NEWS

Interview by Muskan Arora

The NJ Pension Fund CIO Shoaib Khan, who joined the pension fund in early 2021, is widening his investments for emerging managers. Owing to looming geopolitical concerns, back in 2022 the CIO reduced its allocation to private markets and improved their liquidity positioning. This allows them to sail smoothly in the current changing market environment. In this interview, the CIO dives deeper into manager selection, sectors he finds attractive and more. 

Muskan Arora: Unlike other pension funds, you made allocations in private markets, first, within the emerging manager’s sector. What was something, or the few strategies, or the few sectors, that you found very interesting to take that step?

Shoaib Khan: One of the reasons is that we were and are underweight in our private market allocation targets. In addition to that, when we did the research and we looked at the investment universe as we do before starting any new program, there's a lot of homework and a lot of data collection with a lot of analysis to be conducted.

As part of that, we recognize that the number of investment managers in private equity, in real estate, and also in private credit and so forth, is fairly robust, which means that if we are going to start an emerging manager focused effort, then we certainly would have enough managers to pick from. If you only have a few, you can't really have a good portfolio construction methodology. We need to ensure that first, there is an opportunity set. Then as a second step, is there a sufficiently large enough investment universe.

After that work was completed, it just made sense for us to then kick it off with the private market asset classes. That is what we've done. I mean, the pension funds that started earlier, I think, certainly had focused more on public markets and then transitioned to private markets. It completely depends on your portfolio and on your asset allocation plan, your objectives and constraints.

We built it with different sleeves which gave us the flexibility to then focus on one sleeve at a time. While we do that, we also focus on building out the next sleeve. There's a team that focuses on real estate and private credit, private equity, and so these teams can then focus on their respective sleeves so that each sleeve is well constructed and reflective of the asset class. That's how we structured it. Those are some of the reasons why we started out in private market asset classes.

Arora: You mentioned doing a lot of research and executing different research with different sleeves and different teams. Could you elaborate on the factors that you considered while doing all of that?

Khan: While there may be lots of perspectives to consider and look at for emerging managers, for us it has to add financial value to the pension fund portfolio. That's the first and foremost type of analysis that we do.

When we look at the opportunity set, we have to be certain that if we were to embark and build a portfolio, it has to add financial value. This means looking at historical data to show that smaller emerging managers, and by the way, that includes women owned and minority owned firms, actually, add value when we add them into a portfolio. That's an important part of the analysis.

Then, of course, as I said earlier, we focus on picking robust investment firms. There of course, we have the ability to have different parameters and different thresholds for each of the sleeves.

The parameters that we have as thresholds for private equity may be different for private credit or real estate. When we look at public markets, that would be very different too.

For us, for private equity and for real estate, firmwide assets threshold was determined as appropriate is $3 billion. On a fund level, there should have no more than fund one, two, and three, and then beyond I would expect that they've graduated. Now there may be different thresholds and different characteristics for each of the asset classes, but that's the type of analysis that was conducted. So the questions we look to answer through analysis are: does it add value? Is the investment universe robust, large enough? Is it dynamic enough?

Arora: Absolutely. How are you leveraging this program, or this portfolio to help you combat liquidity issues and the denominator effect?

Khan: We're in a fortunate position that we have neither problem. We do not have the denominator problem, we did not have the denominator problem, and we do not have a liquidity problem. We have good liquidity, and part of the reason is that within the portfolio, in our early 2022, we had gone overweight cash and cash equivalents. I don't look at every other pension plan's cash positioning, but if you looked at it, I'm sure we're in and around the top, I think, in that league table if you will, in terms of cash holdings.

Now, that was a deliberate move on our part, and we went above and beyond what we had and would normally hold.  But that was because there were geopolitical concerns. There were concerns about the market being frothy, and also there were concerns around inflation. With concerns comes opportunities. So, if you are concerned about certain things, you want to create greater liquidity, and that's what we did. Basically, what we did was improve our liquidity positioning back in 2022.

At the same time, while you're concerned about inflation, central banks started to increase interest rates. Well, if rates are going to increase and you're holding cash, you're going to get a higher return on it. We manage cash through a cash management fund, which is currently around $40 billion with the bulk of it invested in US government securities. We've avoided illiquidity, or other liquidity issues so far.

Arora: How did you rebalance your portfolio to maintain a higher level of cash? What were the asset class movements like?

Khan: What we did was we didn't pull it all from any one area.

We had some concerns, but at the same time, we did not necessarily see any red flags to pull back from certain public market asset classes, specifically the US domestic asset class. We thought there was still wind in the back with respect to the US domestic equities. In addition to that, we thought there were opportunities for high yield. We kept our target allocations in certain areas, which is why our performance has actually continued to be strong but with a portfolio profile, which is in fact taking less risk and has better liquidity.  At the same while we de-risked the portfolio, we have been able to deliver the returns that we are looking to deliver out of that portfolio.

Again, being underweight to private market asset classes wasn't a decision that was made in 2022. We had been underweight going into that. When you look at 2020, '21, '22, in fact, we didn't allocate a lot of capital in private equity and private credit in '21 and '22. That was part of the reason and what that leaves us with is now a lot of dry powder. Now that valuations are lower, opportunity sets are changing, we can actually put that capital to work. That's how we did it. Where we did have underweight positions, it was in certain public market securities including emerging markets as an example. By the way, emerging markets until very recently, was an underperformer versus domestic US equities, or developed markets equities when you compare it. That's how we maintain that portfolio. We made certain calls based on a changing landscape.  We kept it a balanced portfolio with good liquidity profile and dry powder to be utilized in the future.

Arora: You mentioned keeping an eye out for certain sectors when it comes to US presidential elections. I am curious to know which sectors you are talking about?

Khan: In the US, on the public markets side, we have an internal investment team. A lot of our public market assets are actually internally managed. A lot of those are passively managed. If you think about it, there is alpha in markets that are inefficient. For example, emerging markets, international, small caps, there is alpha to capture because those markets are less efficient as compared to the US market. There we will utilize active investing and we will utilize investment advisors.

On the fixed income side, a fair amount is passive. We invest in treasuries, we invest in investment grade, we invest in high yield. High yield, there could be value in terms of creating alpha by having some active management. We have both passive and active there as well. Of course, in certain countries, when you talk about emerging markets, it's nice to have local boots on the ground. It's good to have the local knowledge, and while we can travel, as you know, traveling isn't the easiest thing to do. That makes it harder. Sometimes it makes sense that we would utilize advisors.

Rather than trying to make sector calls, we don't replicate, and prefer to optimize generally on our passive investing, but it's not making sector calls. It's trying to match a benchmark return, if you will. Then where we thing there is value in active investing, we generally will involve an investment advisor who will then utilize their resources, their teams, and we'll then look to create alpha through there.

Whether it's private or public, we have been underweight some of the problem areas, which were effectively commercial real estate especially offices and retail. At least in the US but also other places post-COVID. When people are working from home, when people have hybrid work schedules that has impacted the office and the retail environment. Of course, retail's been impacted by e-commerce too. We've been underweighted there. That said, we continue to allocate in real estate.

Data centers are a growing area and we have been active there especially given the growth of the need for data and AI. Data centers are an area, if you want to think of that as a sub-sector or an area of focus within real estate. Medical offices are an area that we've been focused on.  Within private equity we continue to see opportunities within buyouts and growth, we also continue to see some opportunities within venture capital.

Rather than trying to identify specific and individual situations, what we do is allocate capital to funds. Those funds then are diversified into various sectors. We certainly look to avoid certain sectors that may have less opportunities available to them, or are higher risk. As you know, it's not only about returns, but about risk and returns combined. That’s why we try to construct a diversified portfolio where we can capture returns while reducing risk.

Arora: What is something that you're doing which is contrary to other allocators in the emerging market space, and what do you think are the tools required to do that?

Khan: I think emerging markets is going to be an important area for us. It's going to be not just for us, but for most investors. There are concerns and there are opportunities that we look at. In September I'll be in India and will try to gain knowledge, but this will be a business trip, traveling for work because there are opportunities and to explore there. Especially with the new elections out of the way and Modi being re-elected. Now, that doesn't necessarily mean that in the next year or two that we would increase our exposure significantly. It may well be the case if the right opportunities are there. I'm not trying to say yes or no, but rather that we are looking to explore more and more in areas where the market and opportunity set is expanding.

Good governance, good regulations, good laws and protections in place are the factors we are eyeing in EM sector. Good IP protections so that when you invest in a venture capital firm there are all good IP laws in place to protect those interests and those IP assets. Then of course we always look at currency. For us, we always have to convert whatever currencies back to USD.

A lot of times we're investing in dollar-denominated investments, but where we not, we want to convert that and make sure that the returns when they convert it back, when you take the currency impact out of it, still then is competitive versus the risk that we're taking. For us, USD is the reference currency. All of those factors are what we take into consideration. Again, I don't think there's anything unique that we're doing.

We also utilize what I would call manager of managers or program partners that have offices, because again, it's hard to travel lots of times. We utilize program partners that have offices in Hong Kong or in Mumbai or in Australia and that have teams on the ground, or in Korea or in Japan. We utilize those resources as well, and again, that's not unique, but that's, again, trying to gain as much information and data gathering from those individuals and those groups that we work with as well.

Arora: In the emerging market space, while looking for managers, what are the few red and green flags that you look out for?

Khan: We say, okay, where in emerging markets are the opportunities? How then do we take that and diversify that portfolio? We're always looking for a diversified portfolio to add some protection and of course, to benefit from those returns that diversified portfolios deliver. One is determining where in emerging markets are the risk and returns.

Then the question is, what's the universe? Like emerging managers, what's the universe of investment managers? What is the track record? As some of these are younger markets that haven't been around as long as the international developed or the US market, or Canada and so forth. That's what we look at. Is there a sufficiently robust universe of investment managers that we could allocate to those who have institutional talent with experience?

Now, that doesn't mean that they must have necessarily been running that firm for the last 10 years. As long as we can look at the track record and feel they are bringing to the table has value. We tend to think take more time in general within emerging markets.

Then you want to make sure because it's relatively a growing area, there is this fight for human talent as well. There's of course this demand for capital, but for capital to do well, you need good human talent.