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Strategic opportunities program moving state pension ahead

Ronald Schmitz said Virginia officials, wary of risk, avoided moving too quickly.

Virginia system carefully expanding practice of alignment with managers

Nearly four years after starting a program of strategic alliances with external investment managers, the $78.1 billion Virginia Retirement System, Richmond, is ready to take the next step in its program.

On June 8, the VRS board of trustees approved broadening the strategic opportunities portfolio by expanding its component parts of private investment partnerships and multiasset public strategies. The change involves adding a few new relationships, and Chief Investment Officer Ronald Schmitz hopes they will be funded by the end of June.

The strategic alliance initiative was a top priority for Mr. Schmitz when he joined the Virginia Retirement System in 2011, after serving as CIO of the $76.6 billion Oregon Public Employees Retirement Fund, Salem, since 2002.

Investment officials in Oregon and other large West Coast public pension funds in particular have been comfortable with these types of partnerships for a while, including the increased risk budget these approaches entail, he said. "VRS, more than any other place I have ever worked, is very risk-conscious, so this program has operated with a slow, deliberate approach," Mr. Schmitz said.

Another reason for the change is to get better performance tracking than what was available when the strategic opportunities program was more of a catchall bucket.

The strategic opportunities program was approved by the board in 2012, with the board setting the risk and return parameters, and a policy limit of 3% of the total pension fund, which was raised to 5% in June 2016. It was fully launched in 2014.

At first, "it was intended to be a catchall for new initiatives we wanted to try. We went through various iterations," Mr. Schmitz said. Since then, the program has had time to evolve and the investment concepts have been tested, and it was time for the next step in the program, he added.

As of March 31, the strategic opportunities portfolio accounted for 2.3% of assets, compared to 41.8% public equity, 17.1% fixed income, 16% credit strategies, 13% real assets, 9.7% private equity, and the rest in cash.

The targets for the two new multiasset-class sleeves are 2% in private markets and 3% in multiasset public strategies. That leaves 40% in public equity, 16% in fixed income, 15% in credit strategies, 14% in real assets and 10% in private equity.

Managers for the private investment partnership are Carlyle Group LP and KKR & Co. LP, legacy managers from the original program.

Function like general partners

With the original private markets program, the idea was to have the firms function like general partners, with approaches that cut across multiple asset classes, such as private equity or private credit, and preferably are global in nature. Using a single evergreen account where managers do not have to constantly return for new commitments, general partners have a mandate to go to multiple asset classes and geographies, and can give Virginia lower fees, the thinking went.

For the private investment partnership benchmark, Mr. Schmitz recommended a weighted average mirroring the benchmark components of the private equity, real assets and credit strategies programs. It will be 40% private equity, 40% real assets and 20% credit.

The multiasset public strategies class, with $2.25 billion, will include risk-based investments and dynamic strategies. The risk-based investments category totaling $1.2 billion has commitments with Bridgewater Associates LP's Pure Alpha II global hedge fund, Bridgewater's Optimal Portfolio, AQR Capital Management LLC for a multistrategy hedge fund and AQR Managed Futures. All are legacy funds; the pension fund expects to hire additional managers.

Dynamic strategies managers BlackRock (BLK) Inc. (BLK), J.P. Morgan Asset Management (JPM) and Morgan Stanley (MS) Investment Management will have an aggregate $1 billion. All three are new managers to the program.

The multiasset public strategies benchmark will be a market value-weighted average of dynamic strategies and risk-based investments. The dynamic strategies benchmark is intended to track the benchmark components of the public equity, fixed-income and credit strategies programs. The risk-based investing benchmark will be a blend of a custom diversifying benchmarks and the Hedge Fund Research risk parity 12% volatility benchmark.

Large public pension plans use strategic partnerships to achieve many objectives, including getting more from their managers, whether it is simply more tactical insights or information about building capabilities in-house. One appeal to Virginia was being more nimble in private markets, with the promise of that also leading to lower fees and costs, given the significant commitment to co-investments.

"It's permanent capital, which is attractive for them, and it is nimble capital. It gets us into new opportunities faster," Mr. Schmitz said.

In the risk-based investing portion, he plans to add more things to control for volatility. "We expect it to underperform in bull markets and overperform in bear markets," he said.

His team is in the process of deploying the second piece, the dynamic asset allocation portfolio, "where the idea is to diversify the sources of active returns," Mr. Schmitz said.

While he is "still very much a believer in private markets," he does expect "bigger dollars" initially for the multiasset public strategies. "We will eventually get there in private markets. We will grow," Mr. Schmitz said.

"I expect this initiative to be around for a long time."