E137: Lessons from Managing $300 Billion Dollars w/ John Skjervem (CIO of URS)

Speaker 1 When we were last chatting, that transparency with a T, capital T, was actually negatively correlated with returns. Why is transparency a bad thing?

Speaker 2 Most public plans, Red Orb, Blue State, have what I call fishbowl governance structures, where the board conducts its business in a public meeting. These things turn into spectacles.

Speaker 2 Big auditorium, 150 people in the room, front rows media, second row is lobbyists, third rows activists, fourth rows, gadflies, fifth rows, crackpots.

Speaker 2 There was never John Q Public responsible taxpayer. That guy never showed up.

Speaker 1 Double-click on your asset allocation strategy. So, what are the buckets and how do you allocate today?

Speaker 1 Last time when we chatted, you mentioned that Utah Retirement Systems has the best governance of any pension fund in America. Double-click that.

Speaker 2 Yeah, that was a bold and brash statement. There's three components to that claim:

Speaker 2 the first

Speaker 2 is rare but not totally unique. The second two are totally unique.
So the first would be

Speaker 2 staff has full investment discretion

Speaker 2 below asset allocation.

Speaker 2 So the board sets asset allocation, strategic targets for the asset classes, and all implementation execution is delegated to staff.

Speaker 2 It's rare but not totally unique. So as I mentioned, David, I'm an advisor at Alaska Permanent Fund Corporation.

Speaker 2 The CIO CIO there, Marcus, and the staff, they have investment discretion, investment authority. There are a handful of programs throughout the country where staff enjoys investment discretion.

Speaker 2 Contrast that to my time in Oregon. My discretion, $100 billion program,

Speaker 2 my authority as CIO was limited to $50 million.

Speaker 2 I'm not that great at math, but $50 million divided by $100 billion is a decimal point with several zeros.

Speaker 2 My authority there on a discretionary basis was quite constrained relative to the size of the program.

Speaker 2 What that means is, in a program in which staff does not enjoy authority and discretion, it means all the recommendations have to come before in front of the board.

Speaker 1 Are there any benefits to that for the board? So obviously, the trade-off is that you kind of have your hands tied, you can't move as quickly. But

Speaker 1 are there any governance benefits to forcing people to go to the board with investments?

Speaker 2 No benefits and

Speaker 2 only

Speaker 2 disadvantages to that structure.

Speaker 2 Disadvantages to the program, disadvantages to the beneficiaries, potential benefits to the board members. But I would characterize it as a highly suboptimal approach.

Speaker 2 Because as staff, you can work for

Speaker 2 weeks, months, quarters, potentially years

Speaker 2 on a transaction, on a recommendation. You know, the gestation period on these things can really be measured

Speaker 2 in years in some cases.

Speaker 2 And so it's a very asymmetric dynamic for a board member when you have staff who are,

Speaker 2 if not expert, much more expert than their counterparts on the board,

Speaker 2 having spent, again, weeks, months, quarters, years of their life on

Speaker 2 this transaction. And then a board member who maybe got off a red eye and read the material on the way over in the morning is forced to make a decision.

Speaker 1 It could be very discouraging for staff that not only have they spent years working on investment that gets ultimately rejected by the board, but also seems like it's somewhat of an arbitrary process.

Speaker 1 So very quickly, the staff could get discouraged in terms of putting their best ideas forward.

Speaker 2 It can be demoralizing because

Speaker 2 it can appear capricious.

Speaker 1 For Utah Retirement Systems URS, you also have two other pillars to your governance.

Speaker 1 Walk me through those.

Speaker 2 The second

Speaker 2 pillar,

Speaker 2 which as far as I know, is unique, is that for all investment matters,

Speaker 2 our board, when it comes to investment matters, the doors are closed, there's no public participation whatsoever.

Speaker 2 And

Speaker 2 that is what enables us to discharge our duties, I think, in the most objective way

Speaker 2 on the merits of the investment, independent of the personalities, independent of the politics.

Speaker 2 I would say that is the number one ingredient to our success. Is the opacity,

Speaker 2 there I said it, the opacity of our process is what enables us to be objective.

Speaker 2 And in my experience,

Speaker 2 the transparency of other programs

Speaker 2 is lauded

Speaker 2 for all the wrong reasons, because it opens the process up to

Speaker 2 all sorts of actors and agents

Speaker 2 for whom the solvency of the program and the performance of the program is not the objective function.

Speaker 1 When we were last chatting, that transparency with a T, capital T, was actually negatively correlated with returns. Why is transparency a bad thing?

Speaker 2 Your knee-jerk or your intuitive response is for a public pension plan that transparency would be good.

Speaker 2 It's actually not.

Speaker 2 Number one, it is not public money.

Speaker 2 So the most important misunderstanding is that public pension funds are public money. They are not public money.

Speaker 2 The money started with taxpayers,

Speaker 2 went through various municipalities, various instruments and organs of the state. But by the time it gets to me,

Speaker 2 it's owned by the beneficiaries. I'm a vested member of the Oregon Public Employees Retirement Fund.

Speaker 2 That money's mine.

Speaker 2 It's not the state of Oregon's. Number two,

Speaker 2 I'm picking on Oregon just because I know it well, but most public plans, red or blue state,

Speaker 2 have what I call fishbowl governance structures, where the board conducts its business in a public meeting.

Speaker 2 These things turn into spectacles.

Speaker 2 Big auditorium, 150 people in the room, front row is media, second row is lobbyists, third row is activists, fourth row is gadflies, fifth row is crackpots. There was never John Q.

Speaker 2 Public responsible taxpayer. That guy never showed up.
So here's another way I talk about it:

Speaker 2 Utah is opaque, Oregon is transparent. Utah is a superior program

Speaker 2 for many reasons, but one of those reasons is because of the opacity.

Speaker 2 Because I don't have to make the argument to you, David, that the elected officials on my board are more political or less political than the elected officials in Oregon.

Speaker 2 I don't have to make that argument. They may be or they may not be.

Speaker 2 It's moot

Speaker 2 because there's nobody for our elected officials to grandstand to. That is the key understanding.

Speaker 2 The key linkage is elected officials on the board, public meeting, activist lobbyists show up, boom, now you've got grandstanding. Investment staff shows up every day

Speaker 2 putting together a portfolio,

Speaker 2 evaluating investment strategies, evaluating managers.

Speaker 2 Everything we do is to try and put together an investment portfolio that can successfully defease those liabilities over the next 40 years. We are truly long-term investors.

Speaker 2 But we serve boards that are often comprised

Speaker 2 with or by elected officials for whom the time horizon is two years or four years.

Speaker 2 That is the fundamental mismatch.

Speaker 2 Their time horizon their time horizon is two to four years to be reelected or to move on to the next higher office. Our time horizon is 40 years.

Speaker 2 Boiling it all down, that is the fundamental mismatch.

Speaker 2 And it gets exacerbated by the fishbowl structure

Speaker 2 that

Speaker 2 is the hyperactive third base coach waving in all these people.

Speaker 2 Come on in. Here's a mic.
Say whatever you want. Again,

Speaker 2 it's not who they are, it's what they represent. They represent

Speaker 2 constituents for whom an elected official has to pay attention to in his or her time horizon, which is two to four years, that has nothing to do with my time horizon, which is 40 years.

Speaker 2 That is the fundamental mismatch.

Speaker 1 So tell me about URS's asset allocation.

Speaker 2 You know, I know a lot about my peer programs because I've, well, I've been around. You know, I'm old and I've been around

Speaker 2 a while. I feel like I'm pretty fluent in what the public funds landscape is like.
And I would say our program is unique in that

Speaker 2 it's probably the closest thing to an endowment in a public fund,

Speaker 2 in that we have a very high allocation to public markets.

Speaker 2 I'm sorry, very high allocation to private markets.

Speaker 2 We have a very high proportion of direct investment activities.

Speaker 1 What type of strategies or asset allocation would an endowment or a URS pursue that may be controversial to the public?

Speaker 2 Gets exposed in the fishbowl governance model as people come in and rail against private equity, or they come in and they rail against hedge funds,

Speaker 2 you know, because of the fees or because of the bill narrows. And that,

Speaker 2 you know, that is across the board, and that just reflects a lack of understanding of the structures and the asset classes.

Speaker 1 Double-click on your asset allocation strategy. So, what are the buckets and how do you allocate today? And how do you expect that to change over the next couple of years?

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Speaker 2 14% private equity. Where we are unique is that a big part of that, as much as 50% of that, is venture.

Speaker 2 That's a legacy issue, a legacy issue in a good way, in that the program went into venture capital 30 years ago exclusively through Fund of Funds and then

Speaker 2 has been successful in converting those Fund of Fund exposures to primary investments where most of the GPs honored the shelf space. We didn't have any dedicated staff

Speaker 2 to private equity until 2017.

Speaker 2 So it was all

Speaker 2 delegated through Fund of Funds and Consultants. But once we started to bring

Speaker 2 those allocations in-house, we were very fortunate to have most of the GPs.

Speaker 2 save that shelf space for us.

Speaker 2 What was

Speaker 2 historically allocated through Fund of Funds was converted to primary exposures. And there were a couple exceptions, but like I said, most of that shelf space was preserved.

Speaker 2 I know this comes off to you and your audience as braggadocia, but just by virtue of being in the asset class for that long, we've got a really impressive roster

Speaker 2 in venture, something that couldn't be replicated today because

Speaker 2 the access issues that you and your audience are familiar with. So

Speaker 2 14% private equity, good part of that venture.

Speaker 2 You know,

Speaker 2 fixed income at 20%,

Speaker 2 really plain vanilla, by design, deliberately plain vanilla. You know, low 30s public markets,

Speaker 2 basically,

Speaker 2 you know, a global ag orientation.

Speaker 2 Would love to say we had a home country bias there, but we don't.

Speaker 2 Real estate and

Speaker 2 what we call EMIP energy mining infrastructure are probably the two most unique.

Speaker 2 Real estate is unique in that we

Speaker 2 started migrating to a direct program.

Speaker 2 And this is timely because the director of that program, Devin Olson, just retired. We had his party last night after 40 years, four zero years in the chair.
And he was really a pioneer and led.

Speaker 2 and led the migration to a direct program out of funds into direct programs. Almost 50% of our staff is real estate just because

Speaker 2 we own the stuff directly. We don't do the asset management.
I mean, we don't do the property management, but we do most of the asset management. And so

Speaker 2 that's been terrifically successful.

Speaker 2 We obviously save a lot of fees.

Speaker 2 And most of the attention on a direct model starts, particularly in

Speaker 2 the press and then interview like this. The focus is, oh,

Speaker 2 you save a lot of money. Well, that's true, but

Speaker 2 I think what's less appreciated and for me me much more important is you control the holding period.

Speaker 2 And real estate assets are fantastic assets in a defined benefit program because they're long duration, they have a big income component, and of course they're indexed to inflation depending on the property type.

Speaker 2 So it's really the ideal asset you want to own as long as you can in a DB fund versus, you know.

Speaker 2 a closed-end fund model where you go in at six and you know you come out at four and everybody high fives because because you're printing a big IRR but then me the CIO I'm forced to reinvest in a four you know four cap rate environment it doesn't in other words it's

Speaker 2 people are looking good in terms of their investment performance but it's not helping me in my

Speaker 2 ultimate mission which is to fees liabilities across 40 years the other this EMIP Energy mining infrastructure portfolio, it's unique in that it's got a big oil and gas exposure.

Speaker 2 Some Some of that is direct.

Speaker 2 Most of it is outside of a traditional fund structure. And it has performed fabulously well and done exactly what it was supposed to do, which was provide inflation protection.

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Speaker 1 You taught retirement systems today. Your job is to manage more than $50 billion.

Speaker 1 What are the advantages of having $50 billion and what are the disadvantages?

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Speaker 2 So it's a lot of money, and I don't want to to dismiss that at all, but it's the smallest program that I've run in the last 20 years.

Speaker 2 So, you know, I was CIO of the wealth business at Northern Trust, and even 15 years ago, or whenever that was,

Speaker 2 you know, that was $180 billion. And then Oregon was, when I left, it was $111 billion.

Speaker 2 So this is a much smaller program. And smaller is better.

Speaker 2 And

Speaker 2 so

Speaker 2 the access and the agility of being small at a place or smaller at a place like Utah those benefits way outweigh whatever scale economies you're giving up on the public side

Speaker 2 so it's it's definitely a trade-off but I would again net net net the the

Speaker 2 the the access

Speaker 2 and agility in private markets that accrues to being small is much more valuable in dollars and cents than the scale economies that you get in public markets for being big.

Speaker 1 If you had your choice, what would be the ideal check size that you would want to work with in the private markets?

Speaker 2 Oh boy, you know, it depends if it's energy, if it's venture, if it's private equity. It's very different in each of those.

Speaker 2 We're doing,

Speaker 2 you know, we've within the within the energy portfolio, we have a carve-out to what we call alternative energy. Basically,

Speaker 2 it has a two-fold purpose. Number one, to provide an explicit hedge to our traditional oil and gas investments

Speaker 2 as when and as society decarbonizes. So it's an explicit hedge, but it's also designed to participate in the energy transition.

Speaker 2 So we want to play defense against our traditional stuff, but we also want to play offense and help facilitate the energy transition.

Speaker 2 And

Speaker 2 that portfolio is nascent, you know, maybe third inning,

Speaker 2 but it has five direct investments in fusion. So it's really all over the map.
You know,

Speaker 2 you're lucky to get into a top-tier venture capital and write a $10 million check. We would rather be with the A team, even if our allocations are smaller, than...

Speaker 2 be with the B team just and be able to write a bigger check.

Speaker 1 Outside of your work at URS, you also have several unpaid advisory or investment committee positions at Alaska Permanent Fund, at the State Pension of Idaho, at IEEE, which is a foundation.

Speaker 1 Why take on these roles and what benefits accrue to you as being involved in these organizations?

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Speaker 2 Oh boy, great question.

Speaker 2 Taking on the role of several of my peers,

Speaker 2 I'm with several of my peers on those organizations, so of course that's fun. Because the governance structure in those organizations is different, because the investment objectives are different,

Speaker 2 because

Speaker 2 the boards are populated with different types of people, and because my fellow advisors are different, I gain insight every single time I participate.

Speaker 2 And that insight ultimately accrues to the URS beneficiaries, to the URS staff, to the URS

Speaker 2 bored

Speaker 2 by Sherman's got one more experience that taught him we ought to think about X and we ought to try and avoid Y.

Speaker 2 Professionally, it's been very rewarding, but I absolutely believe, have a complete clear conscience that it makes me a better CIO for the taxpayers of Utah and for the beneficiaries of URS.

Speaker 2 And

Speaker 2 I'm pretty vigilant in monitoring that.

Speaker 1 One of those roles, Alaska Permanent Fund, also very unique governance structure, very cutting-edge organization.

Speaker 1 What do you see as some of the similarities between Alaska Permanent Fund as well as Utah retirement systems?

Speaker 2 Alaska Permanent Fund is really important because it's America's largest sovereign wealth fund.

Speaker 2 It's important for the country because it's America's largest sovereign wealth fund. It's important for the state of Alaska, obviously, because it's the biggest single asset,

Speaker 2 biggest single financial asset of the state. I'm really proud to serve there because it is such an important organization.
It's such an important fund. The governance structure is quite different

Speaker 2 than ours. It is very much a,

Speaker 2 and I don't use the term fishbowl in a derogatory or a pejorative, but it is very much a fishbowl governance structure.

Speaker 2 It has no direct

Speaker 2 elected officials, but there are political appointees. So it's not then dissimilar to the majority of its peers.
So we have

Speaker 2 those governance dynamics. Where it's similar to URS, and I think key

Speaker 2 to APFC success over the years, has been the delegation of investment authority to staff.

Speaker 2 And it has been very gratifying for me. I'm five years into my service up there

Speaker 2 that

Speaker 2 the commitment to that delegated authority has never wavered. It's what makes

Speaker 2 the size,

Speaker 2 but also the delegated authority is what makes APFC such a potent investor.

Speaker 1 You mentioned when we were last talking that 74% of your staff was not working during the global financial crisis. What key insights did you gain from the global financial crisis of 2008?

Speaker 2 We have very little credit. That philosophy was validated by the GFC.
So it reinforces

Speaker 2 my own philosophy, which again is happily consistent with URS, which is

Speaker 2 we'd rather take our equity risk in equities,

Speaker 2 especially.

Speaker 2 And here's the, I think this is an important distinction, is it also depends on your program. If you're URS and you have access to

Speaker 2 the A-team venture capital roster,

Speaker 2 why wouldn't you spend your equity risk there? Why would you spend it where you can, you know, get, I'm, you know, making the numbers up, but you can earn, you know, 25%

Speaker 2 as opposed to stretching and fixed income into private credit, you know, to go from, you know,

Speaker 2 whatever, mid-single digits to low double digits. It's

Speaker 2 the, I think

Speaker 2 the translation is if you're like me, if you're a CIO, you think about it in risk budgeting terms. You don't have an unlimited risk budget.
You know, your board gives you 100 points of risk.

Speaker 2 Why am I going to spend any of my budget on private credit

Speaker 2 if I've got a world-class venture capital portfolio? That's where I'm going to spend my risk budget.

Speaker 2 And I'm going to design and manage my fixed income for the sole and express purpose of hedging equity risk in a deflationary environment.

Speaker 1 What are some interesting structures or interesting investments that you make that are maybe very risky, but have very high returns potential?

Speaker 2 Probably the best example would be our fusion portfolio. We've got a portfolio of five fusion investments.
Those are very

Speaker 2 probably binary,

Speaker 2 you know, either a zero or 100x

Speaker 2 because fusion is the holy grail. You know, I'm much more bullish on fission because I, you know, I think that is

Speaker 2 a nearer,

Speaker 2 a much closer path to a clean energy alternative,

Speaker 2 particularly with some strategies that are either at or

Speaker 2 near

Speaker 2 approval. Whereas, you know, fusion is still is still the

Speaker 2 Hail Mary

Speaker 2 holy grail, but man,

Speaker 2 when it works, and I don't know if that's five years, ten years, thirty years, but when it works,

Speaker 2 it's a game changer of gigantic magnitude. You know,

Speaker 2 it's not a lot of money, single million

Speaker 2 check sizes, but the payoff is gigantic.

Speaker 1 Assume you have 20 million in that category at 100x's, $2 billion,

Speaker 1 it moves the needle for a $50 billion fund.

Speaker 2 It moves the needle and it also protects against, you you know, the

Speaker 2 couple billion dollars in conventional energy strategies that will suffer in that environment.

Speaker 1 When you look at investing into something very disruptive like nuclear fusion, are you always looking to make a directional bet or are you sometimes picking this is the one company that I think is going to be the one?

Speaker 2 Great question. We're not smart enough to know.
So that's why I describe that portfolio. We actually call it the Utah Alternative Energy Portfolio as very early innings in that we're deliberate in

Speaker 2 getting as many

Speaker 2 pieces out on the board because we don't know.

Speaker 1 What do you want our listeners to know about you, about URS, or anything else you like to share?

Speaker 2 I tell people I'm the accidental CIO.

Speaker 2 I graduated from business school at Chicago and beat a path to Santa Barbara, you know, because I wanted to surf before work and coach my kids soccer games after work. I accomplished that.
I did that.

Speaker 2 But then, you know, all these years later, I wound up as a CIO, institutional CIO.

Speaker 1 Well, it's certainly a big-time CIO, and really appreciate you taking the time. And look forward, Salt Lake is beautiful.
Look forward to sitting down there or in New York City very soon.

Speaker 2 Yeah, you bet. Thanks for having me.