David Villa, CIO of the $110 billion State of Wisconsin Investment Board is worried about the outlook for returns. As a result he’s significantly underweight sovereign bonds in favour of cash. But he’s also positioning the organisation to do better analytics for more complicated portfolios, another result of a low return environment. The fund is working on at least five data and technology projects and has hired a chief technology and operations officer.
David Villa, chief investment officer of the $110 billion State of Wisconsin Investment Board has sold out of sovereign bonds into cash in the belief that cash is, relatively, attractive and a good substitute for bonds.
“I believe we’re late in the credit cycle. Yields on government bonds are low and we are willing to hold cash as a substitute for bonds,” he says.
The core fund strategic allocation to fixed income is 25 per cent, but Villa won’t disclose the current allocation.
“We are underweight duration and sovereign bonds. I don’t want the market to know how much, but it is a meaningful underweight.”
“We are selling duration and holding cash, I don’t want to lend to the US government for 10 years and receive a coupon that’s less than inflation, I’m not being compensated.”
Villa also points out that private assets more expensive than public assets and if there is a correction in equity markets it will add to the portfolio drawdown as private assets are marked down on a lagged basis.
“I prefer to add risk when the compensation is high,” he says. “We have a lot of cash so can be fearless in rebalancing, so we’re waiting.”
The fund’s one year return as of June 30, was 7.62 per cent, net of all fees.
It has a 17 per cent allocation to private assets split between private equity 9 per cent, and real estate 8 per cent. Both have performed well with the one-year return for private equity 14.3 per cent, and real estate 6.95 per cent.
“The real estate is meeting expectations, and private equity is beating expectations over one year.”
But Villa’s expecting it to be disappointing going forward, partly because leverage is high and there is also a lot of capital chasing private equity. Every dollar of private equity creates 2.5 dollars of debt.
“We are trying to tilt our commitments in a direction of more defensive strategies, in particular less leverage,” he says, noting that 90 per cent of the portfolio is with general partners, 10 per cent is co-invested.
Villa is worried that the asset allocation is going to deliver 5 to 6 per cent, well below the fund’s target.
“I’m not so much worried the return will be that for five or seven years but that there will be a combination of good and bad years and we will average 5 to 6 per cent,” he says. “Asset prices are high so as asset prices normalise returns will below.”
He says because current and prospective cash rates are low, when he builds return expectations with cash rates as a base, expected returns on all asset classes are low going forward.
“If equities return 7 per cent and bonds return 3 per cent, you get weighted returns of 4.2 per cent and 1.2 per cent or a total of 5.4 per cent,” he says. “It’s hard to meet the target.”
Technology
In recognition of the fact the portfolio has become more complex, in a bid to chase down alpha, the fund has spent a lot of time and energy on technology.
It currently has five big technology projects underway:
- Building a data warehouse
- Improving data governance
- Upgrading the performance analytics engine
- Centralising the portfolio engineering function
- Upgrading technology platform for private equity
“We have been undergoing a tech transformation,” Villa says. “Many institutional funds managers have lots of technologists, data scientists and engineers but the majority of them are keeping the system working and providing analysis and reporting that has to be done in a semi-manual way and not an integrated approach. In the 1980s and 1990s we had equities and bond portfolios that were totally separated. As we create more strategies that are multi-asset and unconstrained, we need more work arounds in the technology. We are trying to move to a very integrated straight through processing environment where we have a data lake and snap technology on top of that and push buttons. Moving to unconstrained portfolios has meant this is a massive challenge.”
“We want to move away from spreadsheets to run the business which is not timely and prone to mistakes. We need a different technology solution to get there and it has proved to be a big challenge to do this.”
The fund has great aspirations and in the past two years has made good progress. It recently hired a chief technology & operations officer, Julia Valentine, who Villa describes as “the real thing”.
“She’s driving us into the future,” he says.
“It used to be an environment where the typical pension portfolio could earn 8 to 9 per cent. Today it’s harder to achieve your target, so we are all trying to use more complicated strategies and solutions and old technology platforms are just not up to scratch. Now we need to manufacture alpha and it’s expensive. That wasn’t necessary in the past but today it’s mission critical and everyone is doing it at the same time.”
Villa and the team have high aspirations for getting work done, but he admits they are “a little short handed” and will probably have to decrease the list of projects to match with staffing levels.
The fund has hired 34 new staff since the beginning of the year, with a turnover generally of about 8 per cent, but the staffing level is below target.
Villa attributes this to the robustness of the economy adding it takes 30 per cent longer to recruit people.
Added to this is the fact a lot of investment managers are trying to do the same thing in technology and Wisconsin is hiring deep domain expertise with more than 70 per cent of hires being relocations from LA, Chicago or New York.
One of the reasons for spending time and money on the technology platforms is to have a more robust inhouse functionality, and the fund has plans to bring a further $2 to $4 billion in house in global equities and bonds plus enhanced.
Admittedly these are assets that were internal but were outsourced temporarily about four years ago because of the technology transformation, and are now being brought back in house.
It currently manages around $55 billion in house but that is nudging closer to $60 billion.
Villa admits there has been a cost in moving around that management of assets but says it is not so much about disruption but a mismatch of cost and benefit.
“The managers we had the money with are very idiosyncratic, who have resources and technology we don’t have, so they can do things we can’t do – we have been renting their infrastructure while we build our own,” he says. “We still have about two years of work on our technology to be as good as the external fund managers, it’s a big transformation.”
The fund estimates it saves around $75 million a year due to its internal management.
