How Alberta Teachers’ is Investing ‘Between the Seams’

Darryl Orom
Head of Absolute Return, ATRF

When the CAD 17.5 billion Alberta Teachers’ Retirement Fund first carved a 10% allocation for an Absolute Return program, the result was a reasonably classic hedge fund mix. Yet the last couple of years have seen this team steering towards complementary – and less conventional – strategies. “There are a lot of opportunities that other investors don’t take advantage of because of the artificial definitions created for asset classes,” says team head Darryl Orom.

Indeed, breaking away from asset class silo constraints is one of the core principles emerging from “Project Whiteboard” – a fundamental rethink of ATRF’s investment strategy and approach, which has now moved off the drawing board with implementation in full swing through 2019. Key principles include taking a “total portfolio” view, with “everyone speaking the same language – the language of risk factors.”

Q: Darryl, thank you very much indeed for joining us. Before we get into some of your current priorities and challenges could you talk us through the Absolute Return portfolio at ATRF, how it evolved and what it looks like today?

The absolute return program was launched in 2014 with a 10% policy allocation. Our mandate is to deliver returns of cash+4% with minimal correlation to equity risk. This was initially structured as a Fund-of-One comprising a number of hedge fund investments, with our strategic partner GSAM. That was an effective way to become invested rapidly and leverage off the knowledge of a manager as we built out a new team at ATRF and adopted best practices.

Over the subsequent years the team has been implementing a direct investment program to complement that core allocation. This now includes investments such as reinsurance/ILS, and direct Asia-focused hedge funds (which we entered last year). More recently, we have been evaluating opportunistic strategies and agriculture. The AR team is now four people who are generalists with the ability to analyse very complex investments, both across and between asset classes.

As that shift has taken place, the Fund-of-One has become a smaller part of the allocation in percentage terms; they do an excellent job at helping us cover hedge funds which helps free up time so the team can focus on strategies or areas that they don’t cover. The partnership has really exceeded our expectations: we often visit managers together, we share research and we recently teamed up to complete onsite due diligence on an emerging manager. We’ve adopted best practices from them, there has been lots of knowledge transfer and we’ve become better investors as a result.

Q: You mention an “opportunistic” category. What types of investments would you include here?

We’re still in the early days with this, but it’s very broad indeed. I foresee the category including investments that may not suit the other asset class groups but still have attractive risk-adjusted return potential. An example might be Chinese convertible bonds with reset features which are quite unique. They probably wouldn’t be in the strike zone for other teams at ATRF for various reasons, but their risk/return characteristics could be attractive for us.

This broader topic of getting away from asset class definition constraints is one of the issues that was addressed with Project Whiteboard. There are a lot of opportunities that other investors don’t take advantage of because of the artificial definitions created for asset classes. We want to be able to invest between the seams and take advantage of those opportunities./span>

In practice, this meant that we roughly halved equities from 65% to 35%, increased fixed income from 10% (in a relatively standard index) to 25% (with a much longer duration), took infrastructure from 5% to 17%, kept property around 8% (the opportunities in infrastructure were more attractive than in real estate) and built private equity to about 5%. In the last couple of years we’ve also introduced trend-following, which is now at 5% of the portfolio. We still have a dynamic asset allocation strategy. You can see the same mindset in our entry to Asian hedge funds last year: we want to focus on areas that are not as crowded and perhaps less efficient due to, for example, a changing regulatory burden.

Q: That’s fascinating, and this effort to get away from asset class silos really resonates with what a lot of our sophisticated clients are doing. Looking at Project Whiteboard, how is that coming along?

Project Whiteboard has really been a fundamental rethink of how we, as investors, approach the exercise of investing. It was not about fixing anything that was ‘broken’ – ATRF has successfully outperformed its benchmark over a long period of time. We wanted to think about how we should adapt to the changing market so that we can continue being successful over the next ten, twenty years and beyond.

The initial work, which took about a year (2017-18), resulted in a number of key takeaways: we want to focus even more strongly on fund liabilities, we are adopting a risk factor approach to investing, we want to utilise a ‘total portfolio’ approach to managing the portfolio, and we want to do more ourselves using internal talent where it makes sense; there will an expansion of the various teams at ATRF.

The project moved into the ‘implementation’ phase in November 2018 and developments will unfold over the coming years; it’s a long-term process.

Q: What impact do you expect that Project Whiteboard will have on the Absolute Return group?

One of the aims of Whiteboard is really to have everyone speaking in the same language – the language of risk factors. In the AR team we speak the language of risk factors every day: it’s second nature to us and, in that sense, we are somewhat ahead of the curve.

Our portfolio construction and risk teams will look at our liabilities and our assets, see where there’s a need in terms of matching, or where we can play a better role in terms of delivering uncorrelated sources of unique return. More work needs to be done before we learn exactly what the needs will be.

Q: Aside from Project Whiteboard and its implementation, what are some of the other challenges that you’re thinking about at the moment with respect to Absolute Return strategies?

First, there’s quite a high-level challenge in Absolute Return with respect to the overall risk/return picture. These strategies continue to deliver excellent diversification for the overall portfolio, but the real returns are below where the historical track records have been.

Secondly, and perhaps further to the first point, the last few years have been particularly challenging for some managers in trend-following strategies. We have quite a bit of exposure to trend. The low levels of volatility across asset classes relative to history have made it difficult for a number of strategies to deliver returns in line with our expectations. It’s hard to generate returns when markets aren’t moving. But at some point the dynamic with volatility will come back and we want to be ready for that when it happens.

Thirdly, we are giving some thought to our exposure to the catastrophe reinsurance market. We want to make sure levels of risk and positioning are optimal. Again, the last couple of years have been difficult and we’ve spent a lot of time analysing our portfolio here. As we enter the 2019 hurricane season we’ll be watching this area closely.

With investors continuing to seek effective ways of reducing overall exposure to equity risk, the hunt for absolute return strategies has never been more competitive. Yet ATRF’s excellent example reminds us that diversification is best pursued in a framework where the portfolio’s overall risk exposures are fully understood. We look forward to seeing how this team’s investments continue to evolve as Project Whiteboard progresses.