New Jersey’s Tim Walsh: “I Get Paid To Worry”

Tim WalshTitles: Chief Investment Officer; Director, Division of Investment

LP: New Jersey Division of Investment

Assets Under Management (May 2011): $74.7 billion

Overall Return in Fiscal Year 2011: 18.5 percent

Private Equity Assets (May 2011): $5 billion

When you’re responsible for management $74.7 billion in assets, as well as the retirement money for 800,000 people, stakes are high. And Tim Walsh, who signed up one year ago to be New Jersey’s chief investment officer, knows that a lot is riding on him.

New Jersey sits at the nexus of the national debate on pension reform that pits hard-core budget cutters against powerful unions. Earlier this year, after a brutal legislative fight, new reforms were passed that asked the state’s public employees to retire later, contribute more, and forget about most cost of living increases.

The reforms were aimed at rescuing a pension that has one of the nation’s largest liability gaps. Just 57 percent funded, the New Jersey pension system owes $54 billion more to retirees than it currently has in assets.

Amid all that, Walsh has been a force of change inside the New Jersey Division of Investment, which manages the state’s pension assets. Having posted 18.5 percent returns in his first year, the system’s best results in 12 years, Walsh has moved New Jersey’s pension system to a surer footing. His efforts include a big boost to alternative assets, which could rise as high as 38 percent of overall assets.

Walsh sat down with Gregory Roth of Buyouts to discuss his first year on the job.

You’ve now been in charge of New Jersey’s pension for a year. What are your biggest achievements so far?

It’s been a very good year considering we have a pretty conservative allocation. If we had a riskier allocation, we would’ve done better. I don’t really take a lot of credit for that. I’d say the most important thing is modernizing the investment culture. I’m trying to focus a lot more on risk management. Public funds need to be doing more of that. A lot of our investment decisions are constrained by regulations that are more than 50 years old, and we’re finally starting to change them. We made some changes at the last board meeting, and we’ll be making more going forward. We’re trying to modernize the technology. It’s beyond backwards. The treasurer’s office has been very helpful in trying to get the process moving. Those are the big ones.

What’s been your biggest surprise?

It’s a really good board and I’m certainly not saying that to ingratiate myself. We also have people on our staff who are incredibly hard working and incredibly under-compensated. As for negative surprises, we have to deal with a lot of regulatory issues, so some things take a laborious amount of time to get done.

You previously were the CIO of the $9 billion Indiana State Teachers’ Retirement Fund. What drew you to the New Jersey job?

I was sort of late in the interview process and wasn’t initially looking for a change. My main attraction to the role was the frustration I had in 2008 and 2009, when the markets were collapsing, and Indiana Teachers was 100 percent outsourced. There was very little I could do. I remember mentioning that to someone, who told me, “If you really want to put your money where your mouth is, you should talk to New Jersey.” And that’s really how it started. If you’re an investaholic— that’s what my wife calls me—there are very few jobs in the world as good as this one because as director you have a lot of ability to effect change.

Let’s talk about investments. New Jersey recently raised its target allocation to alternative assets to 25.5 percent, and the cap was raised to 38 percent from 28 percent. Are you worried that you may become over-exposed to illiquid assets?

I get paid to worry, but I actually worry more about our public side than our private side, because our public side has the ability to drop 10 percent in a week. If our public assets drop 10 percent in a week, we don’t have a GP to blame. We do it to ourselves.

I’d say my biggest concern is zero interest rates. If 10-year bonds yield 2.9 percent, and my target return is 8.25 percent, that difference encompasses a lot of the problems— whether it’s the Middle East, Greece, Portugal, Spain or Ireland; or Washington’s ability to get something done. My biggest worry is getting an 8.25 percent return when the risk-free rate is at 2.9 percent.

New Jersey was a latecomer to private equity. In the middle of the financial crisis, New Jersey stopped committing to new funds. Was that a mistake?

It was a mistake. Obviously, it’s easy to say these things in hindsight, but to be consistent in alternatives, you can’t be a market timer. You have to invest a certain amount every year. As it turned out, those who did invest in 2008 and 2009 were able to buy stuff at 40 to 50 percent off.

New Jersey has about $5 billion in private equity investments and a 7 percent PE target allocation. How much do you plan to commit to private equity in the next year?

We are in the process of exploring secondary sales, so as far as new commitments, we’ll probably have to wait and see how that goes. I’d say we’ll commit somewhere between $500 million and $800 million in fiscal 2012, depending on the secondary sales.

What private equity assets do you plan to sell?

We’re close to selling two to four funds. We have too many middle-market buyout funds. We have too many large buyout funds. We have too many that haven’t been top-quartile performers where we don’t see much of a relationship going forward.

Is New Jersey likely to exit from private equity funds of funds?

No, I don’t think so. There are some things we can’t do. We have a very limited staff right now. Christine Pastore has been running private equity for six years, and she has one full-time person working for her. So I don’t think we’ll be able to eliminate fund of funds. We may use them in a more focused way than we have in the past. But I think the demise of funds of funds has been greatly exaggerated, at least from public funds points of view.

Where do you see the best opportunities in private equity?

I think the biggest opportunities are really in the distressed side of Europe. This is not a one year event, though. It’s probably going to be two to four years. So you need to be early, you need to be patient, and you need to be disciplined.

What’s the best way for a GP to get a commitment from New Jersey’s pension system?

Everything has to go through a consulting process, number one. Even if I like a fund or Christine Pastore likes a fund, if our consultant Strategic Investment Solutions isn’t going to sign off on it, it’s not going in front of the board. If you can’t pass their screen, you’re sort of wasting everybody’s time.

The board has also come to a resolution about any alternative investment that comes in. They’ll always ask me, or the consultant: Is this an upper-quartile manager? It makes it pretty simple. If you’re not an upper-quartile manager, if your track record is median, it’s going to be tough. As well it should be. The concept of institutional quality is much more important for a public fund.

Pension reform has been a big issue in New Jersey following the election of Republican Gov. Chris Christie. As chief investment officer, do you feel insulated from this discussion?

I’ve been very insulated from it. That it hasn’t been political has been one of the biggest surprises in the job.

The pension reform by the legislature and governor’s office will make my job easier. We don’t really focus on liabilities because we don’t control it. We try to focus on the left side of the balance sheet. But because there will be less money going out and more money coming in, it makes life a lot easier.

New Jersey’s pension system is one of the most underfunded in the nation with a $54 billion gap between its assets and its promises to current and future retirees. Can New Jersey invest its way to being fully funded?

We really have only one official mission, to achieve the best possible return and acceptable level risk utilizing the highest fiduciary standards. Your guess about whether anyone can invest and make 8.25 percent with the 2.9 percent risk-free rate remains to be seen. We’re just going to follow our mission.

Have the recent pay-to-play scandals in California, New Mexico, and New York affected your views about placement agents?

I tell all these GPs that placement agents are great in concept. I think 80 percent to 90 percent of them are very reputable. But the bad 10 percent gives the whole industry a black eye.

Do you think pension funds can create a better incentive system for attracting and retaining good talent?

If you look at the Canadian model versus the US. model, the returns of Canadian pensions vs. U.S. pensions are light years better. Texas Teachers Retirement System has accomplished a lot in this area, as has Wisconsin. I think the average teacher or fireman understands that the more money we make for them, the more secure is their pension, and I think they like that. Do you really want to pay an outside manager 100 cents on the dollar if you can pay your internal guy 50 cents on the dollar and get the same return?

What’s something from early in your career that has come into play in your current job?

When I first started out of grad school, I worked in foreign exchange. The big advantage of forex is that it gives you a macro perspective. If you’re a CIO right now and you don’t have a macro perspective, you’re really be behind the curve. Foreign exchange traders learn to cut losses quickly. To do it, you have to be willing to make a mistake, get back in and change it. I’ve seen a lot of traditional money managers continue to make the same mistake.

What do you wish the investing public better understood about the New Jersey pension system?

People need to better understand that a public fund is not a private fund. It’s not college endowment. There are a lot of things we’d like to do that we can’t do because we’re a public fund. We can’t react quickly and the processes are much more laborious—for both good and bad. So the idea of, “Hey, I’ve got a great investment idea.” That’s great. It may be excellent, but it won’t be happening tomorrow.