Shownotes
Richard Tomlinson joins Alan Dunne for a conversation shaped by experience, not theory. As CIO of LPPI, Richard is responsible for £27 billion in pension assets - but what stands out here is the clarity with which he navigates complexity. From the fading utility of labels like “illiquidity premium” and “hedge fund” to the trade-offs between cost, alignment, and control, this episode is about building portfolios that work in the real world - not just in a model. They explore inflation’s structural drivers, the quiet rise of fiscal dominance, and why some of the industry’s most comfortable assumptions no longer hold. It’s not about being contrarian - it’s about being clear-eyed.
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Episode TimeStamps:
02:14 - Introduction to Richard Tomlinson
07:07 - What makes Tomlinson and LPPI stand out from their peers?
11:52 - Who are LPPI's clients?
13:26 - The investment philosophy behind LPPI's work
18:06 - How LPPI's allocators work together
19:05 - Getting the allocation right
21:29 - Are they worried about the decline of equities?
23:37 - Tomlinson perspective on global macro
26:55 - Public vs private markets
29:05 - Their approach to allocating domestically
31:15 - How their allocation is distributed
33:51 - Is there a place for multi strategies at LPPI?
36:01 - Balancing growth strategies with risk
39:13 - How much would they allocate to alternatives?
41:22 - Their framework for thinking about risk
43:59 - How they approach commodities in their strategy
45:39 - How much focus do they put on ESG?
48:15 - The challenges of high fees in the hedge fund space
50:36 - Is it best to keep managers in-house or external?
53:41 - How they create a strong team of managers
55:37 - The right way of evaluating success and performance
58:41 - Advice for others investors
01:00:19 - The structural themes and trends that are likely to continue
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Transcripts
There's a lot of change coming there. There's a lot of inefficiency in the financial intermediation on the way that the plumbing of the system, and I'm not smart enough to know exactly how it plays out. But to see that whether it's stable coins or tokenization of assets, I think that's coming. And I think that could lead to certain businesses, more precisely, just disappearing. Just suddenly the reason to exist just goes because if you can directly own assets via a token, well, that might change things.
Intro:Imagine spending an hour with the world's greatest traders. Imagine learning from their experiences, their successes and their failures. Imagine no more. Welcome to Top Traders Unplugged, the place where you can learn from the best hedge fund managers in the world so you can take your manager due diligence or investment career to the next level.
Before we begin today's conversation, remember to keep two things in mind, all the discussion we'll have about investment performance is about the past and past performance does not guarantee or even infer anything about future performance. Also understan that there's a significant risk of financial loss with all investment strategies and you need to request and understand the specific risks from the investment manager about their products before you make investment decisions. Here's your host, veteran hedge fund manager Niels Kaastrup-Larsen.
Niels:Welcome and welcome back to another conversation in our series of episodes that focuses on markets and investing from a global macro perspective. This is a series that I not only find incredibly interesting as well as intellectually challenging, but also very important given where we are in the global economy and the geopolitical cycle.
We want to dig deep into the minds of some of the most prominent experts to help us better understand what this new global macro-driven world may look like. We want to explore their perspectives on a host of game changing issues and hopefully dig out nuances in their work through meaningful conversations.
Please enjoy today's episode hosted by Alan Dunne.
Alan:Thanks for that introduction, Niels. Today I'm delighted to be joined by Richard Tomlinson. Richard is Chief Investment Officer of Local Pensions Partnerships Investments in the UK. He leads an investment team responsible for about 27 billion pounds of assets and has been in the industry for many years across the hedge fund side, multi asset side, and consulting side, before joining LPPI.
Richard, great to have you on today. How are you doing?
Richard:I'm very good, thanks for having me, Alan.
Alan:Good stuff. Well, we like to hear a bit about people's background straight away, just to kind of, I suppose, set the scene. I know you studied engineering before getting into markets. How did that come about?
Richard:Yeah, I think partly it's a time-based thing as well. I left university around the turn of the century, so back 25 years ago, and at that point in time engineering wasn't such an appealing place to work. It’s very, very different now. People with engineering skills, IT and similar, and I almost, to be frank, fell into working for a small hedge fund type manager. A personal friend said he has an interesting job, going to have a look at it, I spoke to the recruitment person, and the rest, as they say, is history.
Alan:Good stuff. And so, you've been on the kind of the hedge fund side, the multi asset side, consulting. I mean you've worked at some well-known names, GNI Fund Management, Albourne, Old Mutual and, I mean, true? Does anything stand out or, I mean, what's kind of been the progression for you?
Richard:Yeah, I think, if I look back and obviously it's a little pinch that we'll rewrite history of the future with the views and what we know today. But there was a little bit of an evolution through how the industry evolved. I think I said earlier, almost by accident I ended up working in GNI, where someone put me in contact with a recruitment person. I took the role and that was good.
And at that point then it became clear how interesting what was going on within that, call it, managed accounts, hedge funds, liquid markets type of activity. And I learned a huge amount and that then essentially evolved and grew into working for Old Mutual Asset Managers because they were both owned by the same parent company.
at era, which would have been: cately), the world changed in: Alan:Interesting.
Richard: n little book starting in May: industry was quite different,: ired me. I worked there until:So, you know, again, at the time I joined, I didn't realize what a great opportunity it was, I don't think. But looking back, the opportunity to work with some of the world's smartest, biggest, most global institutional investors and asset owners was phenomenal. And then work in an environment where loads of smart people, high integrity people who genuinely tied to do the right things for the right reasons, and serve your clients, and understand to deal with some of the challenges, let's just say, that the industry faced or has faced, and a hugely rich learning environment.
Alan: obviously since then, I think: Richard: . So, if you go back to about:So, the idea was they wanted to aggregate assets. And I think, you know, if you look at what they were saying early on, I think there was certainly an element of looking at Canada and seeing what had worked there. And they had a handful of goals at that point in time, which was invest more in domestic infrastructure, reduce fees and costs, improve governance or evolve governance let's say, and build scale. So, you could see how that was going.
e early days. And I joined in:So, yeah, you know, if I think about what the LPPI is trying to achieve, it's to bring scale benefits and essentially look internationally for best practice for what good looks like as the optimal way, or what we see as the optimal way to run a large portfolio of assets on behalf of underlying partner pension funds and drive benefits that align absolutely with those stakeholder goals.
So that, at its very highest level, means creating, call it, a platform or an aggregator that is very focused, at the highest level, on paying pensions as they fall due affordably and efficiently. So, if you frame it amongst that, it's then look at the liability profile, design a group to do that, so everything flows back from that.
But it is, as I said, there was an awful lot of commonality between what we're doing and what the ‘Canadian model’, let's say, what that means.
Alan:Now, obviously it's clear there are those benefits of scale in terms of, I guess, extracting kind of cost efficiencies and fee efficiencies, et cetera. But you didn't mention working at Albourne and having that access engagement with highly sophisticated international organizations.
I mean, is bringing a greater degree of sophistication to the investment process also part of what you're, I suppose, what you're trying to do and part of the pitch to doing it that way as opposed to leaving it to smaller local governments?
Richard:Yeah, there is definitely an element of us trying to, what we would say, as I say, I'm always slightly cautious when you say ‘sophisticated’ because sometimes our industry has a habit of building sophistication that doesn't always serve the stakeholders or the clients or whoever you want. But ultimately, it's looking at what is the optimal way to do that? And there's a great, I think it's from Keith, I don't can’t his name right, Keith Ambachtsheer, the guy that writes extensively on the Canadian system, the founder of CEM. And I forget, he quotes his view on resistance, “They need to be complex enough, but not overly complex.” It's something like that. I've got that slightly wrong. But it's that idea.
I think it's an Einstein derivative quote. But it's that idea. It's getting it. You've got to be sophisticated enough to do the job properly. But you absolutely don't want to build in sophistication for the sake of sophistication because that then creates complexity, that can create additional risks that you might not want. But ultimately, it's designing a platform, team process, business, whatever word you want to use that is able to execute portfolios in the optimal way for alignment with client goals.
But in more practical terms, that means building a very solid investment due diligence, operational due diligence process, a portfolio construction process, risk, oversight, governance, building these things in a way and managing them in a way that we believe aligns with accepted industry best practice. So, we're not trying to reinvent the wheel, we're not trying to be super smart. We're just saying, Will, you know, like many areas, you do a little meta survey, you think this is what we're trying to achieve, these are different ways of doing it, this is what we think good looks like, this the optimal way of doing it. And how do we implement that in a cost efficient, controlled way?
Alan:Yeah. So, obviously it's pension money, it's long-term investing, I guess. The underlying clients are local authorities, and the benefits are their employees. Is that fair to say?
Richard:The partner funds we work with, who also own us, are local government pension schemes. So, I think that, you know, I forget what the US would call them. They call them municipal schemes, I guess they would probably call them, state pension schemes would be the equivalent, I think, in the US. The beneficiaries of those schemes are the members themselves.
But you get quite a bit of debate, because the specific structure of the way the LGPS operates, the contributions from the members are fixed by parliament.
Alan:Okay.
Richard:By statute, essentially, but by the ministry or central government. And it's the employers who have, essentially, the financial risk that hold the performance count, if that makes sense. So, contributions from members are fixed, contributions from the employers can flex.
So, the key risk constraint, and the thing you're optimizing for, is actually managing the contribution level. So, the goal, I think in the regs, we'll talk about stable contributions, affordable contributions (I forget the exact wording now), but essentially, you're managing that contribution affordability for the employers. So, if we do a great job, contributions go down and it's more affordable. If you don't do a good job, they go up. And that then has direct line of sight through to local authority budgets.
So, you know people, I have been known to say that if you do a good job that means you can improve services, or less cuts to services, or whichever way you want to view it. So, there is real purpose and mission there.
Alan:Yeah, very good. And then obviously, I mean, that feeds into how you think about, I guess, portfolio construction and the investment philosophy. I mean, I guess it's a long-term mindset. Would you describe it in diamond style? How would you describe the investment approach and the investment style or philosophy?
Richard:Yeah, absolutely. So, it's absolutely long-term. I would describe it as liability aware. I think people in the pension world get very hung up on, is it LDI, liability matched etc. etc. And I often will say to people, if I look at the UK corporate defined pension, the framing of that, I totally get why people did LDI, do LDI, and all that matching piece because you have a very precise definition of liabilities. But within the LGPs, the liability and the discount, it's much more open ended let's say, much more open to interpretation. So, you don't have this direct, very precise matching of liabilities. Therefore, you have more scope; therefore, you have more ability to run a liability aware long-term approach which then means thinking, looking almost like over the horizon and being much more strategic about it.
So, the way I'd think about it is I love my job, it's a great job. You have a very open ended and actually quite complex thorny set of goals to meet which is building, and if I have to really summarize it, you've got to build to invest; build capital to invest, build capital for the long-term to pay pensions of the future whilst managing liquidity and cash flow to pay pensions of today. And the portfolio, we believe certainly, is LPPI that we think is optimal. It looks a lot more like an endowment star portfolio based on that.
If you think what I've just described, that sounds a lot more like endowment management than a very heavily hedged UK*DB corporate pension scheme.
Alan:Yeah, yeah. So obviously, as you say, the portfolio is drawing down to pay benefits at the moment. So, what kind of percentage of the portfolio is kind of drawn down every year?
Richard:Yeah, so, if you went back 10 years, the majority of LGPS schemes were cash flow positive, so i.e. contributions were greater than the outgoings in any given month or quarter. Now it's increasingly rolling over as the schemes mature.
But at the moment I say, off top of my head (I haven’t quite got the numbers in hand), it's low single digit percentages in terms of cash funding needs, but that will accelerate through time, on average. So, there is a need for increasing cash funding as the schemes mature.
Alan:Yeah, and the way you're set up, you basically manage distinct pools in different asset classes and the underlying partner pensions can choose or you can work with them to set the asset allocation, isn't that right?
Richard:Yeah, that's exactly right. So, the model we use, which is a little different to some of the other pools, we provide advice to our partner funds and say this is what we suggest asset allocation is, but they own that decision and give it back to us, essentially. For example, they might say we want 45% in listed equities, 10% in credit, or whatever it will be. We then have investment, broad what we call investment pooling vehicles, which then you can invest to meet those to meet the asset allocation. However, the structure we're using is we've always run what you might call, we call it whole portfolio management, our whole scheme management, where we take the whole portfolio and manage that on a fiduciary basis. So, we are managing all the cash flows.
So, we do have some assets in pooling vehicles and then we'll have some, which we would say we would call balance sheet assets, which are directly from the scheme's balance sheet, which may be legacy, or it may be something that's not common to our other partner funds. So maybe a bespoke investment directly for them, such as a local investment streak. So, that's how the portfolio comes together. But we manage all of that for them, do the heavy lifting of implementation.
Alan:So, in that sense you're probably like an OCIO. Is that fair comparison to draw?
Richard:Yeah, it is. So, funny, if I had this debate earlier this week with one of the very large banks, a US bank, who I won't name, but they have to do some head scratching to define, a little while back what OCIO meant because it means different things to different people. I would define the activity when taken as an OCIO.
And by that what I specifically mean, I'm using the definition that now seems to have been evolved by the CFA Institute and others, which is you can provide advice to an underlying asset owner on the strategic asset allocation. They give you the asset allocation, you implement the portfolio, and you report back to them. But they still own the SAA decision, which is a little different to the fiduciary management language that we use in the UK, where that means you just get given some goals - meet this liability profile. So that's the definition I would use. So, I would describe us as an OCIO in that context.
Alan:And obviously, as you say, you advise the underlying schemes or partner groups and it's up to them to set the strategic asset allocation. Is it quite similar across the different groups you work with or are there notable differences?
Richard:It's broadly similar. They're not all the same. There are differences. So, we have two of our partner funds that have funding levels at about 100% and we have one who's a little bit lower, let's say. So, they have slightly different dynamics in terms of the sort of risk appetite, let's say.
So, our process would be to start with risk appetite, frame that, and then put that into an ALM model. And so, the two that have a sort of, let's say, higher funding level have more similar asset allocations.
The one that's slightly lower has a slight differentiation, but broadly, you've got to get quite granular to start seeing the differences, to be honest with you. Those are the big leaders, they are all in the 45%, 50%, 60% type equity allocation levels.
Alan:Yeah, okay, that's interesting. So, they're long-term investors, but they're not 100% equities. I mean, how do you think about what the right allocation is - how much equities, how much is not? What else goes into the mix?
Richard:Yeah, so, something we've done a lot of work on over the years, and actually we've published a paper on this, our SMILE paper, let's say six months ago. And we've got something else quite similar coming out soon, talking about the role of illiquids and alternative assets in a broad pension portfolio. Is it a feature, is it a bug, is it volatility, laundering, is it not (type thing)? And I think we're trying to put that in context and grow the conversation around that.
So, in broad terms, you know, if you're a long-term investor, you need, and you care about long-term affordability. You need to be running risk to get the right trade off. Because with any process there's (what's the word?) the trade off, let's say, between surety or security of returns and affordability or quantum of return. And that's exactly the same for us.
So, it's all very well saying, de-risk because you're above a certain funding level, but if you do that, you're then putting more of the workload in the future onto contributions. So, you're asking future generations to pay.
Whereas, we would probably argue, you want to run the capital you've got appropriately, not be overly risky, but try and find that sweet spot where you can hit, call it, an efficient portfolio where you're managing future contributions, but you're also sweating the capital you've got today. And in our mind that means a portfolio that really, again, goes back and looks more like an endowment portfolio.
There is healthy, healthy risk of equity risk there. Because it's a whole different conversation as to why equities might return more than risk free over the long run and what the risks are of that. But balance that off, then, with a range of other assets, but fundamentally a relatively low, low weight to traditional fixed income and direct duration.
So, to put some meat on those bones, what I'd say is what we'd have, we've got something like 20% circa real assets (actually near 25% in some cases), a reasonable slice of credit, but it'll be shorter duration and a slice decent checking - that will be private credit. We do have some exposure to hedge funds at times, but it has been a smaller part of what we do. There's been a small amount of private equity in there, I think in the 5% range. I think that's everything, isn't it? And within the real assets is real estate and infrastructure.
Alan:And obviously it's long-term. So, you're not too hung up on markets this year, next six months, etc. But when we're at a point in time, like we are at the moment, where a lot of people will say, well, valuations are on the higher side for equities. And if you look at the studies and everybody sees current valuations versus historically what has been realized in terms of 10-year returns, etc., it's somewhat sobering, I guess.
So how much do you worry about, you know, a lost decade for equities or you know, a prolonged period of kind of subdued real returns in equities?
Richard:Yeah, and that was something you definitely think about. But there's also the question of if you don't own equities and other things, and sort of, call it, risky inverted assets, what do you own?
Alan:Yeah.
Richard:So, I think betting the farm on what equities will do over the next decade and trying to put a number on it. I'd be very reticent on that. And what I often say in conversation is, I don't know if equities will beat fixed income over the next decade. Not just now I'd say that. What I do know is if you have a sense of investment principles, and you invest, and you manage the portfolio appropriately, a portfolio of risky assets with positive carry and spread on it is likely to outperform, running less risk, in the medium term.
And the here and now, the thing I worry about, is that interaction of valuations are quite high. But that could be for a reason. If I look forward, do I think inflation's likely to print a 2%, or maybe more like 3%, or maybe even a bit more in the next decade? I think I'm going to go for that latter view.
I think about deficits, I think about the reaction function of fiscal and monetary authorities, and I think about the geopolitics, all that stuff. It doesn't make me want to own a lot of sovereign bonds or similar. So, you go back to what do you own?
And then I think if we're going to segue potentially slightly into a more volatile risky environment where you probably want to be a bit more tactical, there is clearly risks to the equity thesis. You have to own more. But I'm deeply unconvinced you just want to own a big pile of (what's the word I went look for?) passive fixed income.
Alan:Yes, sure. And obviously, it is approach. A lot of people in the private sector, obviously private pension teams, have gone down the LDI route, and in many cases were encouraged to do so. I mean, obviously you don't have that constraint and you're trying to manage in a different way.
But it does sound like that macro conditions are part of your thinking. It's not that this is constructed in isolation from what's going on in the world. I mean, it sounds like you're a believer that we're into an environment of structurally higher inflation. I mean, the points on this, I suppose, have been well talked about, hard government spending, etc. I mean what's your particular lens on that that's going to likely drive it?
Richard:Yeah, absolutely. So, within the way we frame things is we don't try and be too cute on short-term macro calls. There are a couple of people on earth who have got an edge on that, but I'm not one of them, nor is our team. We don't try.
However, in the long-term I think there are some things you can think about and look to and especially where our long horizon is investment. and (how do I put this?) we can warehouse volatility. We don't have to be deeply hedged, we can run risk.
So, when I look through that and I think what is likely to happen, the different scenarios that are likely to happen in the next decade, and you have to think, what would you need to believe, to think that we're going to have low inflation? It’s long-term interest rates back to 2%, everyone starts playing nice, the peace dividend goes back to being a dividend, not attacks or whatever you want to call it.
Alan:Yeah.
Richard:You've got to make quite a lot of assumptions. Some of them are herculean. So, I think balance of probability, you know, for example, I often say this. I've got no issue with owning duration but I'd rather own second order duration rather than direct duration. So, I'd rather own second order duration through owning real assets because there's an implied discount rate in there.
Alan:Okay.
Richard:So, because then you’ve got some asset backing and you’ve got something real. And I think inflation is… You know, I'll go down a slight segue. So, I've been thinking about this quite a lot. But you think, even in the UK (I can't comment a lot), everyone in the UK is obsessed with house prices.
You see these charts going like this, and they say house prices have gone up loads. But then you go, that analysis doesn't make any sense to me. You’ve got to disaggregate land value from what's on the land, cost of construction. And now you start looking at cost of construction of an average house in the UK. It's not that dissimilar to the average price of a house in the UK.
So, you can start thinking through that. That has changed a lot in the last five years. The value of the land is a long duration asset - ultra long duration asset. It may be the ultimate long duration asset with a huge impact on interest rates. Your cost of building, bricks and mortar, is absolutely linked to inflation and the cost of doing it.
So again, when I think about the next decade, is it going to be cheaper to build a house in a decade, or so or a building, or a shed, than it is today? I find that hard to believe, really hard with demographics.
So that's kind of underlying the thesis. It's that looking over the horizon, what's likely to maximize our probability of paying pensions as they fall due over the next decade or two. And I think it's something with a real asset style portfolio, and that's including high quality equities and things that have defensible cash flows, all that sort of stuff.
Alan:Yeah. So, as you say, it kind of leads you towards more of a risk growth oriented portfolio. Obviously, the composition of that is still up for discussion.
I mean, you touched on private equity at 5%, I think you said, which is not extraordinarily high relative to some of the numbers here, particularly in the US. So, how do you think about that debate, public versus private? Is there an illiquidity premium or not? Or what's the attraction or the unattraction of private equity in that sense?
Richard:Yeah, it's interesting. So, I'll go straight off with something that sometimes gets me in trouble as a statement, but I absolutely reject this idea of illiquidity premium and then you always get paid for it. It's a really neat marketing thing. If I was selling a private credit fund, I'd be using it all the time. But what does it really mean?
So, in my mind, if you'd be a bit more sophisticated, you step back, people say illiquidity premium, most people, but what does that really mean? The academics would break it down into a whole series of things. But to a practitioner you'd probably say, well, there's some complexity premier in there, there's some kind of sourcing premier, there's a whole series of other things. And that can be positive and negative. So, I would say I would absolutely agree that there is a spread between public and private. It's time varying. It can be positive and negative.
I absolutely kick back on the idea that you had, say, 5, 10 years ago where pension funds were saying the narrative, we're underfunded, therefore we've got to invest heavily in private markets and private equity. I would reject that absolutely. I've got no issue with owning a lot of private equity. But don't just do it because you think it's going to be a return kicker, because it might not be.
And in private markets in general, I would say there are really good reasons to own a portfolio of private markets that may not be any good return, it may be pure play exposure to certain things. There are certain things we want pure play exposure to, for whatever reason. You can only do it in the private market.
And a really obvious example is local investing. Local investing is very important to both our partner funds and government as well. Central government is pushing the future in that direction. It's stated, well, if you want to invest, if you're a pension fund in the west country or wherever you want to invest in something, you're probably not going to do that via listed markets. So, there are lots of reasons to think about private markets but the idea that it's just about excess return is one that I think is flawed and dangerous, frankly.
Alan:Yeah. And then on the public side, obviously, historically I guess, you had kind of home country bias in lots of cases, and I get the impression that's changing. But being, I suppose, a UK domiciled plan, you have to think about currency risk etc., and if you benchmark yourself versus the global index you end up picking up a lot of US exposure. So how do you think about all of those factors?
Richard:Yeah, well, that's a really interesting one and a pertinent one at this point in time. So, we've certainly, as part of the broader government, call it policy backdrop, we've certainly thought long hard about how much we have in the UK as is everybody else, because government has made some very clear policy signals and are in implementing that. So, we have (off the top of my head) it's going to be in the 20%, 25% of our portfolio in the UK, something like that. The bulk of it's in the private markets.
And the challenge, if you talk about it from a political point of view, people will say UK pension funds have very little in the UK, with double benchmark weight in equities in the UK, but it's still only 6% because the benchmark's got 3%. So, it's all about that lens.
But I think the really interesting one is, A, how domestic assets help you meet your long-term liabilities because our liabilities are linked to UK CPI inflation. So, there's some good reasons why owning a degree, some, UK assets can help you meet that long dated liability because there's either direct linkage or indirect linkage to CPI. Two, you've got the currency transmission channel back to inflation. You know, weak sterling tends to drive inflation so there's a little bit of a currency hedge if you own some overseas assets to your real liabilities long-term. So, I think there's an element of that.
But then obviously the questions you do end up with (and we have international benchmarks), we have a reasonable exposure to the dollar and that has been a little bit painful this year (as is well known for people), we do offer our client advice on FX. So, we do offer a range of options. So, our clients, partner funds, make the choice on how they want to approach FX. So, we can do different versions for them.
Some of them do decent aggregate hedging and we'll also hedge them in the investment vehicles for nominal assets. So, I'm not sure I've quite answered the question, but that gives you an indication. But we do have a reasonable degree of overseas non-sterling, non-hedged exposure.
Alan:Yeah. And then in terms of kind of security selection, and we should say some of the trading and investing is done in-house and some is done externally. On the equity side, is that more in-house?
Richard:Yeah, it's about half and half. So, our clients, partner funds, have around 45%, 50% of their portfolios in global equities and around half of that equity piece is managed in-house and the other half is with external managers. So, to complement or to build on the internal piece.
And I think the way we've approached this is, again, if I go back to what we're trying to achieve, if I think about the goals, it's quality compounding really. When you think about paying pensions long term, you want a ‘compound quality’ over time.
So, i.e. build a strong capital position with contained risk as much as you can. Risk is obviously unknowable, but you try your best to do that. And in our view, the way you've got different ways investing in equities, but part of that is owning that quality approach quality to reasonable price, whatever you want to call it. So, that's the backbone of what we do and that then maps very neatly against those long-dated liabilities.
Our internal strategy is focused on, as I say, sort of Buffett style quality compounding. And then there's a handful of external managers. One or two have also got that quality type of approach to it and one or two do something a little bit different, let's say.
Alan:Yeah, so that's, it's very much driven by that factor lens, if you want to call it factor or style lens, as opposed to being more benchmark driven.
Richard:Absolutely.
Alan:So presumably, that leads to a slightly different orientation in terms of exposures to the Mag 7, some of which I guess are quality but some maybe not at a reasonable price. Do you tend to be quite different from,
say, the MSCI world, would you say?
Richard:Yeah, we do. I think, if I'm honest, being an asset owner who's got active equities managed has been quite difficult for the last few years. I know we're not alone. We are behind MSCR World in list global equities. I think many others are, as well, in our position. And that is, if you start thinking about that factor lens, most people didn't own enough Nvidia. So Nvidia went up a lot and it was a very heavy weight in the index. Time will tell how that plays out. Who knows.
The AI has been a huge thematic in listed markets and generally, much, much more than just Nvidia. So, we have been underweight that factor, which thus far has had performance implications, let's say.
Alan:Obviously, you know, going back in your career you have started off on the hedge fund side and so you are very familiar with hedge funds, multi asset, all of that stuff, active strategies. And you mentioned you have had that in some of the portfolios over time. I mean, you obviously can still see a place for those strategies in, in a long-term portfolio?
Richard:Yeah, I can actually, and I think it goes back to, this sounds like portfolio Construction 101 but it's what role are you looking for? And I keep going back, and I've been doing this for a very long time, and I still find myself, remind myself to say, is this an equity type substitution product or is this something, because I don't want to own bonds in the more balanced part of the portfolio.
And my view would be, hedge funds people use this generic term. It's nonsense. Yeah, nicking this from my old employer Albourne, hedge fund is a business model not an asset grouping. So, it's, what is that?
And actually, I take this one step further. I go, you start looking at what the big multi-funds are today. I was born in the mid-70s. I wouldn't have seen what Goldman and those banks were, the Solomons in the 70s, but I can imagine they probably didn't look that dissimilar to the way the large multi-funds operate today which is just a slightly different version of a set of pool of capital. And then you start linking that back to what is the purpose of that trading strategy or activity.
And then you got to think about what are the costs of running it and who, what, and where are the rewards. And the reason I say that is because people get quite het up sometimes about fees on hedge funds. So, you know, I mentioned the big multi-funds. They look horrendously expensive. I'm not saying anything I shouldn't say there.
But then you’ve got to think about what activity is driving that outcome, the stream of returns, and how does that work? And the same for each other strategy. So, I think there is a role for these things. It's just a case of, is this an equity subsidy? Is this a fixed income subsidy? What role do I want it to play and what's it? And is the fee structure and the split of economics fair between the capital provider and the manager?
And sometimes it hasn't been in the past, let's be honest. But that's not to say it can't be in the future. And I think there's a much more mature conversation on that now than there may have been in the past.
Alan: ance in major down years like:So, I mean, things can defy or be very much been jammed into these kind of either growth or defense buckets. And then, depending on what level of volatility a strategy is running out, it could be a return generator or return driver as well. You know, as you say, it's important to simplify things as much as possible, but not too much. How do you kind of balance that simplification where there are these complications?
Richard:Yeah, it's interesting. So, one, I'm sure you probably had this debate where you take a CTA trend portfolio, people will throw the words around, it's long vol, VIX spikes, correlations jump and it goes down and they go, you failed. And it's like, well, it didn't quite mean… So, I'm really careful now. I'd be like, I'm defining long volatility as generalized economic or market volatility, and over a timeframe.
And so, what you’re getting is you're getting at the complexity of how a trend follower works, what time horizon, what contracts they're trading, all of that sort of thing. But the idea of a macro or a CTA strategy, something that can be genuinely short generalized risk is incredibly powerful in the portfolio because you do get times where any risk asset gets hammered, liquidity gets washed out, and everything's going down. And you've probably only got one or two things you own that might just be able to stand up. Cash might be one of them or potentially macro CTA . And then not to get completely caught in the, oh well, it's gone down for the first three days because … Keep it as simple without getting too technical. You get the big correlation spike, you get the big vol spike, everything blows up, everything correlates when everything goes down.
But then when that unwinds in the coming days and weeks, suddenly you get a reversion and that's when that decorrelation piece can really help. So, it's being quite precise on how you talk and frame things. So, as I say, I think personally, It's all very well. So, we're going to be 100% risk on, we're not going to worry about some things to hold up the portfolio when everything goes out the window.
And then, if you want to get to the next level, which I think is really fascinating, is then thinking on the liquidity side, is having things in the portfolio that provide you cash and liquidity when everything else is getting hammered. Because there are times when, take a simple example, you can say we've got liquidity and global equities. Yeah, sure. But are you really going to want to start liquidating global equities when they're down 40%? Now, you don't want to use a CTA as a cash machine, obviously, but finding things of ways you can structure bits of the portfolio that might give you an automatic payout, either that's a derivative position or similar. But finding ways that you can manage that liquidity, it's not just mark to market but it's also cash, is a really interesting piece of work to do, let's say.
Alan:Yeah, so it sounds like some of the clients have used kind of diversifiers like that at some point, but not everybody. I mean, if it was down to you or if you had a blank canvas, do you have a kind of asset allocation model? How much would you prescribe to allocate to alternatives? Or is that too much of a loaded question?
Richard:No, it's fine. As I said, I don't own the SAA for our partner funds, they tell us. However, I'll use the obvious get out that you've got to go back to goals about what someone's trying to build. But let's start on the assumption that you're running an endowment type portfolio where you want to manage risk but you don't have to be crazy short-term with some kind of vol limit. You can look over the horizon. But you want to be thoughtful how you do that.
I would probably argue that you're going to want to have a reasonably hefty chunk of equity risk. So, what can you do to diversify some of that? I think there's then a thoughtful degree of thinking about real assets and duration and then you move into the stuff that is genuinely different and that might be insurance linked strategies which some people may or may not put into the hedge fund bucket.
You've got the sort of more market neutrally type equity strategies, fixed income strategies which I think have a place but just be aware of the vol or fix and correlations sensitivities short-term on those, but fine.
And then you move into the stuff that I think you can genuinely put your hand on your heart and say you can really make money when everything else is going down and that is predominantly macro CTA, GTAA type stuff. And there are many versions of the world where I'd rather be invested in that than sovereign fixed income at times. It's looking forward. Are you going to put 50% of your portfolio in it? No. But 1%, or 2% doesn't really matter and doesn't move a needle.
So, you know, if you're thinking, in my mind, you'd probably be thinking somewhere in the region of 5%, maybe up to 10%. But then that's then back to a question of scaling risk. You know, if it's a 30 vol CTA, you might size your position a bit lower than if it's a 5 vol CTA.
Alan:Yeah, exactly. I mean that's the important point that's often lost in the debate. It's what level of volatility.
And I mean, in terms of kind of portfolio construction, obviously you've kind of mapped out an asset allocation, how are you thinking about kind of risk and portfolio construction? Do you translate this into, okay, this will map into a portfolio that runs at about 12 or 13 vol and that means it might have a drawdown of 25%, 30% over time? Or do you have a kind of have a different framework for thinking about risk?
Richard:Yeah, we certainly think about that the way I said, to just go into a little bit more detail. So, our primary constraint is the… valuation in terms of risk framing.
So, every three years we have to that our partner funds will talk to actuary, who will then look at the portfolio and define what contribution levels that will set. So, then you're thinking we've got to build an SAA, run a portfolio that works and makes pensions affordable in the long run and has sufficient liquidity. So, it's quite a complex process. But in terms of that, absolutely, I would probably, in some ways, in my mind, I'll just look at it relatively simplistically.
But if you're thinking if you're 100% equities, you could be down 50% in a not very long period, let's say a quarter or two quarters, that's plausible. So, obviously that would be very, very, very challenging for DB pension funds such as ourselves for so many reasons.
So, you're going to come back from that level, then you're going to try and say what at what level, if we're talking vol or drawdown, does it feel more reasonable? You're probably going to try and bring that down, not to crazy levels, but volatility levels of 8%, 10% are manageable.
You know, if you're running in the 4s and the 5s, you're not running enough risk, probably, to meet the liabilities long run. And if you're running in the 20s, 25s, you're going to blow yourself up.
As a slight, curious aside, which is one thing I've seen, I spent the early part of my career, when I was at GNI, building models to look at structured products and running specifically CPPIs and things like that.
And when I started looking at the maths of defined benefit pension schemes, it's quite similar - the stochastic framework, but it's also this get the trader on, a structure that we called Gap Risk. And in a defined benefit pension fund it's your funding level, the gap between your assets and liabilities, which in a CPPI or similar as your bond floor. So therefore, that defines how much risk you can run before you hit the knockout.
So, it's interesting and it's very much like running… CTAs. It's exactly the same idea. So, you can draw those parallels. So, then you start thinking in that way. But there is, going back to the stuff I looked at many years ago, you’ve got this inverse relationship between expected return and leverage.
So, at some point the leverage gets too high, and your risk of blowout goes through the roof, and you blow yourself up. If it's too low, you're not running sufficient risk to defer the costs.
Alan:What about, I mean, obviously, you know, inflation protection is a key part of it, and you obviously have a healthy allocation to real assets and, you know, in theory it gets that via the equities as well. What about commodities? Not just precious metals, which are obviously topical at the moment, but more generally managers giving traded liquid exposure to commodities. Is that something you consider?
Richard:I think what we try and think is what risk factor it builds. And people, a lot of people, own commodities because of the inflation participation. And I think if you start breaking down the inflation conversation, I talk about, you've got to think what sort of inflation.
You can own something that supposedly correlates with inflation, and you get a bout of inflation, and it gives you zero benefit because it's the wrong sort of inflation, i.e. supply side versus demand side, monetarism versus cost driven type inflation. And you look at history, and people will tell you that owning oil is good because that tended to lead. But that was like when you had an economy that where oil was a huge part of the inflation basket and drove inflation. The world's changed, so you’ve got to be quite mindful of that. But the idea of owning things that are participating in inflation for the long run is helpful.
Owning oil has been more challenging at times, people, because of some potentially climate and ESG type considerations. The way I would think about it though is, I have to say, is goes back to trend following or some form of active management of commodity exposure.
So, if you do get a breakout in the commodity complex, something that can then start giving you convexity into that and that again would bring you back to some form of trend, some form of CTA type exposure. I'd probably rather go down that route than owning oil or any of these commodities directly.
Alan:Yeah, fair enough. And I mean, is that something, I mean, you touched on ESG? Is that a big focus or do you tailor that depending on the underlying client?
Richard:So, the way I'd frame ESG is one of those things where it's a word that it's quite difficult to talk about at times because now, that set words, it's gotten politicized, rightly or wrongly. Maybe it was always politicized, who knows? I think you have to start breaking out the ESG, first of all.
Well, first of all, there's two key points I'd make. One, I normally talk in terms of stewardship and real-world outcomes, not ESG. And two, even if you're going to drop into ESG, talk about them as an E and S and a G.
So, on the first point, I think your job as any fiduciary or owner of an asset is you've got to be a good steward of it. You know, you wouldn't buy a house and then kick holes in it and think you're going to sell it for more if you've knocked around on the walls or something. Yeah, you're going to be a good steward of it. You repair it, you maintain it. You're trying to maintain financial value from the assets. So, I think a lot of it comes back to that stewardship.
On the real world outcomes, everyone wants to see better outcomes in the real world, but that might mean affordable housing for the less well-off sections of the community or whatever. I don't think that's particularly ESG. I think that's just, especially for a quasi-sovereign group, you're thinking about the world that we live in. It's that type of thing. So, to me it's about stewardship and I think in terms of ESG, it's got a challenge.
Certainly, the way we've always looked at it, we've defined it as financially material. So, where you think about these things is where they have a financially material impact on the investment portfolio. So, it's risk management. It's not about political posturing, or woke, or anything like that. It's about if there is a financially material impact on our investment, then we care.
And then you break down the E, S, and the G. The G is about governance. Well, if you speak to any hedge fund managers, say, in the equity world, they're going to care about the governance of the businesses they invest in, one way or the other. They're going to say, I want to be able to remove the chief executive if they're not doing good job. I want my governance rights. So, that's the governance piece. That's always been there.
The S, I think, links to the real-world outcomes. It's about that social fabric of, it's probably going to be value damaging for your business if you demolish a load of houses in the local backyard and put something there that people don't want. You've got to be mindful of that interaction, that political piece.
The bit that's more difficult, obviously, is the E because that's then dealing with the externalities and who pays. So, that's the bit where I think we're having the debate, and that's a political question. I view my job, I'm an implementer, I'm an instrument of implementation, not a politician. So, I'll do what my political masters tell me basically, on that one.
Alan:Yeah, yeah, fair enough. Just going back to the kind of the hedge fund side, and you did touch on kind of multi strats, high fees, etc. But I mean, I guess the proposition from the multi strats, and the large ones have definitely been able to deliver it. It's kind of high single digit returns, fairly consistently, and some years maybe a bit better, but I mean it's more around that consistency. Obviously, by blending many strategies they're able to boost the Sharpe ratio and achieve that kind of high single digit with low drawdowns, etc. I mean nothing to say that they will always be able to do that and that's the big question. But from your perspective does that not look attractive? Or is it just that the fees means it's a no-go as a conversation?
Richard:So, you know, every time you look back at the history and you think, surely at some point the big multis must fall over, and the returns must stop, and yet they keep going. So, I think you'd have to be somewhat either idealistic or naive to say the return stream doesn't look very appealing. Okay.
The challenge for people like us is the cost. So, the fees are very, very high on optically, when you look through, and say how much you're paying on capital, when you look at the activity that's taking place going back to why you're running a business. Well, is it silly? You know, I jokingly say about equities, if you're going to be in that low latency HFT space you need to spend hundreds of millions of dollars a year on tech and trading firepower. So, that's not free. So, I'd put it in that context that there are challenges around the multimodal.
As a pure investor who doesn't care about fees at all, I see the appeal. And I would frame it exactly like you, I'd say look, what's your source of value? Running your own hedge fund is difficult. People can join and make a very good living. Let's just say that's putting it politely. And a lot of the pain of running a business gets taken away. Yes, they run very high leverage. They counter that with very aggressive risk management and all this other stuff. And they have strong relationships and they've made the pools of capital run less liquid, and they have a significant market footprint which gives them an edge.
So, you add all that up, you can see why that might make money in the long run. So, for us it's fees that is the big one, really, for us.
Alan:And maybe, moving more broadly in terms of manager selection, obviously you mentioned some strategies; internal strategies, external. And I guess, anything you're running internally, you’ve got to be comfortable that you have the in-house expertise, that the infrastructure is suitable for the strategy. Any other consideration that would help determine what goes in-house versus external?
Richard:I think the big one, for me, is at the top level, it's got to serve stakeholders. It's got to have its place in the portfolio and it's got to be to the benefit of our stakeholders. That means partner funds, client capital, that type of thing. Because some of these are on unlimited funds, you can probably do anything. But why would you.
So, I would always come back to, what's the investment case, how does it benefit stakeholders? And then, is it coherent? And I'd probably just go back a little bit. In my degree, I studied Michael Porter and Five Forces and that sort of management consulting type approach. I tend to take a very simple make versus buy, back to the production engineering type stuff of doing things in house.
So, you would only make something in house if there's really strong strategic reasons for doing so and it's within your risk appetite and you can do it appropriately being blunt that, you know, certain pay rates for certain people just don't fit within what we can do because the amount of incentivization that's needed to get the best people, we just can't do that, and in the risk appetite of the organization.
And then just as importantly, actually I'll say it very openly, there are certain strategies where you can pay a third party a very, very, very competitive fee to suck up a lot of the operational risk that you'd have to wear yourself and you're never going to do it as well as them so how is that serving your stakeholders by trying to do that in house?
Alan:And then other considerations when it goes to external managers. Obviously, you've been on the hedge fund side, you know, you've been deep in the weeds on manager selection. So, you know all of the ups and downs and the behavioral biases, etc. So, how do you think about starting with the top of the funnel, narrowing it down to managers you actually allocate to?
Richard:Yeah, so top level, it's rolling portfolio. What do we want to find? Starting with the portfolio need and how that fits together, you then move into (just to be clear, I don't think we're doing anything particularly revolutionary), stating the obvious, that you're looking for edge, you're looking for credibility, the principals having good, call it 5Ps, whatever you want to call I but it's the team process, credible platform.
The performance, for me… people get hung up on performance. To me, whenever I look at a track record, it could be good or bad, it's always then how is it driven? And then the way I would look at it as I frame what the manager tells you, frame what they say they're doing and then you look for evidence that is true - reasons to believe in the track record.
So, if they tell you they're running a certain positioning with regard to volatility or whatever and you see that it just doesn't correlate with when they make or lose money, that, to me, is where the numbers come in. And then, obviously, you do a much better risk assessment. But for me it's fundamentally portfolio fit, credibility, edge and then risk profile.
Alan:I mean, in terms of kind of edge, credibility, team, obviously they're all qualitative factors. Is there anything that stands out? I mean is there a label you put on or a thing you like to see in terms of the focus? Some people don't like big firms, asset gatherers, they're not focused on alpha. Some like smaller firms, anything like that?
Richard:Yeah, really interesting question. And being candid, I'm slightly further away from the manager selection piece now. My deputy, Dev Jadeja is much more in the weeds on this than I am now.
But to my mind, because we're running multi asset portfolios, we have different portfolio sleeves, let's say, you have a slightly different feel in different areas of the portfolio. So, we've been really careful not to have blunt rules like, say, minimum three-year track record, minimum AUM, we're very flexible on that. But there'll be different parts of the portfolio where you prioritize different things.
So, as an example, if you're looking for someone to run multi asset credit, you're probably going to lean more towards a global platform because it's about breadth of opportunity set and depth, and about institutional platform. And there are elements, as a large allocator, where we need people to be able to take the volume of capital we've got.
But there are other areas where we can and will work with much smaller management groups who have a very different ODD, risk profile, let's say. So again, the ODD, we take it in context. We have a very detailed process, very senior mature team on that side and we can take a view on that to say, well, we can accept risk on that, because that's coherent with the manager.
The one for me, personally, that I would hold dear is integrity. So, it's a really important one - integrity of the principles, integrity of the business. If we perceive there is lack of integrity that is genuine, then that is a big issue because, ultimately, public funds are running. So, we will hold people to a high bar. And, in my mind, if we sense there's impropriety, we are aggressive, we're very aggressive on that.
Alan:In terms of the governance and evaluation of LPPI, I mean, obviously it's not an easy task to assess if you guys are doing a good job or not. And I'm sure there are plenty of people tasked with examining that. But, I mean, what do you think is the right way to evaluate the success of an organization like yours?
Richard:Yeah, it's really interesting. So, I think I said at the start, when George Osborne and the then government put in place pooling, they set out these four goals, we smashed through them, frankly, we delivered them. I think we've had £200 million of cost savings since inception. Performance has been good.
We've built an infrastructure manager, frankly, a direct infrastructure manager in partnership with Greater Manchester and some of the Northern pool. So, we've done very well on that. But there's more to it than that. And what we found is evaluating performance, just like hedge funds, actually, you compare two equity long/short managers, the higher returning one could have done a bad job and the lower returning one could have done a great job because it's all about the strategy, what they told you. And our context is very similar to that.
So, where we've got to, If I'm honest, is we're very close to agreeing with what we've call a balanced scorecard with our partner funds and clients which looks across multiple dimensions. So, breaking the scorecard into four quadrants, essentially. So again, you know an idea that's not similar to production, manufacturing or engineering, that sort of idea – performance, risk, sort of non-financial factors, and sort of contribution type stuff.
So, if you think about what matters, if you look back in 10 years time, you want to have that scorecard, if all those things are green, you think yeah, we've done a great job. So, it's not just relative return, it's relative and absolute return. It’s the cost of the pension, the funding, the income, oh, there are many dimensions. So, short answer to bring it together, balanced scorecard, key KPIs, and then report on that on a quarterly basis. On that basis we're looking good.
Alan:It's interesting the balanced scorecard idea. When you say it, it sounds right but then I guess investors invariably put 80%, 90% of the weight on performance, rightly or wrongly. But it is funny how we kind of default to that where it does make sense to kind of think in that kind of balanced scorecard.
Richard:Well, but is it not, if I invert that statement a little bit? If I think about you, I'm sure you, many times like me, have run a Markovitz style optimization and you crash straight into corner problems.
odd years ago, yeah:So, that is what I'm getting at. So, we could, I'm sure we could find ways where that pure performance dimension is all cost, for example. Note is, I'm joking.
You know, there are different ways you can do this. So, you have to think holistically and how it meets the mandate because it's multidimensional.
Alan:Conscious of time. We're coming up to the hour and we do like to get a bit of perspective from our guests before we finish off about maybe advice to people both from a career perspective, investment perspective. Also, you've done a bunch of different things; consulting, hedge funds, multi-assets, which probably has yielded benefit. But I mean, what’s been influential or helpful in terms of things you've done or things you've read or people you've worked with? Anything that's been hugely helpful for you?
Richard:Well, I think the advice I give people, and I speak to youngish people at University, what I'd say is that it's this idea of the wind at your back, and it's in both the investment portfolio and your career. So don't try and push water uphill is another cliche you could use.
So, when you're thinking about what your next steps are, make sure it's a growing industry or a growing space in the industry. So, if you're in that space, you can be a lower performer and still do well as opposed to being amazing and still not being able to get a job and struggling. So, thinking about your career dynamically and pivoting through that. So, it's that.
And then, obviously, the parallel in the investment portfolio is, if you've got the structural growth you can make mistakes on the way, or in the right strategy you can make mistakes, and you still do. Okay, so it's that type of idea.
The other thing I'd talk about is just, you know, hold integrity and that type of thing. It can be really tough at times in your career to do the tough thing in the short-term that is painful and hard. But if you fold and people find out, people see it and then it can be very painful to fix it later down the line. You know, it’s the idea of a reputation takes a lifetime to build and heartbeat to lose. It’s that type of thinking.
Alan:I got this question from somebody recently in kind of career context, you know, if you were to identify the structural themes and trends that are likely to continue. If people were trying to position with a wind on their back, is it. You might have said private markets, but, well, has that gone too far? But I mean if you were to identify two or three, what would you say?
Richard: I took when I joined LPPI in:I think private markets will continue. But I think the more important piece is the blurring line between private and public, and the hybrid securities, and the breakdown of what was traditionally public and private I think is being blown apart, and the holding structures, and that sort of bleed maybe slightly into tokenization crypto. There's a lot of change coming there.
There's a lot of inefficiency in the financial intermediation or the plumbing of the system. And I'm not smart enough to know exactly how it plays out, but to see that whether it's stable coins or tokenization of assets, I think that's coming, and I think that could lead to certain businesses (more precisely) just disappearing. Just suddenly, their reason to exist just goes because if you can directly own assets via a token, well, that might change things.
I'm not expert on that, but I can see there's a lot happening there.
What would the third one be? I think it would be strap on seat belts for I wouldn't be betting on the next 10 years looking like the last 10 or 15. If I'm going to put it into context. I think rates will be higher, inflation will be higher, geopolitical tension will be higher, asset returns, spreads will be thicker. You need to be compensated for that risk.
The risks have been wrong, I think they will be materially higher, to nick the BlackRock idea that we are potentially in this unanchored world where I don't think inflation's going to be nice around 2%. I think Central banks have got a game on to try and hit that. And I think if I had to put one word in it, it’s fiscal dominance type thinking. So, be very aware of risk and be mindful.
But to counter that what I'd say, as well, owning a broad risk, a broad asset, broad portfolio of risk assets that you manage thoughtfully and be sensible with I think will outperform in the long run as well. So don't be scared and run to bitcoin or whatever.
Alan:Just could be a rocky ride.
Richard:Yeah, just might be a bit bumpy.
Alan:Very good. Well, very much appreciate your coming on today, Richard. It's been great. We've covered a lot of ground, so, very much appreciate it.
So, for our listeners, you can obviously follow the growth of LPPI and Richard’s work over time. But from us here at Top Traders Unplugged, thanks for tuning in and we will be back again soon with more content.
Richard:Thanks so much for having me on.
Ending:Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today's episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you you'll be sure to get all the new episodes as they're released. We have some amazing guests lined up for you, and to ensure our show continues to grow, please leave us an honest rating and review in iTunes. It only takes a minute and it's the best way to show us you love the podcast. We'll see you next time on Top Traders Unplugged.
