This summer the Washington State Investment Board will conduct two “deep dives” using its new risk tools to examine the portfolio exposure to US debt, and the impact of turmoil among the European Union. Executive director, Theresa Whitmarsh, discusses the board planning session, which will also include a review of the fund’s resource constraints.
The successful deployment of the $82 billion Washington State Investment Board’s risk modelling data warehouse – developed inhouse – means the fund can conduct concentration risk analysis featuring almost any variable.
For example during the time of the Japanese tsunami the WSIB knew it could measure its geographical exposure to Japan (3.6 per cent) and its nuclear exposure across all assets.
Similarly it knows it has a relatively low exposure to the Middle East directly (0.6 per cent) but can also measure its oil exposure.
“It doesn’t change anything but is useful information to reassure the board how truly diversified we are,” executive director Theresa Whitmarsh says. “No one single shock can alter our portfolio.”
The fund recently looked across the portfolio by concentration of issuer and found the greatest concentration was to US government debt. This will be furthered explored in the upcoming board offsite, as will the impact of turmoil in the European Union (in a presentation called “Breaking up is hard to do”).
“We will look at what is the impact of the US debt burden on our portfolio. It’s not news to us but the board can sit back and say we’ve done a good job in moving across the globe but we still have a huge exposure to US debt.”
The WSIB has about 18,000 holdings and mapping that has been a technological challenge. It has almost completed implementing Barra into that system, and will then be able to more thoroughly stress-test the portfolio.
Whitmarsh has identified the board’s risks as fiduciary, reputation, and government and the environment, and has set a board discussion around all of those different risks.
“We want to discuss these risks and spend less time on ‘administrivia’,” she says. “Risk tools are all about the dialogue it creates.”
The fund’s capital market assumptions were examined at a recent board meeting as part of an annual routine review.
“Because there has been so much in the press regarding returns, we need to look at whether we can return what we have in the past. It needs more thorough discussion,” she says.
The SWIB conducted three education sessions of the board, and partly because chief investment officer, Gary Bruebaker, is more positive in outlook, other points of view were brought in.
Rob Arnott, presented on “Hope is not a strategy”, and a local funds manager, Andy Turner – who runs his own firm, but was formerly at Russell – addressed the equity risk premium.
Whitmarsh says this allowed the board to think about its fundamental investment beliefs, one of which is a belief in the equity risk premium, as well as the illiquidity risk premium, namely that private markets will outperform public markets.
“It’s really valuable to evaluate your beliefs. Our investment beliefs were challenged but not changed,” she says.
The WSIB invests for 39 funds including 17 retirement funds, 4 state insurance funds for injured workers, and 18 permanent and other trust funds.
The strategic asset allocation for the retirement funds – which make up about $67 billion of assets – has not been changed, with the last review conducted in 2009.
At the end of March it was fixed income 20.5 per cent, tangibles 1 per cent, real estate 12.2 per cent, global equity 40.72 per cent, private equity 22.73 per cent, innovation 0.17 per cent and cash 2.65 per cent.
Some adjustments were recently made however, evolving the fund’s approach to public equity investments.
It now has seven funds managers with global/non-US active equity mandates: Aberdeen, Arrowstreet, Mondrian, William Blair, Longview, Tradewinds, and Wentworth, Hauser and Violich.
The WSIB’s capital market assumptions were recently adjusted down, by about half a point – from 7.98 to 7.5 per cent. This will then go to the state actuary who makes a recommendation to the state legislature.
Whitmarsh is very positive about the fund’s structure, its open plans are fully funded, with the benefit payout based on the five consecutive top years of employment.
“The benefit policy of the state has been more progressive,” she says, and the WSIB has also had a hybrid plan for about 10 years.
But unlike its global peers of a similar size, the WSIB has a relatively small amount of money managed internally, with fixed income the only asset class to be managed inhouse.
“We are lean, but not mean,” Whitmarsh says. “I think we have done an amazing job optimising within our constraints.”
A July planning session will look at the resource constraints and how the fund can move into the next phase.
“The options include having more flexibility on budget, and the ability to be more timely, as well as the option to go to the Canadian model and be a Crown corporation,” she says. “We don’t have any preconceived idea of the best model. And we have to be careful what works in one jurisdiction works in another, there are a lot of ways to be successful and we have been. But we can make improvement at the margins.”
About five years ago about 72 per cent of the fund’s assets were in North America, in 2010 that was about 54 per cent.
“There has been a real increase in complexity and oversight and the fund is way more complex than five years ago and will become more so. We are at the limits of what we can do within our resource constraints,” Whitmarsh says.
Whitmarsh is heavily involved in the ICPM and is well aware of the research by Keith Ambachtsheer and CEM which finds that funds with internal management do better because of fees.
“The bigger concern for me is positioning the fund for what is next. That is not an internal versus external discussion but examining if we have the right people. Even if we have external managers then we need people to monitor managers, hire and fire. It is a more complex skill set than the past,” she says. “If it was a fee issue, our history of returns net of fees means there is not a compelling reason to have more internal. We have been successful with a very lean model, and want to be careful in how we proceed.”
