Every five years or so $27 billion Nebraska Investment Council, NIC, conducts a deep dive, or what state investment officer Michael Walden-Newman terms a blank sheet approach, into one of its three main portfolios.
The process, currently underway in the 30 per cent allocation to fixed income, involves inviting up to 25 current and potential external managers to Lincoln to pitch their best ideas, particularly seeking out contributions from researchers and analysts rather than portfolio managers who usually meet the asset owners.
“It’s fascinating, free advice. We are one of the few that do this,” says Walden-Newman who observes Lincolns’ location “not really on the way to anywhere” and requiring “a couple of stops” doesn’t deter.
“We’ve only had one firm in all the time we’ve been doing it say they didn’t want to come; the rest have all been glad to talk and we’ve been glad to listen.”
The process begins by wiping any preconceived notions around an allocation’s role in the overall portfolio and justifying its place as if from scratch. Portfolios are deconstructed and then reconstructed, ensuring they are aligned with current and future thinking rather than past ideas in a process that takes around two years from those initial thoughts to issuing mandates, nine months of which involves in-house analysis by NIC’s small investment team.
It also requires Nebraska’s existing managers put aside everything they’ve learned about the investor, often garnered over long relationships, ahead of working meetings that last a couple of hours with all materials sent ahead.
“Taking time on the front end of a decision makes for a better back end,” says Walden-Newman who joined Nebraska four years ago from Wyoming State Treasury where he developed the novel process as CIO.
The fixed income blank sheet, due to complete in Q1 of 2020, will review allocations added to the portfolio in anticipation of rising interest rates that haven’t materialised, like high yield and bank loans. Walden-Newman also hopes it will lead to an increased and permanent allocation to private credit, an asset class he has been looking to build out for a while.
“In its simplest sense, if we have money to lend and someone is willing to pay a premium to access that money for a short period of time, why not do that every day? Once our blank sheet analysis is finished, we’ll be able to see where private credit fits as a permanent allocation.”
The portfolio is currently divided 70:30 between equity/alternatives and fixed income, and the review could see a 5 per cent allocation to private credit within the fixed income portfolio. It equates to around $700-800 million and the idea is to have around $500 million of that in direct lending and $200 million or so in other types of more opportunistic credit, he says.
Whatever the outcome for fixed income, any decisions will be informed by the NIC’s cautious philosophy where asset preservation of the 32 programs it manages which span retirement pools, public endowments, savings plans and various trust and funds, is written into state law.
“This dictates a conservative portfolio that is less volatile than others,” says Walden-Newman.
The long-term strategy isn’t rattled by short-term market moves but structured to withstand volatility with ample liquidity on hand given the small allocation to illiquid assets. The approach is also reinforced by the fact the NIC isn’t governed by the state’s defined benefit retirement system whose assets it manages. It means NIC doesn’t manage the portfolio to the pension fund’s 7.5 per cent assumed rate of return, unlike peers at most state or local public pension funds. Instead the NIC sets volatility at 12.5 per cent and targets a 6.5 per cent return.
“That divergence is not troubling to us, the retirement system or for policy makers,” he says.
The NIC uses Aon as its consultant in a relationship that spans general consulting, performance analysis, manager research and help with private equity and real estate, the only alternatives in the portfolio.
The bulk of the money is run externally in around 70 manager relationships in 150 different investments, but the NIC does manage Nebraska’s check book or operating funds which account for around $3.5 billion in short term cash and bonds, internally.
Reflecting on the responsibility he feels that the funds under his management touch every corner of Nebraskan life, Walden-Newman recalls a conversation with Nebraska’s then governor at his appointment four years ago.
“He said for me to keep in mind that this is all of Nebraska’s money. It was a nice, chatty conversation that ended with that serious comment. I answered, ‘Yes Sir.’ He stuck out his hand and said, ‘Welcome to Nebraska’.”