New Mexico On Dynamic Investing, Co-investments

As institutional investors eye a maturing real estate cycle, many are asking how they can be more dynamic with their asset allocation tools. PrivcapRE spoke to New Mexico Educational Retirement Board about the challenges of being a more active investor, and how co-investments will play an increasingly critical role for the pension.

Having more dynamic asset allocation strategies offers institutional investors greater flexibility to maximize performance by actively placing and rotating capital into market opportunities based on analytics, timing, and capitalizing on dislocations. However, Mark Canavan, senior portfolio manager of real assets for the New Mexico Educational Retirement Board (NMERB), admits, “It’s definitely not for everyone. It’s tons of work, requires a lot of hours and it’s definitely more stressful.” Yet, for Canavan, the benefits of pursuing investment opportunities best suited to market conditions far outweighs being hamstrung by strict allocation mandates. Canavan spoke about the strengths of NMERB’s real assets strategy, staff structure, decision-making process, , and the importance of co-investments for the platform. PrivcapRE: What is the main theme that drives your plan’s preference for dynamic allocation models? Canavan: You don’t want to be forced to invest because policy says you have to. Why have a policy or allocation that dictates that kind of behavior? In 2006 and 2007, if your policy and pacing plan mandated a strict target for core and you were underweight in your allocation, you had to invest in core anyway. This would have been the worst time to invest in core. You should have the latitude to do what’s best for the portfolio and you shouldn’t be making decisions solely based on strict preset mandates. You say the flexibility of NMERB’s real estate tactical strategies plays a large role in your ability to maximize risk-adjusted returns. Why aren’t more plans pursuing similar strategies? In my opinion, the market has been oversold on the concept of traditional asset allocation. NMERB has a board that’s forward-thinking and saw the potential of giving staff more accountability and creativity. They saw the investment acumen of the staff and felt they could trust us. A lot of boards are consultant-driven. We are staff-driven and have a very collaborative relationship with our consultants. They are, in essence, outsourced employees. What role does the co-investment program play in executing your strategy? To continue to be tactical you need to move towards co-investments or direct models. You need to have flexibility over entry and exit—when the play is over you want out. It’s important to have liquidity mechanisms. Our mandate has ranges that allow us to maneuver and I do have authority to sell secondary positions into the market if I have to. If you’re a large enough plan you can run a co-investment program in-house. We created a compromise and made our own private label funds—a “fund of one”—so we had a platform to execute. We are the LP, and we outsourced staff for co-investments to [consultant] Real Asset Portfolio Management. They have discretion within a box. First, I get a pipeline report that I can use to steer my consultant staff in the direction I want them to go on a macro basis. Then they pursue opportunities, for which they will send me a “heads up memo” on the investments they like. At this point I can say yes or no. Then I get a final recommendation, and again, at that point I can give them discretion to execute, or I can veto. Once I’ve given them execution authority, they have full discretion to close without having to come back to the investment committee. Given staff constraints, how is your team is structured and who do you lean on most? There are a few layers. You need to start with a good generalist consultant who can see the overall lay of the land. Then it requires adding consultants with a tremendous amount of area-specific expertise. Lastly, in executing specific investments you need a rifle-shot level of expertise. It’s also important to have a high-level of collaboration between the consultant and the staff where they arrive at decisions through consensus. I have a consultant dedicated to infrastructure and another for real estate, where the real estate group has an affiliate that handles timber, agriculture, and mitigation banking. How do GPs fit within the scope of your program? While we’re really focused on our co-investment program right now, we still value our manager relationships. They bolster our capabilities by creating access to additional co-investment flow. Without access to co-investments, there’s a lower probability I’ll work with you.