The Employees Retirement System of Texas is re-allocating around a quarter of its public equity portfolio to external managers, away from the internal team, a move at odds with the internalisation trend among asset owners. <\/p>\n
The 80-person in-house staff will now run around 50 per cent of the public equity allocation \u2013 equivalent to $8-9 billion \u2013 along with $4 billion in public credit, a $4.8 billion rates\/treasury book and a $1.3 billion cash portfolio.<\/p>\n
ERS plans to upsize with existing fundamental mandates but also allocate to new incremental relationships with diversifying strategies, says chief investment officer David Veal in an interview with Top1000funds.com in the fund\u2019s Austin office.<\/p>\n
The objective is to create a more diversified set of uncorrelated alpha streams and provide consistent returns in today\u2019s highly concentrated market.<\/p>\n
Navigating market concentration and maintaining diversification is one of the biggest challengers for the$46 billion fund. For example, ERS has deliberately kept its allocation to small caps and emerging markets which has caused the portfolio to lag the benchmark on a one-year basis. But it is an ongoing struggle as AI becomes an ever larger portion of the capital markets.<\/p>\n
\u201cOur public equity is up 26 per cent, which sounds awesome until you hear the benchmark is up 28 per cent. Our portfolio does best when diversification works,\u201d says Veal.<\/p>\n
Take Nvidia, he continues, ERS\u2019 largest single stock exposure valued at over $700 million and accounting for nearly 2 per cent of the total portfolio: equivalent to an asset class in its own right. And that doesn\u2019t include additional exposure to AI and chips from allocations in private equity and private credit, and infrastructure, via data center exposure.<\/p>\n
Capacity constraints with preferred managers; the shift to RfQ\u2019s<\/p>\n
ERS allocates to around 12 public equity managers already. But Veal says up-sizing with some of these existing relationships has run into manager capacity constraints. <\/p>\n
\u201cOur top two managers that together manage around $2 billion between them have only $50 million of extra capacity.\u201d<\/p>\n
To try and help the search, ERS has just completed a US small cap Request for Qualifications (RFQ) in a deliberate shift from the extensive back and forth that can take 12-18 months under a Request for Proposal, (RFP). The small cap RFQ process has produced two good managers in a successful test test run for a process that he says he will now extend to global strategies.<\/p>\n
An RFQ gives the fund more control. IN the process ERS produces its own standard agreement, and requests that only managers that can meet their stated terms apply.<\/p>\n
\u201cIt allows us to negotiate terms while we have most negotiating leverage instead of at the back end, when we have less. We get better cooperation in the RFQ process,\u201d he enthuses.<\/p>\n
He is looking for managers with moderate risk levels. Mandating to heavily concentrated managers can put up a \u201cspicy\u201d 1200 basis points of tracking error, but he believes 400-600 basis points (of tracking error) equates to good value for the fees ERS will pay in US small cap (around 40-50 basis points).<\/p>\n
\u201cYou can get an 8 to 10 multiplier on the fees you pay so that\u2019s a good return on investment, and worth doing,\u201d he says.<\/p>\n
Strategies for when alpha gets harder<\/p>\n
Veal says finding alpha is increasingly hard. Strategies that worked well yesterday are more challenging today and managers must constantly optimise and refine their models to stay ahead of the competition given the proliferation of talent, and the fact many original strategies now face headwinds.<\/p>\n
It is leading the team to explore new approaches and portable alpha, a departure from traditional long only, is on the radar.<\/p>\n
\u201cIt is a question of trying to get comfortable with a sustainable source of alpha that is worth the fees we are paying, and also exploring how correlated it would be with the rest of the portfolio.\u201d <\/p>\n
He says portable alpha is also more complicated to get through ERS\u2019 governance as it crosses over asset classes. But trustees are ploughing new ground, and keen to put the right structures in place.<\/p>\n