Anne-Marie Fink - Cutting Edge Pension Investing at SWIB (EP.389)

28:46So I would say that's the primary place where we start. And then you look at the numbers to see, does that support what they're saying? So if somebody says they're really risk controlled, and then you look at their numbers and they have a 40 % drawdown, something doesn't quite compute. Or if somebody says they're really conscious about rates and then you look at the regression against rate moves and it doesn't quite foot, then you know there's something a little bit off as well. We're going to take a quick break in the action to tell you about SRS Aquium. Want to make sure your M &A processes aren't stuck in the past?

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30:12And now, back to the show. I'd love to walk through a bunch of the asset classes and just get your views of how you think about investing? And maybe we'll just walk through it like your background and start with the long only world. So the obvious question there is active versus passive. We're actually relatively big believers in active. So we do have about 20 to 25 % of our portfolio in passive, mostly because we want to do all of our rebalancing in passive space. So we're also very rigorous about rebalancing each month. And we want to be able to do that without hitting our active managers all the time.

30:51So we keep some passive around for that. We also keep some passive around to help with the leverage so we can convert it into futures, which gives us the leverage. And then other than that, we are pretty big believers in active. The one thing I would say we've been doing more recently, both internally and externally, is, well, externally more of a 150-50 type strategy. So we are trying to bring in some short exposure to one because we think certain managers have some capabilities to think about if I really like something, maybe there's a loser that goes with this. So that's one thing. And then the other thing why it's been salient recently is particularly last year with the magnificent seven and the stock market being so dominated by seven companies, it's been hard to be active because so much of your allocation gets eaten up by just even having a market weight in those seven.

31:47So what we find by loosening the long only constraint and going to extension strategies is it just gives managers more room to put on positions and have more opportunities to make returns. So that lends itself into the hedge fund world, which you spent a lot of time in. How do you think about using hedge funds in your portfolio? So we have a very distinct way that we use them, which is portable alpha. So we do not actually, and you'll notice when I gave you the allocation, there were no hedge funds in there. It's because we actually think of the hedge funds as almost an overlay. So we do the hedge funds as portable alpha.

32:24So we're looking for strategies that have little to no beta and really are absolute return type funds. And then we port that on top of equity and fixed income beta. And it works well because we're paying really high fees, but we're paying only on the alpha, the stuff that is hard to replicate, and then the stuff that's easy to replicate the beta because we do it passively. It's very inexpensive. What types of strategies do you use? So it's pretty much across the board. I don't think there's any strategy that we don't do other than long biased. So we do have long short equity hedge funds. We do have macro funds.

33:06We have quant funds. We have multi-strats. We have some relative value. And then we also do a little bit of specialty finance in there. So a lot of those strategies, there is a package with a blend of, let's say, idiosyncratic positions and then some type of market beta. How do you measure and then manage the risks so that you can just deliver that portable alpha piece when you will have some residual risks in a portfolio like that? So we're not maniacal about taking out all the residual risks. Certainly, if you think about macro in general, that usually is directional. What we're looking for is something that's not consistently the same direction.

33:48So if it's directional, today I'm long rates and tomorrow I'm short rates and I'm good at it, that's fine. What we don't do is try to take out the betas underneath. Partly, we haven't done it because operationally it's difficult. And then partly because if a manager tells us at the end of the month or even the end of the week that they're along something, by the time we put an offsetting position on, they might be shorted. So it's too hard to try and offset it. What we do look, though, is over time, does anybody have a bias? And if they tend to have a beta bias, then they're probably a candidate to leave our portfolio.

34:28How do you think about partnering with these managers to help the rest of your portfolio? So whether it's the areas that they find interesting or leveraging the skills of your internal team with your assessments of the external managers? So we do a number of things. Certainly, we keep the dialogue open with our internal teams. If managers come to visit us, we make the meetings available to our internal teams and they will come join us. And it's actually helpful on both sides. So it's helpful for them to hear what other investors are doing. And it's also helpful for us to, after the fact, talk to our internal teams and ask them what they thought about the thesis, the thought process behind people's views.

35:10Because I said earlier that I used to be able to read back the bear case to somebody. I'm removed at this point, so I'm not as good at that. Bringing our internal team in is often very helpful on that front. How do you think about leveraging your size, so the size of the pool at Swib, to effectuate outcomes? One of the ways that we try to leverage both our assets and, again, the delegated authority is by going into managers relatively early on. We have on occasion done day one, but we will often do year one investments. And we are willing to work with managers on what they're looking to achieve from a business perspective and what we are looking for as well.

35:56So let me give you a few examples. One, during late 2020 and early 2021, it was hard for some managers, particularly younger managers, to raise money on the PE side because everybody was scared about what was going on in the world. So we had some managers where we had made an initial allocation and we went back to them and said, okay, you're having trouble getting to your final close. What if we give you another$25 million? That'll get you close enough. And in exchange for us giving you another$25 million, one, you're going to close the fund and stop fundraising and start making investments. And two, we want better terms as a result of this.

36:35So that's one way that we've done it. Another thing that we've done is we partnered with one of our multi-pad hedge funds. They basically spun out their technology and created a separately managed account platform. So us and UTIMCO together basically anchored this new manager. And as a result of that, we were able to both help them to design the systems and the reporting and all of that. And then we also have favorable economics as a result. So there's always a challenge when you have competition for capital, but defining best in class, you can look at people's records and teams and establish managers, and then trying to plant some seeds early on.

37:18How have you thought about comparing and contrasting the two to receive allocations in your portfolio? So we have a big enough portfolio that we're doing a little bit of all of the above. We actually are pretty big believers in lower mid-market funds, but we think that the opportunities in lower mid-market, if you've got the skill to really go in and assess people, we think the opportunities for returns are better. So it's a place where we've concentrated more of our efforts. Now, we certainly still do some mega managers because one, we have a lot of capital to put out. And two, there are some great mega managers out there, but we have tended to go a little bit smaller where we can have a little bit more control where the opportunities for return we think are a little easier to access, maybe a little less competitive.

38:08When you lay all that out, I mean, there's a bunch of public documents just in your private portfolio. There's like 12 pages of line items of managers. How do you process all that information effectively and make good decisions? I have a great team and a large team. Whereas I said in Rhode Island, there are three of us basically doing it. I have 28 investment professionals working for me. So we just have a much bigger team. We've seen more stuff before and we talk to a lot of people. It's a lot of hard work. How do you think about private equity in the markets today when we're seeing opportunities?

38:43What we're seeing is the mega end of the market. It's harder to get liquidity. We had a period of frothiness there in 2021 where it was easy to go public. Everything was moving really quickly. And then we hit 2022 and we had a denominator effect because all of our portfolios went down. Nobody talks about this, but I think we also had a numerator effect in that everybody, GPs and LPs, we were all so excited in 2021 that everybody was raising bigger funds. We were making bigger commitments. It was just getting a little overdone. So now what we're doing is we're dealing with that. So now there's a bit of an overhang.

39:25The 2021 liquidity was unusual. And the 2023, 2024 liquidity is probably less than normal, but not vastly abnormal. It just feels vastly abnormal because 21 was so amazing. So in that environment, it's particularly more difficult for larger managers because you have fewer ways to exit. You really can only exit through IPO or through publicly traded company making a very, very large acquisition. Those don't happen every day. Whereas in the lower mid market, where we'd be thrilled with a billion dollar exit or even less, There, we've got three avenues to exit. Some of them are big enough to IPO, but we're not dependent on the IPO markets.

40:12The other two ways that we can exit is one, to a bigger PE shop, so another sponsor. And a lot of these companies are really quite manageable for that. And then three, we can exit to a corporate strategic acquirer. And again, because it's a smaller bite size, it's easier for them to do that. How do you think about incorporating venture capital in such a big portfolio? So we like venture. At the same time, we recognize it's a much more capacity constrained strategy than anything that we're doing elsewhere in our portfolio. So our portfolio is relatively smaller. It's about$2 billion. We've also found that in general, there's more serial correlation with venture.

40:55So it's even more important in venture to be in the best managers. So there's a few strategies that we pursue to do that. One is the person who runs venture for me is a guy named Chris Presta Giacomo. He's the most friendly, outgoing person you've ever met. So he's just really good at making friends with a lot of GPs. And we're also playing very much the long game. Actually, that's true in everything that we do. We're playing a pretty long game, but particularly in venture where we will do, we prefer not to, but we will do five or$10 million checks to get a toehold with somebody and then try and grow it over time.

41:33So it's a combination in our venture portfolio of going after the who's who of venture. And there we're really fighting to just get some capacity. And then we have another portion of our portfolio that's a little bit more speculative. And there's two aspects to that. One is we have a Wisconsin venture portfolio. So we have a portfolio that is designed to either invest in managers that are based in Wisconsin or ones that spend a lot of time with Wisconsin companies. Now, unfortunately, I don't have a lower return hurdle for that. So we can't do everything that comes around. But we do spend a lot of time trying to foster the local venture ecosystem.

42:17So that's one thing that we do on the smaller end. And then we also will take a few shots a year on newer managers that we're hoping that we can get in early and then grow as they grow. How are you thinking about the opportunities in private credit? It's a very interesting space. We're active and I would say a little bit cautious. So on the positive side, if you look at the size of the publicly traded and then bank market, it does seem like private debt is not that huge. So you could say there's plenty of runway to go. On the other side, the private debt markets haven't really been around during a proper distress cycle because they really weren't of any size in 2008, which was the last time you had a real cycle.

43:07And even if you look at there was a mini cycle in the energy markets in 2014, and there were a lot of distressed folks that didn't do so well in that period. So we're somewhat cautious on that front. Anybody that we're working with on the private debt side, we are looking for people that have some workout and distressed experience. I'm a little cautious around that, though, because everybody says they have it. And if it's been 10 years or 15 years, we'll see who's really got it. We're doing more in mezz, more in distressed. and a lot of the distressed people that we're working with were giving them trigger funds.

43:46So that will give you a certain amount of money today. And if there's a real proper distress cycle, we'll give you more, but we don't wanna pay fees if a proper distress cycle doesn't come around. And then interestingly in our hedge fund book where we're doing specialty finance, some of that also looks like private debt, though it tends to be three years in terms of the tenor and it tends to be a little bit more asset backed. So that's another area where we're finding some opportunities. As you look at some of these one-offs and opportunistic things that come up, what are you most excited about?

44:20So some of the things that we're most excited about are the separately managed account platform that I talked about earlier. And part of the reason we're excited about that is it also allows us to take a page from the multi-pads and notionally fund things so we can be much more capital efficient. So that's really interesting for us. Another thing that we're interested and excited about is on the private side, there's been less capital available and many people are still a little bit over their skis. We're finding some opportunities to partner with people and do more interesting things. So we recently helped a group get a secondary strategy up and running and in exchange got really interesting economics out of that.

45:04As you've built the platform, the multi-pad platform, how have you found the competition for talent when these pod shops are so large and doing everything they can to suck up all the talent in the hedge fund space? Part of the reason that we did a separately managed account platform now and not in the past is we feel like now that there's not negative selection bias on the talent. So what we're finding is there's a lot of folks who are high quality managers often worked at those multi pads and for whatever reason wanted to go out and hang out their own shingles. They tend to be folks that are not very excited about doing the marketing.

45:42So if they can get to a billion or so and assets that are happy just running that. So that's a manager that we really like because the incentives are very much aligned. We can be very important to them. They're important to us. And they can just focus on the investing, which is what we want them to do. So oftentimes, at least by reputation, when a manager leaves one of the platforms, it's because of a drawdown and certainly have some of the risk rules work. Have you found doing your diligence effectively so that you can get comfort that they'll be able to produce in the future? So it's a combination of reference checks.

46:18We're talking to as many people as we can to determine whether they really left voluntarily or not. About eight of the 10 that we started with actually have been running money for a little while on their own. So we can look at their track records. And then the other thing that we really like about the managed account platform is that we can watch them so we can see every day what they're doing. And I think that's been enormously helpful, both for the managers, because we can take a slightly longer timeframe than maybe some of the multi-pads can. So for instance, we had a manager recently who there was a situation that they wanted to go above their risk limit.

46:55It was something that was going to IPO. So there was a relatively short window on it, though not IPOs can go wrong, but it had a relatively short window on it, but it was definitely above their risk limit. So they could come to us and say, here's the situation. Do you agree? And we agreed and they held it for about a week and we made a lot of money off of it. It's also been, I think, enormously helpful for our team to watch what the managers are actually doing, because it's one thing, again, to see the pretty pages in the flip book that say, this is our philosophy, this is our process. But then when you watch what they do every day, it gives you a much better feel for who they really are.

47:33So you have these managed accounts that have all this transparency. You've got all your internal teams in all those positions. You have these external accounts across asset classes. When you roll all of that up to look at the risk of the WRS as a whole, what tools are you using to assimilate all of that information? So let me just be clear about one thing. Our internal teams don't see what the positions that our external managers have. So let me be clear about that. There is a Chinese wall there. We're using a number of different tools. So one is we have a risk team that uses primarily fact set to look at what the exposures are across the board.

48:10Another thing that we have is we added a position we call portfolio engineer about two years ago, and it's been amazing. So essentially what our portfolio engineer is, it's an investment professional who sits between me and my investment staff and our technology team. So somebody who can speak both investments and technology and has created a number of systems and reporting that has transformed our lives. So we can see things more clearly now. When I started at SWIB a little over four years ago, I met with my senior folks and asked each of them what their pain point was. And by far and away, the biggest pain point was reporting and pulling information together.

48:55We now have systematized a lot of that. And so it's given us a lot more time, the ability to look through things. It's really been transformative. I recommend for everybody to get a portfolio engineer. Once you had all that built with the Portfolio Engineer, what did you find that you might not have known before? Well, we have 12 pages of private equity funds. I kind of knew that. It's the ability to dig in on things very quickly and look both at a broad level and then drill down has been very helpful. So SWIB for a long time has been fully funded. It's quite different from a lot of public plans though, many are catching up.

49:33What are the ramifications in your day-to-day, year-to-year of investing with a fully funded plan compared to an underfunded plan? I think it allows us to focus on the investments and be more pure about risk-adjusted returns. I think a lot of places will be spending all of their time thinking about, well, can we fund this? Do we have to go to the legislature and ask for more money or things like that? So it just takes away from your ability to focus on the investing. It turns out this isn't your first rodeo on a podcast because SWIB has created the SWIB podcast. What was the thought process behind creating a podcast highlighting the people inside of SWIB?

50:14Going back to the incentives being aligned and the shared risk model that we have with our pension participants, that only works because there's a lot of trust. And in fact, other states would love to set up a similar system, but there's just not enough trust between the pension participants, the taxpayers and the investment professionals to set that up. So we understand how important that trust is. We recognize that we've built it up over 70 years and we don't want to do anything that would damage that trust. So one of the ways that we try to keep that trust intact is through the SWIB podcast, is to share with people what we are doing so that they can understand that we're not perfect, we're going to make mistakes.

51:03But the mistakes, if we make them, are not coming from a cavalier attitude that we are very focused. We understand how important this is for people and for their retirements. And we're going to do what we can to deliver returns for them. So you mentioned that a lot of other states would love to have this model of aligned interests, but Wisconsin started it so long ago that it's worked. A lot of people feel like the public pensions are broken in their ability to invest the way you have. I'm sure you have a lot of these conversations with people at other states. Where does that potential come to improve the model in the way that SWIB has at some of the places that haven't been able to do it?

51:44building up that trust. And that you do incrementally. You can't build 70 years of trust in a couple of years. What you can do, though, is make incremental improvements and then have it get a little bit better. And then maybe people will believe you more when the politicians often have their own logic and their own motivations to make changes. And if the system and the participants in the system feel that you've done a good job, then they're more likely to listen to you. If they feel like you haven't done a good job, then it's harder. So you just have to build it up slowly. As you look at over the next couple of years, what are some of the areas of innovation that you're leaning into to continue to develop the investment program?

52:29So we talked about our separately managed account platform. The other area that we're spending a lot of time, and I think we'll be spending more time going forward, is on the privates in co-investment, both co-investment as it is, which is an area that we've been good at, but really have ramped it probably over the last seven, eight years. And we think that there's more opportunity there. And then there's a bunch of ancillary things that go along with that that I think are going to develop, which is, I used to call them unnatural liquidity from private equity. So if you think about private equity firms, we're seeing a lot of selling off partial positions or selling off a majority but holding a stub position.

53:11We're seeing continuation vehicles and we're seeing nav loans. All of this is in an effort to get more liquidity, which is a bit of a collective action problem because we don't need the liquidity. We're actually growing our privates allocation at the moment and we're happy to do that. So when people are giving us a natural liquidity, we're not very excited about it. But I had an aha moment recently where I think these are going to become more and more parts of the universe going forward. They're not going away. So we need to get better at figuring out how to assess a continuation vehicle, how to help do our part as part of the industry to figure out what are we going to do with all these stub positions and where are we going to ultimately get liquidity?

53:58So I think there's a lot of stuff around that. And then the third thing I would say is around secondaries recently, again, because we're in a good position to take on more liquidity. And as those markets continue to develop, we hope to be able to do more. Where do you think these various stub positions, liquidity needs in the private markets unfold over the next few years? I think it's going to be fascinating. I don't have a good answer for it. And whenever I ask managers, I would say I haven't gotten a great answer from them either. It's an interesting challenge because I do believe that the governance model of privately held companies is better than the publicly traded governance model.

54:42And the difference has only gotten starker over the last 20 plus years that I've been doing this. So I think there are challenges in the public market, which means private's going to continue probably to grow, but there's still this liquidity challenge. So there's going to have to be some solution. The industry has been feeling around for something. What was it? Five, eight years ago, there was the whole wave of permanent capital vehicles, but nobody really liked that either. So I do think it's something that the industry is going to have to try and figure out over the next few years. Well, it's going to be, as you said, fascinating to wait and watch.

55:23Anne-Marie, before I let you go, I want to ask you a couple of closing questions. What is your favorite hobby or activity outside of work and family? I love to travel and I'm a big reader. So traveling both without moving and then by getting on airplanes. Any particular places to go? I probably was a nomad in a prior life. I have loved Australia, have loved Japan, China, Europe, Africa, a little bit of everything. Which two people have had the biggest impact on your professional life? Probably Susan Ulick, who was the first manager I had when I was an equity analyst at J.P. Morgan. And then the other person I would say is Gina Raimondo, who was the treasurer at the state of Rhode Island, who brought me over and had faith that I could figure out these other asset classes and run a total portfolio for the state.

56:12What's the best advice you've ever received? Keep going. So when you have a mistake, you just got to pick yourself up and keep going. All right, Anne-Marie, last one. What life lesson have you learned that you wish you knew a lot earlier in life? I think the thing I wish I knew earlier was, it sounds obvious, but the 80-20 rule is that just get 80 % of the way there and you don't have to get it perfect. I think that was something I wish I had figured out a lot earlier. Anne-Marie, thanks so much for sharing this incredible success story at SWIB. Thanks for having me. Thanks for listening to the show.

56:48To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more. Have a good one, and see you next time.

57:16Thank you.