| Peter Gilbert: “We can be much more nimble” Photographs By Chris Crisman |
Running a multibillion-dollar state pension fund certainly had its advantages. The ability to invest larger amounts in hedge funds and other private vehicles, and even lead other investors in such transactions, gives a retirement system negotiating power, allowing it to win more favorable fees and other terms from money managers. Size also helps a fund seed managers and strategies and maintain separate accounts, which can enhance performance. But bigger isn’t always better, says Peter Gilbert, chief investment officer of Lehigh University’s $1 billion endowment since August 2007. Gilbert’s previous job, as CIO of the then-$32 billion Pennsylvania State Employees’ Retirement System, gave him the power to play hardball with managers. But he contends that a smaller endowment makes it easier to invest with smaller, more niche managers, and that can help diversify a portfolio.
“At Lehigh,” Gilbert says, “We can be much more nimble and can access funds that would have been very difficult to access given our size at the State of Pennsylvania.”
As a result, Gilbert has been able to diversify Lehigh’s portfolio among 15 different investment buckets, compared with the typical pension fund portfolio of three to six. Lehigh now has some 50 to 60 percent of its portfolio invested in different styles of alternative investments, including hedge funds, private equity and real estate. Some 18 percent of the portfolio is allocated to absolute return strategies, but Gilbert has tucked hedge funds into other portfolios that are not hedge fund specific. For example, the equity portion of the portfolio includes funds that can short stocks in both developed and emerging markets. Some of the endowment’s other investments include long-only strategies for developed and emerging market equities, U.S. Treasuries, developed and emerging market credit, private equity, real estate, oil and gas, and cash. The overall portfolio returned 18 percent for its last fiscal year, which ended June 30.
Gilbert also moved away from funds of hedge funds to develop more direct relationships with managers. He has retained only one of five funds of funds that Lehigh used previously, and now invests directly with 30 hedge fund managers. Before, the pension had no direct investments in hedge funds.
The endowment fund’s investment subcommittee used to oversee the fund’s investments, but as part of the board’s decision to start investing in alternatives, it hired Gilbert and two other investment officers to revamp and run the portfolio. One is Jennifer Sassani, who was co-director of alternative investments at PennSERS. (The other, Mark Siddoway, has since left.) Soon after the three came on board, however, the market crashed.
Although Gilbert hit snags because of the 2008 market crash, he later wound up developing an even more thorough asset allocation plan meant to weather different market conditions. This, coupled with the endowment’s having raised a lot of cash going into 2008, has made the portfolio revamp even more effective. Gilbert says the crash yielded some other benefits, such as access to popular hedge fund managers who had closed their doors years earlier but were suddenly taking in money again following the redemptions that accompanied the 2008 financial crisis.
Gilbert says he is now mostly finished with the overhaul and that he expects to be invested in the current portfolio for the long term. AR Staff Writer Anastasia Donde recently spoke with Gilbert to discuss his work over the past four years.
AR: What did Lehigh’s portfolio look like when you first joined?
Gilbert: They used to have 15 percent in alternatives, all of which was invested in funds of funds, so we started to expand to a more diversified portfolio, including a larger use of alternative-type structures in a variety of areas. As we started in, the market ended up blowing up. It was a particularly interesting time to try to move into alternative assets.
| Peter Gilbert: “In markets like these, you don’t want to have implicit leverage” |
AR: How so? Gilbert: We were in a good position, as this was a very liquid portfolio coming into the situation. We were also raising more cash at the time as we were transitioning to a new allocation and exiting some of our developed market equity and fixed-income strategies. We terminated some managers that no longer fit into the structure. So in addition to the portfolio generally being quite liquid, we also had raised a fair amount in cash and were waiting for a market opportunity to invest in. We knew we wanted to invest in some things like emerging markets and commodities, but at the time they were reaching all-time highs, so we were waiting around, hoping for something of a market correction. We certainly didn’t anticipate what happened, but we were in a nice, liquid position for that.
AR: What happened when you started to put money to work?
Gilbert: In the hedge fund area, but also to some extent in private equity, a lot of funds were suddenly open. Hedge funds were down about 20 percent in 2008 and had about 20 percent redemptions, so a lot of them lost as much as 40 percent of their assets. We were fortunately there in that small window of opportunity when a lot of hedge funds that had been closed to new investors for quite a while opened up.
In private equity, it was a very difficult time to raise capital because a lot of endowment funds and foundations had a liquidity squeeze and didn’t necessarily have capital available. Because of the market downturn, many were already overweight private equity. There again, we had some advantage of accessing private equity funds as we were putting new capital to work in the area. We had raised our exposure to private equity to 14 percent from 3 percent and were putting all the new money directly into single-manager funds, as opposed to funds of funds.
AR: You now have less money to invest. How does that affect your allocations?
Gilbert: There are pros and cons. Going into a private equity fund as a large state pension fund, we could put in enough money that we’d have an advisory board seat, and we could drive the terms of the fund much more easily.
Generally, we can’t do that now. We’re rarely the lead investor. We’re much smaller. We’d probably take more terms, rather than dictate them. So that was a big advantage — we could put out larger chunks of money and have more strategic relationships, set up separate accounts and be able to really control them, and we don’t have the size to be able to do that here at Lehigh.
But on the other hand, we can now access some of the smaller funds. If we were going into a venture fund at [PennSERS], we would want to put in a minimum of $20 million, and for a lot of smaller funds that’s a bigger chunk of money than they want to take from one investor. Whereas at Lehigh, if we can put a $5 million or even a $2 million to $3 million commitment into a venture fund we really like, that will be really significant for us and really important. So sometimes we can access funds because a small allocation makes more sense for them.
AR: How do you go about finding those small niche managers?
Gilbert: One of the advantages we had in our team is that we all had come from large pension funds, but they were fairly diversified and aggressive pension funds, so we came with a good knowledge of the universe of managers out there. We came in and were able to cherry-pick who we really wanted, and we went out to seek access to those funds we were interested in. Quite frankly, I get bombarded with solicitations. You attend conferences and meet managers and talk to people all the time.
At this point, in terms of the asset allocation, we’re pretty much on target and have our lineup of managers that we’re comfortable with. It doesn’t mean that in the future we won’t look to trade up when we have that opportunity. It’s definitely not a static situation. But it took us four years to get things in place with an allocation that makes sense for the university and the lineup of managers that we think would do really well in that structure. A lot of what we have been doing is building a portfolio for the long term.
AR: What did you have to do in terms of overhauling the investment strategy after the crisis?
Gilbert: We were moving in the direction of a new allocation, and after the market correction we did another review of it. It was more than just asset allocation; it was a total review of the endowment fund in relationship to the university as a whole. What does the capital structure of the university look like, and what role do the endowment funds play? What is the role of spending of the university as part of its budget? We brought in the key constituents involved, including the president of the university and the vice president of finance and the treasurer, to really review and come up with what kind of risk posture the endowment should plan to take in relationship to the university as a whole.
And after that, we came up with an asset allocation policy that can be described as quite diversified with a global orientation, perhaps with a focus on emerging markets in the long term and a fair amount of hedged strategies. We tried to look at a variety of different scenarios and stress test them, such as what to do if we have to deal with inflation situations coming up.
The final allocation has 15 different buckets that are very specific and have specific benchmarks.
AR: How do you use hedge funds within the new structure?
Gilbert: We look at hedge funds that can be used in a variety of different ways: some for growth, some that can protect us in a downturn, some that are there to produce a more consistent return over time. In the absolute return category, we have macro, multistrategy, event-driven, relative value and some credit hedge funds.
We look at hedge funds as a tool that can be used in different areas, because we think that’s where some of the brightest and most talented investors are.
AR: The endowment model of investment is characterized by very diversified portfolios with large alternative allocations and hedge funds used in a lot of different areas. Do you think it is optimal for most institutions in general?
Gilbert: I think one of the lessons that came out of the market turmoil is that there is no one right model for everybody. Each endowment, each foundation, each pension fund has a different set of liabilities that they have to deal with. During the bull market, a lot of people lost track of the correlations and risks inherent in some of their portfolios and treated these pools of assets on an asset-only basis. They were not looking at the liabilities, whatever those liabilities happened to be, whether it’s providing pension benefits, or providing spending to a school’s operating budget, or funds for a foundation to meet their mission.
AR: At PennSERS, you were one of the pioneers of using portable alpha strategies, which use derivatives to mimic a market index and then invest the excess cash in hedge funds. But many showed unwanted correlation during the market downturn.
Gilbert: Portable alpha is not a strategy for all times. You really have to understand what you’re doing there, because at the heart of it, it’s not necessarily financial leverage, but it’s economic leverage.
AR: What are your thoughts on the strategy now?
Gilbert: It was a fantastic strategy at the time, when the markets were on an upswing and both equities and hedge funds were performing well. The thing that kept me up at night is the correlation between the hedged strategies versus the equity beta. We tried to have a very diversified stream of hedged strategies; they were pretty neutral to the market. The concern was that if those correlations started going up, you had to derisk the portfolio. On a general basis, we’d look at those correlations and try to adjust the equity beta. As I was leaving there, the correlations started getting really high. At the last board meeting I attended, the board approved setting up a new category called absolute return, which we didn’t have before, to house some of the hedge funds that were in the portable alpha strategy, and to start taking off some of that beta risk. What happened after I left, I can’t say.
But as I came here, we did just the opposite — we started raising some cash. For the time, portable alpha was a fantastic strategy and it worked really well, but in markets like these, you don’t want to have that implicit leverage.
AR: Do you think it’s something you can see coming — correlations rising to the point where you need to derisk the portfolio?
Gilbert: In that specific strategy, yes. You saw that the correlations were getting very high, so if you were disciplined about it, you would start taking the exposure down. Would you take all of it off? I’m not sure you would’ve seen that. But would you continue to take some of it down? Yes. And they did start doing that, and I think they have continued to do so. You do have fat tail events. That strategy wasn’t great for that.
AR: Have you tried to replicate the strategy at Lehigh at all?
Gilbert: No. This is not an environment where we’d want to do that. In fact, if anything, we have a portfolio that is much more defensive.
AR: What are you specifically doing along those lines?
Gilbert: I think the asset allocation we put together is already pretty defensive. We’ve tried to have a very diversified portfolio that will protect us in a variety of different markets, but we’re not making a big bet versus our benchmarks in one way or another. We have a lot of hedged strategies that are meant to achieve different things in the portfolio, so we hope that if the market goes up, we’ll participate [though to a lesser extent], and if it goes down, we’ll participate less. I think it’s very hard to time the markets. For example, in this last go-round, we raised a lot of cash, but we didn’t get back into the market at the right time, so we missed a lot of the market rally that started in March 2009. To time the markets, you have at least two decisions that you have to get right.
AR: Are there any strategies you’re interested in right now, or are you done moving the portfolio for the time being?
Gilbert: We’ve been creating this portfolio over the course of four years and we’ve only recently had it stabilized in a way that we’d like to see it stay for some time, so I think anything we do now would be at the margin. But I think that right now and in the near future is a time for consolidation of what we have, as opposed to making any big moves.
