Lawrence M. Schloss always knew he would have a career in finance. “I wanted to work on Wall Street since I was a kid,” said the chief investment officer of the $115 billion New York City pension system, made up of five city pension funds: the Employees' Retirement System, Teachers' Retirement System, Police Pension Fund, Fire Department Pension Fund and Board of Education Retirement System. While childhood friends were taking summer jobs as camp counselors, he took the subway from his home in New York City's Jackson Heights neighborhood to work in the back office of a brokerage firm for several years during high school and college.
When choosing a college major, he selected economics because “there was a complete focus on working on Wall Street,” Mr. Schloss said. After getting his bachelor's from Tulane University and MBA from The Wharton School at the University of Pennsylvania, he achieved his dream when he joined Donaldson Lufkin & Jenrette. Mr. Schloss worked at DLJ for 22 years, eventually becoming chairman of merchant banking. When DLJ was acquired by Credit Suisse in 2000, he became global head of the Credit Suisse private equity business.
When his three-year Credit Suisse contract ended, Mr. Schloss decided to take advantage of what he called “the first break in my life to go do anything,” and headed to Mount Everest. “I go as a trekker; I'm not a climber,” said Mr. Schloss, who has since taken trekking trips to South America's Patagonia and Europe's Mount Blanc. “There might be another mountain in my future.”
Mount Everest, however, provided only a brief break from finance. In 2004, Mr. Schloss co-founded Diamond Castle Holdings, a private equity firm at which he was chairman and CEO, until he took the job with the New York City comptroller's office in January 2010. “I literally got a phone call out of the blue” from Bill Mulrow, a former DLJ investment banker who was a member of the transition team for John C. Liu, the then newly elected comptroller, Mr. Schloss recalled. “He said, "You can have a real impact. And you can leave it better than you found it, and then you can go back to your normal life.'”
The call came at a time when Mr. Schloss was looking for a new challenge. Although Diamond Castle had about $1.8 billion in assets, “I think I longed for something bigger,” he said. And this is bigger.”
How does your private equity background affect your managing the city pension portfolio? The beauty of being trained in private equity is I tend to think long term. A private equity fund goes on for 10 to 13 years, so you're kind of used to thinking longer term. And when you manage a public pension fund, it's even a longer term than private equity. You have to think about 20 and 30 years in the future.
What are the differences in management? What's different now: you're little bit removed from it. Now, we pick managers as opposed to investments. The manager is the investment, as opposed to picking the stock. It's more of asset allocation and manager selection. You do get a chance to change the allocation of assets within bands; you get to be an active manager of the asset allocation. ... For instance, our private equity portfolio is suboptimal. We have to fix that. That's going to take two or three years to fix. We don't have enough top-quartile managers. We have too little money with each manager. And we don't have enough exposure internationally.
What changes have you made? I looked at the (aggregate) returns at the fund — which were 2.7% (annualized) for 10 years — and I said, "We've got to get that up.' The first thing to get that up: let's get rid of the managers that are hurting us. So we pruned the managers. ... If you're the CEO of a company, you prune your product lines. So, in our case, you can terminate managers, but it's very hard to hire managers because you have a long procurement process.
What's the process for hiring new managers? The typical RFP prior to my arrival took 12 to 18 months. If you see a market trend happening and you want to take advantage of it, and if it's going to take you a year to hire the managers, that's not very nimble. ... So we took it down to about six months. That's still too long. We are going to work on that optimizing even further to get it down to three to four months.
In March, New York City made its first commitments to hedge funds. What's your goal? We are beginning to execute a hedge fund investment strategy that had been discussed for several years prior to my arrival. ... Three of the five New York City funds — the New York City Employees' Retirement System, New York Police Pension Fund and New York Fire Department Pension Fund — have committed $450 million to a fund of funds run by Permal Group, subject to negotiations. This is less than one half of 1% (of aggregate assets for all city pension funds) and will get us instantly well-diversified with roughly 25 to 30 managers. We will then set about to build a direct hedge fund portfolio, the exact target size of which will be determined by each fund's pending asset allocation.
How do hedge funds fit with the rest of the portfolio? There's a couple of philosophies of hedge funds. There's what I will call the-make-as-much-money-as-you-can hedge fund. And then there's the low volatility hedge fund. The low volatility hedge fund is supposed to have less than half the volatility of the stock market, and returns of 8% to 10%, let's say, on an annual basis. They're designed not to go for the home run, not to maximize return, not to maximize volatility, not to maximize risk. We're looking for singles and doubles. And if we can get a portfolio of singles and doubles, that would be great. We have an 8% actuarial rate, so if we have a piece of our portfolio that's targeting 8% to 10% with low volatility, that's great. And if we're taking that out of our equities, that's even better. That's how it fits into the gumbo of asset allocation.
How have you have been shifting the overall portfolio allocation? Working with Seema Hingorani, our head of public equities and hedge funds, we set about a review and reallocation of each fund's mix of active vs. passive managers, and large-, medium- and small-cap U.S. equities. This had the effect of shifting more into passive, from 60% to 75%, thereby reducing fees, terminating some active managers, and reallocating away from large cap and moving toward midcap equities. We also cleaned up some poorly performing managers in the process. This has worked out well.
How have you improved your approach to passive investments? We didn't have what we call a complete tool kit of indexes; the only passive index we had was the Russell 3000. So we did an RFP for indexes; so now we have large-cap, small-cap, midcap and MSCI and emerging markets (indexes), among others. We now have the tools so if we terminate a manager, we can keep the portfolio similarly balanced, replacing them with the most appropriate index.
What other portfolio adjustments have you made? We've lightened up our high-yield exposure; they've had their run. We had $5.8 billion so getting out takes a bit of time and you can never call the exact bottom. We've sold $2.3 billion so far. ... We have reallocated the capital to equities, which has worked out fine.