Everything comes bigger in Texas. As pools of Lone Star state institutional assets go, there are larger and better known entities than the Texas Treasury Safekeeping Trust Company. The Texas Teachers Retirement System and the University of Texas Investment Management Company both come to mind.
Which isn’t to say the TTSTC isn’t giant; it runs about $47 billion in state monies. Within that pool, there’s $3 billion in endowment assets, spread across a dozen separate pockets, including $1.5 billion in tobacco company settlement money.
Within that $3 billion endowment pool is an interesting lesson in investing, where theories meet practice and new prisms get formed.
A few years ago, with help from their consultants, the Austin-based fund decided to attempt to figure out an asset allocation for that $3 billion that transcended the tried and true 60/40 with a splash of alternatives approach, which, in the words of deputy CIO Danny Sachnowitz, “just wasn’t doing it.”
“It,” in this case was a reliable 8 percent annual return, achieved with less volatility. The target return of 8 percent was not chosen out of a hat, nor was it a subtle nod to the expected rate of return of equities over long-term periods per Roger Ibbotson’s charting. The endowments pay out 4.5 percent a year, give or take, and it assumes a 3 percent inflation rate plus some expenses, maybe 50 basis points. So 8 percent would do it.
But how could they get there?
Most interesting, to me, was the conscious decision to scrap the standard buckets (large-cap growth, large-cap value, small-cap, mid-cap etc) and create a new list. Sachnowitz, along with his boss, CIO Paul Ballard, St. Louis-based consultant Tom Margolis, as well as a team of scenario modeling/risk budgeting experts at RiskData, threw out all the usual conventions of asset modeling, even so far as doing away with basic category labels, such as equity and fixed income. “We realized right away that if we were going to figure this out, the first thing we had to do was allow for our primary goal – obtaining true diversification – drive our vocabulary, and not semantics,” Sachnowitz explained.
The four new thematic investment buckets they selected: Stable Return for which they established a target allocation of 39 percent; Market Return (38 percent); Enhanced Return (15 percent) and Inflation Protection (Real Assets) Absolute Return (8 percent).
Bucket one, SR, was designed to be low beta, and contains the bulk of fixed-income portfolio and Absolute Return some real estate, but it’s also an inflation-protection investment repository. One-fifth of the category is dedicated to commodities and inflation-linked securities. Bucket two, MR, is where traditional long-only equity strategies can be found but there are some long/short hedge fund investments (10 percent of the 38 percent) in that slot too – so, that no longer are hedge funds relegated to a portion of alternative investments, a category in itself often relegated to around 5 percent of assets. Bucket three, ER, home to illiquid investments such as private equity and opportunistic/value added real estate. Bucket four, Inflation Protection AR, has some hedge funds in it but also some contains commodities, inflation linked securities, core real estate, infrastructure and hard assets such as timberland.
By 2007 the new approach was firmly in place, sub strategies were being implemented. And then ... the financial markets went haywire.
So how did the $3 billion endowment pool’s new handpicked buckets perform? Looking at a period that includes 2007, 2008 and 2009, when the financial markets super heated, corrected, imploded, bottomed, stabilized, and even came roaring back, the endowment performed ... not so well. The three-year average annualized return for the period ending Dec. 31, 2009, was -2 percent. That’s a long way from 8 percent and not even par with a peer group bogey (-0.17 percent).
Sachnowitz said the biggest disappointment was in the absolute return bucket during the market downturn in 2008. “We expected a lot better performance,” he said. The category was down in the mid-teens in 2008 when by design it should have either produced some form of positive return or at the very least be down a single digit, Sachnowitz said. One tweak the fund has made since then was bagging the use of funds of hedge funds as the primary way to gain access to these strategies. In retrospect funds of funds contained vehicles with overly similar styles and which were too vulnerable to a vicious redemption cycle in a time of crisis. The fund has since set out to set up its own hedge fund program, selecting them more carefully and with an eye toward a lineup of non correlating styles, but with more liquidity.
Maybe there is no perfect model portfolio, and the markets have been extreme. But the Texas endowment is still trying to get that 8 percent and they are not discouraged. Sure there may be some board members who express some concerns but for the most part Sachnowitz and his boss, Ballard, and the other guys in charge of the endowment, have a wide birth and time to see it through. “Our board has been great,” Sachnowitz. “We have their support to see this through.”
Rich Blake is a New York City-based freelance financial journalist. He currently contributes to Institutional Investor magazine, Reuters HedgeWorld and ABCNews.com, among others.
