The New Mexico Educational Retirement Board’s aggressive move into alternatives has not been without hurdles. Chief investment officer, Bob Jacksha, spoke to Amanda White about the plan’s alternatives strategy, the bumps along the road and his expectations of the sector.

Two years ago the $6.6 billion New Mexico Educational Retirement Board started looking for a chief investment officer with specific alternatives experience. The aim was that the CIO could bring relationships and also overall analysis and understanding of the asset class to the table.

Bob Jacksha, who has 25 years investment experience, most recently as deputy CIO of the New Mexico State Investment Council, has an MBA and holds a Chartered Financial Analyst and Chartered Alternative Investment Analyst designations, had the right qualifications.

Since Jacksha’s hire, the New Mexico Educational Retirement Board has been transitioning to a new asset allocation which will decrease its equities exposure from 65 to 45 per cent, and double alternatives to an overall allocation of 30 per cent.

“We increased alternatives from 15 to 30 per cent, doubling hedge fund and private equity allocations, with allocations coming out of equities and fixed interest,” Jacksha says.

That new allocation will be split 10 per cent hedge funds, 10 per cent private equity, 5 per cent real estate and 5 per cent real assets, including infrastructure, timber, and agriculture. An allocation to commodities was discussed but it was decided not to allocate at the time.

Jacksha oversees four investment professionals (the fund also has two internal investment staff on the operations side) and while he would like to expand the internal team, that would require an act of legislature, and so seems unlikely.

NEPC, the fund’s general consultant, has shown the asset allocation in the past quarter has contributed a positive 2 per cent to the fund’s returns, while manager impact has been -4.8 per cent.

Investments have been trickling in to meet the allocations, with a recent $25 million allocation in ORG Real Property’s secondary fund fulfilling the plan’s target allocation for real estate. A chunk of that allocation is in an internally managed REIT index fund and over time, Jacksha says, that allocation will be transferred into private real estate.

Some infrastructure and private equity commitments have already been made, and that will be ongoing, with Jacksha predicting a good environment for private equity deals.

“In the past few years the market for deals has been good, endowments have been selling and there are opportunities in the secondary market,” he says. “For the first time in many years private equity firms are going out and having to market their funds.”

The ERB has $745 million in private equity commitments in 25 different funds, which have a market value of $162 million.

In the time since the new asset allocation was made, the ERB has seen some dramatic turns which have somewhat derailed the initial investment strategy.

“In the past year, hedge funds didn’t do what we wanted them to do – they didn’t give much protection on the downside,” Jacksha says.

For the year to December 2008, none of the alternatives investments contributed much to the fund. In that time the absolute return composite delivered -23 per cent to the fund (the most dramatic return being the -28 per cent contributed by the Gottex Market Neutral fund), the private equity composite returned -13.3 per cent and the real estate assets returned a damaging -30.6 per cent.

And while not having a huge adverse effect on the investment outcome, because the allocation was small, the controversy over an exposure to one of Madoff’s investment funds, was also an unwelcome distraction.

In a statement the ERB said: “As part of our overall investment plan, ERB allocated approximately 10 per cent of our assets to hedge funds. One of our hedge fund managers has an investment in a fund managed by Bernard Madoff. As the press has widely reported, Mr. Madoff is alleged to have committed fraud in the management of several hedge funds. While the ultimate outcome of this investment is unclear at this time, we do know that our maximum possible exposure is $9.75 million. Although this is not an insignificant amount, it represents only 0.15 per cent of our total fund balance. Regardless of the outcome, it will not affect the payment of retiree benefits. It will not have an impact on the stability of the fund. We are examining all of our options in this matter with an eye toward maximising our return of capital on this investment.”

Jacksha has faced his fair share of controversy during his tenure at the fund, and most of it has been in the alternatives space. As recently as last week, the investment committee decided to suspend its private equity consultant, Aldus Equity, following the indictment of former New York state comptroller executives over claims of receiving kickbacks from an Aldus fund and other investments.

Aldus is also private equity adviser to the $14.1 billion New Mexico State Investment Council, which has put about $350 million in private equity funds.

The Dallas-based Aldus Equity has been paid $905,000 a year for advisory work for the State Investment Council and $750,000 a year for work for the ERB. While it is unclear what the Investment Council will do regarding its private equity advice, the New Mexico ERB has decided its general consultant, NEPC, will widen its scope to include private equity until a decision is made whether to replace Aldus permanently. Its other specialist consultants are ORG for real estate and timber, and Corkland Partners for infrastructure.

These adverse experiences in the past couple of years have taught the fund not to be complacent when it comes to its alternatives investments.

In particular, Jacksha is adamant when it comes to fees paid for alternatives that transparency reigns. He has no problem with performance hurdles, and almost always agrees with those that are proposed by investment firms. However he believes management fees could be a bit lower.

“Fee sharing, or fees from deals, should not exist,” he says passionately. “It is a perverse incentive to do deals.”

Fund Profile

The New Mexico Educational Retirement Board returned -28.1 per cent for the year to December 2008.

Asset allocation (at December 31, 2008)

Domestic equity	31.5%
International equity	15.6%
Private equity	2.3 %
Domestic bonds	30.1%
Bank debt	5.1%
REITS	3.2%
Real estate funds	1.6 %
Infrastructure	0.2%
Cash	1.4%
Absolute returns	8.9%

Board-approved asset allocation target

Large cap equities	23%
Small cap equities	2%
International equities	8%
Emerging markets	10%
International small cap	2%
Bank debt	5%
Domestic bonds	15%
Real estate	5%
Private equity	10%
Absolute return	10%
Real assets	5%
Global TAA	5%

Denmark’s largest pension fund and the 29th largest in the world, ATP, is not leaving anything to luck when it comes to providing a guaranteed return for its members. Kristen Paech talks to chief investment officer, Bjarne Graven Larsen, about the various risk management methods the fund has implemented across its portfolio.

The DKK400 billion (US$71.1 billion) believes the risk of inflation when the world emerges from recession is higher than ever before.

It is for this very reason that the fund has begun ramping up its exposure to assets that protect against inflation, recently allocating up to DKK3 billion to forestry investments for the first time.

The DKK180 million acquisition of the Upper Hudson Woodland in New York State, which covers 38,000 hectares of forest, was made through new subsidiary ATP Timberland Invest K/S.

It represents the fund’s first investment in timber, and marks the start of what will be a series of investments in sustainable, FSC-certified forestry through ATP Timberland; Forest Stewardship Council (FSC) certification is a voluntary, market-based tool for forest conservation, which encourages more responsible forest management.

Bjarne Graven Larsen, chief investment officer at ATP, says since timber is a real asset, it acts as a good inflation hedge.

“If inflation in society goes up there’s reason to believe that the price of paper and pulp timber will follow,” he says.

“If you’re a long-term investor and if you are concerned about getting a good return long term it gives you some flexibility to decide not to sell the timber if prices are too low and to let the asset grow organically.”

Forestry will sit within the ‘inflation risk class within ATP’s portfolio. Two years ago, the fund split its investment portfolio – which is managed separately to its hedging portfolio – into five risk classes; equities, interest rate risk, credit, inflation and commodities.

The largest portion of the inflation risk class is in index-linked bonds, however real estate is also included, as is
infrastructure and now timber.

“We have increased our investments in infrastructure, we’ve started to invest in timber and we have been trying to find other ways to hedge inflation by using derivatives, like inflation caps and even swaptions in that part of the portfolio,” Larsen says.

“So that has been the other big focus for the strategy: because of the liquidity, because of the significant increase in the monetary base around the world, we think the risk that there will be inflation going forward is higher than ever, so we want to be able to hedge that risk as well. That’s why we’ve been so focused on building an inflation exposure in the last two years.”

The purpose of the hedging portfolio is to hedge the pension fund’s liabilities, which Larsen says have a “nominal long
duration”.

“It’s a guaranteed amount, so we decided we wanted to hedge away the unwarranted and uncompensated risk we had on the liability side,” he says.

This has historically been done using interest rate swaps, but during 2008, ATP closed down a lot of its swaps and
instead bought 30-year government bonds, which it repo’d to finance the purchase.

“2008 has been a year of transformation, and 2009 as well, where we changed our hedge portfolio from a pure interest rate swap portfolio and into a more diversified portfolio where we have interest rate swaps and we have 30-year government bonds,” Larsen says.

“The strategy is unchanged in the sense that we hedge our liabilities 100 per cent, but the strategy has been implemented in a different way.”

On the investment side, the fund’s aim is to create a real return that makes it possible to pay out pension liabilities over a long time horizon, which grows with life expectancy, and increase the yearly nominal amount so that members maintain the purchasing power of their pension.

The equities risk class contains both public and private equities, and was altered in 2007 and 2008 to remove the tail
risk in the portfolio by buying put options when market volatility was low.

“We didn’t reduce our equity holdings – of course markets helped us reduce the equities because prices went down – but we didn’t sell equities, we just protected our reserves by having huge gains in our put option portfolios,” Larsen says.

In addition, ATP began building a credit exposure in 2008 from a very low base.

“We decided during 2008 when the bank crisis started there would be opportunities in the credit area so we allocated quite a substantial amount to bank loan funds,” he says.

“Even though it’s risky, we think the risk/reward trade-off is better in credit than in other risk classes.”

Of the five risk classes, ATP achieved positive results in 2008 in three of them, with the biggest return coming from
the interest rate bucket.

According to Larsen, prudent risk management and targeted use of financial instruments protected ATP’s portfolio and prevented the fund from having to draw on its reserves.

The overall return including the hedging portfolio, which produced a profit of DKK76 billion, was 19.6 per cent. Excluding the gains from the hedging portfolio, which is how ATP presents the results in its annual report, the return on the investment portfolio was -3.2 per cent.

In 2009, ATP’s priorities are two-fold: to make sure that the pension fund remains robust even in a high inflationary environment, and to implement its strategies effectively.

“One priority is to ensure we are not vulnerable to big increases in inflation, and [the other] is to implement the strategies and execute them in the market in the smartest ways we can,” Larsen says.

“With the credit or bank loan funds and derivative structures we’re using, we want to make sure we focus on good execution.”