Five Questions With…David C. Villa, Chief Investment Officer, State Of Wisconsin Investment Board

1) What made you interested in joining the 300 Club, a group of leading investment professionals chaired by Saker Nusseibeh, head of investment for Hermes Fund Managers. Do you share the overall belief of the group that the pace of global financial crises will continue to quicken? 

I am excited about the opportunity to work with investment leaders—especially on a global level—to discuss common issues that challenge large institutional asset holders. I welcome the chance to be a part of the broader economic and financial discussion with professionals of this caliber. As an investment organization, we are not focused on the pace of financial crises. Rather, we strive to build a robust investment portfolio that will achieve the target returns in different market regimes. The Wisconsin Retirement System has a risk-sharing structure with contingent benefit increases that predates the Mercer model by thirty years.

2) Wisconsin enjoys the distinction of being the only fully-funded pension plan in the United States. What is the biggest contributor to this success?

I believe that there are six keys to why the Wisconsin Retirement System has been so successful in providing benefits to its 580,000 members and maintaining its funding status. First, the WRS discounts the liabilities at 5 percent. This requires about 15 percent more collateral to back the promised benefit. This also means the benefit is average, not excessive and the contributions are moderate compared to the national average. Second, the WRS does not provide a cost of living adjustment. Benefit increases are made but they are contingent on the long term return being higher than the 5 percent discount rate. Retiree benefits can be reduced when returns are low. Third, the actual wage growth has been lower than expected wage growth over twenty years. Fourth, investment returns have exceeded the actuarial target over twenty years. As noted above the hybrid risk sharing model has been in place for thirty years. Fifth is the State of Wisconsin Investment Board’s delegated authority over both our budget and the investments we make. Finally, SWIB is a low cost organization. Returns are not persistent in the short run. However, low costs can be harvested every year. 

3) The State of Wisconsin Investment Board plans to start an internally-managed private equity co-investment program. Why are you charting this path?

This is not new to SWIB, which had an active co-investment program from 1986 to 2003 that included deals where we were lead investor. In 2003, the private equity strategy was shifted to focus primarily on fund investments. However, SWIB has been working to bring money in-house for a number of years and we are now managing about 60 percent of the nearly $90 billion in Wisconsin Retirement System trust funds internally. Based on our analysis of co-investments from existing general partners, co-investments outperformed the fund they came from 72 percent of the time and the average co-investment met or exceeded top-quartile fund returns in every period reviewed. It was a very compelling reason to move in this direction.

4) Could you list the most compelling reasons for launching co-investments?

Really, there were a lot of reasons: Lower costs to manage. Increased net returns because of paying no management fees and carry. Enhanced relationships with key general partners. Ability to tilt the portfolio based on our own views on geography, industry, and vintage.

5) Could you talk about your fund returns and the role of private equity? What is your current allocation to private equity and where is that headed?

The role of private equity is to provide a return that is 1.5 to 2.0 times the public market return. We consider the variability of private equity returns to be about double the public market returns over a five-year time horizon. The estimated variability of returns is deduced by our understanding of the underlying investments because we are not able to observe the actual variability. Over the past ten years, the private equity return was 15 percent compared to the 8 percent return of global public market equities. Private equity—a part of our strategy since the mid-1980s—totals $6 billion or about 7.4 percent of the Wisconsin Retirement System trust funds. Recently, we pared down the number of relationships and we are now focused on a new co-investment portfolio. We are recruiting for a senior level investment professional for this new portfolio. We plan to have someone on board in the fall to be able to begin looking at opportunities in early 2014. The initial target is up to $100 million per year for three to five deals per year.

Interview by Steve Gelsi; edited for clarity