Oregon seeks to embark on a big overhaul

Oregon Investment Council officials will know in a few months whether the state Legislature will allow the state treasury to add investment staff, the latest stage in the council's plan to derisk its portfolio, beef up oversight and lower costs.

Among the changes made or planned by the Tigard-based council that invests on behalf of the $70 billion Oregon Public Employees Retirement Fund:

• shifting more of its $13.7 billion fixed-income and its $37.7 billion equity portfolios in-house, while transferring high-yield, loans and unconstrained mandates from the fixed-income portfolio to private equity;
• continuing to reduce the equity risk from its portfolio;
• restructuring its $8.7 billion in real estate investments;
• integrating environmental, social and governance factors into the investment process; and
• planning advance strategic partnership discussions with one or more key general partner/money manager relationships.

But these moves are all dependent on the Legislature approving the hiring of 35 new investment staff. A decision is expected by July 10.

Oregon is embarking on this mission with new state Treasurer Tobias Read and a number of other relatively new members on the six-person council. The longest-serving member is its chairwoman, Rukaiyah Adams, who has been on the council since 2013.

In Oregon, the Public Employees Retirement Fund's investments are managed by the state treasury under the council's direction. A separate pension fund board manages the benefits and the Legislature has oversight, including power over the budget.

“We need more staff ... that is part of my effort in the Legislature,” Mr. Read said in an interview.

The council is exceedingly understaffed, even by public pension plan standards, he said. Oregon was the 14th largest public pension fund in the U.S. as of Sept. 30.

For example, the plan, an early adopter of private equity investing, has two investment professionals, a third position is vacant, running its $13.9 billion private equity portfolio. The $8.7 billion real estate portfolio is run by two investment professionals, and a vacant position as well.

By comparison, the $202.1 billion California State Teachers' Retirement System, West Sacramento, has a staff of 20 investment professionals running its $16.2 billion private equity portfolio, said Ricardo Duran, CalSTRS spokesman in an email.

Mr. Read said adding new investment positions would reduce costs.

“If we have the talent, we will be able to make the decisions better,” said Mr. Read, who served in the Oregon House of Representatives for 10 years before he was elected treasurer last year.

Former Treasurer Ted Wheeler tried unsuccessfully for more than four years to get the Legislature to create a new agency that would manage the pension fund and other state investments instead of the treasury. The move would have moved much of the state's investments in-house. The bills in the latest attempt were co-authored by Mr. Read last year.

Mr. Read is optimistic he will be able to boost the investment staff, noting improvements that were made under Mr. Wheeler.

“We are focused on making sure the positions are added and we are exploring steps to remove the political elements,” Mr. Read said.

The treasury did get approval in 2015 to add back-office staff and use BlackRock's Aladdin system, which gave it the capacity to manage investments in-house and to better monitor investments by external money managers. The additions increased the treasury's investment staff to 30 from 20.

Bringing more passive and “plain-vanilla” strategies in-house would cut costs, said John D. Skjervem, chief investment officer for the Oregon State Treasury.

“We don't aspire to be Canadian,” he quipped referring to the large Canadian pension plans that internally manage the majority of their investments. “We can insource plain vanilla, where there is not a lot of skill required. We have a competitive advantage with passive, plain-vanilla mandates.”

Internal management was contingent on having a risk management and operations system such as Aladdin, he said. That investment paid for itself right away by discovering the council had underreported $800 million in assets.

Oregon is not alone in moving more investments in-house as a way of reducing fees. In January, the $313.2 billion California Public Employees' Retirement System, Sacramento, began developing plans to shift as much as $30 billion to staff from external managers. CalPERS now manages roughly 70% of its assets in-house. The State of Wisconsin Investment Board, Madison, which oversees the $96.4 billion Wisconsin Retirement System, now manages 64% of its assets internally, up from 51% in 2011. SWIB has an investment staff of 160.

CalSTRS has a strategic plan to bring 50% of its passive assets in-house over the next three years, Mr. Duran said in a separate email. As of January, CalSTRS managed 46% of assets internally; over the past year, CalSTRS brought a $13 billion passively managed global equity portfolio in-house. Long term, CalSTRS officials plan to manage 60% of assets internally, he wrote.

In March, the Oregon council voted to shift a slice of the pension fund's $13.7 billion fixed-income portfolio — the $5.08 billion government bond portion — to staff management. It moved $1.2 billion of its $26.3 billion equity portfolio in-house last September. That global equity ex-U.S. risk premium strategy came on top of $5.2 billion in equities already run internally.

“We're not interested in taking in anything that would require higher-priced talent,” Mr. Skjervem said.

Mr. Skjervem added the treasury does need more investment officers to monitor its private markets portfolios — private equity, real estate, infrastructure, minerals and mining, agriculture and a few liquid hedge fund portfolios, which combined account for about 40% of assets.

“We have the oldest public pension fund private equity portfolio in the world and we have two people for that,” Mr. Skjervem said.

Oregon's small staff is one reason it has not done that many direct or co-investments, Mr. Skjervem said.

“We've done co-investments very selectively, very deliberately,” he said. “We have done some direct investment. We may do some more.”

At the same time, Oregon is taking steps to pull out the equity risk from its entire portfolio.

It took loans and high-yield investments out of its fixed-income portfolio and moved those strategies into its private equity portfolio.

The council also has been rolling back its private equity target allocation to 17.5% from 24%, starting in 2012.

“We are slowly but deliberately reducing private equity to 17.5%, but at the same time we are bringing down the roster of active relationships from 80 to 50 ... we had 300 investment portfolios and 80 active relationships with three people (to oversee it all),” Mr. Skjervem said.

Oregon now has 55 active private equity manager relationships. Oregon is also “writing bigger checks,” he said. The average commitment now is now $250 million, up from $75 million. Yet some of the state's bigger managers are getting smaller commitments than they had in the past — $500 million rather than $1.5 billion — while some smaller managers are getting a boost in commitments.

Oregon, along with Washington State Investment Board, is among the largest private equity investors, by percentage of assets, of large U.S. public pension funds, Pensions & Investments data show.

“We're delinking from the great state of Washington,” Mr. Skjervem said. “You guys are on your own ... We liberated a lot of equity risk.”

Oregon is also in the midst of restructuring its real estate portfolio to focus on core real estate by investing in open-end diversified funds and making select reinvestments with existing real estate managers. It is derisking its $1.7 billion value-added holdings, seeking selective separate accounts, while reducing its $2.3 billion opportunistic and $2.1 billion real estate investment trust sleeves.

Mr. Skjervem, who is fond of referring to the pension plan's portfolio as a rock band, said Oregon officials are returning real estate to its bass guitar role.

Both Messrs. Skjervem and Read noted treasury officials are moving toward measuring ESG factors as investment risks.

That move is part of the treasury's goal of improving its job of measuring the pension fund's long-term performance in a more comprehensive way, Mr. Read said.

The treasury has not had the capacity in the past to measure ESG factors on a total portfolio and asset class by asset class basis. Now, with Aladdin and the hoped-for extra staff — including a dedicated ESG investment officer — officials see that changing.