Asset Allocation, Governance, Institutional Investors, Sovereign Wealth Funds

Asset Owner Profile: SITFO’s Madsen Believes Institutional Investment Pros are Underappreciated

In 2015, the State of Utah created the Utah School & Institutional Trust Funds Office (SITFO) to manage revenue from natural gas, oil, and the sale of state lands. That year, the trustees of the fund hired Peter Madsen as the fund’s first chief investment officer, a position he holds today.  Having moved around the industry over the preceding 14 years, during which he “sat at nearly all sides of the table,” including  stints as a managing director at a London-based hedge fund, as a management consultant and as an institutional investment consultant, Madsen says he didn’t join SITFO for the money. Indeed, he says he laments the fact that “some of our peers are adding tremendous amounts of value yet are among the lowest paid in our industry. The disparity between compensation for investment professionals on the asset-owner side versus the investment manager side seems quite large. Compensation at many government institutions is improving, but my perception is that it is improving slowly and modestly.”

Peter Madsen, CIO, Utah School & Institutional Trust Funds Office

IA: Is Utah School & Institutional Trust Funds Office considered a sovereign wealth fund?

Madsen: Yes, the State of Utah School & Institutional Trust Funds Office manages a pool of trusts that receive contributions from royalties and land sales. The primary sources of revenue are natural gas and oil. Other revenue sources include mining and grazing. There are 15 or so land grant trusts in the U.S. that have similar origins, most notably, Alaska, Texas, and New Mexico. Historically, our group have been referred to as permanent trust funds. Given the rise of sovereign wealth funds globally and the increasing wealth of these funds in the U.S., there’s been a change in naming convention in the industry to group us all together globally, given the similarities of funding, structure and purpose. Not as many are familiar with the moniker of “permanent trust fund” as they are with “sovereign wealth fund.”

IA: What is the mission of Utah School & Institutional Trust Funds Office?

Madsen: SITFO, as we refer to ourselves, is the agency tasked with managing the sovereign wealth funds for the State of Utah. We manage $2.5 billion across 11 trusts, which mostly benefit Utah’s education programs. Our stated mission is “to responsibly maximize the return on the invested principal of the School and Institutional Trusts for the current and future benefit of Utah’s education programs.”  The 11 trust funds are: School Fund; Utah State University; Deaf School Fund; Institute for the Blind; Industrial School; Normal School; Reservoirs Fund; Utah State Hospital; School of Mines; University of Utah; and Miners Hospital

IA: What led you to your current role with SITFO?

Madsen: SITFO was created in 2015 as a dedicated entity with the sole purpose of managing the trusts. The state assembled a task force of investment professionals with significant investment experience to create the statues and establish our board of trustees. The trustees used a recruiter to source their first employee, the chief investment officer, namely me. 

I had been living in London for about five years as a managing director at the hedge fund group Cube Capital. We started returning capital to investors in early 2015. We had reasonable success, our peak AUM was over $1 billion, returns were good, and the philosophy and portfolios were easy to differentiate from others in the industry. We invested a lot in personnel and systems in order to match best-in-class expectations of an institutional firm, but we were unable to persuade enough institutional allocators to join us. It was a difficult environment for hedge funds to raise capital and after giving it our best efforts, the founding partners decided to retire.

It seemed like a good time to move my family back to the States, and we wanted to live in the western U.S., and I had been aspiring to move into the CIO position. I was fortunate in my timing, had strong ties to Utah, and I think it helped that I was the investment consultant for the Commissioners of the Land Office, State of Oklahoma for several years, which is also a state sovereign wealth fund supporting education.

IA: Where did you go to school and where have you worked since then?

Madsen: I started out in the trades after high school working for a UHF broadcast television channel (who remembers those?) with a long-term goal of being a cinematographer for outdoor related documentaries. In 1987, when Rupert Murdoch was rolling up UHF channels to launch the Fox Network in the U.S., I was laid off. I started working at a local ski resort as a stop-gap solution and bit of fun. That led me to Alaska for the summer, and after a few summers in Alaska and winters at the ski resort, I ended up studying Russian and political economy at the University of Utah. I spent almost two years in Russia between 1996-1997 to bolster my language skills and immerse myself in the culture. I had the idea of being an academic or diplomat. But, after taking a few econ courses I started to get the bug for international markets. Instead of switching majors I finished with a Russian degree and decided the next best move was an MBA. I attended Middlebury Institute for International Studies with the notion always in mind to work internationally and graduated with an MBA in 2001.

Allocators often only see the very best of investment firms or tend to be overly judgmental about organizational challenges that aren’t mission critical issues.

Out of grad school, I joined Blue Heron Consulting, a spin-out from Russell Investments in Tacoma, Washington, as a management consultant to investment organizations. That was a fantastic opportunity because our clients were investment organizations of all shapes and sizes with all types of challenges. It was a great introduction to institutional investing and provided great insights into future due-diligence efforts. Allocators often only see the very best of investment firms or tend to be overly judgmental about organizational challenges that aren’t mission critical issues. This was a great exercise in normalizing or participating in the mundane within the world of highly paid portfolio management teams and CIOs. Allocators typically only interact with investment managers when they’re pitching us or when they know they’re being scrutinized with potential management fees on the line. In this job, our clients were open to discussing their weaknesses as well as their strengths in order to drive improvements.

I had a short stint at Parametric, a Seattle-based firm, which, at the time, was focused on rules-based equity management and tax efficiency. It was a great experience with a lot of varied projects taking place. However, given they were focused on tax-efficient passive investing, I joined institutional investment consultant RVK in 2005 to broaden my exposure to the industry. My experience at RVK was transformative: I covered several large clients who were undergoing significant change, as well as seeing RVK double in size during my time there. There was always a lot to do and something new to learn.

I began working overseas when I joined Cube Capital in London. I met the firm during a research project for some clients at RVK. The team, the philosophy, the strategy and performance were compelling. However, they weren’t quite prepared for institutional due diligence and lacked a few key organizational and process elements that consultants and large allocators require. I let them know RVK wouldn’t allocate and that it would be a tough battle to convince other allocators. They asked for some feedback and I wrote a memo-like email of what changes I thought would be necessary, as a courtesy. I wasn’t looking to leave RVK, but at the end of that memo I had this feeling that this was my opportunity to get overseas and so closed it down with an offer to help make the changes.

IA: Tell us about your investment team at SITFO?   

Madsen: We’re a small team of generalists. Given we’re a new agency, we’re growing slowly and methodically and planning to hire our fifth person this summer. There are usually a couple of strong interns that work part-time for us while attending graduate school at the University of Utah.

We have primary and secondary responsibilities across all asset classes and collaborate with our consultant who provides support with operations, due diligence, as well as overall investment advisory work.

My first day, I was given a laptop in a box and a hard copy of the statutes governing our newly minted agency and sat in a spare seat in the capitol building.

I think we’ve developed a high-quality enterprise for our size and resources in a short time frame. My first day, I was given a laptop in a box and a hard copy of the statutes governing our newly minted agency and sat in a spare seat in the capitol building. Since then, we’ve built our team, established our consultant relationship, hired a custodian, wrote our beliefs, investment policies, and developed investment processes as well as fully transitioned the portfolio we inherited. I’d say, overall, we have a highly productive and hard-working team.

IA: What is the asset allocation breakdown of Utah School & Institutional Trust Funds Office

SITFO Asset Allocation Breakdown Source: SITFO

Madsen: We build our portfolio using a GRID framework. Growth, real assets, income, and defensive are the categories we use. Those are self-descriptive terms with only income and defensive likely needing a bit of clarification. Income is a risk-oriented category of investments, wherein returns are from contractual payments or obligations and not in anticipation of capital appreciation from share-price increases. There’s a lot of overlap with corporate equity risk in this category through high yield and distressed, but we do our best to minimize the link to equity risk and emphasize consumer debt, specialty finance, insurance related, and other collateralized lending. The defensive category is meant to provide positive convexity in a significant period of market stress. It includes an allocation to 30-year zero-coupon Treasuries, with an active overlay to extend duration in times of a flight to quality, and a custom multi-manager mandate we describe as systematic convexity, which is a portfolio of strategies with a long-vol bias.

IA: What are SIFO’s spending requirements or spending strategy?

Madsen: In effect, our spending policy has two components: 1) a needs-based component which captures inflation and the growth rate of student enrollment, combined with 2) a stability factor which is 4% of a 12-quarter average of the portfolio’s market value. We’ve also capped the distribution amount to 4% over a 12-quarter moving average.

IA: Which consultants does the fund use ?

Masden: We work with David Center and the various heads of asset class research at Fund Evaluation Group. We hired them in 2016 after a months’-long process of screening and meeting with various consultants. Our initial request for proposals allowed for unbundled bids on all segments of the consulting industry. Not many of the proposals came in unbundled, but we did receive several responses to work on the alts segments or some portion of alts. In the end, we selected FEG because they are in that sweet spot of size, having the resources to work with smaller managers and less conventional strategies. They have dedicated analysts across all asset classes, including alts, which makes for one-stop shopping.

IA: How would you describe or characterize your investment philosophy and/or the investment philosophy of the fund? 

Madsen: We have an investment-beliefs document and some formal language around this.  We do our best to ground our decision-making in objective research and sound portfolio theory, but we try to remain open-minded. We value long-term growth over short-term gains and question conventional wisdom. The primary drivers of innovation at SITFO are related to our need to be pragmatic and our belief in the importance of trying to be unconventional. As a relatively new agency, we are constrained on resources, yet we received the mandate to re-invent a traditional portfolio. We’ve spent a lot of time interviewing other investors and try to learn from our peers.

Being resource constrained is better suited to a top-down, asset allocation orientation. Our goal then is to determine the sub-asset class, region, or industry exposures that will drive returns over the coming decades. Note, I started with sub-asset class, and not “asset class”. We take it as a given that there are only a few factors that drive returns and they can largely be represented by a two-dimensional plane. Our asset allocation acknowledges that by utilizing a GRID framework that tries to simplify equity risk (growth), inflation risk (real assets), credit risk (income), and rates/convexity (defensive). We then populate those categories with exposures that reflect those dimensions and are either providing low-cost breadth in a rules-based format or trying to add value through active managers in illiquid or less efficient markets.

Diversification has gotten more difficult. We need exposures to conventional asset classes, but we can’t afford to spend time in search of alpha in those areas. Instead, we try to prioritize areas with structural inefficiencies, long-term tailwinds, or those with meaningful diversification benefits. Some examples of this are relying more on consumer lending than corporate lending; being the first institutional money into strategies in inefficient markets such as microcap and frontier; we are participating in seed and early stage investing in Utah, China and looking at India. We’ve also engineered a systematic convexity strategy with FRM that aims to provide upside in a down market, with a return like cash over the long term.  

We believe the best naïve portfolio is an equal-weighted portfolio and not a 60/40 market-cap weighted portfolio. We believe weights should be adjusted away from our initial assumption of equal weighting based on expected outcomes. While not yet applying volatility targeting, and simply borrowing from risk parity, the underpinning idea is that diversification is hard won, and sizing is critical. It also helps frame the question of the value of adding to the portfolio and avoiding diminishing the hard-won diversification.

We currently have 40 manager relationships and have a target objective of having approximately 50 manager relationships across the total portfolio, including private markets.

The equal-weighting concept is also applied to single-line items as well. If we’re taking the time to do the work on a fund then we want to make sure it is worth adding, and if it’s worth adding, it’s worth adding in size. We currently have 40 manager relationships and have a target objective of having approximately 50 manager relationships across the total portfolio, including private markets.

Given our limited resources, we take as much advantage of our relationships as possible. Where it makes sense, we’ll be the first institutional investor and are happy to work with smaller funds. We have been an early investor in approximately one-third of our portfolio. These are opportunities for lowering fees as well as securing capacity in less-efficient markets. Our rules-based approach to co-investments is also attractive to smaller funds and fosters the partnership experience and knowledge transfer.

IA: What was the best experience in your career?

Madsen: There’s been so many great experiences for me, given I’ve moved around the industry a bit and have sat at nearly all sides of the table. Early on at Blue Heron, I was so lucky to have Jeff Hansen as a mentor and boss. He is a wise individual and a fantastic organizational and personality expert. He was always so generous with his insights and allowing me to work alongside him in VIP-type settings as a junior analyst. Additionally, living in London was one of the best things I and my family have experienced. The team at Cube Capital was a great mix of competitive individuals from all over the world. London is one of the greatest cities on Earth. Those things combined with the growth and changes at the firm over those five years was a highly rewarding experience for me and my family.

IA: What has the worst experience in your career?

Madsen: Being an investment consultant during the Global Financial Crisis was difficult. We were going to client meetings reporting on losses and trying to encourage disciplined behavior. It was a time of great uncertainty and some clients’ emotions were leading them to challenge everything. We struggled with one client who wanted to get out of the market in late 2008. They did not heed our advice and took most of the portfolio to cash. We tried to continue to work with them but they stopped returning calls and emails. I cared a lot for those people and their cause was worthy. I was devastated by that.  

IA: In what part of the industry have you witnessed the most change?

I don’t envy the salespeople representing traditional active management.

Madsen: I think the thinking in and around the industry continues to evolve, but it seems many institutions are understandably slow to change. For example, 20 years ago people relied heavily on style boxes and only a few quants were focused on factors. This led people to assume that alpha was more plentiful than perhaps it really was. Once factors were highlighted and popularized and the notion of “other beta” was established, people more readily recognize alpha is less and less esoteric and can be measured and, in many cases, sufficiently mimicked. The thought leaders and product managers have provided lots of opportunity to avail ourselves of these “other betas.” Clearly, people have responded by going to passive and not just to quant or rules-based strategies, but the effect on active management is powerful. I don’t envy the salespeople representing traditional active management.

IA: What aspect or element of the industry would you most like to see changed and why? 

Madsen: I joined SITFO for many reasons, and money wasn’t primary in the decision. However, I’m still likely biased in expressing my views on government employed investment professionals. I think the staff at many institutions are not appreciated as much as they could be. Some of our peers are adding tremendous amounts of value and are an important line of defense, yet are among the lowest paid in our industry. The disparity between what investment professionals are paid on the asset-owner side and and investment-manager side seems quite large. I’m not questioning if the disparity should exist, I’m just questioning the magnitude. Compensation at many government institutions is improving, but my perception is that it is improving slowly and modestly.

IA: Are there any initiatives in which SITFO is currently engaged that you can highlight to readers?

Madsen: Our work on systematic convexity with FRM is housed in a fund structure available to other investors. We don’t have a revenue share in that structure, but we would benefit from additional scale if others invested. We think this strategy is an effective way to identify and isolate the type of exposures that are expected to have significant payoff in a time of overall market distress. The fund is allocated across a variety of managers and strategies beyond trend and macro that net out to a positive expected return, to avoid the negative carry of many tail-hedge strategies. Yet, it is expected to deliver tail-hedge type returns in a crisis.

IA: How about your personal life? Do you have a family and what do you like to do in your free time?

Peter Madsen, SITFO CIO, with family (and Olive, a German Short Haired Pointer) at home, Salt Lake City, 2017

Madsen: I met my wife Kjrsten while living in Russia. She was also in Russia as a student. It was a great way to get to know someone as times were tough and we traveled and had adventures in a small group with other students. We have three daughters aged 19, 17, and 15 who are every bit as talented and independent as their mother. We make a good travel team and are always up for an adventure. We also have a family member who is a German Short Haired Pointer named Olive

IA: Do you have any hobbies?

Peter Madsen, SITFO CIO, skiing in Wasatch Mountains, Utah, winter 2018

Madsen: One of the great things about living in Utah is the access to the mountains and desert. I love to run on trails and to ski. I try to get into the backcountry as much as possible. One of the great things about these sports is the personal development required to participate. With longer distance trail running the mind is as important as any muscle in the body. Going out alone into remote locations, maintaining your wits when pushing your physical limits is character building and translates into leadership roles and navigating stressful situations. Backcountry skiing is a technical sport as you must learn a bit of science to assess the weather and snow conditions for safety. It also translates well into risk management. At times you put a lot of effort into getting to a beautiful area with tons of fresh snow, but occasionally it turns out the conditions have changed or weren’t what you expected, and you must turn back or change your objective. Not so different from doing a ton of work on an investment only to learn that something is problematic and need to pull back or change your objective based on the data.  

Going out alone into remote locations, maintaining your wits when pushing your physical limits is character building and translates into leadership roles and navigating stressful situations.

IA: What was the last book you read?

Madsen: I’m currently reading The Uphill Athlete, by Steve House, Scott Johnston, and Kilian Jornet but I wouldn’t wish that book on anyone who isn’t prepared to slog through a textbook in order to better propel yourself up a hill. Prior to that I read Sapiens by Yuval Noah Harari. His scope and framing of the history of humanity is surprisingly entertaining. I’m looking forward to reading one of his other books: Homo Deus, which is oriented towards the future of humanity instead of our past. I also listen to a ton of podcasts. There are loads of great options and those that focus on long-form discussions or in-depth interviews are helping to wean me from the noisy short-term news cycle.

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