CIO Jonathan Grabel, is known for his exceptional work in private equity from getting 90% plus DEI disclosures to heading the rock-solid internal investment committee. In this interview, Grabel dives deeper into the breakdown of his private equity portfolio, due diligence using strong internal metrics, red flags in managers and allocations through his fixed income portfolio.
Interview by Muskan Arora
Muskan Arora: You were able to get your Diversity Equity and Inclusion disclosures up to 90%. Could you talk a bit more about how you were able to do that?
Jonathan Grabel: We have a board-approved policy program that we call
TIDE, Towards Inclusion, Diversity, and Equity. It consists of five pillars.
One of those pillars relates to how we conduct due diligence. It is part of our
standard due diligence process that begins with a DEI due diligence
questionnaire. We focus on making sure we have adequate disclosure throughout
the lifecycle of an investment from diligence to monitoring our exposures.
It is predicated upon the belief that effectively
accessing and managing diverse talent leads to improved outcomes. We are gathering
data because we want firms, we partner with to optimize their talent
management. Human capital is the most important investment they make and quality
teams generate the best returns with our members' dollars.
Arora: What are the few factors that you consider during
your due diligence and data collection?
Grabel: We look at the construct of the team. We want to make sure that the firms
cast wide nets to identify the best talent. We look at the progress that firms
make with respect to policies Specifically, policies focused on talent
management practices. We examine who holds the responsibility for those
policies within these firms. Policies and practices tend to endure when they
are a focal point for the board.
We look at track records. We look at a commitment to
promotions, making sure that there are opportunities throughout the tenure or
the arc of someone's career. We look at how economics are shared. We conduct a
comprehensive analysis that is an important component of the diligence that we
do across every mandate in the portfolio.
Arora: Within your private equity portfolio, how do
you choose your co-investment deals and which sectors are you eyeing right now?
Grabel: The team at LACERA is divided between asset categories – for example
private equity, global equity real assets and credit. Then we have a couple of
functional teams that cut across all asset categories. Our functional teams
include a stewardship team and a portfolio analytics group that focuses on risk
management, performance reporting, and asset allocation.
The various teams have a fair amount of autonomy to
operate within board-approved guidelines. The board sets asset allocation.
Within that asset allocation, there are guidelines. Take private equity as an example. The guidelines define allocation bands by
geography, by stage, by direct fund investments, and co-investments. Guidelines also define matters such as fund
concentration. Within these parameters,
we have subject matter experts that look to find the best opportunities. Our
team of subject matter experts conduct due diligence, and then they bring prospective
opportunities to an internal investment committee that consists of colleagues. Our investment committees consist of
colleagues from within their asset category, plus we have rotational members
from other categories, be it and another asset category or one of our
functional teams.
Within our internal investment committees, there is a
multi-stage process to advance to approval.
So, long answer to a short question, that the opportunity set we are
currently focused on is based on subject matter experts that are challenged by
their colleagues to identify the best opportunities within board-approved
guidelines.
Arora: Could you highlight a few of those areas,
especially within private equity? Happy for you to jump in other sleeves as
well.
Grabel: I think there are a variety of opportunities that the team is
evaluating based upon where we perceive the need to be intentional in portfolio
construction, but I am not going to name specific areas of underwriting because
I do not want to get out ahead of any opportunities or forget to identify
things that may be of particular interest to the team. I think the most
important aspect, and maybe this goes back to your question about the
importance of diversity, equity, and inclusion, our process at LACERA
recognizes that we have a diverse team and that every voice is critical to
identification and diligence of prospective investment opportunities
Arora: In the next coming two years, within your private equity sleeve,
what kind of opportunities are you looking at? Can be in terms of what
strategies do you like or sectors that you like.
Grabel: Our target allocation to private equity is 17% of the total fund. There
are three main sleeves of our private equity program. We have direct fund
investments, we have an emerging manager program, and then we have
co-investments and secondaries. Those are the three sleeves, and all three
aspects build upon one another.
Our co-investments help us better underwrite our
direct relationships. Our emerging manager program helps identify
co-investments and future larger direct commitments from the fund.
Arora: What are the few red and green flags that you
look for in managers?
Grabel: Going back to the concept of diversity, equity, inclusion, human
capital management is critical for firms to be successful. This is necessary
for future success. Does an organization have the right team on the field to
position that firm to be successful tomorrow, and then the day after that, and
the day after that? To do that, a firm needs to make sure that they are focused on quality team construction.
I would say first and foremost, we backing business
partners that are investing in their future state and positioning their
organization to be successful in an ever more competitive environment. It is
also important to evaluate teams that know how to learn from their
unsuccessfulness. No firm only has successes.
There are lessons that one can always learn.
We also look
for firms that want to partner with LACERA. It is a red flag when firms are
reluctant to share information with us in diligence. We want managers that
value our partnership, that recognize the importance of our mission.
I would say that another area that is very important
to us, in terms of value creation, are managers focused on mitigating
uncompensated risks. We evaluate an organization’s
infrastructure, and make sure that they have internal risk management systems
and capabilities, technology platforms, business continuity plans, , and valuation
methodologies. Operational due diligence is critical for us. and represent
other potential red flags.
Arora: As investors face the effect of denominator
effect, how are you building out your portfolio to make sure that you're on the
safer side, and what is working best for you to do that?
Grabel: Our board goes through a comprehensive strategic asset allocation study
every three to five years. We just completed one in May, so the most
fundamental aspect of risk management is through strategic asset allocation,
and we diversify our portfolio across strategies to perform in a variety of economic
environments. A key component of the
analysis is liquidity management. We run
a variety of stress scenarios with respect to potential outcomes to make sure
we grow the fund and maintain sufficient liquidity to pay monthly benefits.
Portfolio diversification is the first, second, and
third answer to the question. The fourth answer is we conduct asset category
structure reviews to optimize those portfolios.
Our structure reviews include guidelines for the board to consider such
that we best implement our strategic asset allocation.
One other aspect is we look at our liquidity on daily basis
and run a rolling 90-day cash forecast to make sure that we always have
adequate liquidity to pay all our expenses, including the most important one,
our member benefits.
Arora: To combat liquidity issues and other market
variables, you recently made changes to your target allocation, as you
mentioned. Could you elaborate on what new opportunities have opened since
you've made these changes?
Grabel: The prior asset allocation study was done in 2020-21, at a time when
interest rates were near zero. Currently, interest rates are 300, 400 basis
points higher from that point in time. It is imperative for us when we look at
capital market assumptions and when we model our portfolio that we factor in the
cost of capital. The movement in
interest rates between our asset allocation studies had a material impact on we
shape the portfolio.
Our target rate of return is 7%. When core fixed
income can return, based on our capital market expectations, 4% to 5%, that has
a material impact on how we try to optimize the return risk quotient of our
portfolio. A key aspect to the portfolio shifts is an increased allocation to
investment-grade fixed income - from 7% to 13%.
Other changes include an increased allocation to
credit and a reduction to global equity. We believe that on an estimated basis
that the portfolio that we have begun implementing as of July 1st, 2024, best
positions the fund to optimize liquidity, to be best compensated for the risks
that we take and be positioned to perform in a variety of economic
environments.
Arora: Especially while investing in venture capital,
what are the few factors that
other allocators, in your opinion, should not forget to take into
consideration-- and also while doing due diligence, what are the few factors’
allocators should keep in mind?
Grabel: We have a sizable allocation to venture. Venture is part of our private
equity allocation. It has performed very well. LACERA has been investing in
ventures since the late 1980s.
Venture may be the “growthiest” component of our
growth portfolio. We
recognize that there may be a greater dispersion of outcomes across venture
funds. There may also be less liquidity within a venture portfolio. Those are
some of the considerations.
Arora: How are you using your fixed income portfolio
in this current environment to make profits? What segments of your fixed income
portfolio have taken a backseat because of the Fed rates, higher Fed rates in
this environment?
Grabel: We divide our fixed income portfolio between two main functional asset
categories. We have our risk mitigation portfolio. Risk mitigation includes
investment grade fixed income, long-term treasuries, cash, and non-correlated hedge
fund strategies. Fixed income investments in risk mitigation are more sensitive
to movements in interest rates.
Our credit portfolio is focused more on credit risk as
opposed to interest rate risk and has more floating rate investments. Credit
was our highest performing functional asset category in the fiscal year that
ended June 30th. It returned over 15%.
For LACERA, we implemented a discrete credit
allocation in 2018. Prior to then, credit was in a variety of asset categories.
We had credit in private equity. We had credit in core fixed income. We had
credit in hedge funds. We had credit in real estate. Credit as a standalone
asset category has performed quite well for us. We think that there are many
opportunities from the perspective of combining attractive coupon without
taking too much credit risk in our portfolio.
Arora: What does risk in private credit look for you,
like credit in different portfolios? What does risk look for you and how much
risk are you looking to take and avoid?
Grabel: There is no single definition of risk in any asset category. You can
have macroeconomic risk, you can have liquidity risk, you can have business
continuity risk, you can have manager concentration risk, you can have interest
rate risk, you can have associated with an underlying company, asset or credit, the risks associated with leverage, and operational
risks. These are some of risks that are in all asset categories.
The risk of repayment of an underlying loan is a key
difference between our credit portfolio and our investment grade fixed income
portfolio. We believe that we are compensated for these risks as a result of
our high underwriting standards.
Arora: With AI growing, how are you making allocations
to it? Are you incorporating AI in your decision-making as of now?
Grabel: In the investment division at LACERA, we are embracing and using new
technology, including artificial intelligence. We are constantly trying to
better harness data, use data to be more productive, data to inform and shape
our decisions.
AI is also a component of our portfolio of
investments. We are an investor in
firms, funds and companies that develop platform technologies and incorporate
those platform technologies into business applications.
