The North Dakota State Investment Board is moving to harness the fast-paced growth of the state’s institutional investment pools to build advanced in-house asset management capabilities in Bismarck.
Scott M. Anderson, the State of Wisconsin Investment Board veteran who joined North Dakota as chief investment officer in 2022, said that effort could see the internally managed portion of the $22 billion in assets the State Investment Board oversees on behalf of 31 state clients go to as high as 50% from zero over the coming five years or so.
An ambitious goal, perhaps, for an organization that didn’t have a governance committee as recently as five years ago, but not necessarily out of place for one whose tagline is “Be Legendary,” and whose executives talk about pursuing “big, hairy, audacious goals.”
Anderson paints SIB’s plan to build out internal capabilities now as a natural rite of passage in the life of a public fund.
“When you get past around $10 billion of assets under management, you start to unlock scale economies,” and SIB’s board “recognized that the plans in our care had grown to a size where we could update our governance and move the program forward,” Anderson said in an interview.
The State Investment Board, with only $4 billion in public funds as of 2010, saw its asset growth accelerate markedly that year with the launch of North Dakota’s Legacy sovereign wealth fund, set up to provide a long-term source of funding for the state from a 30% share of annual taxes on petroleum produced and extracted in North Dakota.
With transfers now of between $850 million and $900 million a year, the Legacy Fund’s $10.9 billion in assets as of June 30 are expected to grow to more than $20 billion over the coming decade, Anderson said.
"We're kind of at an inflection point in terms of scale and complexity," with an opportunity to increase return, reduce risk and lower costs, Anderson said in a Sept. 27 presentation to the SIB board.
Other billion-dollar pools SIB oversees include the $4.3 billion North Dakota Public Employees Retirement System, the state’s $3.3 billion Teachers’ Fund for Retirement and the $2.1 billion Workforce Safety & Insurance fund.
The two big pension funds, together with five smaller ones, including municipal funds for Bismarck and Grand Forks, have combined retirement assets of just under $8 billion, with 80,000 active and retired members and beneficiaries, an SIB spokeswoman confirmed.
As of June 30, the Legacy Fund had allocations of 32% to U.S. large-cap equity, 30% global fixed income, 23% international equity, 5% diversified real assets, 4% each real estate and in-state investments and 2% U.S. small-cap equity.
The two large pension funds, meanwhile, have higher exposures to alternatives, even as SIB is poised to raise the Legacy Fund's alternatives holdings going forward.
PERS, as of June 30, had 31% allocated to domestic equity, 24% domestic fixed income, 19% international equity, 10% real estate, 9% private equity, 6% to infrastructure, and 1% each to timber and cash. The Teachers' Fund had 27% domestic fixed income, 26% domestic equity, 16% to international equity, 14% to private equity, 9% to real estate, 6% to infrastructure, and 1% each to timber and cash.
In other news on the state’s retirement landscape, the North Dakota Legislature voted last year to close PERS to new public employees and launch a defined contribution plan for them in its stead, effective Jan. 1, 2025.
That won’t make PERS a lesser priority for SIB, Anderson said, noting that “typically, for a plan that’s closing like that, it remains a risky plan for 10, even 15 years because you still have existing beneficiaries … making contributions.”
Preparing in-house capabilities
For now, Anderson said, laying the groundwork to begin bringing some asset management in-house over the coming year has included establishing committees to oversee governance, investments and compensation while hiring key investment professionals.
Anderson said the plan he presented to the board in August 2022 envisioned three phases — with the first, focused on an initial 15% of portfolio assets in enhanced stock and bond index strategies as well as cash management strategies and the second, covering an additional 15% of the portfolio in rules- or factor-based portfolio strategies, seen as “low hanging fruit.”
That first 15% is a “slam dunk because it’s doing the same things we’re already doing in the portfolio” at lower cost while giving SIB’s team added flexibility in areas such as efficiently rebalancing the portfolio, Anderson said.
That foothold for in-house capabilities will set SIB on a path to evolve from an organization reliant on external providers to “an advanced funds management organization,” yielding around $16 million in annual savings despite the addition of five new investment team members the Legislature approved for phase one, Anderson said.
The five, who have yet to be hired, will expand the size of SIB's investment team to 13 full-time employees.
Internal capabilities for enhanced indexing and cash management will give SIB’s investment team “the opportunity to overlay our cash with an exposure like our asset allocation,” eliminating leakage of returns, while using futures to rebalance more efficiently, he said.
Relying on external managers to rebalance SIB’s equity and fixed-income exposures could cost SIB 15 basis points and 25 basis points, respectively, Anderson noted. The costs of using internal overlays, by contrast, would be closer to 2.5 basis points, dramatically lowering “our costs for these plan level operations,” he said.
Phase one should be completed by 2025, Anderson said.
Likewise, the rules-based active strategies to be brought in-house next under the second phase are sufficiently commoditized to allow SIB to achieve returns similar to what it’s currently obtaining from those strategies at lower costs, he said.
That second phase — for which SIB will seek legislative approval for five additional hires — should be completed around the first half of 2027, Anderson said.
Phase three
The final 15% to 20% of the portfolio with the potential to be brought in-house under phase three — which would bring SIB’s internal investment team into direct competition with external managers in certain market segments — will be “much more challenging,” Anderson conceded.
For that last 20%, which the team will likely begin to grapple with four or five years from now, “you have to take a serious look because then you’re investing in very specialist resources,” such as a small-cap equities team, he said.
Of course, Anderson noted, it can be — and has been — done by, among others, including the $130.9 billion State of Wisconsin Investment Board, where he served as managing director of asset and risk allocation for the five years through late 2018.
Getting there requires building a first-rate investment team and an “analyst-driven culture that’s more focused on managing the fund from within,” prioritizing areas such as asset allocation and optimizing risk-return outcomes, Anderson said.
Anderson said he’s optimistic he'll be able to assemble that kind of team in Bismarck, taking a “remote hybrid” approach, with younger professionals — who will ultimately be the keepers of the organization’s cultural flame — working in the capital even as more senior professionals may opt to work remotely, Anderson said.
SIB’s latest hire — Chirag Gandhi, a 24-year SWIB veteran who joined SIB in September to head North Dakota’s internal fixed-income team — is a case in point, a “very skilled active investor … and standout leader,” who will remain based in Madison, Wis.
Anderson said forging an advanced fund management team capable of bringing sophisticated strategies in-house will be a compelling opportunity — “something really cool to work on because we’re building something. We don’t have this 30-year-old system we have to tear down to build something new,” he said.
