Interview with Jeff Scott, Chief Investment Officer, Verus Investments

David Grana: What is a strategic partnership model?

Jeff Scott: We have defined it as a partnership with an institution that has investment professionals. I will contrast that with outsourced chief investment officer (OCIO) or implementable consulting. With OCIO, typically there is no investment staff. There could be an investment committee from a board, an administrator and CFO who is overlooking the pension, but there isn't a full time investment staff making investment decisions. With a strategic partnership, you are going into an entity that has full time investment professionals managing an institutional portfolio.

David: You are essentially bringing on new members to their investment team?

Jeff: Yes. In a strategic partnership, if they have 5 to 10 investment professionals and they want a certain expertise or more resources, we fill in the gaps. They basically hire us via a contract to manage a portion of the assets or manage certain investment-related tasks. We work in tandem with and report to the chief investment officer (CIO), just as the other staff members do, but we have discretion in an investment management agreement (IMA).

If we take the example of a 60/40 portfolio, with 60 percent in equities and 40 percent in bonds, the investment staff may want to only focus on equities, as that may be their expertise, but they may have less experience in fixed income. The entity would hire us to work with them to manage the fixed income portfolio, either managing it internally with our team, or having us select and manage third-party managers. We report to the CIO and show what we have done in the fixed income portfolio, the internal team would report on equities and, together, we would put together the whole portfolio and present to the Board or Investment Committee.

The CIO would have part of the team working on-site as direct employees, while the Verus part of the team is headquartered in the Seattle office, and we are frequently in their office. We currently have employee contractor badges for our strategic partnership accounts.

David: Whereby they go into their offices and have meetings around the day to day operations?

Jeff: Every month there are multiple Verus people in and out of those offices, so we will have a place that we can sit within the strategic partnership premises. And again, it is to feel that we are employees and part of the internal team.

David: What types and sizes of institutional investors would opt for this model?

Jeff: A typical profile would be larger institutions, but not too large, so a dollar range between $3-$20 billion. At the $5-$10 billion range, managing a portfolio in a global context in public and private assets requires a large staff. What happens for many of these entities is that they become resource, compensation or geographically constrained, such that it is difficult to retain, attract and get the right resources from the organization to run a globally diversified public and private portfolio.

What you will find is that for a $10 billion organization, they may only have access to 5 full-time employees because of certain internal constraints. So we will partner with the organization and complement the existing resources to help them in the areas where they may not have the breadth or depth of people to manage a certain portion of the assets.

Once you get into the $20 billion size, often times you will see that organizations with a more substantial staff of 20+ people. It is that middle ground where you have hardly any staff, say $2 billion to $10 billion, where the portfolio gets large enough and sophisticated enough, but lacks the resources. Furthermore, it might be cost prohibitive to build a 20-30 person organization when the assets are less than $10 billion.

David: Are we generally talking about small retirement systems or endowment foundations?

Jeff: We have found that it is more in the pension arena, but that said, within the endowments and foundations (E&F) space, there is a big gap between the sizes. It isn't difficult to find $10 billion plans in the public and private pensions. In the (E&F) space, you have a lot of plans under $1 billion and many of them are moving to a complete OCIO model. There are few in between $1-$10 billion, so with the sheer numbers, it makes much more sense in the corporate and public space to search for opportunities.

David: Are you finding that because of buy outs and possibly the shutting down of pensions particularly the Defined Benefit (DB) plans are you finding the universe to be shrinking at all?

Jeff: It is definitely shrinking with the closing of funds, buy-outs and lump sum payments, but it isn't going to go away. The DB plans are still going to be around for 10-20 years, so they are not dinosaurs yet. And the plans still need to be managed. It is a perfect way to work with an organization who prefers to de-emphasize staffing talented resources in pension investments and may want to put them in the corporate finance department and other areas to help build the business. We can partner with the organization and manage either the liability driven investments (LDI) or risk-seeking assets within a frozen plan, as it doesn't have to be a live DB plan. What we find is that CFOs often want to take the talent that they have and put them to work helping the organization build a profitable business.

David: At that stage they need to allocate their resources wisely as opposed to having it in a plan that will eventually die a slow death?

Jeff: Also it helps in retaining investment talent, as it is harder to recruit for an investment plan that is frozen or a partial LDI from a career excitement standpoint. Rather than trying to fight that recruitment war and high wages, the CFO can go to an OCIO provider, like Verus, as we have the experienced and well-resourced team.

David: This then may not be CalPERS that you are dealing with?

Jeff: No, they are way too big. Although I wouldn't say “no” outright, they typically have a large enough staff and believe they can handle it all themselves. And maybe they can. We find that the sweet spot is with organizations who have a limited staff and have come to the realization that to manage the operations and complexity of a global public and private portfolio, it requires people with the breadth and depth of skills that they may not have.

David: Which asset classes does this model cover? What happens if a strategic partner does not have in-house expertise in a particular asset class of which the investor wishes to gain exposure?

Jeff: For most asset classes, we have a large enough team to cover them. In general, Verus has over 100 employees and within our strategic partnership business, we have 28 dedicated employees. In-house today, we don't have enough co-investments or direct investments experience, but what we have done as a fiduciary within one of our strategic partners is to hire a third-party entity who does the co-investments and direct investments for us.

For most areas, we don't have to partner with anybody, but on occasion, we will hire a third party. As an example, direct investments in infrastructure projects are not something we do. We will invest in infrastructure primary funds but not directly invest, like building physical structures.

David: What would be the likelihood of something in that context if you are talking about $5-$20 billion?

Jeff: That is only one example. There are asset classes we can manage internally too, however, it is up to the client to choose what they’d like us to do: either manage the assets internally or only use external managers. Our investment team has managed assets for decades for institutions like Microsoft and Alaska Permanent Fund Corporation in the fixed income and public equities. We will manage cash, investment grade fixed income, equities, commodities, foreign exchange, and option-related tail risk hedging strategies due to the team’s background, but there are areas that we don’t take on, such as emerging market credit, non-investment grade credit, co-investments or direct investments.

We do pick primary funds in private equity, real estate, infrastructure and hedge funds. A key area that differentiates Verus from many other firms is that we also have a proprietary risk-based framework for analyzing the entire portfolio. Let's say we are only managing the fixed income in a 60/40 portfolio. If the client desires, we will run full risk analysis daily on the entire institution’s portfolio. Not just the assets we manage. The analysis utilizes position-level details to report various lenses of risk, plus compliance for the entire portfolio daily.

David: How does the strategic partnership model work in practice, whether day-to-day or quarter to quarter?

Jeff: In the initial year, the in-person visits are quite frequent, definitely monthly. After the first year, it becomes multiple times per quarter from different individuals. As a CIO on the strategic partners, it used to be monthly for me in the first year, and now it is down to once or twice a quarter that I am physically there. But I am on the phone with them frequently, with regular scheduled meetings. The managing director who is assigned to the strategic partnership is also there with the same frequency, and more interaction during the month via phone and email. The portfolio manager assigned are physically there with a little bit more frequency in person. We also assign an operations person who doesn't typically visit, but they are on the account for daily operations and communications to ensure that there is cash for the pension payments, etc. There is also a head risk person who typically meets once per quarter with the client and also speaks frequently with them because risk is run daily. We find that with our smaller size and dedicated staff for the clients, our clients are able to speak with the Verus staff member that is most appropriate for their concern – whether it be a risk analyst, operations, portfolio manager or the CIO.

For the more regular communications, some weeks it is daily, but it is for sure weekly. Daily communication is email and reports, as our risk dashboards are web-based. Our clients log in to see those along with the compliance reports.

David: Do you have any geographical limitations to who you work with?

Jeff: We currently work with two companies who are based in Toronto and Atlanta, so today it is North America. We don't have any geographic limitations and have spoken with prospects in Asia. One of the nice perks of being located on the West Coast is that we are happy to go to Asia - it is an overnight flight. Or we fly over the North Pole and be in Europe fairly easy.

David: You have the advantage because of the time zone and location you operate in.

Jeff: Yes. I typically work New York hours so I can cover what is going on there, catch a little of the late Europe action and check in on the early morning Asian markets after dinner.

David: Thank you for sharing your views on this subject.

This interview is part of the Investing in Multi-Asset Strategies North America 2016 report - enter your details online to receive a copy of the full report.