Guest: Steve Edmundson is the Chief Investment Officer at the Public Employees’ Retirement System of Nevada (NVPERS), overseeing over $60 billion in assets.
Recorded: 3/18/2024 | Run-Time: 48:01 
Summary: As pension funds continue to hire more employees, pay more and more fees and build more complex portfolios, Steve is an outlier for his approach that emphasizes simplicity over complexity. He’s one of two investment professionals on staff and has indexed 100% of all publicly traded asset classes. I love it!
Steve talks about the culture that allows this model to work and shares some thoughts on the rise of private markets and the impact of higher interest rates.
The late Jack Bogle had a quote that applies well to Steve & Nevada PERS: “Don’t do something, just stand there!”
Comments or suggestions? Interested in sponsoring an episode? Email us Feedback@TheMebFaberShow.com
Links from the Episode:
- (1:43) – Welcome to our guest, Steve Edmundson
- (3:46) – An overview of Nevada PERS $60b+ pension
- (8:20) – Focusing on indexing and low fees
- (15:53) – Framework for adding additional asset classes
- (17:39) – Steve’s take on the rise in allocations to private equity and private real estate
- (30:47) – Why the Nevada Model has been successful
- (34:46) – How the higher interest rate environment impacts pension plans
- (41:33) – Steve’s most controversial opinion
- (42:31) – Steve’s most memorable investment
- Learn more about Steve: LinkedIn
Transcript:
Meb:
Steve, welcome to the show.
Steve:
Thanks for having me.
Meb:
I’ve been wanting to have you on the podcast ever since we had a former podcast alum, Ron Lieber, wrote a piece about you darn near a decade ago, was it? It was 2015, somewhere around there?
Steve:
That was a long time ago, but I think that’s about right, yeah.
Meb:
Well Ron is great, and I said I love this guy from the get go, we got to get him on and talk to him.
When did you get the investing bug? I know you were slinging some wine for some point up in Bozeman, but did you study undergrad? Or as a kid where you got the investment bug? When did it all begin?
Steve:
Yeah, I would say that I started to get it while I was in college and then I really got it during grad school, and that ultimately led me to a job in Reno in finance was my first stint in corporate treasury world. I had a terrific group of mentors there and an outstanding group of people to come up through and then they were willing to teach me the ropes.
Meb:
If I got the timeline right, in Nevada, what’s the acronym? What’s the correct way to say it for y’all? What does he say?
Steve:
Nevada PERS or NV PERS, either way.
Meb:
NV PERS. So the timeline there would’ve been like ’05, maybe?
Steve:
Yep, 2005. So I’m coming up on, I believe my 19th year anniversary here at Nevada PERS, so almost two decades now with the retirement system.
Meb:
Well, you guys have seen some pretty phenomenal growth if I get the number right, somewhere in the odd 60 billion-ish. Does that sound correct?
Steve:
Yeah, as of this morning we’re just at 62 billion.
Meb:
Awesome. All right, so we’ll talk about all things current here in a little bit, but let’s rewind to the beginning. You join Nevada PERS. Explain a little bit to the listeners what that is, what that means. I feel like people have a somewhat familiarity with pension funds they’ve heard maybe of CalPERS or maybe the woes in places like Illinois or elsewhere. Talk a little bit about what this organization is and we’ll walk through the timeline and when you joined as well.
Steve:
Sure, so I joined the system in June, 2005, as the I guess, assistant investment officer at the time. Nevada PERS is a divine benefit pension plan. Here in Nevada, we only have one large public pension plan, so we cover all public employees in the state of Nevada, whether they’re a county employee or a city employee or they work for the state of Nevada. If you’re a public employee, you are a participant in the Nevada retirement system. We’re a non-social security state, so we are the primary source of retirement income for all the public employees in the state of Nevada. My job at Nevada PERS as the CIO is ultimately to oversee this investment program that’s designed to deliver returns over a long time horizon that’ll meet our actuarial goals.
Meb:
There’s the long held, people love to say, the 8%, right? Is that the target? Where do you guys fall on that today?
Steve:
Yeah, so eight was the number for a lot of years and when rates fell and ultimately bottomed out, those numbers started to come down. So what used to be eight a decade and a half ago is now seven is the median fund. We’re a little bit above that at seven and a quarter, so our long-term actuarial return target is 7.25.
Meb:
Rewind back. So you join, it was probably what at the time, was it like 10 billion? Do you even remember?
Steve:
I want to say we were around 15 billion.
Meb:
Okay, 15 billion, so still a pretty good size. What was the philosophy at the time? You came in and joined, I know it was a bit of an evolution, but what was day one? What’d the portfolio look like back then?
Steve:
So the portfolio looked similar to how it does today, but not as simple. We’ve become known as being the fund that’s 100% indexed across all of our publicly traded asset classes. Back when I joined, we were around 50% indexed across most of our public market asset classes, both fixed income and equities, so a little bit more complication in the portfolio. We had a few more asset classes in the portfolio, we had non-US bonds, but for the most part we were still relative to the industry, a pretty simple approach starting from the get-go. So I was fortunate enough to step into and inherit the structure that’s been in place here at the retirement system for a long time.
Meb:
If you look at some large institutions, their policy docs, their holdings pages, they can easily run into 200, 300-plus pages. Famously, you have hundreds of employees and thousands of different funds and relationships and you guys are the antithesis of that, your investment policy statement and all these things from the website or almost could be on note cards. Talk about the framework. So from the early days and how you guys have eventually gotten to where you are today, the philosophy. How does this all shake down for you guys?
Steve:
Well, first of all, every public fund is structured differently and we all have our own unique challenges. One of the things that we have at Nevada PERS here is we have a really small staff, relative to the industry, we’re paid relatively less, we have fewer resources available to us. So that lends itself, I think, to a more simple approach from the get-go. So with I would say the smaller staff size and the more limited resources, we really decided to think about what we do well here at Nevada PERS and what can we do well under this structure? Ultimately as we all know, asset allocation is the most important thing for any big investor or even a retail investor, asset allocation is going to drive the bus. So we decided that we were going to spend most of our time focusing on the most important thing, which again is asset allocation. That ultimately drove us to figuring out the most efficient way of doing that.
Meb:
So as you think about asset allocation, I love to think there’s an investing phrase that we use quite a bit here when we’re talking about something. We say everyone’s always out looking for a unique insight and here’s how we’re different and we have to be this very unique setup. We say sometimes the most critical insight is not a unique one. So this insight of, hey, we want to get this asset allocation right, we want to focus on low fees, it doesn’t have to be reinventing the wheel. This seems like a great solution. So did the low fees, was that by design? Is that a by-product or your process? Was it a little bit of both?
Steve:
Yeah, I would say it’s both. Again, getting to this almost holistic emphasis on asset allocation and then trying to figure out, okay, what’s the most efficient way of implementing an asset mix and what’s the most low cost way of getting the market exposures into the portfolio that we want? Indexing lends itself towards that and thinking about what are our strengths here at Nevada PERS and what we can do well. We’ve always felt that we’re pretty good at discipline, we’re really patient and one of the most important things that we can control ultimately are our costs. So it’s a chicken or an egg thing I suppose, but looking for the most efficient path but also knowing that that is going to be the lowest cost. So if we can keep our fees low, we know that’s going to be a relative advantage for us. So that’s something that we put a heavy emphasis on.
Meb:
What does the broad portfolio look like, as far as stocks, bonds, other stuff? Then we can talk about blended fees too.
Steve:
Pretty traditional asset mix and we’re largely, so we’re 41% US stocks, which is 100% index to the S&P 500. We have a 16% allocation to international stocks indexed to MSCI World, XUS. One of the more unique things about our fund though is that our bond allocation is 100% Treasuries, so we have 28% of our fund in the full curve Bloomberg US Treasury Index. The idea there is relative to the industry, we have more publicly traded stocks. Then on the other side of that, we wanted the best diversifying asset that we could find and Treasuries to offset that equity exposure. Then we do have a 12% allocation of private market assets, 6% private real estate, 6% private equity.
Meb:
So when you say indexing, I feel like different people mean different things. Is there a ballpark fee or per asset fee that you guys target? I imagine over time it keeps going one direction.
Steve:
Our fees have come down over the years. When I joined, we were already one of the lowest fee funds out there, but then when we moved to the 100% index structure, that really dropped our fee loads down. Our total fund fees are 13 basis points, but the bulk of that is that 12% in private markets. Our public equity and fixed income fees are around a basis point.
Meb:
For listeners for perspective, a lot of the large institutions, and you could, Steve, you probably know better than I do, but it’s probably all in fees, around half a percent, does it feel about right?
Steve:
The last I checked, I think the median industry fee was around 54 basis points, we’re 13 basis points, and then again, the bulk of those fees came from private markets.
Meb:
What’s so interesting about our world that we’re in is we all start from the similar information and extremely well compensated, massive organizations, and you end up with extremely different conclusions and implementation methods and layers of complexity and simplicity. So it’s fascinating to hear you guys in $60 billion, no small chunk of change. To be fair, you guys have doubled the size of your investment office. Did I hear right? You guys are now up to two people?
Steve:
We’re now two people. When I joined, we were actually three people and then we whittled it down to two and then we became one person for, I forget how many years I was here by myself. Then I had been lobbying for a number of years like, look, we need to get another person in here. So in 2021 we were able to add an investment position back, so we doubled it to two people now.
Meb:
He said, look, I’m lonely guys. I need someone to talk to about what’s going on in the sports world or something today. Once you have this indexing set up, how do you then manage it going forward? Even though they know you, that you probably still get a lot of inbound pitches probably every day.
Steve:
We get tons of inbound pitches and I tell people not to take offense, but we are the worst sales call in the world. Again, it’s just a byproduct of the way that we decided ultimately to implement our approach here.
In terms of evaluating the portfolio, we don’t make changes too often. We occasionally make changes. One of the things that we try to do is to avoid the noise. We don’t want to get cute with adding a 1% allocation to commodities and then pretend that we have an inflation hedge. If we do something in the portfolio, our broad rule is that we’re not going to do it unless it’s at least 5% of total fund assets. So we make relatively few changes, but when we do make changes, they are usually pretty significant. We have an underlying philosophy that we have an emphasis on high quality assets, so we own large cap US companies and S&P 500. We own developed markets only securities on the international side, so we don’t have any in our allocation, we don’t even have any credit in the portfolio currently, we’re all treasury bonds, so high quality across the board. Even with our private markets exposure, our private real estate allocation consists entirely of unlevered core assets, so we don’t even have leverage in that piece of our portfolio. So about as simple and as high quality as you can get.
Meb:
When I think of the global market portfolio, you guys have a lot of the main pieces, US stocks, foreign stocks. Then it seems like the decisions come down a fork in the road where you say, look, there’s some other things that exist in this global market portfolio, but because of this quality decision, we’re going to take a left instead of a right. The ones that mainly pop up in my mind, you can speak to any of these, are foreign bonds, which is one of the world’s largest asset classes, sovereign is what I’m talking about. You mentioned some of the layers of emerging market stocks, junk bonds, things that most people would see that were probably out the risk curve. Is that the overriding factor when you think of quality that you’re saying, all right, these things don’t check the box for us, or how does that work?
Steve:
Yeah, I would say that’s a great summary, I mean, basically. I think it’s really important to note, one of the important things that we’ve done here and as important a decision as anything else is to say no to things and leaving things out of the allocation because those are the big gaping holes. If you were going to look at our portfolio relative to everybody else, you’d say, well, you don’t have any emerging market stocks in your allocation, but the median fund has anywhere between 3% and 5% of their total fund assets in emerging market stocks, so it’s not a huge piece. So again, you get to the spot where it’s probably not going to move the needle, adding the 3% total fund allocation, it’s going to increase some complication.
We don’t have any commingled funds in our portfolio, so it’s all separate account mandates. It’s really difficult to implement some of those other asset classes and separate account mandates. The fees are going to be higher and you’re going to run into a whole bunch of other headaches and it violates our high quality bias as well. So when it comes to those smaller things, it’s a little bit easier for us to say no. Hey, listen, we’re willing to skip out on some of the volatility and some of the potential upsides and downsides of owning some of these other asset classes like high yield bonds or credit altogether at this point, or emerging markets.
Meb:
As you review academic literature, you listen to podcasts or talk to people and there’s some ideas that on paper you’re like, okay, well hold on, this might actually sound interesting. I’m going to make one up. We don’t go down this route, but I know a lot of institutions, so low vol investing would be something that theoretically might be interesting to someone in your seat, versus say a traditional market cap weight. What do you guys think about the potential of things making their way in?
Steve:
Yeah, the bar I would say is pretty high for us to include additional asset classes at this point. We don’t invest in strategies, per se, we invest in markets. We’ve very much started from the mindset that investing is a really simple activity at its core. Especially being a long time horizon investor, you just consistently allocate capital to an asset allocation that has a reasonable risk return profile and you do consistently over decades and let those dollars compound.
Looking at it from a risk perspective, I always think of things in terms of equity linked risk. So how much equity linked risk do we have in our portfolio, because our fixed allocation is entirely treasuries, so that’s our safety bucket and we use that as a diversifying measure against our public equity allocation. All those other riskier things in the mix are a compromise between the risk-free asset and the equity asset. So high yield bonds, you’ll end up with a risk return profile that looks like a 60-40 mix at the end of the day, in terms of volatility and return stream. So we can strip that away and say, all right, let’s just get our risk and our return out of equity and let’s get our risk control out of our diversifying bucket, which are treasuries.
Meb:
The one thing that sticks out, if you were looking at this from the outside and trying to review the portfolio with what you guys say, is you go down, makes sense, makes sense. Hold on, what is this private bucket? You guys got this little private bucket, so you got to explain yourself here, Steve, what does that mean? Is this just like you got some private casino holdings, because private means a lot of things. It could mean, I think you mentioned paid up real estate, but tell us what that is.
Steve:
I get asked about that a lot because it’s the one part of our portfolio that everybody says, well, hey, you guys pitched this simple thing, this low cost structure, and then over here you have a 6% allocation to private equity and then a 6% allocation to private real estate. I would argue that our private real estate allocation is fairly simple. Again, it’s completely unlevered core assets. We don’t do any developmental, value added, or opportunistic investing in that portfolio. So from that perspective, it’s about as clean as it can get.
Then the private equity piece, surprisingly, we’ve been doing it maybe as long as any other public fund has. When I joined the fund, we had I think around a 2% allocation of private equity at the time, which has grown a little bit over the years. Again, because we wanted to not violate our 5% rule. We wanted to make sure if we have an allocation to the asset class that it was ultimately going to move the needle.
But then the question becomes, well, why the heck do you have private equity at all? That’s a terrific question, because we have, in addition to our large $62 billion PERS portfolio, we manage three other portfolios as well. They’re smaller allocations, one’s for our legislators, we manage another portfolio for the judges in Nevada, and then a totally separate portfolio for some post-retirement health trust investments. Those portfolios are 100% indexed. They only own three asset classes, US stocks, international stocks, and treasury bonds, and we’ve been managing those portfolios in that manner for a really long time, decades. Those portfolios have generated returns that are in line with the larger PERS fund but so the question is, well why the heck do you have the expensive private markets in the middle of it? The answer ultimately is that by adding private real estate and adding private equity to the allocation, we’ve been able to, over time, produce a return stream that’s a little less volatile than those smaller portfolios. So we’ve added a few basis points in return and we’ve done it with a little bit less volatility. So the diversification piece of the private market allocation has worked over time. We’re not going to go headlong into those asset classes for a number of reasons, but they have provided that diversification measure that we’ve been looking for out of them.
Meb:
It’s interesting to hear a fresh perspective, particularly from the industry that seems to move, it’s like a swarm of bees together, it’s like a herd tends to be, and you’re a little bit out of the main flow there, as opposed to New York or Boston or San Francisco or Chicago or something. During the zero interest rate period you had, all right, everyone said, okay, well we can’t do bonds for this, so private equity is going to be the savior. Certainly, that trend feels like it’s continued and only increased, and ditto with other types of funds, but private equity being really the big one that most do it more traditional. When you say private equity meaning like LBO, late stage buyout, smattering of VC, but often tends to be later stage. Does that ever worry you at all as you look around at your brethren and say, look, we’re doing this thing over here? Do you ever get a little bit of the FOMO feeling, you’re like, all right, hold on, are we missing something here? How do you avoid the siren song and say differently also, do you think as you look around your space, is there anything that makes you nervous?
Steve:
Yeah, we’ve always been a little bit different than other funds. I would say that the dispersion has grown over time, largely due to the private markets, just the tremendous growth in those asset classes. I don’t worry too much about being different. It’s one of the reasons why we’ve been successful is we’re willing to be different. One of the key things there is just managing expectations. We know what types of environments we’re going to look good in, we know what types of environments we’re going to look bad. We can forecast those environments. I can tell you exactly when we’re going to look good and when we’re going to look bad. As long as we can manage expectations around that, being different hasn’t been a huge problem and I think it’s been one of our benefits. I mean, you definitely stick your neck out there a little bit being different, but the only way to, I guess, end up ultimately with a different return stream and a different portfolio is to actually stick your neck out there and be different. So we’ve been willing to do that and we’ve been able to manage those expectations over time, which has kept us in the game when things get tough.
But as I look at the landscape and the growth of private markets, I would say that that really started in earnest back in ’08 and ’09 during the financial crisis. Obviously public equity was a really difficult time for public equity, and I would say publicly traded assets, obviously junk bonds, anything else, and it drove a lot of folks into privately held assets.
On the public fund side, there’s a really good reason why private equity, private real estate, and private credit are such attractive asset classes. We have a really interesting dynamic for public pension funds and a unique challenge, in that we are among the longest time horizon investors in the market. So we have time horizon that’s measured in decades, so we look out 30 years, but at the same time, our actuary looks at our asset values on an annual basis and our contribution rates, the amount that needs to get paid in from our employees and our employers to fund the plan over time, they look at that on an annual basis and our contribution rates reset every two years. So it’s like we have this long time horizon from an investment perspective, which would lend itself to owning a lot of risk. On the short end though, we have real world implications if we have a lot of market volatility over a short time period.
Enter private markets, and that’s as you said, the siren song. It’s the ultimate solution for a long time horizon investor that’s sensitive to short-term market disruptions because you get to own these risk assets but not see them marked to market on a daily basis. The pricing mechanism is a lot slower and it’s usually a lot more muted than you see in publicly held assets. So it’s in a lot of ways the perfect solution for a public pension fund. You say, hey, listen, we can own risk without really having to experience that risk on an annual basis. So I absolutely understand the attraction for public funds specifically for these asset classes.
However, I get a little bit worried that it’s become somewhat of a crowded trade. I also think that over time, the only thing that’s going to ultimately matter for us is going to be, what’s our total allocation to risk or equity-like assets, and what does that look like compared to other funds over long time horizons? I think that we can still get to the same place over a long time horizon, and most public funds have. All of our returns if you go out 20, 30 years, the dispersion of returns is pretty narrow and we’re just going to see a pretty wide dispersion over shorter time periods as a result of that. So I don’t think that it’s necessary to hold those assets, but it does mute volatility even if that volatility is maybe a little bit of a mirage. Everybody knows that there’s a lot of risk embedded in those asset classes, but it helps when you don’t have to look at it on a daily basis.
Meb:
Talk to us about why you think the world hasn’t transitioned more to Steve’s view of the world or mine to an extent? We probably differ on some things, but in general, framework.
Steve:
Well, I think there’s a whole bunch of reasons, and I can’t obviously speak for the industry in total. I can only speak for what we do here in Nevada specifically, but I think one of the key things is putting together an investment portfolio that the constituents, our members and beneficiaries, our trustees, the taxpayers in Nevada can get their head around and understand and can get behind. Our fee simple structure is something that’s worked really well for our culture here in Nevada, I don’t believe that it would necessarily work well in other places. There’s a lot of different ways to get to the end goal in this industry.
I get asked this question a lot, and I even get phone calls sometimes from people in other states and trustees in other states saying, hey, we want to do it the Nevada way. I’m like, hey listen, stop right there because you’ll go out and abandon your hedge funds and abandon your private markets allocations and 40%, 50% of your portfolio into US stocks. Then all of a sudden you’re going to wake up one day and stocks are down 35%, 40% and you’re going to wish you had those hedge funds and all the other stuff, and then ultimately that will be abandoned. You can’t put together an investment portfolio that’s going to work over a long time horizon if you abandon it at the wrong time. So what I think works here well in Nevada would not necessarily work well in other places.
I’ve seen wildly successful public pension funds, there’s a whole bunch of them out there that do things polar opposite to us, but they’ve been doing them that way for a long period of time. They’ve been doing it consistently, they haven’t changed their portfolio structure. The kiss of death is abandoning the structure at the wrong time, selling stocks ’08, ’09, liquidating your private real estate portfolios when assets are down 30%, 40% from their marked values. So those things are generally not the right way to do it. So putting together a portfolio that the culture can sustain, I think is the single most important thing. So what works in Nevada, I don’t believe necessarily you would work in other places and vice versa.
Meb:
It’s interesting comment about culture and incentives and who’s involved, because you hit the nail on the head earlier where you talk about investing time horizons being in the decades, and the vast majority of investors they want, whether the markets will give it to them or not, they want certainty and results in 1, 3, 5, 10 years, I used to say, now I say 1, 3, 5, 10 quarters or months. But you start to have all these various people, organizations involved.
You look at universities like Harvard, historically been a monster endowment for a century, totally opposite approach with active management. We used to write articles about this a decade ago. They went through a lot of CIOs, a lot of struggle, and articles in student newspapers and various alumni flip back and forth between when they were underperforming because this is actively managed, that was the narrative. They were saying, what are we paying these guys so much for? They’re underperforming this year, the benchmark, look at Nevada, they did this and we underperformed. Then on the flip side, when they actually did well, they said, look how much we’re paying all these managers. This is crazy. So it is just a hot mess in my mind and you see so many of these organizations that are built in my opinion, to really struggle with just the structure and governance and all of that, and indexing is such a simple message and it’s really hard to argue with. It’s really tough… But I hear it on the other side where people say, no, no, no, Steve, you’re just sitting there in your office. You’re not doing anything. We could be hiring KKR, these guys are showing us these 20% returns they’re promising. Not KKR specific, but you guys know what I mean, listeners. So it’s tough to be able to stand up to either side.
Steve:
I think there’s some great examples of funds that have done both really well. Obviously Yale pioneered it, but there’s other public funds that have been doing that. Investing in a similar style for a long time, and they’ve stuck with the approach. I think your comment about turnover in the CIO role, turnover in strategy, that’s the kiss of death, is when you’re steering from one side of the road to the other. It’s like, pick a path and understand when it’s going to work and when it’s not going to work. Sticking with it when it’s not working is the most important thing.
This job is really easy when everything’s going well, it’s when things get really difficult like they had in ’08, ’09, or in 2022, or when everybody’s looking at negative numbers on their screens that things become difficult. That’s when I think we ultimately earn our money if we keep people on board and like, hey, listen, we know this is going to happen, this is not a surprise, and the most important thing at this point is to stick with it. Don’t abandon it at the wrong time and also, don’t chase returns either.
Meb:
That’s easy to say, hard to do. That’s in my mind probably the number one driver of bad behavior and chasing returns on both sides. So something screaming up and chasing that, but also the thing that’s doing poorly, selling on and on, rinse, repeat.
Give some advice, just general comments to the professional investors listening. It could be financial planners, advisors, but also individuals. Many individuals say, “I’m investing on a long-term time horizon,” and yet they have the daily seduction of everything that’s available. It’s like going to the grocery store, trying to buy some oatmeal and then walking down the Froot Loops and all the other offerings, it’s hard to not get seduced by all the goods. What would you say from someone who’s been in the seat for quite a while? How do you set up the structure so it works?
Steve:
I would start with a reasonable investment allocation if you really do have a long time horizon. My daughter asked me this, she’s out in the professional world now and she has a 401k plan and she’s like, what the heck should I do with it? I’m like, Emily, if you really do have a 30, 40 year time horizon, implement the Warren Buffett portfolio, 90% stocks, 10% bonds, shut your eyes, rebalance it every few years or put in place a rebalancing program that’s mechanical and don’t look at it, but 40 years from now you can open your statement, you will be a very happy individual. That’s true with public funds too, if our time horizon was really 40 years, you should be at a 90% risk and shut our eyes. But unfortunately, we have those near-term realities that we have to balance. Again, that’s the most difficult thing. But for an individual investor, I would say that the most important thing is picking an approach and sticking with it. Again, discipline is probably the most underrated skill set available in this industry.
So I told my daughter, who owns a bunch of stocks, don’t worry about it. There’s going to be moments where you’re going to lose 40% of your money, I can guarantee that, but the trick is to keep allocating, keep those monthly contributions going, and then look at it 40 years from now. Then back in 2020, ’21 when the meme stock crypto thing was going on and earnest, she’s like, I really want to get in on this. I’m like, are you kidding me? After everything I’ve told you, after all this? But it becomes really difficult when your colleague’s sitting in the cubicle next to you is like, hey, I just made 400,000 investing in some cryptocurrency, and all of a sudden that fear of missing out. At that point I tell her when that feeling is the most acute is when you want to avoid it the most because that generally indicates that a top is in or there’s a bubble going on, but stay away and just stick with your approach and you’ll be happy over time. But it’s difficult to tell somebody that when their neighbor is getting rich.
Meb:
On the quote of the day, we have an old school John Neff quote this past week, and I was targeting it at my crypto friends, but I didn’t specifically say crypto friends, but he says, “Just when I think about bragging about an investment means it’s usually about time to sell.” The humility of an investment that does well, goes back to the old Buffett when the listeners have heard this a million times, but it’s like it’s not greed and fear that drives markets, but envy. That’s the worst feeling, is your neighbor getting rich. Not necessarily anyone else but just the neighbor, your good friend, is tough.
There’s so many intermediaries in our world that love to take fees, but it seems like a wonderful brokerage or fund model would be almost like the inverse Robin Hood where it’s almost like a lockbox set up where like, hey, you can invest, but this is going to get held for whatever, 10, 20, 40 years. Maybe there’s some incentives that are said differently, some penalties for behaving poorly. But the short math I always love to do is that in 25 years, an investment can be 10x at 10% and at 50 it’s 100x, 100x. So if you come out of college, plop down 10,000, that sucker is going to be a million bucks by the time you retire, on average.
Steve:
But you have to survive watching your 401k balance go from 200,000 to 100,000 and not abandon ship at that point. Also at the same time, continue to implement that while your neighbor’s getting rich in whatever the hot dot of the day is. It’s a behavioral thing, really.
Meb:
Yeah. As you look around, is there anything here in 2024, there’s a lot of overlap in philosophy and what Buffett and Munger would talk about, even though they’re an active shop, but the advice he gives is very much what you’ve been talking about, but they talk about being sloth-like in their activity. As you look around in 2024, here we are a few months in, and we have interest rates again, inflation has come down, but who knows? Is there anything you look around and you see that either just got you worried, excited, confused?
Steve:
The higher rate environment is a huge deal for public pension funds. It’s created a mess with certain asset classes. Obviously, it had its way with bonds. Private real estate is going through it right now. The cost of capital and private equity is no longer free, and so it’s definitely changed and shook up a bunch of asset classes. But if you can widen the lens out, the increase in rates is the single most important thing that has happened to public pension funds, it is a huge deal. If you go back to the last time rates were where they are today, the median public pension fund had an investment return target that was around 8%, and the median allocation fixed income at the time was 35%. Now here we are, the median fund investment return assumption is now down to seven, and so all of a sudden public pension funds can hold 40%, 45% of their holdings in fixed income and now get to their return targets. This is a much stronger foundation for public pension funds to be starting from. So the increase in rates has been a godsend to the industry, it’s obviously been a problem for a lot of asset classes and a lot of asset classes continue to work through that. But from a longer time horizon, we now have an alternative to disowning equity.
If rates had stayed, say 10-year rates had stayed below 1%, all these public pension funds, including Nevada PERS would’ve had to have 95% of our assets and risk assets, which probably would not have been something that would’ve been sustainable over time. Now we can go back to a more traditional approach and have a bunch of our assets in lower risk bonds and still realistically get to these long time horizon targets. So it’s been a really important event for public pension funds that we were ultimately hoping for. In a lot of ways this ripped the bandaid off going from zero to five on the short end and going from 50 basis points to four and a half on the 10-year. Painful, but the best thing that could have happened to our industry.
Meb:
Weird time, looking back on it, zero interest rates, negative in some places certainly, but it’s always weird in markets, but particularly weird.
Steve:
Yeah, I think it was the weirdest thing that I’ve ever seen in my career, to be honest. Going back to tech bubble zone, there were a lot of froth markets getting ahead of themselves that happened, but 10-year treasury bonds trading at 50 basis points is almost nonsensical and negative yielding sovereign debt is absolutely nonsensical.
I think everybody’s going to look back at those time periods and scratch their head and wonder, how the heck did we let this happen? There was a lot of mispricing of assets as a result of that and the market continues to work through that. There were business models created on free money. The idea that companies can burn cash and just raise capital cheaply forever into the future, that’s going away. So that’s impacting the VC world. Cap rates in private real estate dipping down to 4% or below because the spread over 10-year treasuries at the time, it seemed reasonable relative to history, but what wasn’t reasonable were 10-year treasury bonds below 1%, completely nonsensical. If you assume that the Fed is going to get it right over time and say, hey, inflation is going to settle out between 2% and 3%, well then it doesn’t really make sense for a 10-year treasury bond ever to dip below, say 3%. A tenure treasury bond at four makes a lot of sense, but it did not make any sense back when rates were zero. So I think that was maybe the single biggest anomaly I’ve seen in my career were what rates did. I hope we never see that again.
Meb:
I’m going to bounce around and ask just a handful of questions that are probably a little shorter, but feel free to answer longer. One of my favorite responses you had earlier that I have conversations with a lot of investors about is they’ll be hemming and hawing talking about something or an asset or investment, and it’s like 1% of their portfolio. I want to say, it’s not going to even do anything. Why are you even stressing about this? Even throwing it in the historical simulator, you need to move the needle for it to even get you out of bed in the morning. So I was laughing as I was looking at your investment relationships, some you’ve had for 40 years. When was the last time you guys hired or fired a new manager? Was it this decade? When was it?
Steve:
Oh boy, it’s been a while. We brought on a new manager to manage a fixed income index portfolio and an international stock portfolio maybe six or seven years ago but the changes that we make are really infrequent and not surprising because we’re indexed. As long as they don’t mess it up and keep doing a good job, we have no reason to change those relationships.
Meb:
No, it makes sense. I’m looking around your office. I don’t see a Bloomberg. Where’s your Bloomy?
Steve:
I do have a Bloomberg terminal. Yeah, it’s a keyboard right here. I’ve got the-
Meb:
Oh man, you guys are getting fancy in the world.
Steve:
Yeah, I do have that, and I actually really appreciate Bloomberg, that’s where I get most of my news. I like to read my news rather than listen to editorialized versions of the news. That’s both in finance and politics. I just assume, read it, and formulate my own opinions, rather than get somebody’s opinion on markets. So I do enjoy my Bloomberg. I guess it would be my guilty pleasures here in the office these days.
Meb:
I was reading one of the old articles and they were talking about how successful y’all have been on the returns, and they said something along in the headline that almost feels like a slight, but I saw it as a huge compliment. They’re like, what does he do all day? So I was like, I don’t know if they’re saying something positive or not, but I loved it. So are you like a Warren Buffett style? You spend most of the day reading? What’s your day to day on the investment side look like?
Steve:
Yeah, I spend a bunch of my time reading. Obviously, we have a lot of internal compliance, due diligence stuff that we’re constantly dealing with. All of our assets are held within our custody bubble, so we have things like tax reclaims from our international stock portfolios. There’s seemingly always something coming up on the operational front. So we spend a lot of time doing things that aren’t all that exciting, but every now and then we do get to do and we’ll implement some changes that are always meaningful. Whenever we make a change here, it makes a difference. We’re not going to spin our wheels talking about adding a 1% allocation to hedge funds, that would be a complete waste of time, but when we do make changes, we spend a lot of time with those changes, spend a lot of time with our trustees, and we make sure that they count.
Meb:
This is a question we ask a lot. I know probably what you’re going to say, but if you go to drive down to Vegas and there’s a big endowment manager conference, you got all the big CIOs sitting at the table and you guys are chatting over a coffee or beer or something. What’s the main belief you hold that’s non consensus that if you said out loud, 75% of them are going to shake their head and say, what is Steve talking about? We don’t agree with that at all. Anything come to mind?
Steve:
One of the things that I hear a lot in the market these days or in the industry is this concept of hire for longer. I don’t see interest rates now as being high. I see the last 15 years as being an anomaly. I see current rates, maybe the front end is a little bit high, five at the front end relative to a 2% inflation assumption might be a bit high. I could see that coming down, but the rest of the curve I think is priced about right. I think the 10-year sitting around four, four and a half, provided the Fed can get their inflation targets and ultimately get there. I think rates are about normal now, not high, they’re just high relative to recent history.
Meb:
We love to ask, what’s been your most memorable investment? Now without knowing, I imagine Steve is also an indexer in his personal life. You can correct me, you may be a cowboy, stock picker, crypto trader, arbitrager in your spare time, but anything in your history that particularly stands out on the investment side that was particularly memorable?
Steve:
Yeah, so just because we’re indexed across public markets doesn’t mean that we don’t do things. Again, we are reallocated into equities after oh ’08, ’09. So we can control the exact market exposures we want in the portfolio at all times because we’re indexed and when 10-year Treasuries bottomed back in spring of 2020, so we have a big allocation to fixed income, 28% of our portfolio. We took that allocation, which was in the full curve Bloomberg Treasury index at the time, and we moved the entire allocation to a short duration posture back when 10-year Treasury was around 60, 70 basis points. So we got lucky on the timing, but conceptually I was pretty happy with the outcome. So we avoided a lot of the train wreck in bonds on the way back up.
Meb:
Having fixed rebalance, either time-based schedules or tolerance-based listeners. So Steve, I love what you commented earlier. We like to rebalance every few years. People assume you have to rebalance frantically and really, even on all the asset allocation research we did, particularly when you add more assets, even if you rebalance every three or five years, it really didn’t make any difference. But for most people, yearly, I feel mentally the review, getting things back is a good one, but also the tolerance where if something moves too far one direction, you rebalance then, whether it’s asset class goes up or down 20, 30, 40, 50%, whatever it should be listeners, but is a good way of thinking about it. The worst way to do it, it’s just either not doing it or doing it by gut or emotionally, where usually the outcome is the opposite. When something’s going up, you not only don’t want to sell, you want to add some more, buy some more.
Steve:
Yeah, a mechanical rebalancing process is a free lunch. We think We’ve added about 20 basis points. We have a trigger based system here, but an annual rebalance system works really well too. As long as it gets implemented in just a consistent approach and leaves our emotions out of it but does it every year, is as good as anything else, and you can add a few basis points to your total fund and keep your risk profile in line with who you’re comfortable with.
Meb:
Steve, thanks so much for joining us today.
Steve:
Yeah, thanks for having me. Appreciate it.
