September 28, 2023

Face to Face

Commonfund's Mark Anson on why a 30/30/40 model makes sense

Long before he joined Commonfund as CEO and CIO, Mark Anson had a decadeslong career in investing, both on the asset management and asset owner side. Once a practicing lawyer, Anson was named CIO of CalPERs in 2001.


In subsequent positions, he was CEO of British Telecom's Pension Scheme, president and global head of investment management at Nuveen Investments and served as CIO for the Bass family office in Texas before taking on the Commonfund CIO role in 2016.

Ari Oshinsky

Pensions & Investments sat down with Anson to talk about why the 60/40 investment model isn't dead yet, his views on the Federal Reserve, U.S.-China tensions and why a hefty allocation to alternatives plays a key role in Commonfund's asset allocations, as much as 40% in alternatives, with the remaining 60% split equally among stocks and bonds, for its endowment and foundation clients and other nonprofits. Commonfund invests about $30 billion on their behalf. Questions and answers have been edited for style, clarity and conciseness.


Q: Your first pension fund job was at CalPERS?


A: It was. And getting to CalPERS is a fun story. I had moved off the trading desk at Salomon Brothers, and I was working as a portfolio manager for Oppenheimer Funds. A recruiter called me up and he says, "Hey Mark, would you ever have any interest in working for a pension fund?" And I answered, honestly, "No. I can't imagine why I'd want to do that." And he said, "Well, I can't reveal the name of our client, but what if I told you it was the largest pension fund in the country?" And I said, "Gosh, the largest one I know is in Sacramento, Calif."


I got offered a job to join CalPERS. It was fascinating. It was fun. It was a big change. Again, from moving from Wall Street to Sacramento. My wife is also a lawyer. How are we going to blend our two careers, uprooting us, our two kids at that time and our cats? So it was a big move, but so well worth it.


Q: What was it like working at the country's largest pension fund?


A: A lot has changed. But the best lesson I learned at CalPERS and working for a pension plan, is you're forced to look at your liability stream. You're entrusted with paying out the benefits to hundreds of thousands of beneficiaries. I learned at CalPERS to first focus on the liability stream and then figure out what's the right asset allocation that will produce a stream of revenues to pay off that liability stream. When you're in asset management, you want to manage the money because that's the fun part. If you're a pension fund, it's very clear you have to pay these benefits for all your pensioners. If you're an endowment, you're drawing from the endowment to pay for potentially the salaries of the professors or to provide scholarships to the students. If you're a foundation, you have a philanthropic donation schedule. And if you're just ordinary people, you've got probably two liability streams, your own retirement fund and then paying for your kids' college education and hopefully someday getting them off the payroll. I live in hope.


Q: From there, you went to British Telecom Pension Scheme?


A: So Wall Street, Sacramento. Sacramento to London. I've learned in my career when you make a big change like that, there's a lot of things you have to understand about the new culture you're stepping into. But if you're doing it as an individual, there are big risks associated. I have found that the rewards to that risk taking more than compensate you for the risks that you're underwriting.


CalPERS was that case. CalPERS gave me greater authority, greater responsibility for managing a much larger pool of assets than I would've had at any other part of my career, but it was a risk to move from Wall Street, taking a pay cut to go work for a pension plan. But the amount of responsibility that I got and the broad range of asset classes that I now had authority and responsibility for, again, just elevated my career to a level that I would not have achieved otherwise. The same thing moving over to London. But again, the rewards that I learned from that, and not just the economic rewards, but just being able to expand my mind and think globally as opposed to regionally or domestically was just something I may not have gotten if I hadn't decided to move overseas.


Q: How did you get to Commonfund?


A: I've always known about Commonfund. It has a great history: born with a $2.5 million grant from the Ford Foundation about 52 years ago. We're a little over $30 billion today, starting with just $2.5 million. That's a pretty good return on capital. I like to joke with Darren Walker (president of the Ford Foundation) that's probably the best investment the Ford Foundation ever made. But Commonfund has had this great tradition of working with endowments and foundations over those years and helping them manage their money. Long before Yale had David Swensen, Commonfund helped to manage the endowment at Yale.


The original seed investors at Commonfund were all the large endowments, but back then, they didn't have the professional management that they do today. Commonfund was founded to help professionalize the management of endowments and foundations. And when the opportunity came along, I was like, gosh, what an interesting thing to try and do. So that's what got me here.


Q: You've heard that 60/40 is dead. We hear it may be replaced with something closer to 40/30/30. So 40% stocks, 30% bonds and 30% alternatives. Can you talk about asset allocation today?


A: Well, first let's deal with 60/40. When you look at 2022, that was the worst year for stocks and bonds combined that we've ever experienced in 40 years. Both stocks and bonds declining by double digits in 2022. There was no immunity. Every investor got hurt, whether you were an individual investor, whether you were a Commonfund, whether you were a large well-known endowment or foundation, everyone was hurt. Even in 2008 in the middle of the great financial recession, yes, stocks got clobbered, but bonds had positive returns.


So this balancing between stocks and bonds, this whole idea of 60/40, that you should have a balanced portfolio of stocks and bonds because while one is up, the other might be down or vice versa, that didn't work in 2022. Hence a lot of new rhetoric like 60/40 is dead. Well now what have we seen? In 2023 stocks have rebounded. Bonds are still struggling a bit because the Fed is still on a very active schedule of potentially raising rates even one more time this year. It's still been a difficult year for bonds in 2023, but it's been a great year for stocks. Stocks have recovered dramatically. We don't think 60/40 is dead, whether it's 60/40 or 70/30, but what we have seen is that 60/40 or 70/30 begin to extend into more and more alternatives, specifically the private asset classes.


Q: And is that coming out of the 60 or the 40?


A: It's coming more out of the public equity side, but we see a lot of institutions taking some from public equities and some from their other bond portfolio as well. So instead of going from 60/40, they're going to 40/40/20, so maybe 20% being private capital or broadly alternatives. Some are more aggressive than that. With regard to our clients, they have a much larger allocation to privates and illiquids in their portfolio. More than 20%, and in some cases, more than 30%. And the clients that have been with us for the longest have allocations upwards of 40% into illiquids. So they're following more a model of 30/30/40.


And they've been able to then reap the rewards from what's called the illiquidity premium. So what has changed not only for CalPERS and pension plans, but also for endowments and foundations, is a higher allocation into the illiquid asset classes. And that's private equity, what used to be called buyouts, venture capital, private real estate, and private credit has grown quite a bit just in the last five to six years.


Q: So if your most aggressive clients pursuing alternatives are 30/30/40, where was CalPERS when you were there?


A: CalPERS had a much smaller allocation to privates. That was one of the things that we worked on when I was at CalPERS, was to expand our investments in private equity, private real estate — hard for a pension fund as large as CalPERS to get into venture capital. But we did add that and then started to bring in some private credit as well. But we expanded out significantly our real estate holdings and our private equity. And that was one way that we could start to capture this liquidity premium.


Maybe we should talk about the liquidity premium for a moment. If you're locking up your capital for five to 10 to 12 years in a private capital investment vehicle, you should earn some additional premium over the public equity markets. But this whole idea of what that liquidity premium is has been a best guess finger in the wind for many years. And if you would talk to consultants, and indeed back in my days at CalPERS, they say that liquidity premium is about 3% over public markets. So if you expected to earn, let's say 7% in public equities, you should expect to earn about 10% in private equity for that additional 3% premium. So here at Commonfund about four or five years ago, we sat down and decided to actually identify what that liquidity premium is, and we published a paper. Spoiler alert. The conclusion we found is that long-term liquidity premiums are about 3.5%, not too far off from what consultants have been saying for years.


Q: On private credit, talk about why these are becoming the lenders of choice, replacing the banks.


A: Well, certainly it's accelerated, the shift to private credit, as a result of Silicon Valley Bank and First Republic and other banks unfortunately going under or having to be rescued. There's even more of a pullback now by traditional banks, particularly in the middle market part of America, small- to medium-sized enterprises are the ones that are being hurt the most. So this used to be called "shadow banking." OK, it's now out of the shadows. It's in the full sunlight. It's now called private credit.


We look at the private credit opportunity set and we talk to our private credit managers; it's more robust than they've ever seen. Partly it's because of banks pulling back. Partly it's just the growth of our economy. Partly it's the growth of just the greater acceptance of private credit as a form of financing for small- to medium-sized enterprises. Now, it's fascinating when you look at private credit today, it's one of the few places where an arbitrage exists in our financial markets.


Right now with private credit, you get more than you should for investing in private credit. When you look at private credit, I'm talking now about senior secured floating rate loans, and you compare the credit quality of the underlying entity, the small- to medium-sized enterprise to whom they're lending, and you compare that with the high-yield bonds of similar credit rating, you're getting a higher return from the private credit senior secure floating rate loan compared to a similarly rated credit rated high-yield bond.


First, the high-yield bond is junior, it's subordinated debt. The senior secured floating rate loan is higher up in the capital structure. So it has less risk, it should yield less. The subordinated debt, being lower in the capital structure, being more risky, should yield more. It doesn't. Furthermore, high-yield debt tends to have fixed coupons. So they're subject to duration risk, the up and down movement of interest rates. A senior secured floating rate loan is a floating rate loan. It doesn't have duration risk. So again, a high-yield bond with the same credit rating, which is subordinated junior, unsecured, earns less than a senior secured floating rate loan. There's your arbitrage, it should be flipped around. Now, why is that? The reason for that is primarily market segmentation. The high-yield market for our high-yield bonds is primarily a retail mutual fund market.


Q: So high yield for retail, private credit for institutional?


A: In private credit, again, being private is typically a market for institutional investors. So this market segmentation of private credit, mostly for sophisticated institutional investors, and the high-yield market being primarily for retail mutual funds, creates a market segmentation that allows that arbitrage to exist. And while it exists, we tell our clients, you should take advantage of what the market's giving you in this case, an arbitrage.


Q: And what is the difference in yield?


A: It can be anywhere from 2% to 3%. Let's say if high yield's yielding 7%, we would expect private credit to yield somewhere of the range of 9% to 10%. And in fact, in our portfolio, we're looking at our private credit investments to be in the range of about 10% to 12%. That's before fees, but still net comes out 9% to 11%.


Q: You talk a lot about building a recession-resistant portfolio. What is that?


A: One of the things we talk about is the demography of technology. So when we talk about demographics, we normally think about population growth. We also think in terms of what's the long-term growth of technology because it's pervasive now in everything we do in society, whether we're talking about artificial intelligence or quantum computing, ChatGPT, big data. Several years ago, we began to invest in things called server farms, data centers. All this data has to be captured and analyzed someplace. Well, it's in a server and you've got to connect all these servers together. Where do you do that? At a server farm or a data center.


And so when we think about big data, we think, OK, is big data going to slow down or stop if we hit a recession and we agree, we're shaking our heads, we think in fact there might even be more data. Because we will have a recession to analyze. So we think big data is a trend you don't want to bet against whether we're in a boom times or bust. That's now part of our real estate portfolio, bending on this long-term trend or demography of technology, we think that is recession resistant.


Another thing we talk about, and this may surprise you, is venture capital. And people say, venture capital, gosh, that's investing in startup companies. Over the last 20-plus years, we looked at when were great companies formed, when did they get their first round of seed capital, that first round of A financing, seed or round A. And what we have found is great companies, whether it's Meta or Google or Amazon or Netflix or Dropbox or Twitter, they're formed in great times and in bad times. The bottom line is, technology, or more specifically innovation, is uncorrelated with the business cycle. It doesn't matter whether the business cycle is up or down, innovation's going to happen and these great companies are being formed and they're being seeded and venture capital is going into it in both boom and bust times.


Q: However, you prefer to invest in a certain stage of venture capital.


A: Actually, we prefer early stage over late. One of the reasons why we prefer early stages is first, we like to be on the ground and get the biggest bang for the venture buck, so to speak. And you do get that with the earlier rounds of venture, the A, B and the C rounds. The second is what you've seen coming in for the D, E, F and even G go all the way out to Z round are what are called non-traditional investors. Pejoratively they're called tourist investors. These are mutual funds coming in trying to capture some of that upside with startup companies in the final rounds of their financing, maybe the D, E or F rounds. Hedge funds also coming into the market. And that's the reason why the venture market has changed.


Q: How so?


Twenty or so years ago, it used to be a company like Google would have an A round, a B round and then go public. And so that much of the percentage increase in price appreciation for Google came when it went public. Now you have private venture companies staying private much longer.


Look at Nvidia. They're having great price gains now, but they stayed private longer than traditional venture firms. But nonetheless, we see more and more venture firms, startup companies staying private longer. Again, not just A and B rounds, but C, D, E, F and G rounds and more and more of that price appreciation being captured in the private market before they go public.

Venture capital funds are capturing more of it. And why these non-traditional investors, or the "tourist investors," are now coming into the later rounds to try and capture some of that gain before these companies go public because less of that gain is coming after they go public. So that has changed how we think about venture.


Also, secondaries, we love secondaries in every recession.


The financial crisis saw a lot of secondaries come to the market. A lot of some of the smartest investors in the world got caught in a liquidity trap and they had to sell some of their private capital investments. So when you have a recession, it tends to be that more of these private capital investments come to the market as other investors may get caught in a liquidity squeeze. And that's just a good time to buy things at a discount. And in a recession, things tend to be at even a little bigger discount. Our secondaries is a direct fund program, and we're now just finishing off our fundraising for our fourth secondaries fund, which means we'll be doing our fifth secondaries fund in the next year or so. Again, in a recession the market comes to us, discounts tend to be a little bigger. There tends to be more deal flow in a recession. So you get to pick and choose a little more. It's a good market to operate if you're a secondary player.


Q: There has been a shift out of dollars because of the U.S.-China tensions. Any thoughts on this?


A: So first it's clear China wants to make the renminbi a reserve currency like the dollar. That won't happen though until they have a fully floating currency, which they don't right now. So they're going to have to give up that and allow their currency to float freely against other currencies as opposed to being managed or pegged. Until then, it's not going to be a reserve currency. Are they willing to make that trade? And only the Chinese know that. Going back to China, putting aside the political tensions that exist between the U.S. and China and the president's new executive order, China's got some really big domestic problems. They've got to correct themselves putting aside trade wars, etc. And the biggest one they have right now, is China's the most indebted nation in the world.


When we think of what's the poster child for bad debt management in the world, we would like to think of Greece, right? Well, it's not Greece. Greece comes in third, the second most indebted nation is Japan at about 250% debt to GDP and then China is well over 300%.

The U.S. — we're at about 130%. Prior to the (2008) financial crisis, we were at about 60%. So we've more than doubled that over the last decade plus. So we shouldn't be pointing fingers at anyone, either.


Not only is China the most indebted nation in the world, they also have deflation. So if you're the most indebted nation in the world and you have deflation, that's a problem. And why is that? The reduction of prices inflates your liabilities. If you're a debtor, and most of us are one form of another, you want inflation. As a debtor, inflation erodes the amount you have to pay back in the future. You borrow today dollars worth 100, and you pay back next year dollars that are worth only 95 cents. So as a debtor, you benefit when there's inflation. When it's deflation, it's the reverse. You borrow dollars today at a 100 and you have to pay back dollars that are worth 105 next year. So deflation hurts you as a debtor. So that's the first thing, if you're the most indebted nation in the world, you want some amount of inflation. You don't want deflation in China's gut deflation.


Q: How do you invest in China? Through VC or hedge funds or directly? And what are your thoughts on Biden's executive order barring further private equity and venture capital in Chinese technology?


A: We invest through primarily venture capital partners. So when you look at our venture capital program, I'd say about 80% is domestic U.S. and about 20% is outside the borders of the U.S. So that would include Europe, Israel and China. So out of that 20%, maybe about 10% is going through our Beijing office into China. And we do, we look for good partners in China, good venture capital partners in China, and we invest through them.


Will that limit our ability to invest in China? And will it impact the investments we already have in China through our venture capital partners? I don't have an answer for you on that. We're still assessing how that will work. And the reason why we're waiting on that is we still need to see the actual Treasury rules are going to come out. We have the executive order that now has to go through the Treasury Department to actually promulgate the rules. Then we'll all have a better sense how this is going to impact us. So right now we're all waiting.

.Reprinted with permission from Pensions & Investments. © 2023 Crain Communications Inc. All rights reserved. 
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