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  2. PENSION FUNDS
July 20, 2020 01:26 PM

Texas Muni reduces downside risk during pandemic, finding opportunities now

Christine Williamson
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    T.J. Carlson
    Photo credit: Korey Howell
    T.J. Carlson

    The radical transformation of Texas Municipal Retirement System's defined benefit plan from a traditional 60%/40% indexed model to a broadly diversified investment portfolio reduced the potential damage of COVID-19 market impact on the $30.5 billion pension fund in the first quarter.

    T.J. Carlson, CIO of the Austin-based pension fund, said in an interview with Pensions & Investments that his job when he joined the fund in November 2013 was to modernize the portfolio and create a more sophisticated approach to managing the defined benefit plan. He acknowledged that he has "a fix-it kind of mentality," which suited the new job well.

    Mr. Carlson came well prepared to TMRS, which is his fourth tour of duty as a CIO and is the largest pension fund he has overseen to date. He previously was CIO at the $13.4 billion Kentucky Retirement Systems, Frankfort, and Marshfield Clinic Health System Inc., Marshfield, Wis. (the asset size for the clinic was not available). His first CIO role was at the $16 billion West Virginia Investment Board, Charleston.

    In his nearly seven-year tenure at TMRS, Mr. Carlson and his investment team, with the backing of the board of trustees, reshaped the defined benefit plan portfolio.The public equity allocation was halved to a 30% target with a mixture of active and passive strategies. Fixed income was reduced to a 30% target with 10% in core fixed income and 20% in public and private non-core fixed income, including high-yield, opportunistic, direct lending, bank loans, collateralized loan obligations and structured credit.

    Mr. Carlson said TMRS only began investing in alternative investments around the time he joined the pension fund and new target allocations of 10% each in hedge funds, real return, real estate and private equity were added. Investments and commitments in the first three alternative categories are at or near their target allocations, but private equity was only at 3.5% as of March 31.

    "Our asset allocation is a little different than other funds with 30% in equities, 20% in non-core fixed income and big chunks of private equity, real assets and other alternatives," Mr. Carlson said.

    "The asset mix has helped us hit our 6.75% assumed rate of return over 10 years," he said, adding that the combination of "a lot less equity risk and forward-looking volatility of 9% compared to 12% for most public pension funds created downside protection for the portfolio."

    TMRS' net return in the quarter ended March 31 was -8.6% compared with median returns of -12.5% to -13% for other pension funds, Mr. Carlson said, adding that TMRS outperformed the median pension fund return by 400 basis points in the quarter.

    "The first quarter of 2020 was the proof in the pudding. The asset allocation worked phenomenally well in the quarter," he said.

    See more of P&I's coverage of the coronavirus

    As for prepping to take advantage of investment opportunities in global markets ravaged by COVID-19, TMRS already had cash on hand prior to the pandemic outbreak.

    The pension fund's staff began to amass cash in 2019 because "we thought everything was overpriced. We were overweight in public equities and we kept reducing the allocation to take gains until we had $1 billion in cash, about 3% of plan assets," Mr. Carlson said. "Having cash was good and very helpful" to capitalize on swift-moving opportunities, he said.

    For example, hedge fund managers that had closed funds reopened some to additional and investments and TMRS increased its positions in several firms, Mr. Carlson said. The pension fund also made four co-investments in hedge fund firms set up to accommodate niche-play investments.

    TMRS also made new commitments to private equity funds and co-investments and acted on some opportunities in public equity strategies.

    Mr. Carlson declined to name the managers and strategies in which TMRS invested.

    The team also took a look at TALF funds tapping the Federal Reserve's new Term Asset-Backed Securities Loan Facility and decided against investing this time around, Mr. Carlson said, stressing that "there was too little bang for the buck."

    Regarding credit, Mr. Carlson said his team sees "really strong — probably the best — opportunities in private credit, but we likely will only invest with existing managers."

    That's because TMRS' "differentiated" manager due diligence process has already filled the pension fund's manager pipeline likely through the end of 2020, Mr. Carlson said.

    "Our team meets with 1,500 managers a year," he added. "It typically takes between 12 and 24 months before we hire a manager because we want to get to know these managers very well."

    Given market conditions, Mr. Carlson said the TMRS team likely will be paying close attention to smaller, niche investment opportunities in private credit because "managers can't raise a $4 billion private credit fund now, but they could raise a $400 million fund."

    It was obvious during the interview that Mr. Carlson is passionate about what he does for a living, but he said in conversation that he loves his job.

    Despite COVID-19-induced market turmoil in the first quarter, an investment team of 26 that has been working remotely for more than four months and keeping the board of trustees apprised about the health of the retirement system's defined benefit plan, Mr. Carlson said he's ready "to meet a different challenge every day," noting "it's really a labor of love for me. It's very rewarding to work for a public pension plan that will help nearly 200,000 people have a good retirement."

    TMRS employees are scheduled to work remotely through Aug. 31, but Mr. Carlson said a more realistic timeline likely will be September at earliest.

    Mr. Carlson said home-based management of the defined benefit plan has worked well, and the investment team continues to recruit new employees remotely.

    But he added that "this is the part I worry about, our culture. It's hard to bring new people into the fold to learn about our culture and methods and to get them into the debate about investments. The lack of ability to mentor people in person if this situation drags on will make it harder to continue to foster our culture. It's really a critical factor for us."

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    October 23, 2023 page one

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