This is a Deep Dive with Damon Krytzer, Trustee, the City of San Jose Police and Fire Retirement Plan.
Damon Krytzer is a senior consultant with Park Alpha. To learn more about consulting opportunities, please contact firstname.lastname@example.org.
1. Regarding asset allocation, given today’s investment climate what are some key points that public investors such as sovereign wealth funds and public pension funds need to keep in mind?
First that the assumptions used in portfolio construction are much more dynamic than those used in developing the strategic allocation; specifically cross-asset correlations and volatilities of reference asset classes. It is also important to consider that returns are not normally distributed. There are many ways for an investment to reach a long-term return number. Some assets or managers reach that with consistent returns and small tracking error, while others have very fat tails – fewer big years and some large drawdowns. Ultimately the same number, but extremely different investor experience. Frankly neither is right or wrong in itself, but the portfolio construction process, especially within sub-asset classes such as structured credit for instance, must blend sources of return to reduce the overall portfolio volatility.
2. What is one of the most important points you’ve learned as a trustee at the San Jose Police & Fire Retirement Plan when it comes to making investment-related decisions?
That in light of the extremely high transparency of our portfolio it is critical to communicate with the public often, and in terms that are understandable to an audience wide in sophistication level. We of course base decisions on probabilities rather than on certainty. Sometimes outcomes are on the wrong side of these probabilities, or may take multiple reporting periods to work out. At these times, we must be consistent in communicating, and must assume that our reporting can easily be shown out of context in the media. This of course works in both directions when our timing is simply spot on, or just plain lucky as well. Sometimes the weatherman says that it is likely to rain, but there is nothing but sun all day. Again, decisions based on probabilities and past heuristics are just that, and need to be discussed in this context.
3. With regard to recent asset-liability studies, should public investors begin a more tactical approach or stick to the long-term strategic plan?
At the total portfolio level, long term decisions are quite important assuming that they express well-defined goals set out in the IPS. It may be a spending policy, or a pension obligation, or simply a return target. In most cases this should be the focus of the policy allocation. That said – creating rules from which to operate a tactical decision-making process are critical as well since the world is extremely dynamic. To me, tactical decisions, at least in the pension context, are not return seeking but rather should be in place to smooth the volatility of our assets in light of our liabilities. They may be defined by a risk budget assuming the fund has a strong risk reporting process, or may be tactical based on other factors. On the other hand, within asset classes there is more room for alpha opportunities. In credit for instance, managing allocations to and from opportunity sets such as RMBS or spread products are effective because they are highly specialized. In hedge funds, assuming you consider that to be an asset class in itself, increasing allocations to CTA’s or multi-strategies would be tactical alpha examples.
4. What massive risks are not being taken seriously enough by public funds?
How quickly movements in volatility can be expressed in seemingly steady assets. A large volatility spike can effect asset pricing, market perceptions, and unfortunately cannot be hedged through diversification as we witnessed during the big risk on-risk off swings a few years ago. There is an active movement to rely on strategies like risk parity or convex investment programs to inherently respond to this type of spike, regardless of the root cause. This is of course appealing since the structure can be explained, and my statement isn’t a judgment on these strategies, but I fear that it is luring many market participants into a false sense of security – not only in the volatility exposures, but also in uncompensated risks such as the recent increase in interest rates. We saw in some cases a 4% decline in risk parity strategies with a 40bps increase in rates, and this risk is not one that adds to the returns otherwise.
5. What safe havens exist to public investors when navigating through today’s regulations and policies?
I don’t think there is a single safe haven. We make decisions to meet our fiduciary duty, but with the speed of regulatory changes in today’s environment, and the actual and perceived funding gaps that exist, nothing is a given. Rather, we do have a defense in the courts. When we are considering the impact of a regulation or a measure, our first instinct is to ask the courts for direction. Our first job is to manage assets in the most appropriate way for our constituents. That said – we must do so within an ever changing regulatory environment that often conflicts with itself. Our choice is to turn to the courts for these decisions where appropriate and to focus our opinions within the scope of our appointed task.
6. Throughout the last couple of years, you’ve had the opportunity to meet with some of the most renowned public investors in the world and listen to their presentations. Are there any re-occurring themes that challenge the global market?
The challenges aren’t so much about the global markets, but I do see recurring themes about how to access and compensate for alpha. On one hand we have the notion of Smart Beta; a rules-based blend of active and passive management. This could include timing, or diversification rules through a correlation budget, or as a regime-oriented weighting scheme for example. Institutions have paid for this through alpha performance fees in the past but some asset owners are building these rules internally as directed beta. Another theme is to invest with a focus on risk factors, and in effect to think in terms of the economic regime rather than in diversification between asset classes in themselves. This is a work in progress, but I do like the trend in thinking about investing based on risk and return drivers in the context of economic assumptions.
7. At the Institute Fund Summit held in Frankfurt this October, we will be hosting quite a few central bank governors discussing the situation in Europe, is there anything in particular you hope they discuss while you are there – and why?
There is of course an inherent difference in how the U.S., Asia and Europe have addressed the so called crisis. Our timeframe is frankly too short to accurately judge which program is more effective, although there are many lingering issues that remain in Europe both on balance sheet quality and on economic growth that I hope to hear addressed. In particular, I would like to hear perspectives on where growth will come from, and whether individual decision makers are weighting growth as a tool to recovery versus as a consequence of other systemic measures.
8. What can Europe learn from the rest of the world?
This is something that we continue to debate in this country as well; that growth is a critical component of a sustained recovery. Yes, it is important to sure-up balance sheets and to deal with systemic issues, but without wage increases and incentives for growth you likely end up with a weakened economy well into the future. It seems that Asia is the other extreme in some ways, focusing attention on growth initially, and now forced to address asset quality, social safety nets and other structural issues at a very rushed pace. It is an exciting time to work in the financial markets right now.
9. Recently, African countries seem to be rising up in the sovereign wealth environment; any words of insight could you offer to a future wealth fund or a newly established fund?
For there to be a focus on governance and sound decision making process early on. These issues are critical in the sustainable success of an investment program for so many reasons, and extremely difficult to change down the road.
About Damon Krytzer
Damon Krytzer is a senior consultant at Park Alpha and has been involved in the global capital markets for 18 years, with experience in asset management and trade execution. Damon ran a global tactical asset allocation portfolio, founded a trading desk to manage concentrated equity transactions, and managed a pool of emerging markets rates and currencies. Damon’s professional experience includes roles with Oppenheimer & Company, UBS Financial Services and Prudential Securities.
Damon is active in advising board trustees on alternative investments portfolio construction. In addition to his role at Park Alpha and Waverly Advisors, Damon serves on the boards for The City of San Jose Police and Fire Retirement Plan, R2 Alpha Fund Management, a private equity portfolio investing in infrastructure, and ERNY Financial, developing products to invest in earnings rather than equity share price. He is a CFA Charterholder, adjunct professor for alternative investments at the University of San Francisco Business School, holds MBA degrees from Columbia Business School and the University of California Haas School of Business, and studied political science at Rutgers University.
Yu Ben Meng, the new Chief Investment Officer of the California Public Employees Retirement System (CalPERS), detailed a picture on why the institutional investor needs to augment its allocation to private equity. [ Content protected for Sovereign Wealth Fund Institute Standard subscribers only. Please subscribe to view content. ]
The U.S. Federal Reserve board released minutes from its January 2019 meeting. There was a split among board members whether any interest rate increases would be necessary for this year. In addition, these officials chatted about ceasing the reduction of bonds on the central bank’s balance sheet before the end of 2019. Board members are keeping an eye on the stock market and current credit spreads. The Federal Reserve started reducing its bond portfolio in October 2017, a measure of quantitative tightening (QT). The US$ 3.8 trillion pool of bonds held by the central bank’s balance sheet is a topic of concern for U.S. fixed income investors.
Minutes of the Federal Open Market Committee
January 29-30, 2019
An excerpt from the minutes details that “Participants commented that, in light of the Committee’s longstanding plan to hold primarily Treasury securities in the long run, it would be appropriate once asset redemptions end to reinvest most, if not all, principal payments received from agency MBS in Treasury securities. Some thought that continuing to reinvest agency MBS principal payments in excess of $20 billion per month in agency MBS, as under the current balance sheet normalization plan, would simplify communications or provide a helpful backstop against scenarios in which large declines in long-term interest rates caused agency MBS prepayment speeds to increase sharply. However, some others judged that retaining the cap on agency MBS redemptions was unnecessary at this stage in the normalization process. These participants noted considerations in support of this view, including that principal payments were unlikely to reach the $20 billion level after 2019, that the cap could slightly slow the return to a portfolio of primarily Treasury securities, or that the Committee would have the flexibility to adjust the details of its balance sheet normalization plans in light of economic and financial developments. Participants commented that it would be important over time to develop and communicate plans for reinvesting agency MBS principal payments, and they expected to continue their discussion of balance sheet normalization and related issues at upcoming meetings.
Following the discussion, the Chairman proposed that the Committee communicate its intentions regarding monetary policy implementation and its willingness to adjust the details of its balance sheet normalization program by publishing a statement at the conclusion of the meeting. All participants agreed with the proposed statement.
STATEMENT REGARDING MONETARY POLICY IMPLEMENTATION AND BALANCE SHEET NORMALIZATION
(Adopted January 30, 2019)
After extensive deliberations and thorough review of experience to date, the Committee judges that it is appropriate at this time to provide additional information regarding its plans to implement monetary policy over the longer run. Additionally, the Committee is revising its earlier guidance regarding the conditions under which it could adjust the details of its balance sheet normalization program.5 Accordingly, all participants agreed to the following:
The Committee intends to continue to implement monetary policy in a regime in which an ample supply of reserves ensures that control over the level of the federal funds rate and other short-term interest rates is exercised primarily through the setting of the Federal Reserve’s administered rates, and in which active management of the supply of reserves is not required.
The Committee continues to view changes in the target range for the federal funds rate as its primary means of adjusting the stance of monetary policy. The Committee is prepared to adjust any of the details for completing balance sheet normalization in light of economic and financial developments. Moreover, the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.”
Led by Masayoshi Son, Japan-based SoftBank Group Corporation continues to run the gargantuan Vision Fund scooping up exciting technology investments, both big and small globally. Armed with a roughly US$ 100 billion warchest, the Vision Fund has been disrupting both suppliers of capital and the industries that receive it. Are the big-money limited partners of the Vision Fund the technology backers of last resort? Two of the major backers of the Vision Fund are Saudi Arabia’s Public Investment Fund and Abu Dhabi-based Mubadala Investment Company. SoftBank has invested billions into tech companies like Compass, Katerra Inc, WeWork Cos., Coupang, DoorDash, and Uber Technologies. For example, a beneficiary of the Vision Fund, Katerra is a manufacturer of modular building parts, in which many people question the company’s profitability and business model. Uber is driving toward its initial public offering. SoftBank recently participated in an investment round in Clutter, a storage company.
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