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The Committee on School Finance/Permanent School Fund met on January 27 to discuss proposed amendments and private equity data. An archive video of this meeting can be found here.

This report is intended to give you an overview and highlight of the discussions on the various topics taken up. It is not a verbatim transcript of the discussions but is based upon what was audible or understandable to the observer and the desire to get details out as quickly as possible with few errors or omissions.

 

Item 1: Discussion of Proposed Amendment to 19 TAC Chapter 109, Budgeting, Accounting, and Auditing, Subchapter C, Adoptions By Reference, §109.41, Financial Accountability System Resource Guide

David Marx, Senior Director of Financial Compliance

  • Need to incorporate changes in legislation and accounting
  • 1,500-page document, needs clean-up
  • Accounting for school districts and charter schools
  • Additional details for auditors
  • Instructs school districts with state compensatory clarification
  • Annual changes
  • Need to include fund codes for federal stimulus funds
  • Maynard – Corporate accounting follows a set of standards. Is GASB related to government accounting standards?
    • Marx – Yes, and we also have the school district one which the school districts follow.
  • Maynard – Are financial accountability ratings included?
    • Marx – Financial accountability resource is its own rules and its own document.

 

Item 2: Review of Permanent School Fund Securities Transactions and the Investment Portfolio

David Trice, Texas Permanent School Fund Staff 

  • Increase in value of $4.7 billion from October to November
  • September 1st to November 30th – gains/losses of $910.8 million
  • Details annual summaries for 1994-2021
  • Historical summary of revenues and contributions by general land office through Nov 2021
  • Comparative status summary for October through November 2021
    • Remaining capacity – $10.2 billion
  • Summarize additional statistics
  • Broker commission costs, internally managed commodity portfolio
  • Fixed income security ratings changes for fiscal year through Nov 30
  • Short term month-end cash balances

 

Item 3:  Ratification of the Purchases and Sales of the Investment Portfolio of the Permanent School Fund for the Months of October and November 2021

  • Motion to ratify; Motion passes

Item 4: Report on Permanent School Fund Liquid Account and Ratification of Purchases and Sales for the Months of October and November 2021

  • Overviews the liquid fund account
  • Maynard – We’re still at 25% cash?
    • Trice – Yes, as of Nov 30th
    • Veintemillas – Currently we’re fully invested in stocks so have moved up to targeted allocations
  • Maynard – So how much cash now?
    • Veintemillas – $88 million in cash and all assets in portfolio are on target
  • Maynard – Do you have any sense from Rusty if they’ll need to make any draws?
    • Veintemillas – I haven’t heard anything
    • Timmins – Last time they sent $500 million to us, I suspect we’ll receive money rather than sending it back
    • Veintemillas – The portfolio is highly liquid
  • Maynard – For anyone watching, this is a temporary situation on a relatively short-term. By end of the year we can fold everything into the portfolio.
  • Motion passes

 

Item 5:  Annual Reporting Requirement of the Internally- Managed Permanent School Fund Investment Portfolio

  • Timmins – To the best of my knowledge, we’re fully following the rules
  • Maynard – This item is basically saying you attest
  • Timmins – Yes; we have systems in place to detect any deviation
  • Maynard – A better reflection of that comes through our audit; we have internal controls and the agency has also been monitoring so we get it two ways
  • Maynard – There are a lot of guardrails and that’s a good thing

 

Item 6:  Third Quarter 2021 Permanent School Fund Performance Report

  • Maynard – It’s January and we’re talking about the third quarter of 2021
  • Mike Maher – Some things have come full circle.
  • Maynard – I’m not sure how instructive some of this is. One might argue some of these numbers are stale.

 

Mike Maher, VP/Consultant in Global Risk Solutions at BNY Mellon

  • Mixed asset class performance
  • Ongoing vaccine rollout
  • Supply chain disruptions continued and employers add more but shortage of available workers continues
  • Commodities gained – energy index up 25%
  • Robust corporate earning
  • IMF economic growth (5.9% in 2021 & 4.9% in 2022)
  • Rising inflationary pressures – CPI up 5.4% as of September
  • Domestic equities review – third quarter 2021
    • Stocks rose in August
    • Financials and utilities were best performers
  • International equities review – third quarter 2021
    • MSCI Pacifix x Japan net-dividend was worst performer with returns of -4.4%
    • Positive outlook in 2022
  • Fixed income review
    • S. bond market increased by 0.05%
    • Bloomberg Corp High Yield bonds performed well
    • Energy index continued to increase
  • Alternative investment review
    • Real estate continued positive streak
  • Showed quartile charts and bar graphs showing funds exceed benchmark
  • Stronkowsky – The alternatives (real estate, private equity) drove performance. As we see more volatile markets that diversification will continue to help.
  • Maynard – Carlos can you tell us about international equity?
    • Veintemillas – Emerging markets have been hit with COVID. They should be able to recover faster
  • Stronkowsky – Regulations around education/real estate in China put a damper on equity markets over there. That fed into the markets and so far, EM last week was up. We are constructive.
  • Maynard – Does a country ever graduate out of emerging market?
    • Veintemillas – China measures at GDP per capita and theirs is low compared to US. I think Korea is one that graduated to developed market.
    • Stronkowsky – Per capita and also markets in terms of access. China has loosened up. The main point in GDP per capita.
  • Maynard – I’m guessing these emerging markets look the same. The good news is there’s a lot of growth potential.
  • Veintemillas – Since this is an index portfolio to benchmark, there’s a number of funds that don’t have market exposure. On pg 34 the real driver is emerging markets that move around in quartile charts because of exposure. I think looking at this is the most important metrics.
  • Maynard – Very good.
  • Maher – Private equity and real estate provide most diversification
  • Pie charts represent actual asset allocation as of 9/30/21
  • High yield bonds and emerging market programs had not yet been funded at this time.
  • Veintemillas – We began funding high yield bonds early this year; the contracting process takes a long time but our legal were up to the task
  • Scatterplot showing 10 years annualized ending as of 9/30/21
    • Places fund just above meeting return at a lower risk level
    • Lower risk, higher reward
  • Veintemillas – In liquid account we added 10x income that was at state treasury.
    • Stronkowsky – this has been 2 years in the making, and within a year this will all be rolled into a portfolio
    • Maynard – Liquid fund is a temporary situation
    • Timmins – Private equity has been phenomenal over the past year. The more you have, the better you look.
    • Maynard – You can see the benefit of diversification. If this fund looked today as it did 10-12 years ago, we wouldn’t be in great shape. Different asset classes perform different in different classes.

 

Keith Stronkowsky, NEPC

  • Inflation is still front and center; the Fed is saying we need to get a hold of this
  • Some countries in Europe are getting rid of restrictions so hopefully that eases some of the inflation
  • Big theme is economic crossroads in Fed policy
  • Veintemillas – Main source of stick inflation is wages which are increasing because it’s difficult to cut wages on employees
    • Wages are going up because of supply and it’ll be difficult to cut wages if the economy is growing
  • Stronkowsky – We’re going to see a lot of volatility going forward
  • Veintemillas – If the Fed raises rates 3 times this year, it’ll be 0.83% which in my opinion is close to zero

 

Item 7:  Review of the Bond Guarantee Program Capacity

  • Timmins – Given challenges in legislative environment, their primary focus is on the regulatory solution and discussions with Department of Treasury. We’ll have discussions over the next month or two and those could be permanent solutions.
  • Maynard – Based on current trends, when do we hit the ceiling on BGPC?
    • Timmins – We have guaranteed about $97 billion through end of November and Fed capacity is $117 billion so roughly $20 billion remaining and that should last 2 and a half to 3 and a half years
  • Maynard – Do you know how close they might be to closing a deal?
    • Timmins – We’ll know more in a month; the next discussions will be significant, and it’ll help inform if a permanent solution is possible
  • Maynard – They’re coordinating with Congressman Doggett’s staff? Also corresponding with Senator Cornyn’s Staff?
    • Timmins – Correct and Congressman Arrington from Lubbock

 

Item 8: Proposed New 19 TAC Chapter 33, Statement of Investment Objectives, Policies, and Guidelines of the Texas Permanent School Fund, Subchapter A, State Board of Education Rules, §33.21, Texas Permanent School Fund Corporation

  • Maynard – The terms of the members have to be by rule and that means the administrative code; this amendment is to satisfy that statutory mandate
  • TEA Staff – The terms of directors need to be reflected in rule; was discussed yesterday, the appointment of directors will be addressed in operating committee
  • Maynard – This is the most important legislation you’ve never heard of

 

Item 9: Review of the Private Equity Asset Class for the Permanent School Fund

Brien Smith, Neuberger Berman, Chief Operating Officer

  • Excess liquidity has emphasized volatility
  • Looking for first time in a while at rising inflation and we’ll see interest rates rise
  • Sponsors are trying to lock in rates anticipating higher rates
  • Do not know what will happen with taxes
  • Global issues will disrupt the markets
  • Trying to be as highly selective as possible and focusing on more resilient industries
  • Private equity has outperformed in each of the quarters
  • Significant equity realizations in 2021, particularly in fourth quarter

 

Kaci Boyer, Principal at Neuberger Berman

  • NAV by asset class: mid-cap buyout 40%
  • Exposure by asset class: mid-cap buyout 41%
  • Since 2010, $8.7 billion commitments into private equity program

 

Erin, Neuberger Berman, Director of Private Markets, Chief of Staff

  • Majority is buyouts; diversified across geographies in U.S. and all geographies except Latin America
  • Record distributions in 2021; $1.3 billion vs $1.5 billion contributions
  • Program target has increased so we’re contributing larger amounts
  • NAV by sector; largest weight to technology at 29%
  • Historical investment deployment; slightly over target in 2021 which is determined by deal flow

 

Discussion:

  • Maynard – Do you consider Mexico North America or Latin America?
    • Smith – We consider it Latin America
  • Maynard – So is there not private equity opportunity in Latin America?
    • Smith – Not a deep pool of opportunity; had an investment in Columbia that was impacted by currency issues
  • Maynard – How do we meld all this together?
    • Timmins – GLO has energy as a third of their assets and we don’t have exposure to energy
  • Maynard – Who is their external manager?
    • Timmins – They’re doing internal work with advisers
  • Maynard – Look at it in terms of allocation. Are we on target with private equity in terms of asset allocation?
    • Timmins – The target is 15% and the high returns have taken us to the top at 19%
  • Maynard – We have a range in there?
    • Timmins – Yes, but we don’t want to reduce allocation because of range. It’s important to keep investing in private equity
    • Timmins – I assume the board will vote to increase private equity allocation.
  • Maynard – Private equity is a different animal; every dollar we return is helping young people in Texas

Item 10: Review of Real Return Asset Class for the Permanent School Fund

Carlos Veintemillas, Deputy CIO at Texas Education Agency

  • Portfolios must be protected from inflation
  • In 2021 inflation rose 7%. The last time it was that number was June 1982
  • Large increases in energy prices, they came back from low levels in 2020
  • Highest increase in prices was used cars/truck which rose 37% last year
  • Intel will invest money in Ohio to build a chip plant
  • Core goods inflation rose from 0% pre-pandemic to over 9%

 

Katy and Bill, Texas Permanent School Fund Staff

  • Unexpected inflation is most dangerous kind
  • Real return strategy comprised of tips and commodities
  • Adding asset class isn’t productive if it runs in tandem with portfolio
  • Real return strategy protects against unexpected inflation for 2 reasons:
    • High correlation to movements in inflation
    • Low correlation to existing portfolio
  • Tips underperformed in 1-year period as a result of lower market call in break evens, we’re starting to recover some of this underperformance
  • Commodities overperformed
  • We expect to see inflation pressures easing for many reasons including:
    • Less stimulus, consumption will decline
    • Fewer supply chain issues, inventories rebuilding
    • A hawkish Fed, they plan on hiking this year
    • The wildcard is COVID

 

Item 11: Report of the Permanent School Fund Executive Administrator and Chief Investment Officer

Holland Timmins, Executive Administrator and CIO, Texas Permanent School Fund

  • Reaffirmed Triple A rating
  • Summer Intern Program; 25 applications from 20 different schools nationwide
  • Emerging Manager Program contracts signed in December
  • Maynard – Do we get some intern applications from HBCUs?
    • Timmins – I didn’t see any from those schools
  • Maynard – We’ll have to continue doing some missionary work there