Insights from a Pension Pro: Kevin Killeavy, CIO at Montgomery County Retirement Plans

By Madeline Heckman

In this dynamic discussion, Kevin Killeavy shares his team’s secrets to success. Montgomery County Employee Retirement Plans boast a 100% funded status and investment team longevity. From his approach to private markets to his unique take on leveraging complex investment strategies, Killeavy shares how his team is creating their own success. 

Click to watch the video interview, or read the transcript below.

Madeline Heckman: Kevin, why don't we start with you sharing a little bit about you and your background and your role?

Kevin Killeavy: Sure. As you mentioned, I'm the Chief Investment Officer here with Montgomery County Employee Retirement Plans. We are a public pension plan based just outside of Washington DC in Rockville, Maryland. We oversee just over $8billion in assets, and that's roughly split 80% to fund benefit plans and 20% to fund contribution. I joined the team here in 2015, so I've been here a little bit over eight years. Prior to that, I spent the first eight years of my career on the investment team for a large multi-family office, also here in the DC area. I was promoted to CIO in 2021, and prior to that, my primary responsibility was overseeing our private equity portfolio.

In terms of our team, our entire organization has 20 professionals, and that's across investments, operations, accounting, and benefits administration. I oversee the investment division, which is comprised of myself, a dedicated five-person investment team, as well as a three-person investment operations group.

Heckman: Kevin, in one of our last conversations you had shared with me that your plan is right around 100% funded. Can you share a bit about what you would attribute this to?

Killeavy: Sure. Achieving that 100% funding level is something that we're very proud of here and something that we're certainly striving to maintain. To have 100% of our projected future pension liabilities be fully offset by the assets within our plan is a great accomplishment, and that's really the goal of public pension plans everywhere. It's really all the more impressive when you consider that the average public pension fund in the United States is only 75% funded, which means that there's a 25% gap that's going to have to get plugged at some point in the future through some combination of extraordinarily high investment returns, tax hikes, cuts to services, or reductions in benefits for current or future retirees.

In terms of what drove that funded status, achieving that 100% level, it's multifaceted, but I will say the tone starts at the top with our plan sponsor, Montgomery County Government. They have made their actuarial required contribution consistently year in, year out. That certainty has allowed for our investment staff and our board to take a long-term and strategic investment approach. I think our investment performance has also been a key driver of the funded status as we've had attractive long-term absolute returns as well as relative to our benchmark and public plan peers.

Starting with absolute returns, we've generated an 8.5% return net of fees compounded annually, and we've done that with roughly half of the volatility of the public equity markets. This is over our almost 40-year inception. Relative to our public policy or our passive policy benchmark, we've also generated some nice outperformance with a compound outperformance of around 90 basis points per year, which over several decades has corresponded to roughly 750 million in incremental value that is now within our plan. Then, if you look at relative to peers, we look pretty attractive, particularly over the long term. Our 5, 10, and 15-year returns are all in the top quartile of our public pension plan peer group.

When you think about what has driven that performance, a few things that I'd point to, the first being we have a very deep and experienced investment team with a lot of continuity on the staff. The average tenure on the investment team is over eight years. We also have an excellent group of consultants that serve as an extension of my team and assist in areas like asset allocation, investment manager sourcing and diligence, as well as governance. Finally, we have a great board of trustees overseeing our plan that are truly industry leaders in terms of public pension plan governance.

Heckman: Wow. Kevin, I'd love to dive into some different asset classes. I'd love to hear your thoughts on commercial real estate right now.

Killeavy: Commercial real estate is certainly an interesting sector at the moment. I don't think a day goes by where I don't see a story about an institutionally owned commercial property that's heading into foreclosure. We think there's going to be some pretty big bifurcation into the market in the next few years, particularly for funds raised and investments made prior to about 2022. We're really going to find out who are the true value-add real estate operators and who were truly just managers riding the tailwinds of low and decreasing interest rates since the financial crisis.

We've been pretty fortunate in that we have a pretty big underweight to the office sector, which is clearly the sector that's experiencing the most acute stress at the moment. We've also been overweight to some of the sectors experiencing more positive fundamentals like multi-family residential and logistics. Having said that, we still think that even those sectors are going to have some challenges in the coming years, driven by the rapid increase in borrowing costs, the inflationary impact on operating expenses, and in many cases overly optimistic rent growth and exit cap rates assumptions that were baked into many of those purchases.

The way that we have accessed commercial real estate historically was through smaller value-add managers that typically had a property type or a regional specialty. We still think that that is a good place to invest in real estate long-term. We have been shifting some on the margin and making some allocations to some more opportunistic managers that may be more generalist in terms of region or property type, but that have demonstrated an ability to invest across the capital structure in an opportunistic way.

When you look out at the sheer volume of commercial real estate debt set to mature in the next few years, and you consider that it's entirely unlikely that these property owners are going to be able to refinance their loans like they have been in the last decade, it stands to reason that these more opportunistic managers should have a very attractive opportunity set, particularly the managers that have had experience investing in the last downturn.

Heckman: Let's dive into your investment structures a little bit. Can you tell me about what complex strategies or unique structures that you've found to be effective or successful?

Killeavy: Sure. Investment complexity is a very interesting topic and sometimes can be a hot-button issue for institutional allocators like us. We try to make it very clear that we aren't pursuing complexity just for the sake of complexity. I think that's where a lot of pension plans can get into trouble. We have found a few pockets in less efficient areas where pursuing complexity can certainly pay dividends, and has paid dividends for us historically.

One area I'd point to is our experience within private markets. We started building out our direct private equity program back in 2008, and we followed soon thereafter with private credit and real assets. The approach we took at the time was certainly one with a lot of complexity as well as it was also very resource-intensive in that we wanted to access private markets through smaller, less well-known, typically more emerging managers, investing in the less efficient lower middle market.

That strategy today probably doesn't sound as unique or novel as I think the allocator community has sort of come around to the idea that that really is the best way to play private markets going through the lower middle market. If you look back to 2008, when we started that strategy, it was certainly very unique, particularly for a plan of our size. I think most of our peers at that time probably didn't even have private markets, but if they did, they were probably getting their exposure through some of the name-brand mega managers or through fund-to-funds. I think our performance within that area certainly speaks for itself across our three direct private markets programs, we have generated on average 90 basis points or 900 basis points of outperformance relative to our public market equivalent benchmark.

The next area I would say where we have pursued complexity over the long term has been our currency overlay strategy. This is a strategy we've had in place almost 20 years. It's a very capital-efficient strategy where we're not consuming capital from other parts of our portfolio to fund it. We simply will settle up gains and losses with our investment managers on a periodic basis. Within this strategy, we are partnering with a small handful of currency trading groups who are trading currencies globally. Since we've been invested in this structure almost 20 years now, it's added 10 basis points to the overall return of our plan, which is great. I think just as important, that performance has been with zero to slightly negative correlation with the rest of our portfolio.

I think the last area that I would touch on in terms of complexity is private markets co-investments. We've had exposure to private equity and private credit co-investments going back about five years. We recently launched an infrastructure co-investment program in-house earlier this year where we are going to be partnering with some of our value-add infrastructure managers on some of their highest conviction deals. When we think about co-investments, primary motivation there is really to reduce the gross to net return spread within our private markets program.

The last last thing I'll say is it's very important for allocators like us to be very realistic about where we think we can and can't add value through complexity. There are a couple examples in very efficient asset classes like domestic large-cap equities or high-grade fixed income where we have opted to go with a more simple, passive, and low-cost approach there. I think it is important to balance where you want to be complex and take your opportunities versus where you want to be simple.

Heckman: That's great. Kevin, I'd like to switch gears a bit. I'd love to hear your thoughts on energy. What is your approach to that sector?

Killeavy: Sure. We continue to think that it is prudent to have a healthy allocation to the energy sector as part of a diversified portfolio. It's really one of the cornerstones of the global economy. There's an element of diversification, and there's also inflation-hedging characteristics of energy that has a defined benefit plan with retiree pay outs explicitly linked to CPI, having that inflation hedging can be very valuable for us.

We like to have exposure in energy spanning public and private markets across the capital structure and also across the different energy verticals including upstream energy, midstream energy infrastructure, as well as traditional and renewable power generation. I think many of our peers abandoned the energy sector or wide swaths of the energy sector a few years ago, given some lack luster relative performance as well as some non-investment considerations creeping into the investment process.

We think that that was really a mistake, and we're proud to report that we've remained committed to the energy sector playing a role within our portfolio. I think the last few years has really been an indication of that approach, both from a return but also a diversification standpoint as the US has struggled with its largest bout of inflation since the early 1980s.

Heckman: Kevin, what would you say are your priorities for the year ahead, and off the back of that, what are the priorities of your team?

Killeavy: Sure. 2024 is shaping up to be an incredibly busy year here for us. Our top initiative is our asset liability study, which we should be wrapping up the middle part of this year. That is where we, in concert with our board, our actuary, and our investment consultants will set our long-term strategic asset allocation targets. This is something that we undertake every two to three years where we make tweaks to our strategy based on our long-term capital market forecast, alpha expectations, and we also will rigorously stress test our plan's liquidity profile.

I'll say I've been involved in a few of these since I joined in 2015. This is certainly the first one since I've been here, where certain high-grade sectors within fixed income are offering what appear to be pretty attractive returns and yields on a prospective basis, so we may take the opportunity to increase our exposure there.

I think we're also going to continue to lean on our private market strategies, given our performance and expertise there. That's about one-third of our program, and we're likely to increase that to some extent. I alluded to it earlier, but our approach and our bias has been towards smaller, typically employee-owned managers that are targeting a given sector or niche, and typically in the smaller end of their market. We're attracted to the smaller end because you typically see more attractive entry multiples, lower leverage, higher opportunities for operational value-add, and a more fruitful exit environment is given the vast amounts of capital that has been raised by mid-market and upper-market funds that need to put capital to work.

That's an area where it's looking like it may be somewhat of a barbell approach where we increase our private markets exposure, but balance that by also increasing high-quality and very liquid high-grade fixed income.

The next area, I alluded to it a little bit before, is our infrastructure co-investment program that was just launched. This has been very time-consuming on investment, operational, and legal fronts, but we do think that infrastructure is an ideal sector for co-investments given the capital-intensive nature of the space. The large equity checks needed from our managers to close these deals.

Given that we expect an abundance of deal flow from our managers, and our expectation is that we'll be offered these deals on a no-fee and no-carry basis in return for providing our capital to these managers so they can close the deals and retain control. Infrastructure it's also a less cyclical sector relative to other areas in private markets, meaning that there should be less return dispersion and also less likelihood of materially adverse outcomes.

With that low dispersion, when you look at underwritten returns for value-added infrastructure, it's in a pretty tight band in the-- call it, mid-teens gross IRR. What we find very attractive is that in value-added infrastructure co-investments, you can take a 15% gross IRR deal and convert that to a 15% net IRR deal with a co-investment structure.

I guess the last thing that we haven't wrapped anything up on it, but we are highly considering is, increasing on the margin, our exposure to non-US private market strategies. Historically, over 90% of our exposure in private markets has been in the US, which has certainly served as well, and the US has significantly outperformed the rest of the world over the last 15 years due to the strong dollar and the dominance of the US tech sector.

We're just not going to count on the next 15 years looking exactly like the past 15 years, so we do think that now could be a prudent time to diversify that to some extent. Also, we're just very attracted to the alpha profile of many of these overseas managers, particularly those that are targeting the smaller ends of the market. Those are a few of the initiatives that are going to be keeping us busy this year. It's certainly going to be a lot of work, but my team and myself are very excited about it.

Heckman: Kevin, thank you so much. We really appreciate your time and you lending your expertise to all our listeners.

Killeavy: Of course, I really enjoyed it.

Heckman: Thank you.