While growing up in Lowell, Mass., Timothy Walsh received an early education in finance. His next-door neighbors taught him to read the Wall Street Journal “when I was in the single digits.” He received an early introduction to the business world while in high school and college, working for seven years part time as an assistant service manager in the auto department at a Sears, Roebuck & Co. store in Lowell. “I knew nothing about cars,” he recalled. “It was still probably the best job I ever had, dealing with the public, dealing with a lot of personalities from high school-dropout mechanics to the president of the company, to Ma and Pa Public paying to get their brakes fixed.”
Mr. Walsh said the Sears job was tied, in terms of difficulty, with his current job — chief investment officer for the $72.6 billion New Jersey pension system and director of the Division of Investment for the New Jersey Department of the Treasury, Trenton. During the years between Lowell and Trenton, Mr. Walsh has had a varied financial career — a trader in fixed-income securities and foreign securities for several banks, owner of his own investment advisory firm and director of investor relations at a hedge fund. Before taking the New Jersey pension CIO job in August 2010, he was chief investment officer for the Indiana State Teachers' Retirement Fund, Indianapolis.
Mr. Walsh became interested in public-sector pension systems after having served as a trustee for the now-$9 billion Indiana fund from early 2005 to mid-2007.”I was intrigued by it,” said Mr. Walsh, who became the Indiana fund CIO in May 2008. The big difference between the two pension systems — aside from asset size — is the style, he said. The Indiana system relies on outside managers; the New Jersey system relies almost entirely on internal managers. The internal management approach “is the reason why I came here,” he said. “That's also the most difficult part of the job.”
In the Indiana system, if an outside manager was doing poorly, the manager was terminated. “You don't have that luxury here,” he said. “There are no excuses.”
The New Jersey pension fund now is authorized to invest as much as 38% of its allocation in alternatives. How do you plan to achieve that? The big picture is why do pension funds look at alternatives. They don't want to be only in long-only domestic (equities) and long-only international (equities) and long-only fixed (income). They want diversification. They want to reduce their risk, keep their returns up or possibly increase it. In the big picture, they want to have less correlation with the S&P 500; we happen to use the S&P 1500. That's a generalization. Some plans have no hedge funds and huge allocations to private equity; others have two or three times the amount of money in real estate as we do. Different people look at it differently.
What's your alternatives strategy? Right now, we're at about 17% (of assets in alternatives). The regulatory cap is 38%. The concept is flexibility. It's a long-term target. ... The other part, which I think people don't give it credit for, is alternatives allow you us to do things that we can't just do internally.
What can't you do? In New Jersey's case, we can't sell stocks short. I'd like to. Maybe at some point we'll get the regulations changed, but we can't do that. I cannot invest in whole loans — distressed whole loans. I don't have the staff for it. I don't have the expertise for it.
A few months ago, New Jersey announced a reduction in fees — cumulative savings of at least $40 million over five years — paid to managers of alternative investments. What went into that decision? Like any CIO you want to get the lowest fees you can, but I really want people to focus on return. You can make a lot more on the return making 200 basis points than saving 2 (basis points). The first thing we did: We started going through our private equity fund of funds and our hedge fund of funds. Like everyone else who got into alternatives, usually the first way you get into alternatives is through a fund of funds. It's the safest way to get the staff up to speed on how hedge funds work and how private equity funds work. ... We've grown up quite a bit. Our alternatives program is fairly robust size-wise, about $12 billion right now. The question now is do we really need that much fund-of-fund exposure. We had negotiations with I think all of them; there might be one or two still ongoing. We say: “This is what we want to do with the fund of funds. You've been with us since 2005 or 2006. This is how we want to change the portfolio.”
What's your approach with traditional asset classes? I'm a big lover in just basic domestic U.S. high-quality multinationals. We're overweight in domestic equities. That's by design. We are trying to bring down our exposure in fixed income. ... We have brought the fixed-income portfolio duration down 25% to 30% from approximately 12 years duration over the last six months.
What are some of the changes you have made since you became CIO? We've spent a lot of time with risk. We've started trading futures to hedge our duration of fixed income. That's one way we were able to get our duration down so quickly. We try to have a weekly risk meeting, and we look at what risk is going from the international, from fixed income, from equities, from commodities, etc., and where we might take some exposure off.
What investments may have run their course? We have become concerned about the high-yield markets and the large inflow of money into the asset class, especially on the retail side. In addition, I'm personally skeptical of the future near-term returns of core real estate, especially relative to the risk-reward returns of opportunistic real estate. I'm also pleased to see many public funds are doing the opposite and emphasizing core over opportunistic (real estate).
What investment areas are you exploring? We're much more active in the IPO market. We try to use our size to benefit our interest in initial public offerings. ... As far as venture capital, we have been historically underallocated. This has been a good decision in the past. With institutions pulling back from venture capital, I believe it's a very good time to look at the asset class. Historically, the best returns from venture capital have come from time periods when little institutional money is going into venture capital. ... We are long-term investors. Upper-quartile venture capital firms have historically provided quality returns for long-term investors.
How does the underfunding of New Jersey's pension system affect your investment strategy? Theoretically, we only look at the left side of the balance sheet, but we're not blind. We know there's this other side of the balance sheet — the liability side. When someone comes in with an investment proposal, and there's an eight-year term or a 10-year term, it's always in the back of my mind.
How worried are you about inflation? As a general rule, I'm a personal skeptic of inflation in the U.S. over the long term. ... However, if the world markets ever lose confidence in the U.S. dollar, all bets are off. n