefit analysis all the time in terms of where to take the risk. The third would be transaction costs. I think for technical reasons, more than anything, we’ve seen that in this crisis, transaction costs for things that are usually deminimis have gone up significantly and that weighs into when we decide to act and what the magnitude of that is. And then finally, I’d say investor sentiment: because one thing history shows us is that very deep pessimism from investors is often followed by some type of bottoming out and it actually creates an opportunity for those who are long-term investors.

Pliner: I echo what’s been said and I think this really makes you go back and think about those processes you set up or any pre-mortems you had done before the crisis and triggers you may have hit, and how you reacted to them. Did you panic? Did you seize up or were you actually able to make a decision and act? Just to Sona’s point, none of us know when the bottom is, regardless of what your area of expertise is, but being able to make decisions along the way will help in the long run as you’re able to weather the storm and as that pessimism turns to euphoria. So, it’s really important to make sure that you are actually making decisions.

Manieri: I would agree with what’s been said. In terms of what we consider, yes of course we consider liquidities. We have clients that are pension plans, defined benefits pension plans, college endowments, etc. Obviously we need to consider what benefit payments have gone out the door, so we do need to consider liquidity. But then, subject to the constraints of the investment policy statements and the benchmark that we have, the investment process hasn’t really changed this year versus previous years. We’re analyzing economic factors, monetary policy, what’s going on with the markets, and based on all of those views, how do we want to be positioned?

As I mentioned earlier, last year, we were pro-risk because that’s what the analysis led us to conclude. In the first quarter, we cut risk because that’s what the analysis led us to conclude. And so, the process itself really hasn’t changed.

I think we talk about what lessons have you learned. If you recall a number of years ago, I was on a panel and the question was, ‘Well what did you learn from the financial crisis?’ And someone on the panel said, ‘Well, I learned that correlations go to one during times of stress.’ And everybody else sort of expressed their view. When it came to me, I said, ‘I’m not sure we really learned anything because we know the correlations go to one. It’s not the first time you’re seeing it.’

I don’t think there’s anything that we have seen in the first quarter that we have not seen before or lessons in the first quarter given the volatility and so on that we haven’t seen before. I think from time to time, this is the way the markets behave, risks go up, and you need a framework or how to think about how to manage a portfolio made up of different asset classes, and that framework should be robust enough where it works in 2018, it works in 2019, it works in 2020, because otherwise you’re sort of making things up as you’re going along.

Myers: I would just challenge you a little bit, Biagio, because I think that the world has changed. I mean, so I’ve been in the industry for 30 years, and when I started, we had the high yield markets collapsing at that time, and then, the world in fixed income in the early ’90s was incredibly different in terms of how the dynamics and the trading, and think about hedge funds and their impact. We didn’t have ETFs before. And so, with the multitude of different strategies and the different vehicles, that has led to different dynamics and the speed of which the retail investor can invest.

Maybe the basics of finance haven’t changed as much, but the dynamics of it have and the ability to communicate, and how we communicate today and trade today, versus 20 years ago or even 15 years ago. There were surprises. I mean, the world was surprised at how fixed income seized up and everyone was surprised at what the Fed is doing now. So maybe you could have projected it, but I don’t think it’s exactly the same. I mean we learn from each iteration of a crisis and yes there will be more crises to come but it’s not exactly the same as it was in the past.

Manieri: I did not mean to suggest that there are no changes. What I was referring to was the intellectual framework that you use to think about it. So yes, we have ETFs and we did not have them in the past, but with respect to liquidity, for example, if you think back to the financial crisis, GE could not offer commercial paper. I mean that’s a form of illiquidity in the market that we have seen in the past.

I’m not saying nothing has changed, but the way I think about how I need to do analysis: I don’t think that has changed. If there’s something new in the market, a new product, I need to take that into consideration that there’s new technology.

For example, I started off on the sell side and we used to do estimates and so on. So back in the 1970s, if you were able to get access to those company estimates before everybody else, you had an advantage but then First Call came along and published it to everybody at the same time so you lost that advantage. So yes, there was a change, I’m referring to intellectual framework, not the factors in the market or products or technologies that do change from time to time.

Pliner: I think from an actual getting capacity perspective, it’s obviously very varied. Market downturns can provide more capacity. It provides opportunities so managers in many instances are actually looking for capital and to be able to deploy it. In some instances, you have managers that may have had issues, that need capital more than others, and they’ll offer discounts to an employee, even if you think they’re skilled.

On the private side, we think that a lot of private equity or private markets managers in general were thinking about coming to market this year, maybe postponing that because they have a lot to deal with with their portfolio companies, and things may at least go on hold. So that just may push back when that capacity does become available.

From a due diligence perspective, this certainly does make it harder to find new managers that you don’t know very well already, because the inability to actually meet in person, see how people work, see how teams work together, that’s just not possible today at all and the dynamics of how they work today are quite different from normal state or at least historical normal state. We’ll see what it’s like going forward.

And so, what that means is, for today, spending most of your time on making sure those managers that you do have capital with, you do have high views of, you’re very on top of understanding what’s going on, how they’re functioning in today’s new working environment. Are their business continuity plans actually working or are they having issues? Then figuring out from there where there is the ability to reallocate if you want to or need to. Finding new managers and doing due diligence on new managers is just very, very difficult today.

Myers: I think Jon raises a very important point. In the private markets, including private real estate, just the ability to get out on the field is not possible right now. So investors need to understand that, that it’s almost, in some ways, frozen up, in terms of finding new ideas because you can’t travel, you can’t get out there and do your due diligence in that same way. So, again, to Jon’s point, you can review what you currently have, and we’re seeing a mixed bag out there. There are some interesting opportunities, but we’re expecting it to start moving. It’s certainly not moving like the public markets, as you would expect. And so, I think there will be some pretty interesting opportunities coming forward both on the private equity private credit and the real estate. We’re just starting to really watch that.

Menon: I would say there’s nothing like a market dislocation to open up the opportunity set and let you go back to your bench list of ideas that you’ve already done the work on but you couldn’t get into. So that’s certainly opening up. But on the point of ‘where are all the great opportunities?’ and ‘Which new strategies do we want to get into?’ I think that answer is still unfolding. Whereas on the public credit side, some of the opportunities are easier to evaluate and get into, and the opportunity is here today.

I think on the private credit side, we’re seeing interest in more opportunistic things that were nichey. And on the private equity side and even on the hedge fund credit side, I think those opportunities are still developing. So we are still evaluating where that opportunity actually is while the managers are actually thinking it through and also trying to develop an investment vehicle for us. I think engaging in the dialog with the managers now in terms of what it looks like, what they’re thinking about, gives you a little bit of chance to think through whether you want in or not.

Mavromates: There’s a couple of things that I would say differently. It sounded like that question was more about execution and whether we able to implement our ideas. We’ve had no problem in implementing our ideas. We’re continuing in the research that we did before. As I mentioned earlier, we have a little over 200 research analysts around the world, boots on the ground in different counties, and then you say, OK, well why do companies hire us for OCIO? Because they lack the internal resources. It’s complex. It needs ongoing investment. We do that. We have a big parent company that reinvests in us, and we have a pretty significant global resource. That engine is still going, and going, and going, and it’s really continuing to operate and adding some new ideas along the way, i.e., maybe now is the time to invest in high yield. I would say at the beginning, things were obviously chaotic from a financial perspective, meaning the markets, but pretty quickly you went back to your skill set, focused on what you needed to do, took advantage of your resources (albeit it’s remote now, but I think we figured that out) and our contingency plans worked, our managers’ contingency plans works. Clients are asking for more frequent meetings. We’re being responsive to that, so I think it’s as normal as it gets. It’s gotten a lot more normal now than it was three or four weeks ago.

Menon: We don’t treat them differently. Our ideas are equally available to both discretionary and non-discretionary, otherwise it wouldn’t really be fair to our clients, but what does vary is the implementation timing. For the non-discretionary, you have the additional governance step of having to seek approval for our recommendations, whereas, on the discretionary side we can move on it because we’ve got the delegated authority. So, I think that at the end of the day, while both types of institutions have the access to the idea, the timing and the implementation will vary and potentially might be also the returns, good or bad, we’ll see, that will be judged later. I think that’s the only thing that will vary.

Manieri: I was going to say I agree with those comments. That’s the way it works for us. We have both OCIO clients and consulting clients, and whenever we make any changes on the OCIO discretionary side, we tell the consultant clients what we’re doing and then they are free to say ‘yes, I’d like to do it’ or ‘why don’t you wait for the quarterly meeting and let’s discuss it.’ So there is a timing difference, but whatever we’re doing on the OCIO side, we make the clients aware of what we’re doing and then it’s up to them to say ‘yes, let’s pursue,’ or ‘wait,’ or ‘I’m not interested.’ So just as was previously stated. We treat them the same. They’re equal in our eyes.

Pliner: And same for us. Any changes to views for a manger or a strategy is disseminated to both the advisory and the OCIO side simultaneously. It ultimately comes down to the speed, and the governance process to allow the speed with which you’re able to implement. But everybody has the same opportunity to invest in any idea.

Myers: It’s the same for us and I just echo, exactly, it’s the speed. So we have the decisions, we have the views of the strategies we like. Right now ,we talked about opportunistic credit. We’re spending a lot of time thinking about all the different ways you can access this credit, whether it’s private or public, and whether it’s in hedge funds or fixed income and whatever. And so those ideas and the strategies, that information, is disseminated to all equally. And as already raised, the benefit of an OCIO is frequently the ability to act more quickly than a consulting or an advisory relationship.

Mavromates: The only thing I would add is, we think of it as a continuum. We have research and tools they can buy from us. We have our advice, or we could just implement for them in an OCIO, but everybody is treated equally.

Biagio Manieri is a managing director and global chief multi-asset class strategist at PFM Asset Management, and he chairs the firm’s Investment Committee. He is responsible for the investment management of more than $20 billion in institutional assets. Prior to joining PFM Asset Management, he was the investment officer with the Federal Reserve overseeing the system’s pension plans.

Stan Mavromates is the Americas chief investment officer (CIO) for Mercer, where he is responsible for managing investment professionals in the United States and Canada overseeing over $100 billion in OCIO assets. He previously worked at the Massachusetts Pension Reserves Investment Trust Fund and for John Hancock Financial Services. He served in the U.S. Marine Corps and is a graduate of Bentley College’s MBA program and Northeastern University.

Sona Menon is the head of the North American Pension Practice and an OCIO at Cambridge Associates, a global investment firm, where she oversees investment portfolios for discretionary and nondiscretionary clients. She earned her master’s from Harvard Business School and her bachelor’s in government from Cornell University.

Heather Myers is a partner and nonprofit practice leader at Aon, where she is also chair of the U.S. Investment Committee. She joined Aon in 2016 after 27 years with Russell Investments and has been in investment industry for more than 30 years.

Jon Pliner is the US head of Delegated Portfolio Management for Willis Towers Watson. He has more than 15 years of investment industry experience and has been with Willis Towers Watson since 2004.