Lone Star fund breaks new ground

AUSTIN, Texas — The $115 billion Teacher Retirement System of Texas intends to hire several large money management firms that will run large, broad global mandates in a hunt for higher returns.

These strategic partnerships will give the pension fund access to capacity-constrained strategies and early access to those under development, said trustee Dory Wiley.

“It’s groundbreaking for a public plan,” said one industry source familiar with TRS, who asked not to be identified. Texas Teachers is believed to be one of the earliest U.S. public pension plans to establish such partnerships with managers.

Some U.S. corporate pension plans have had partnerships for more than a decade. In fact, T. Britton Harris IV, Texas Teachers’ chief investment officer, was with GTE Corp.’s pension fund in 1995 when officials there set up similar arrangements with Grantham Mayo Van Otterloo & Co., Goldman Sachs & Co., J.P. Morgan & Co. and Morgan Stanley & Co.

Mr. Harris declined to be interviewed for this story. But in an e-mail, Texas Teachers’ spokesman Howard Goldman said fund officials will select between three and six “of the world’s most effective, compatible and highly resourced investment organizations” to run global multiasset portfolios of roughly $1 billion each. Fund officials also will create three “micro-level” partnerships, in which the manager focuses on a single strategy such as global tactical asset allocation, absolute return, private equity or real estate, according to Mr. Goldman’s e-mail. It is not known how much each of the micro-level firms will manage.

Texas Teachers officials have winnowed a list of 13 candidates for the global mandates to a list of six finalists. Mr. Goldman declined to say who the finalists are.

The search will be discussed at an April board meeting, Mr. Wiley said. He said it was not certain whether the board will vote to hire firms at that time.

One consultant, who asked not to be named, said Boston-based GMO is a likely candidate. “Ben Inker (director of asset allocation at GMO) is well-respected in the asset allocation space,” the consultant said. “They’ve done a good job of walking the walk.”

BlackRock Inc., New York, reportedly is one of the finalists, although BlackRock officials would not discuss the issue.

The performance of the multiasset-class managers chosen by Texas Teachers will be benchmarked against the performance of the target asset allocation of the fund’s total portfolio, a source said.

According to a Texas Teachers document, multiasset managers will make bets based on the fund’s customized asset mix and using high alpha products and ideas.

“You have to make a conscious decision on where to make the weights and underweights, and use a global tactical allocation overlay with macro views on top of it,” the source said.

Money managers may use their own views on currencies, timing and individual equity and bond markets to add value to their portfolio, as long as they stay within the set tracking error relative to the fund’s overall asset allocation, industry sources said.

As part of the arrangement, TRS executives could ask the managers to research certain ideas or investment themes, Mr. Wiley said.

Texas Teachers officials would also get to look under the hood at some of the new research and development projects the manager is working on and would gain early access to those projects.

“The best scenario from a money manager’s perspective is the research project they work on together can result in an investment vehicle and the sponsor can participate in that vehicle,” the source said. “That sponsorship becomes a possible way to incubate new ideas.”

Some consultants question how beneficial these partnerships are to managers, however.

“What innate advantage does a typical asset management firm have across several different asset classes vs. a specialist?” asked Carl A. Hess, practice leader of the Americas for Watson Wyatt Investment Consulting, New York.

Mr. Hess agreed that getting early access to these strategies is an advantage for an institutional investor. And strategic partnerships allow the money manager to implement a new idea much faster, he explained.

The question is, “who is going to navigate that internal competition for ideas” at the money manager, Mr. Hess said. He points out that there could be internal “political temptation” to dole out the assets to different investment teams. “What does that say to the organization if you give it all to one part of the company?” he asked.

While rare among public funds, other institutional investors have used this approach.

General Motors Corp., Detroit, awarded similar broad mandates that stretch across different asset classes to managers in 2004, said Nancy Everett, chief executive officer of General Motors Asset Management in New York, which oversees GM’s $110 billion in defined benefit assets.

Six different managers have broad investment mandates with GMAM. But instead of setting the managers’ benchmarks around the performance of the total fund’s target allocation as TRS is proposing, GMAM’s first guideline is that each manager should reduce volatility in the fund’s surplus.

Lower chance for loss

The managers are encouraged to generate high returns, but “generally over five years you want (the manager) to lower the probability of a loss to zero,” Ms. Everett said.

While refusing to speak about the TRS partnerships, Dan Waters, managing director and co-head of the global portfolio solutions group at Morgan Stanley Investment Management, New York, said his group has a number of these relationships with corporate pension funds and sovereign wealth funds.

Barbara Novick, a vice chairman for BlackRock, said her firm has several partnerships similar to the partnerships TRS is seeking with managers.

Mr. Waters said he expects more U.S. public plans to pursue these relationships.

“These public funds aren’t just competing against each other,” he said. “They’re competing against sovereign wealth funds and other large pools of money for access to the best investments and the best investment talent. These partnerships are a way to do that.”