The Derivative - A US state with a sovereign wealth fund? Utah’s new approach to old money with Peter Madsen

Starting point is 00:00:00 There are 22 western states that Thomas Jefferson at one point, I'm pretty sure he thought that, you know, we'd be an agrarian society and so he drew a grid on every territory before it became a state and required that a decent portion of the state would be held in trust for public schools. And instead of blocking off or being strategic about any oil and gas, et cetera, it's just every so often you're going to have a public square or a school campus of some sort. And so just all over these 22 Western states is just this checkerboard of land that's held in trust for public education. Welcome to The Derivative by R. Sam Alternatives.

Starting point is 00:00:53 Send it. Hello, my name is Peter Madsen. I'm the Chief Investment Officer for the state of Utah's Sovereign Wealth Fund called the School and Institutional Trust Fund's office, or better known as SIPFO. We like to say the money's old, going back to Thomas Jefferson and the inception of the state of Utah, but SIPFO is relatively new. And I enjoyed the discussion talking about, of course, skiing, as well as asset allocation and our use of managed future strategies. Hope you enjoy. Coming up on The Derivative. All right, everyone, we're here with Peter Madsen. I'm guessing coming to us from Snowy,

Starting point is 00:01:46 Utah. Where exactly are you in Utah? I'm downtown Salt Lake City, Utah. I live a couple miles from downtown. I'm in the office today. We're right on Main Street. Nice. So where, as listeners know, I always spend way too much time talking skiing. So what's your favorite ski hill where do you go um yeah we could do a skiing podcast uh might be more might be more enjoyable but uh you know being based in salt lake it's more of a strategy about given day and given conditions and where you think crowds are especially with the the way the new passes work so for example this weekend the plans were that we expect a little bit of snow should we go to the resort which one will be enough snow for it to be a pow day or should we do some backcountry where there's we expect there to be fewer crowds

Starting point is 00:02:36 and get a little more exercise so that's kind of the nature of it versus it but i did spend four winters right after high school working at brighton ski resort so a fondness for brighton i love going there and can really just kind of feel like i can let loose because i know the mountain so well i love it i was a similar except after college ski bum and aspen for two years um slop and chili up on the mountain so i know it and then i'm out there probably twice a year now with uh some friends houses in park city and so love it out there except i'm always torn i'm at park city my buddy's got a house on deer valley beautiful ski in ski out what's not to love except i'm like oh can we go over to alton snowbird

Starting point is 00:03:24 yeah like there's not quite the terrain at deer valley that i would hope for but beggars can't be choosers right yeah it's deer valley is the go-to for icon pass holders when alton snowbird are snowed in or the canyons closed yeah and then tell me quickly about your backcountry so you're skinning up and skiing down what are you doing out there yeah skinning up uh occasionally do something a little more adventurous that might require you know having some crampons or putting your skis on your pack and post tolling up uh you know something a little steeper but a lot of it's, you know, in the interest of just being safe and having a good time. A lot of it's pretty mellow. There's a lot of low angle, you know,

Starting point is 00:04:11 not really massive peaks here in the Wasatch, you know, or like Snowbird and Alta and some of those resorts have great steep terrain, but off on some other canyons, it's pretty mellow. Some of them, you can take your dog. So it's really more about getting outside you know getting some exercise being with friends and you know making some making some turns but it's not aggressive or challenging skiing typically yeah and it's always interesting to me we've had um veneer bensali who runs a volatility fund super concerned with risk and hedging and volatility and he goes out on these helicopter skiing snowboard he does this desert run all this stuff so his personal life he takes a bit more risk than in his professional life so it's always funny but it sounds like you're

Starting point is 00:04:57 saying i'm aware of the risks in the backcountry as well yeah we're pretty safe there's a couple of us climbers that you know have been around a long time and you know taking safety courses and and you know training avalanche rescue training etc so we don't you know we don't tend to just you know it's a pretty select few that i'll go out with you know experienced people who i trust and who have really strong knowledge about either the weather or snow conditions or, you know, avalanche safety, those kinds of things. Oh, well, that just blew my next question of whether when I get out there, whether you

Starting point is 00:05:32 can take me on one of these backcountry trips. So we'll see. You can do an easy one, maybe. All right. I've passed some of that stuff. I've always wanted to do, what's the mountain when you're sitting in the Snowbird Alta parking lot, Alta parking lot, looking kind of back down valley right there that big one yeah and people you can see them going up yeah um you've done that superior that's a that's a great one um high

Starting point is 00:05:57 pretty typically pretty high risk to ski that one you need the right conditions but that whole ridgeline right there is a go-to back country spot that um yeah it's uh don't don't get me started on on parking and infrastructure and crowds anymore it's just so busy like there's a just a stream of people doing back country especially right up in that area well i did want to ask you, are you Utah born and raised? Are you a transplant? More or less, I grew up in North Carolina. I went to junior high, high school, University of Utah. I moved away for almost 20 years.

Starting point is 00:06:37 And then I've been back now about nine years. So my wife teases me because I don't like to say I'm from Utah. I like to give the full longer history. But at some point, I'm just going to have to say I'm from Utahah i like to give the full longer history but at some point i'm just going to have to say i'm from you're from utah right but what what do you make of the growth like park city just seems to be going crazy right they're going all the way out to the reservoir now six million dollar houses like is that sustainable are you tons what do you call yourself you utahns utahns yeah are they happy about that or is it no one's happy about that all right and you gotta you gotta kind of make peace with it but you know growing up being able to go skiing at lunchtime you know when when I learned to ski you got on the bus out in the

Starting point is 00:07:20 valley and you know during lunch and had a sack lunch and skied you know took lessons in the afternoon home by dinner and anymore it's like on a weekend powder day it might take you two or three hours to get up to Altair Snowbird yeah it's crazy um so what do you do about that like and then there's this new private mountain that's up near snow basin with who knows what that costs five million plus to get in yeah it's a 500 000 membership fee and then i'm not sure if like the yellowstone club you're required to buy a property um it wouldn't surprise me i'm i'm just not sure about that but because that's you know ultimately how how they make the money i'm not sure that they just want to sell you know lifetime memberships but that resort is yeah that's something else that that that was really surprising somewhat controversial just you know the locals

Starting point is 00:08:15 around there had access to that area and you know now they now they no longer will and it's a pretty big swath of i mean it, it's a proper resort. Who sold it? It was privately owned? Yeah, it's kind of, yeah, it's just interesting. It was a ranch. I guess they called it a ranch. They marketed it, but maybe that's still in the name.

Starting point is 00:08:38 I think it might be called Wasatch Peaks Ranch. The owners of Snow Basin, which is a great resort in Ogden, which used to be less traveled traveled but the olymp the 2002 olympics the i think was the downhill was competition was held there though that family i think it's a family the people who own snow base and owned that property and sold it and not sure why they didn't develop it themselves but sold sold it. And the buyer, the condition was they couldn't create a competing resort. So the private resort was, I don't know if that was the original intent. I'm sure it probably was, but that's the stipulation for selling it. I have the specs right here.

Starting point is 00:09:18 One million to join, must buy land for eight million plus, must build 5 000 square foot house minimum and break ground inside five years wow so i'm just shy i'm just shy there's a lot going on there um all right for all those who didn't come here to hear us uh talk skiing um but what's your overall we'll close up utah you're you're bullish everything's going great i mean you must be you work for the state but um you think it'll cause problems long term or you guys will figure it out yeah hard to say i think we'll figure it out i think um you know one aspect of you know utah originally was built around this kind of um original i don't know if you call it infrastructure but the streets are really wide downtown i'm sure you remember being down here

Starting point is 00:10:12 and a lot of our downtown streets are are you know if there isn't a train or bike lane now there are four lanes um so two each way plus a turning lane so there's you know plenty of room to you know all this it's traffic-y, et cetera, but if you're just in and around Salt Lake and the valley, it's not terrible. You know, public transportation's okay. And then the opportunity for, I think the term is urban infill, you're just creating density in Salt Lake City is, you know, the buildings are going up rapidly.

Starting point is 00:10:46 We've got our first couple new skyscraper type hotels downtown. There's tons of luxury apartments going up. And so I think it'll be, you know, we'll manage, we'll become ultimately like Denver or Seattle, hopefully not as traffic as LA, but, you know, getting from one end of the valley to another is pretty painful. But as long as you can stay pretty close to home and manage to get out early to on a powder day, you know, you'll be all right. Ride the bus on a powder day. Let's get into the firm and we'll weave back you said north carolina um and then back to utah so what was your kind of personal background got into the investment world and how'd you end up working for utah you know uh i kind of fell accidentally into institutional investing i

Starting point is 00:11:42 i was studying russian spent a little bit of time in Russia. I thought I'd be an academic, really liked the idea of, you know, studying great novels and history and art and, you know, sharing that with others. I thought that was something I really wanted to do. And as I met my wife and things started to kind of change and people I was meeting and things I was learning and pivoted as quickly as I could into international relations or international political economy type of classes. Ultimately graduated with the Russian degree and then went straight away into an MBA program and graduated right, you know, at a time. It was tough to get. It was early 01. And a family friend of my in-laws happened to work at Russell and a group that spun out of Russell, their manager research department.

Starting point is 00:12:43 An individual named Jeff Hansen. Great guy. I'm still friends with him. He was consulting, doing management consulting, if you will, and research for asset managers. So, you know, they're like, maybe they want to rationalize the product line, or they're wondering if they have the right PM and, you know, and the right talent on the team and personality profiles and all those kinds of things. So I joined him not really knowing much at all about investing, especially not institutional investing. This is like Russell, the index company now? Russell was one of the first pension consultants. And they were, you know, they were maybe the

Starting point is 00:13:22 biggest pension consultant for a long time. And so their manager research group, you know, then they started managing money. Their manager research group was pretty strong, pretty big. Again, like one of the first, you know, folks to even do manager research. And they were managing their own funds at one point. So, you know, a lot of resources, a lot of people, a lot of coverage, a lot of strengths. But a small, one guy spun out and a couple of people joined him on contract. And they all were seasoned professionals. And I was the newbie who just happened to be in the room with CEOs and CIOs of large asset managers, taking notes and running

Starting point is 00:14:00 the data, being the guy behind the software and the spreadsheets and all that and that was great but um we just it was a it was a boutiquey thing and it was uh what was the the regulatory um i want not sarbanes oxley but elliot oh was elliot spencer passed something that got rid of the soft dollar. Oh, yeah, yeah. Really put the dampener on how soft dollars were used. And of course, all of our fees were basically paid by soft dollars. So that we really struggled. And I ended up taking a, ended up the short stint at Parametric. And they were doing a lot less strategies than they do now. It was mostly passive, taxfficient, passive, separate accounts.

Starting point is 00:14:48 And so that didn't last very long. It's great people, great shop. Invest with them today. But just as a research-oriented person, being on a mostly passive desk, if you will, was something that wasn't in my destiny. So ultimately joined rvk yeah it was uh yeah it was like running optimizations on how to keep the tracking error low and what to buy and sell attack you know tax efficient kind of good for the ski life like that's good we're all lined up going skiing yeah basically uh yeah joined rvkK in Portland and did some consulting there for about five years

Starting point is 00:15:26 and great people loved living in Portland. Family was super happy. Things are going really well, but met a group fund to fund that it's kind of a hedge fund platform that had some direct strategies as well, as well as a fund to fund and did some research. Ultimately joined them, moved to london super important for the family great time you know could talk about that all day again yeah and uh

Starting point is 00:15:54 and then that wound down as well just you know fun to funds it was tough to raise capital when i joined it was we were about 1 billion when i When we decided to wind it down, it was about $1 billion, but we had also raised about $700 million during that time. It was kind of being on a treadmill. A couple of the consultants, once they saw the flows coming out, they decided they didn't want to be the last one. We ended up winding it down and was fortunate enough to have a long runway to, you know, talk to some recruiters. And I was telling them, it's pretty laughable, but, you know, I guess I didn't know any better, but I was telling them what I'd really like is to be a CIO in a mountain town or, you know, on the West Coast somewhere. And they were laughing like you and everyone else. And then

Starting point is 00:16:43 a few weeks later, one of them that I had talked to got the contract for the CIO position to recruit here for SIPFO in the state of Utah. And she's like, you're not going to believe this, but this would be a great fit for you. At the time, it's like, you know, the pay is not great, but it's a brand new office. And, you know, it sounds like they're going to give whoever joins a lot of runway and so that was nine years ago and we've you know a lot's changed and 12 people now the um a lot to unpack there first part of me goes to everyone thinks soft dollars nefarious right so there was nothing nefarious you guys were doing that was just how the game worked right you think that kind of got they threw out the baby with the

Starting point is 00:17:31 bath water with that whole ruling yeah i'm not really sure just because the um the it is nice to just have an explicit price for something have a service of a product and have a price for it. Um, so I'm not really, you know, other than, uh, I was super happy doing what I was doing, could have done that forever. Um, you know, it's, I wouldn't be, you know, doing the things I've done. And so I'm not really too disappointed in that. And the, the, the idea that you're paying for something and, you know, the fees are used elsewhere.'s just not you know it's not ideal so and then my brain did was the cia ever uh recruiting you when you were getting a degree in russian i uh i went to a school where it's a most people were employed by one government or

Starting point is 00:18:18 another because half the student body were foreigners you needed to speak another language was that kind of kind of policy oriented school they only have a few degrees and one of them's policy one's business one's translation and interpretation and what's the school it's the middlebury institute of international studies oh yeah it's in monterey california um there's a few military kind of things going on there naval Naval Postgraduate School and Defense. I can't remember the name of it, but the Defense Language Institute or something like that. So, yeah, I did get a call from like Acme Incorporated or something at one point and talked to them a couple of times. And they had me fill out this all this paperwork and international exports and ships in russia and then i had to write an

Starting point is 00:19:07 essay and this is really embarrassed you know it's kind of embarrassing i guess i don't know it's funny but this is a long time ago but you know russia was in a pretty strong period of chaos and you know yeltsin was a bit of a crony right just put it lightly yeah and russian history of you know the philosophy is that you know they need kind of a strong hand or a strong ruler and they go from order to chaos and order to chaos etc and so when putin was announced it was like oh well here's a strong hand and that will be better than because when i was living there was it was mid 90s and there was a lot of suffering a lot of poverty was. It was really dramatic, actually, really tragic. And so I thought I wrote my essay on why Putin's good for Russia. And I didn't hear back after that. Someone may argue that that was the case. Maybe not good for the rest of the world but maybe good for russia let's get into the firm or do you even call yourselves a firm what do you what do you call

Starting point is 00:20:13 yourselves we are we call ourselves a sovereign wealth fund really nice yeah um a lot of folks would historically would have called this the permanent fund yeah there are a few uh there are like in alaska yeah so like alaska um if you'd like i could kind of describe this there's a cohort of us i could kind of describe yeah definitely we are and so there's there are 22 western states that thomas jefferson at one point I'm pretty sure he thought that, you know, we'd be an agrarian society. And so he drew a grid on every territory before it became a state and required that I think it's either one, it must be one 16th, I always forget the exact number, but a decent portion of the state would be held in trust for public schools. And, you know, instead of blocking off or being strategic about any oil and gas, etc., it's just every so often you're going to have a public square or a school campus of some sort. And so just all over these 22 western states, there's just this checkerboard of land that's held in trust for public education. And different from Alaska, who set their sovereign

Starting point is 00:21:31 wealth fund up just as a benefit from the royalties of oil and gas. They also have 22, this public education type of trust, slightly different. But some of us have oil and gas. Some of us have a ton of oil and gas. Some just have land that they sold off and just distributed the money right away. But a few of us are pretty active endowment-like strategies, if you will, teams that kind of look somewhat like a pension fund, somewhat like an endowment, portfolios that are kind of between. And, you know, some of us have more public scrutiny than others, but one of the, you know, New Mexico is growing rapidly,

Starting point is 00:22:17 really strong performance, lots of oil and gas money, you know, really important to the state. I think they have multiple trusts now and you know offsetting taxes and supporting other programs so we're about 3.7 billion we distribute about a hundred you know we're all unique in our in some ways but those are the kind of basic similarity 22 i'm trying to think how many states are west of the Mississippi, but... Basically, yeah. Basically those, yeah. Yeah, Oklahoma, Texas, and, you know, kind of west and north.

Starting point is 00:22:52 And we distribute about 100 million to K-12 schools every year. And those checks go to what's called a community council, which is majority parents of the school. And then there's someone, you know, representing the school on that council. But that, you know, kind of advising the parents or, you know, recommending how that money be spent to the parents. And, you know, there's an auditing function to make sure it's being spent on, you know, education or academics. And, but yeah, we're, we're those that's it's really great

Starting point is 00:23:27 leverage because it isn't part of the overall education budget it's goes directly to the school who has a certain need in a certain year and so what year was this where he put these all who who'd you say it was thomas jefferson all right so way back way back so way before they were even states yeah so the it's called the enabling act and when a territory becomes a state there's you know that that's basically the enabling act and it's part of that so it's kind of like the constitution of the u.s the enabling act and then the state constitution for for utah and it's so it's super senior in terms of you know where it sits and what what claims it has but anytime there's a national park or something like

Starting point is 00:24:11 or you know not many national parks these days but these national monuments that get created the feds have to make us whole so to speak so there's a whole separate office separate group that does land management and optimizes and generates revenues, et cetera, from these royalties or disposal of land. And, and, but anytime that, that's usually a really great windfall for us. So, you know, we're for, in terms of the assets under management, we like to see those, you know, feds do these big projects and then we get to cherry pick what BLM land we might want and, you know, group it together and make sure it's near oil or near a developing city. What's BLM land? Bureau of Land Management. Got it. Which is federally owned. Yeah. It's like most of the West is the BLM land. Wait. So that's separate from your trust lands.

Starting point is 00:25:00 That's right. Trust lands. Okay. And so some of these states just went ahead and sold the land to raise money and then you get money or it's kind of a it's kind of a uh yeah it's some fared a lot better and some like i said have you know oil and gas and and just good governance early on but for example the state of utah was the i it was 1896, right around there, that we became a state and this trust was technically established. And in 1995-ish, so about 100 years later, there was $100 million in the trust. And most of the, you know, like half the land was disposed of already oh no 100 years you know not much growth and then it got professionalized uh um you know legislation oriented around making sure that it had a secure future and now we're at 3.8 billion who's the gold standard in this kind of in this club oh man um we all have our freckles besides

Starting point is 00:26:08 yourselves yeah yeah we talk to each other quite a bit there's a there's a a dozen or so of us that are pretty active and you know have kind of long-term pension or or endowment-like portfolios because some are just held in cash, for example. They haven't bothered to change the statutes or change the constitution. But for example, we have a lot of the characteristics that an entity like us should have. So we have four independent trustees. The state treasurer is always the chair, and he's elected official. And then there's independent committees that work to he's elected official and then there's you know independent committees that work to nominate the other four who there's criteria about them being

Starting point is 00:26:50 investment professionals basically to become a trustee and then there are and then their you know their responsibilities are outlined really well in the statutes so they have to live in utah no you don't have to live in utah all right throw throw my hat in the ring. Okay, I'll put your name in the ever-growing list of people who are kind and generous enough to take this on and help us out. But we are given discretion to manage the portfolio, the team, the CIO, and through that, the team. We obviously have transparency requirements and reporting, but our trustees look at asset class, asset allocation, asset class level performance, total fund performance,

Starting point is 00:27:34 long-term horizon. We talk about governance matters, investment philosophy, investment policy, intergenerational equity to make sure we're not favoring one generation over another. So it's actually really great. That's not a thing in the United States. Did they know that? You're supposed to just kick the can down the road and screw the next generation. You guys didn't get the memo. Yeah, I guess not. So I want to back up for a second and i'm going to ask about the

Starting point is 00:28:06 trustees but backing up so you had that 100 million and 95 how did and you'd sold half the land so how did it become besides investment gains how did you get the three three and a half billion in there like what are the ways you get revenue out of there whether in your in utah specifically or some of these some of the others alaska is clear right it's just a piece of every oil barrel so yeah so the the more the larger groups uh these larger funds it really is about the oil and gas money for the most part the you know it's it's dominant but there is also uh you can like we'll one of the one of the so we can do you can lease it for you know mining so you know gravel pits or grazing a lot of those you know if we if we had owned that ski mountain you know probably uh yeah that would be nice

Starting point is 00:29:01 um but the the big windfall for us was shortly after that professionalization, if you will these these plots of land are like a few acres every few miles or so and so that it's really hard to just do something on you know three acres and make get a lot of value out of it especially if it's in an area where there is no oil and gas there is no development you know the zoning whatever so when they created that massive national monument all of those lands that you could argue were trapped were moved were traded for land adjacent to a town called saint george which is growing southern utah it's just a couple hours away from vegas and so all the new homes and all the development down there is more or less on trust lands and so that was a big windfall then and so any disposal of land or any use of these lands, you know, those royalty checks or proceeds from the sale come into the trust.

Starting point is 00:30:11 From the U.S. government? What's that? From the U.S. government? No, it's like, well, like if you want to, you know, Or this black desert course I played. Trust lands will, you know'll they'll strike a deal with you and you'll pay a certain you know leasing fee royalties etc so that black desert golf course in outside saint george i played in an outing there uh oh yeah in october yeah flew into vegas

Starting point is 00:30:37 drove over so that is crazy right it's like you're on the moon there's lava rock everything it doesn't look like anything else in utah but you're that area was was traded for this in this scheme more or less yeah yeah cool um and then i've also driven from moab to zion and you go down that grand staircase but that was weird you're like what i don't get it you see the signs and you're just driving and then all of a sudden you're on a like six foot wide road with everything That's falling off the second. You're like, okay, I get it. Yeah. Yeah, it's great But so and so I'm being dense here But like the for you guys to succeed you have to constantly be selling off pieces of it or not

Starting point is 00:31:21 Ignoring the investment piece which we'll get to for a second But in order to get any new money you have to be selling off pieces of the land or you could or leasing it um yeah selling it uh we the the mineral rights are always retained so to the extent you wanted to do some fracking under some land you already sold and you know you could arguably do that still there's some you know uh there's some land out that like it could be repurposed for solar um you know there i think there were some coal mines at one point that are maybe winding down and there's some discussion on you know a solar farm going in in that area so just these constant they're constantly innovating and optimizing and generating strong.

Starting point is 00:32:07 It's been a strong few years of cash flows, which you would think would just be declining. But yeah, that's cool. But it's been great. And at some point, if you think about it, it's really just one trust. Some of it happens to be physical. And then we have the financial trust but if even if that did stop you know cash flowing it's you know if you value the two at once it's sort of you know it's it's basically just like one big trust at the hopefully inflation plus plus five percent

Starting point is 00:32:37 kind of and then are you required to pay out that 100 million or you're paying out basically what you can we have a distribution policy that sounds really thoughtful i think and actually we've we've changed the state constitution twice now wow amended it to increase that distribution um which is one of the more important restrictions that was lifted that some of these other sovereign wealth funds haven't worked on yet or haven't, you know, don't think it's, you know, worth the lift maybe. But a lot of them were only meant to be invested or defined to be invested in bonds and distributing the coupon. And that's kind of how the original language reads. You mentioned the trustees, so that's kind of a smaller trustee group

Starting point is 00:33:26 versus most institutional would you agree versus most endowments or who knew um i yeah i think that's fair to say i think there's some research that says any group larger than seven starts to make worse decisions than smaller groups and that was going to be my follow-up, like how, not to get yourself in trouble, but how are they to work with, right? There's horror stories about trustees punting, right? CalPERS punting on LongVol right before the spike happened and all that stuff. So trustees kind of get a bad rap for not understanding the investment side as well as they need to and making kind of retail investor type mistakes over the years. Yeah, we're super fortunate in that. So when SIPFO was established, so the money is,

Starting point is 00:34:13 I like to say the money is really old, but SIPFO is pretty new. And when SIPFO was established, it was basically a task force or study group because it started, it got to about $2 billion and the beneficiaries were like, Hey, how's this being managed? And, you know, we talked to these other groups and they have, you know, a team and this and that and consultants and it was held passively or managed. It was held mostly at Vanguard. Absolutely fine way to go if you don't have a big budget for managing a portfolio. It probably should be just a straight do no harm approach. Things were going pretty well. A lot of money coming in from land management, strong growth from a 70-30 portfolio,

Starting point is 00:34:59 get to $2 billion. And someone was like, should we be diversifying and having an investment committee and, you know, staff, etc. And that task force really kind of took as best they could, a best in class approach. So these things like, you know, the trustees, the four trustees need to be investment professionals or investment experts. And there's a committee that chooses the trustees and they nominate two and the treasurer as the chair picks one. So it's pretty independent. And these guys are great because they're all volunteers and they're either former CIOs or current, you know, CIOs or director level folks at family offices. And we meet once a quarter. We have an annual summit. And we talk in between these quarterly meetings, just me and a couple of them or one or two of them at a time. And it's great. I mean, we're, you know, they really focus on governance and not trying to micromanage, not worried at all about meeting the managers.

Starting point is 00:36:20 It's probably smaller than some of the family offices. That makes me depressed that it's hundreds of years of Utah's pristine natural resources, and it's 140th of Elon Musk's network. Right. I think we have our priorities screwed up as a country. What does CITFO stand for as I'm bearing the lead 40 minutes into our talk here? School and Institutional Trust Funds Office. All right. does sit fo stand for as i'm bearing the lead 40 minutes into our talk here school and institutional trust funds office all right do we like that name i feel like we need a better name i feel like sit fo is the way to go sit fo all right we'll keep it for now um and i meant to ask this before like is this does utah doesn't have a state lottery i don't believe right no no which is probably for different reasons but right our other east coast states are running

Starting point is 00:37:11 lotteries to do the same thing this seems a much better uh better setup yeah well idaho has both a sovereign wealth fund and a lottery so oh so they get they get double i've never seen anyone all excited like we built this whole new school because of the lottery but maybe it just feeds the beast and nobody knows about so let's get into the investment structure so what did you come in with your whole own philosophy or as you said it was all in in Vanguard and how did that work of starting to diversify it and get it into, you know, you're here because you believe in alternatives and do alternatives. So what's the current portfolio look like and what was the journey to get there? You know, when I was fortunate to, when I was a consultant at RVK, one of my clients

Starting point is 00:38:03 that I worked really closely with was this sovereign wealth fund for the state of Oklahoma. And so I was really familiar with the structure, the, you know, kind of the constraints, if you will, around that original constitutional language. And we worked, I worked with Oklahoma to try and change to amend their constitution as well. So I had some pretty good experience and understanding with what it would take to run this office and having had a lot of clients, you know, at RVK just being in and out of a lot of different, you know, entities, seeing the investment committees and, you know, the team structure, team size,

Starting point is 00:38:42 team, you know, the talent, all those kinds of things. And then having a little bit of a management consulting experience, I felt like I was in a pretty good place to build something from scratch, if you will, here at CIPFO with the idea in my mind that it will grow over time. It will be sophisticated. We'll have a strong team, well compensated, all the resources we need. That was kind of a gamble, you know, anyone takes starting a new job. And, you know, it's really paid off, but it started with, I remember the first meeting I had with the trustees, I came up with a, I did a quick mean variance analysis where we were still under the dividends and interest only framework. And it was late 2015, early 2016. And there was a bit of a correction going on. And so I recommended BDCs, MLPs, EMD, high yield.

Starting point is 00:39:47 Yeah, I think that might have covered it. And this little basic optimization and talking about how we can increase return, get some diversification and also increase the dividend and interest payments. And one of the great trustees who's been with us the longest was like, we need to document our investment beliefs and we need an investment policy before we do anything else. And I was like, oh man, the timing's really good right now, I think. But anyway, so we took the right approach because we had really strong trustees with experience to set the governance up and make sure we had consultants early on and work with them to build out some important parts of the portfolio. It was a pretty tough slog for the first few years, trying to get additional budget

Starting point is 00:40:39 and funding for growing the team and being able to attract and retain the right talent and so this first call like the first half was pretty rough and um that was it kind of the year was uh covid and was kind of like a really a really tough spot right then but things just really picked up from there i was gonna say 15 mops had just gotten hammer right? And oil and everything got hammered in 14. So you were not just picking here's these highest performing things. You were doing real work. Unfortunately, it was six years later until MLPs actually took off. So that was a rough road.

Starting point is 00:41:22 We have a good blog post. We put in the show notes called but the you but the you right people are like down 80 on their principle and arguing like but i get 12 percent you know yeah it's weird to think of this this thing's literally supposed to be there for hundreds of years right yep forever right i need to, oh, it's really good timing. But like in the scope of the thing, what is good timing? Yeah. It doesn't matter. So you started to get these pieces in and what's the portfolio look like now?

Starting point is 00:41:54 Yeah, well, actually, there's an important point I should raise about a lot of these sovereign wealth funds. where one of the things that I like about New Mexico that they do better than us from a governance perspective is there's something called the corpus in the Constitution which defines every contribution to the financial trust or every contribution to the trust as the corpus and we're not allowed to breach it so we can't we so it's basically like having a cost basis and theoretically everything shuts down if we go below that cost basis in terms of a drawdown so that's a really important starting point and in the way it can exist through return it's like a principal protected bond kind of thing. Like once you get. Yeah, it is supposed to be that way. But, you know, I made the argument pretty long and pretty forcefully and unsuccessfully over the last nine years that, you know, modern portfolio theory suggests that you shouldn't worry about that. You should manage your risk appropriately. But if you have a long enough time horizon, you know, certain types of drawdowns should be tolerable. And, but that's, you know, not, that's not, that wasn't the thinking in 1896. And so here's an important part of how we started building the portfolio. And I've always been a fan of other strategies, so to speak, which by that I mean not just

Starting point is 00:43:33 equities. And when you think about the potential returns from a fair few other asset classes and the relative volatility, you can get competitive returns from a forward-looking basis from a lot of lower vol strategies. Maybe they have more of a left tail or maybe not. So we do a lot of things in what we call income, real assets, and defensive. And then we also have growth, obviously, which is public and private equity, but we're targeting about 40% private markets. And we have a 15% daily liquidity risk framework that we put on ourselves. That's roughly three years of distributions.

Starting point is 00:44:27 But we have more than that in data liquid and a lot of semi-liquid stuff. So you think about these tweener type of strategies, a lot of hedge fund structures within what you might call credit or private credit or structured credit, MD, ILS, things like that. And then in defensive, and real assets is what you'd expect, everything kind of real assets oriented, but no duration. So growth is equity beta, supposed to be mostly equity oriented returns, not just beta per se. And like private equity obviously has equity beta, but you need to proxy it to show it. Income is, so we call it grid. So real assets, REITs, natural resources, MLPs, but we try to avoid duration. So not as much

Starting point is 00:45:17 real estate as what you would call real assets. And then in income, we have open-ended private credit funds, hedge funds, and structured credit that do semi-liquid, let's call it, and ILS and distressed emerging market debt. And then defensive, we have 30-year strips and macro and trend. No long ball in the defensive? We slugged it out for a long time, for about six years, with what we call systematic convexity, that part of the portfolio. And we spent a lot of time trying to construct it and think about working with the consultants to pick managers and we ultimately went with the fund of funds and that approach was having a having a trend in macro is call it the core

Starting point is 00:46:19 and then the tail hedging and then carry to kind of pay for the tail hedging. But the way it worked out was those two things kind of canceled each other out. And we didn't have enough trend and macro and we didn't have enough fall. So we rebuilt that portfolio where our manager count is, you know, not super high i can't remember where we are now but let's let's say if we're at 9 to 12 is like a range of of tolerable uh headcount for managers in that space but we're trying to get as high of all we can so like one of our managers has 40 vol um we try and talk if they don't have a high vol share class we try and talk them into creating one and or like these options-based strategies where the vault or the var can be really high but um you just put a small dollar amount in so that's

Starting point is 00:47:12 that's kind of how the trend and macro portfolio looks like and the theory is that those should do well over times on a standalone basis whereas the carry and the tail hedge combos kind of gets you nowhere and the tail might the tail hedge might not pay off actually so grid is growth real estate income defensive real assets real assets Yeah. What did I say? Real estate? No, not real estate. Real estate. And so talk to me for a sec. The real assets and duration piece. That was interesting.

Starting point is 00:47:53 How do you think of that? Just because you have to hold real estate for a period of time is what you're saying? Or it reacts? So for us, factors are pretty important. And so we're looking at each of these. If you think at a really high level, the growth portfolio has the equity factor. The real assets portfolio has the inflation or commodity natural resource type factor. That's the idea is that it helps with inflation. But if you're doing real estate lending, and like we saw in 2022, both real estate and anything with duration got hammered.

Starting point is 00:48:35 And things that were equity in nature, the equity share class linked to commodities or resources in some way typically did well. And that's the thesis we have. And fortunately, it worked out in 2022 quite nicely because there hasn't been a real period of inflation to test that theory. And then income is supposed to be competing with equity returns. While we don't expect it to necessarily beat equity returns. We expect it to be more competitive and we expect it to be kind of call it higher in the capital stack, even if it's, you know, not necessarily lending to a corporation. You can just think of these as contractual, you know, contractually obligated cash flows. So a lot of the return we, that comes from there, not all of it, but a lot of it is from some kind of coupon and that's that's um and then yeah

Starting point is 00:49:27 defensive is meant to be the diversifier and and contribute negatively on a on a risk basis and then how are you putting these together they have a set percentage or it's risk weighted what is the overall structure look like we went through a a pretty fun process that took about a year. We wanted to be really thoughtful recently. So every year we do an asset allocation and we've evolved it over the years and working with consultants and doing it ourselves to try and look at not just a mean variance optimization, but make sure we're doing stress testing or scenario analysis, looking at mean downside and mean CVAR and all these things and putting them all together and putting them all in a table. And then we worked with this consultant called

Starting point is 00:50:15 Hyperion, I hope I'm saying that correctly, based in Chicago. And they have a multivariate optimization tool that you can include like kind of any factor. So we included the probability of breaching our corpus, the probability of meeting our CPI plus five, the probability of a forced rebalancing due to illiquidity. And I think that was it. We might have had just regular drawdown in there just to be different from the corpus breach. And we put those all on one frontier, if you will, and worked with that consultant to have some cool kind of not very deterministic analyses that ultimately got us to the current asset allocation we have. And then we have pretty wide ranges around, we have like a healthy range around growth. And then within growth, you have public and private equity and healthy ranges around that.

Starting point is 00:51:17 But if you think about the very high level, we sort of have an equity beta expectation that we should be delivering. And if we can do like, for example, we decreased our defensive allocation because we were able to improve the contribution to volatility from that part of the portfolio. And then we put that into other parts of the portfolio. So we increased our return a little bit and improved our risk and then took advantage of the lack of reported volatility because that corpus breaches, if that's an arcane accounting

Starting point is 00:51:53 quirk, then the accounting quirk of private market funds is something we can use to- Our advantage. Yeah. What are your thoughts on that? that's just everybody's playing that game so why not like it seems it seems weird for lack of a better term right of like everyone knows they're not really true marks everyone using them knows they're not really true marks so you just kind of bake that into the into the pie yeah you know there there could be a different way, I guess. You know, the open-end real estate funds, you know, go out and get appraisals every so often on a decent part of the portfolio and kind of cycle through that quarterly. That's maybe something that could be, you know, standardized in other private markets. And in fact, for example, these 40-act funds that invest in private deals have daily marks. Yeah.

Starting point is 00:52:49 So there's a way. Not sure how meaningful it is, but I don't think it really bothers most of us who spend a lot of time with it because, you know, it's such a huge, the private markets are such a huge part of the economy to not invest there would, I think, be imprudent as long as you can tolerate the illiquidity and you think you have the resources to work with the right GPs in private markets. I mean, there's definitely risk there and make sure, you know, tread carefully, etc. But most of the companies are actually private. Yeah. Well, I'm not going to invest in most of the economy because I don't like how they, you know, get to mark their portfolios.

Starting point is 00:53:31 Not quite right. And we spend, you know, most of us spend a decent amount of time looking, you know, you go once a year, you go on site somewhere with the manager and talk about the portfolio in detail.

Starting point is 00:53:41 And hopefully, you know, they're, they're quite transparent about the successes and failures of how things are going in these um mostly private equity companies and then not a lot changes quarter to quarter so you know you kind of forced to be patient forced to force to stick it out and and then in the other markets you know real assets is the same way but in private lending, that is a nice catalyst.

Starting point is 00:54:06 They either amortize or the coupon's being paid back and liquidity is decent in terms of the life of the funds are shorter and there's oftentimes money coming out quicker. It's a little more liquid. That's also why we have probably a little more real assets and income, especially on the private market side than a lot of others. Because when you do the analysis, you see that they're lower risk, competitive return, and more liquid. Do you think you have less private equity than other institutional investors? We just upped our target to 20%. And our total private markets target is 40%.

Starting point is 00:54:50 And I think a fair few folks have 40% in private equity. Yeah. And then have you seen the, right, I think at the conference we met at, there was a lot of talk of distributions not getting pay, right? There's kind of a hold on money coming out of private equity. You're seeing that personally? Yeah, we're definitely experiencing that. We're in a really great spot right now in terms of being below our target.

Starting point is 00:55:16 So a lot of folks are trying to manage their, they were overweight private equity, their relationships that they want to keep. They're trying to make sure and, you know, keep those relationships. And they're having trouble rebalancing. Yeah. So they're not able to commit or re-up as much. And so there's less competition for these capacity constrained GPs. So we've managed to, you know, get access to some strong names over the last few years because of that. And then we'll probably organize a secondary sale, our first one ever here pretty soon. And the sophisticated groups, I don't want to say sophisticated, but a lot of folks who've been

Starting point is 00:56:00 in private markets for a long time, kind of regularly harvest their private market portfolio uh do a secondary sale every i don't know two or three years maybe every five years and just as you know there's there becomes a lot of that tail end capital which yeah so what what does that look like there's investors out there that want access to such and such fund that they can't get access to so you're selling them a piece of your portfolio essentially? Yeah, sometimes that's the case. A lot of times it's these secondary funds themselves or these 40 act funds where, you know, you can get a nice IRR, put some leverage on it. You know, it's a really diversified portfolio, put some leverage on it and, you know, get a 15% IRR and maybe not a very high multiple, and the money comes out pretty quickly. So that works for the 40-act funds and they're growing quite rapidly. And then

Starting point is 00:56:52 secondary funds, everyone typically has a small allocation of secondary. So that's a pretty big market and growing as well. So there's some liquidity there. It just doesn't operate in the... You just need to be really forward thinking about that and be really careful about how as well so there's there's some liquidity there it just doesn't operate in the you know just you just need to be really forward thinking about that and be really careful about how much illiquidity you take on but us private equity haters that's probably not quite a fair term but just right in being in my career managed futures the whole time that's marked a market minute by minute every day i was like ah went into the wrong business but But that doesn't worry you at all that they're not paying out? Like it's just part of the cycle?

Starting point is 00:57:28 Or is there growing angst amongst institutional that this could be a problem? Well, we're only kind of five to seven years into it. So our plan was that at about this time, we'd start to see some distributions and we are seeing some distributions, but we've only had, you know, when you go from zero to we're now at about 10 or so percent private equity, you know, a lot of that's newer, newly deployed. And so we don't have any expectations yet. So we're not in a very much of a crunch situation. And we, we actually got, you know, this December, I think we had 50 million in distributions from our managers on a, you know, on a call it a 30% maybe allocation to private markets. So that was just one month.

Starting point is 00:58:31 So moving on, kind of what you're looking at in the markets, what does keep you up at night? That's not a huge worry. What is a huge worry for you? Or do you think you've got it set up nicely where you don't have to worry very much? I have two. Yeah, well, firstly, I'd say we're so diversified that my biggest worry is that we don't deliver strong enough returns that you're just the t-bill rate essentially yeah we're we're if we if like everyone looks at the s&p or the nasdaq and then they look at our performance i mean that's not unique to sitfo it's every CIO out there is like dealing with even their sophisticated trustees who are like, oh, yeah, S&P was up 24% this year.

Starting point is 00:59:12 How much were you guys up? You're like 15 or whatever. And they're like, oh, and then you have to explain to them, you know, like the drivers and they, you know, they're like, oh, yeah, I know. But you just kind of get that sense of disappointment. And then when you talk to some lay folks or present to the legislature, they're like, why aren't you in all equities? Why aren't you in NVIDIA? Yeah.

Starting point is 00:59:35 And so my biggest worry is upside participation not being robust enough. I think we have good downside. Like 2022, we were, according to some peer groups, we looked at, we were, you know, top performer just because we were flat. And, but this year, like I said, we're, you know, we don't have a ton of public equities. We were overweight. We had some good strategies in the book, good managers. So we, I think we're calendar year to date, maybe 15%. So feeling really good about that. But I do worry that we don't have enough upside participation. And that's really what stresses me out is that and outperforming my benchmark, which does have a lot

Starting point is 01:00:17 of equity beta in it. What is the benchmark? It's Acqui basically for for growth um oh each bucket has s&p real assets and high yield one to three and 30-year strips and hfri macro and cta indices all right uh and then do you worry that or does your weighting fix that of like that those defensive right how do you let the carry in theory managed futures 30-year strip should carry positive over time but over some three one to three year period they could carry negative easily right so how do you wait it's just a waiting concept to make sure that negative carry doesn't over take the the growth and the income strategies right because when in the past two years when income's also been down then you have an unexpected negative carry in

Starting point is 01:01:12 income yeah it's 30 year strips has not been pleasant yeah last uh last few years but especially the nature of the drawdown in 2022. But when you look over time and you look at the stress periods, ultimately, there's only a few quarters and 2022 is one of those time periods where there's a negative return from duration from treasuries when equity markets are down. So there ultimately tends to be a flight to quality. I'm not here to guarantee that that will continue. We took our- The past three weeks would be another example. Yeah, we took, yeah, that's a good point. We started out with seven in strips

Starting point is 01:02:02 and five in trend and macro type strategies. And we then flipped that to be five in strips and seven in trend and macro. And now we're seven in trend and macro and 3% in strips with a tactical duration extension kind of leverage model with a third party group. Nice. And do you ever, do you get that feedback from trustees or whomever, your neighbor? Like, dude, what are you doing? Why would you be long bonds right now? Like all the time, right? Like be like, because this is abnormal. The ILS one was really painful for a period too. And that was, that's something that, you know, our trustees were like, we really need to revisit this allocation here. And I was

Starting point is 01:02:53 like, fair enough. And we did. And fortunately they were, they were like, we get it. We get why you want to do it. We get where things are right now. and so fortunately we topped up the last couple of years and it's been you know like a high teens you know net return the last couple of years from from that anything else keeps you up at night that's it our uh our our overweight and small and micro right now really really losing sleep over that one and should have closed it out as soon as the election results came in but uh the russell proxy essentially yeah we have we've got act fortunately we've got some good active managers in that space so they you know their downside part uh protection is really nice and then you know they tend to participate in the upside and um but yeah it's

Starting point is 01:03:41 been it's been a rough six weeks and how do you view things like that when it's become right the rust growth or the russell 2000s usually i look like and long bonds have basically become equal right every time rates go up those get hammered so when when correlations shift like that are you guys on deck and looking at that or kind of a longer term let it we try and make sure we're taking a longer term view and you know we do have cash flows that come in and cash flows that go out so instead of a formal like annual or quarterly rebalancing each week we were we're looking at cash flows and forecasting out cash flows for the next kind of six weeks. And it's like, okay, well, in each quarter, we have about a one, well, yeah, one and a quarter percent payout.

Starting point is 01:04:30 And so we look like, oh, well, this is a good, you know, this is attractive or, you know, we tend to look at value. We try and have an understanding of the macro economic view through some third-party providers. And then we have a valuation and momentum score for each of the sub-asset classes. We roll that up into a simple kind of quantitative model and it scores in ranks. And we look at it and say, yeah, I just don't think it should come all from this,

Starting point is 01:04:59 you know, whatever it is. And do we really want to sell, you know small cap right now we just you know added and it went really well but then we had a drawdown and you know should we pull from elsewhere should we cut risk we have those conversations all the time but fortunately we have money coming in we just deploy you know to kind of offset those things and kind of move in, in tranches. Very rare that we make a big, you know, rebalance or big tactical move. And most of the stuff is really just on the margin. Have you seen over time, do you measure at all? Like, do you get a rebalancing premium? I don't think that, I think there is a rebalancing premium. Um, but it, it but it's not much. It's better to rebalance than to let your risk drift

Starting point is 01:05:49 and be unaware of where your equity beta is, for example, as it's growing over time. We think of it more along those lines, but it can be hard to rebalance if you have distressed emerging market debt managers, for example, with, you know, either their capacity constrained and if you redeem, you can't get back in or you have to get in the queue to get back in and things like that. So. Right. Or it's the prudent thing to do. It's more of a risk management tool than anything else, I think. Yeah. Right. If you're selling your S&Ps to buy more Russell all year year every month or every quarter that was a losing proposition yeah here we're going to finish up with our new segment myth busters so if you can what's a market, investor myth out there that you want to get to work busting?

Starting point is 01:06:46 One of the, I kind of alluded to this in the philosophy and asset allocation work we've done, but I don't think you need to be max equities in order to get a strong return. I think you can compete with equity-like returns having a diversified portfolio. It's obviously dependent somewhat on the cycles we're in. But there's this guy, Edward McQuarrie, who recently has, I don't know if it's a book or just a research paper, but I heard him on a podcast and was really excited because I've always thought, you know, like, look, there's a few lost decades out there just in the last, you know, not even

Starting point is 01:07:29 about a hundred years. And, you know, do you really want to have it go 10 years as a trust like us with the expectation of making these payouts and having the corpus and, you know, rocking up with the 0% or worse return? With the the 60 exposure or something you're saying yeah yeah so that so you know so yeah so why why would you want a zero percent decade return and a lot of people are like well it's about the long you know it's about the long run and you should tolerate that volatility you should tolerate that uncertainty for the for the payoff but i think you can compound at a competitive rate without taking that kind of risk. And in fact, this Edward McQuarrie guy's research shows that, I'm not going to get this exactly

Starting point is 01:08:11 right, but bonds sometimes outperform equities over the long run, depending on when you start and stop the clock. And that some of that research that was done done that was called stocks for the long run i think was the name of the book a while back that research the bond portion of that research turns out was quite selective so the early segment of that research looked the the earliest history of that research the bonds they used were i think it was just one issue from a boarding school in New England. And so there's like 10 or 20 years of this one bond competing with equities. And then as they stapled on other bonds or whatever to look at the full history, turns out bonds about 50% of the time outperformed equities over really long horizons. And I don't remember the very specific details on, but we're talking about like rolling 10 and 20 year periods of bonds

Starting point is 01:09:10 outperforming equities. Wasn't Warren Buffett's bet against the names escaping me now, right? Of hedge funds versus equities. And actually they both put the money for the bet into like some more advanced bond program that outperformed both oh i didn't know about that yeah um so yeah i hear you so the myth is you got to have at least 60 percent in equities and you're saying yeah i'm not so sure to get a big people say yeah to outperform or to get high performance that you know for your pension or your endowment or your personal retirement account, you need to have a large and significant portion in equity. And I think. Or if you're a young person, that's a big one, right? Like, oh, you can afford to have 90%

Starting point is 01:09:58 in equities. You're young. Yeah. But as you know, if you do the research and you look at, you know, trend and macro, and if you have any skill in manager selection, but even if you don't, well, I guess the survivorship bias, if they haven't solved for that in the HFRI, I don't remember. But you put that time series up against a 70-30 portfolio, which is predominantly equity risk, and it outperforms over most long-term horizons. Recently, leading up to 2022 was really terrible for that strategy, but the cumulative performances or rolling long-term performance, lots of things compete with or cannot perform equity. My theory is there's a macro managed futures fairy and they just see everyone get disgusted with it and throw it away. And then they sprinkle some performance dust on it and it comes right back. Maybe so. Right, because it's without fail.

Starting point is 01:10:52 Like, oh, wait, crushed it. Oh, nine, redeem, redeem, redeem. Yeah. Awesome. Well, thanks so much, Peter. It's been fun. We'll definitely give you a call next time I'm in Utah. Cool. We'll grab a beer or coffee or some get some turns. Yeah, that'd be great. All right. Thanks so much. Thanks for the chat.

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The Derivative - A US state with a sovereign wealth fund? Utah’s new approach to old money with Peter Madsen

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