Capital Decanted – Season 2, Episode 5: The Evolving Asset Owner - New Tools for a New Regime with Molly Murphy and Scott Chan

Hosts:

• John Bowman
• Aaron Filbeck

Guests:

• Molly Murphy, CIO of the $25 billion Orange County Employment Retirement System (OSERS)
• Scott Chan, CIO of CalSTRS, the second largest public pension in the United States

Release Date: January 28, 2025

1. Episode Introduction

John Bowman and Aaron Filbeck kick off the episode by redefining the scope of capital allocation beyond traditional market takes and superficial sound bites. They emphasize a deep dive into the complexities and nuances of modern asset management, aiming to challenge and expand listeners' perspectives on capital allocation.

Notable Quote:
John Bowman (00:00): “Say goodbye to tired market takes and superficial sound bites.”

2. Sponsor Messages

• Alternatives by Franklin Templeton: Returning as a title sponsor, highlighting their 40 years in alternative investing and managing over $260 billion across six asset classes.
• SLR Capital Partners: New sponsor introduced, specializing in direct lending with a focus on senior secured financing for US middle-market companies. Special guest Michael Gross, co-founder and co-CEO of SLR, appears at halftime.

3. Historical Context: Endowment and Canadian Models

John Bowman elaborates on the evolution of asset ownership, contrasting the traditional Endowment Model with the Canadian Model:

• Endowment Model: Popularized by David Swensen at Yale, this model emphasizes heavy equity allocation, broad diversification, and long-term orientation. Originals were influenced by John Maynard Keynes, who shifted King's College's portfolio from fixed income to equities, believing in better risk-reward profiles for capital compounding.

  Notable Quote:
  Aaron Filbeck (05:46): “The Endowment Model is grounded in the belief, frankly, that the portfolio should have an equity orientation.”

• Canadian Model: Originating from Ontario’s Pension Management Act of 1990, this model focuses on insourcing investment capabilities, building robust operational and risk infrastructure, and fostering innovation. It emphasizes internal management over reliance on external General Partners (GPs), aiming for long-term sustainability and superior returns.

  Notable Quote:
  John Bowman (06:01): “The Canadian model, even today, is about cultivating a durable culture that promotes innovation, repeatable and defensible processes, and a robust operational and risk infrastructure.”

4. The Limitation of Traditional Models

The hosts discuss how both the Endowment and Canadian models offered binary choices between insourcing and outsourcing, likening it to a single slider knob. However, the rapidly evolving asset management environment requires a more sophisticated and flexible approach.

Key Points:

• Agency Problems in the Endowment Model: High fees and misaligned incentives with external GPs can degrade returns.
• Challenges in the Canadian Model: Building and maintaining an insourced team is costly and complex, potentially leading to organizational inertia.

5. Introduction of the Collaborative Model

Aaron Filbeck introduces the Collaborative Model as a third, innovative approach that transcends the binary choices of the traditional models. This model integrates multiple strategies and partnerships to enhance flexibility, sophistication, and control over asset allocation.

Notable Quote:
Aaron Filbeck (18:39): “Asset owners have jumped their own wall in the last five to eight years… this is not about moving that slider button up or down farther… it’s truly jumping onto a new dimension.”

Components of the Collaborative Model:

• Direct Investments: Including co-investments alongside GPs and solo investments managed internally to increase upside potential and reduce fees.
• Alternative/Custom Vehicles: Tailored funds such as GP-directed and LP-directed vehicles to meet specific needs.
• Secondaries and NAV Lending: Creative financial structures to optimize portfolio liquidity and returns.
• Partnerships and Joint Ventures: Collaborations with other asset owners and firms to leverage collective expertise and resources.

6. Halftime Sponsor Segment with Michael Gross, SLR Capital Partners

Michael Gross provides a primer on Asset-Based Lending (ABL), distinguishing it from Asset-Backed Securities (ABS) and Specialty Finance. He highlights the complexity premium associated with ABL strategies, which involve highly specialized lending tied to tangible assets such as healthcare equipment, inventory, and life sciences.

Notable Quote:
Michael Gross (60:10): “ABL strategies are extremely high in labor intensity… which allows us to generate higher yield to investors.”

7. Guest Interviews: Molly Murphy and Scott Chan

Molly Murphy – OSERS

Background and Catalyst for Change:

• Joined OSERS in mid-2017 with a mission to enhance returns and reduce dependency on traditional LP-GP models.
• Initiated a "listening tour" to understand stakeholder frustrations and identified the need for change.
• First Move: Entered a direct co-investment in a venture company, diverging from traditional fund-of-funds strategies.

Key Initiatives:

• Capital Constellation: Investing in GP funds and taking equity stakes to double the utility of deployed capital.
• Collective Global: A VC staking platform aimed at providing capital and support to innovative startups in California, enhancing optionality and investment alignment.

Notable Quote:
Molly Murphy (85:14): “We are not going to be a set-it-and-forget-it passive investor… Capital Constellation was attractive because it hit all the buttons.”

Board Engagement:

• Implemented education-driven strategies using dashboards and streamlined reporting to keep the board informed and engaged.
• Transitioned from cumbersome reports to actionable, digestible data presentations via Power BI.

Scott Chan – CalSTRS

Background and Catalyst for Change:

• Joined CalSTRS as Deputy CIO in 2018, spearheading the Collaborative Model to enhance returns and control risks.
• Focused on "bending the cost curve" by insourcing investment capabilities and reducing reliance on external GPs.

Key Initiatives:

• Collaborative Strategies Portfolio: Developed to allow CalSTRS to act nimble across asset classes, enhancing flexibility and responsiveness to market conditions.
• Operational Enhancements: Streamlined procurement processes and legislative changes to facilitate faster decision-making and global competitiveness.

Performance and Results:

• Achieved significant cost savings ($2 billion) and added over $10 billion in value through direct investments and collaborative structures.
• Expanded private market allocations from 2.5% to 25% of the portfolio, demonstrating the efficacy of the Collaborative Model.

Notable Quote:
Scott Chan (73:40): “We added over $10 billion of value to the total fund… focusing on cost savings and enhancing net returns.”

Future Plans:

• Emphasizing dynamic, cross-divisional decision-making to tackle mega themes like climate change and AI.
• Aiming to maintain flexibility and superior returns by continuously evolving organizational structures and investment strategies.

8. Comparative Insights and Organizational Strategies

Hosts and Guests Discuss:

• Organizational Design: Both OSERS and CalSTRS have restructured their teams to support collaborative and direct investment strategies, emphasizing specialized talent and operational efficiency.
• Cultural Shifts: Moving from traditional, hierarchical models to more dynamic, team-oriented structures that foster innovation and rapid decision-making.
• Technological Integration: Leveraging AI and automation to streamline repetitive tasks, allowing investment professionals to focus on strategic deal-making and relationship building.

Notable Quote:
Molly Murphy (102:46): “We've spent the last three years automating everything functionally that happens more than four times a year… Focused on deals, making every interaction meaningful.”

9. Conclusion and Takeaways

John Bowman and Aaron Filbeck reflect on the transformative journey of asset owners like OSERS and CalSTRS. They highlight the importance of balancing cost management with return enhancement and the critical role of organizational flexibility and cultural adaptation in implementing the Collaborative Model.

Key Takeaways:

• The Collaborative Model offers a multifaceted approach that integrates multiple investment strategies and partnerships, providing greater control and enhanced returns.
• Success in modern asset management relies on technological integration, specialized talent, and fostering robust relationships with partners.
• Continuous evolution and adaptability are essential to navigate the complexities of today's financial landscape and to capitalize on emerging opportunities.

Notable Quote:
John Bowman (115:57): “This business is fundamentally changing… the roles and responsibilities are just completely different than what they were six or seven years ago.”

10. Final Reflections and Closing Remarks

The episode wraps up with playful banter about personal resolutions and organizational changes, underscoring the human element behind the strategic shifts in asset management. The hosts express their appreciation for the guests' insights and the listeners' engagement, promising continued exploration of evolving investment strategies in future episodes.

Closing Quote:
Aaron Filbeck (119:56): “But it is… fascinating stuff.”

Summary Highlights

• Evolution of Asset Management Models: From Endowment and Canadian models to the innovative Collaborative Model.
• Collaborative Model Essentials: Direct investments, custom vehicles, secondaries, joint ventures, and operational flexibility.
• Guest Insights: Molly Murphy and Scott Chan share practical implementations, challenges, and successes of the Collaborative Model in OSERS and CalSTRS.
• Technological Advancements: Emphasis on automation and AI to enhance efficiency and focus on strategic investments.
• Future Outlook: Continued adaptation and dynamic strategies to address emerging global investment themes.

This episode of Capital Decanted provides an in-depth exploration of how leading asset owners are reinventing their investment strategies to navigate a complex and rapidly evolving financial landscape. Through historical context, detailed analysis, and expert guest insights, listeners gain a comprehensive understanding of the transformative trends shaping the future of capital allocation.