# Asset Management Insights From Vrs Wcix1

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[00:00:03.380] Hi, friends. Welcome back to another episode of Peer Connections, the podcast series brought
[00:00:08.440] to you by the Global Peer Financing Association, also known as GPFA. These podcasts offer our
[00:00:13.380] GPFA members and global beneficial owner friends a forum for information sharing and discussion
[00:00:18.180] on topics most important to them. And we hope you, our listeners, appreciate the insights,
[00:00:22.760] best practices, and transparency offered from our members and industry friends about securities,
[00:00:27.120] finance, or related investment areas. Now let's get into the episode.
[00:00:35.740] Welcome everyone to another episode of Peer Connections. My name is Chris Benesch. I'm a
[00:00:39.760] Senior Portfolio Manager here at the State of Wisconsin Investment Board. I'm also a board
[00:00:43.740] member and the Treasurer of the Global Peer Financing Association. GPFA tries to bring
[00:00:47.980] educational information and opportunities to our membership and the industry at large.
[00:00:52.280] Today, I have joining me Brock Bell from the Virginia Retirement System. Brock, welcome.
[00:00:57.520] Excited to be here. Thanks, Chris.
[00:01:00.180] So Brock, you've been at Virginia for a little more than a year and a half. Tell us a little
[00:01:04.060] bit about your role there and where you were prior. Sure, happy to. I'm the Director of
[00:01:09.450] Treasury at VRS. We're the state pension fund of Virginia, as you mentioned. We run about $126
[00:01:16.850] billion in total assets across public and private markets. I work within our Portfolio Solutions
[00:01:23.010] Group, which is a cross-asset team of investment professionals and portfolio managers. I manage
[00:01:29.350] the core treasury functions like liquidity management, cash and collateral optimization,
[00:01:34.950] counterparty risk and financing across all asset classes and also manage an enhanced
[00:01:41.010] cash investment strategy. Very interesting. And prior to VRS, where were you in the industry?
[00:01:47.630] So started in the securities finance industry right out of college. I graduated from Princeton
[00:01:53.290] in 2006, started my career at Barclays and their sales and trading program and spent the first 10
[00:02:00.910] years of my career at Barclays, Morgan Stanley, and JP Morgan, all in different types of securities
[00:02:07.410] finance trading roles. I built up the treasury and portfolio finance function at Capstone
[00:02:13.250] Investment Advisors, the multi-strategy hedge fund for about six and a half years, and was also
[00:02:18.630] head of treasury at Hidden Road, a multi-asset prime broker, before coming down to VRS about a
[00:02:25.210] year and a half ago. VRS decided they wanted to employ leverage, which was a new initiative for
[00:02:31.110] the fund. And they brought me in to build out the treasury function. Great. We're really excited to
[00:02:36.570] have you join us today. And certainly your perspective coming from the sell side will
[00:02:40.170] be incredibly valuable as we talk through some of these trade ideas. So Brock, why don't you
[00:02:44.690] tell us a little bit about your structure at Virginia Retirement System, how VRS employs
[00:02:49.810] leverage and how you're involved in some of these strategies? Sure. So we run about $126 billion
[00:02:57.570] in total assets across public and private markets. On the public side, we have public equities and
[00:03:04.550] fixed income. And on the private side, really have three main private asset programs. And that's
[00:03:10.590] real assets, which is largely real estate and infrastructure, credit strategies, and private
[00:03:17.550] equity. We also have an allocation to what we call diversified strategies. These are meant to
[00:03:23.810] diversify the return streams and the risk exposures across market cycles in different
[00:03:28.990] investing environments. And there's really two different types of diversified strategies.
[00:03:34.630] One we call risk responders. These are generally things that are negatively correlated to the rest
[00:03:40.350] of the plan assets. You could think of something like tail risk protection as a good example of
[00:03:45.670] basically something that's long volatility, when there's a big shock to the market or a big drawdown,
[00:03:51.770] we would expect these to perform well. The other is what we call return enhancers. These are things
[00:03:57.810] that aren't negatively correlated to the rest of the plan assets, but are completely uncorrelated
[00:04:03.410] to the rest of the plan. And here, you really have traditional hedge fund strategies. So
[00:04:08.490] things like relative value, volatility, global macro, and different types of arbitrage strategies.
[00:04:15.150] We also have a small allocation to cash and a few other things.
[00:04:19.970] I think it's really interesting to talk about our motivations and rationale for using leverage.
[00:04:26.730] And it's much different than how most hedge funds and many other levered funds use leverage.
[00:04:32.790] And I think it's also different than how a lot of people, even people that have a lot of experience in financial markets, tend to think about it.
[00:04:40.550] So when most people think about why you'd use leverage, really what comes to mind most
[00:04:46.930] frequently is just enhancing returns.
[00:04:49.570] So you think of something like a pretty plain vanilla treasury cash versus futures basis
[00:04:55.110] trade.
[00:04:56.070] Typically, those are pretty thin spreads.
[00:04:58.810] You might be looking at something like a 25 basis point P&L forecast.
[00:05:03.950] So if you are looking at that potential trade, you need to lever at 40x just to get a 10%
[00:05:09.890] or an attractive annualized return.
[00:05:12.670] The VRS, the motivation and the rationale for leverage is quite different.
[00:05:17.310] There's really three or four main reasons why we want to deploy leverage.
[00:05:21.050] One, to free up capital to invest in private assets in our diversified strategies.
[00:05:27.570] Two main reasons for this.
[00:05:29.670] One, it diversifies returns and reduces the risk of the overall portfolio.
[00:05:34.910] So it's a little counterintuitive, right?
[00:05:36.690] by taking leverage, because we're investing in things that are uncorrelated or even negatively
[00:05:42.870] correlated to the rest of the plan, we're actually reducing risk in the portfolio.
[00:05:47.870] Second is the illiquidity premium. So particularly in private markets, you lock up money over a
[00:05:54.190] longer period of time, you expect to get higher returns. The second one is it gives us additional
[00:06:01.190] liquidity for retiree disbursements. In the state of Virginia, looking at our actuarial
[00:06:06.330] projections. And this goes for most of the country where you have a lot of baby boomers retiring.
[00:06:13.110] We're expecting our retirees to go up and therefore our monthly retiree disbursement
[00:06:18.730] estimates are also going up. So this gives us additional liquidity for that.
[00:06:24.340] Third, it gives us a dry powder facility. For example, if we see a new investment or a new
[00:06:30.240] opportunity, or we want to take advantage of a drawdown period where assets are at attractive
[00:06:36.300] prices, we're not in a position where we have to sell one asset to buy something else. We're
[00:06:42.060] not a for seller. We can simply tap into our available funding resources and make those
[00:06:47.500] investments. Finally, just as an auxiliary benefit, we do expect it to be a positive carry
[00:06:53.480] trade. So in most years, we expect that our investment returns are going to exceed the
[00:06:59.580] cost of leverage. And so over time, we expect it will increase returns. That's an incredible
[00:07:06.530] opportunity set that you guys have developed. I'm curious, as you developed your leverage program,
[00:07:10.610] did you enter it knowing you would have those different strategies employed or has it been
[00:07:16.530] an evolution as you've employed leverage? I would say it's been an evolution. The things
[00:07:22.870] that I outlined, that was really the rationale and the strategic plan. And then coming in the
[00:07:28.710] things I've been working on and building really is making sure that we're able to get access to
[00:07:34.570] funding through different funding channels, different account structures, and a variety
[00:07:39.490] of liquidity providers and counterparties. That's great. Maybe talk a little bit about
[00:07:44.070] how you access some of those liquidity channels. Historically, BRS has a longstanding securities
[00:07:50.110] lending program. One way we're able to access liquidity and funding is through a mechanism
[00:07:56.050] called cash release. Basically, what we're doing is we have the ability to borrow back
[00:08:02.090] cash collateral on the back of our public equity and fixed income securities loans.
[00:08:08.050] So that's been a core funding source for us, something that we've had in place for a while.
[00:08:13.030] We've also onboarded several new ISDA counterparties for index swaps and single
[00:08:18.530] security total return swaps. One thing that we're also working on is prime brokerage,
[00:08:23.910] something that we expect to launch in the near future.
[00:08:26.890] So Brock, from the beneficial owner's perspective, how would you think about utilizing the swap
[00:08:33.630] capability in regards to how it interacts with your balance sheet or other positions
[00:08:38.630] you might have on?
[00:08:39.530] I think there's a few different motivations that you have from a beneficial owner or from
[00:08:44.990] a buy-side perspective, why you'd be motivated to move a position from cash to swap or vice
[00:08:50.730] versa.
[00:08:51.370] One of the biggest considerations is obviously going to be a better financing rate.
[00:08:55.830] So I think a good example of this, let's say that you have a cash equity long position, either at your PBE or custodian, where it's trading special, and you're not getting a market rate.
[00:09:11.000] In this case, you could sell your physical cash equity, buy it on swap with a swap dealer who's willing to pay you something close to that market spot rate and be able to monetize that value.
[00:09:24.640] Another benefit would be reducing margin. So for example, if you have a cash equity position that
[00:09:32.340] sits within a portfolio or within a margin methodology where you're hit with a concentration
[00:09:38.420] or diversification add-on, and you can move it to a swap dealer where it has better standalone
[00:09:45.020] margin or a natural risk offset with the rest of your swap portfolio, you're basically going
[00:09:50.740] to be able to reduce margin of both sides. So capital efficiency, freeing up capital being an
[00:09:56.280] important benefit there. Dividend and tax treatment, that's something that depending on
[00:10:01.250] your tax jurisdiction, your trading, that could be a consideration as well.
[00:10:06.900] Another important one is return metrics. So it's obviously important to be a good partner
[00:10:12.380] to your counterparties. You want to make sure that you're ensuring you have a healthy,
[00:10:16.540] mutually beneficial mix of business. Dealers are often very transparent with names that are
[00:10:22.140] good fits and bad fits. They'll communicate that with you. They'll publish things like Axelus. So
[00:10:28.800] being able to improve your return profile as a client, that's something that could have a
[00:10:34.620] positive impact across the whole firm. Another big one is customization. One of the benefits
[00:10:40.240] of a swap wrapper is that you're able to customize all the different terms of a trade.
[00:10:45.260] So I think a couple of good use cases for this would be getting a termed financing rate.
[00:10:51.800] As we know, the securities lending business, PB.