GE CIO Harshal Chaudhari
Harshal Chaudhari, the CIO at GE speak about his early days in the industry, his take on the current market environment and the Fed and his views on ESG.
Harsh Parikh, Head of IAS’ Real Assets Research Program, and Syed Haque, CIO at Novant Health, recently discussed hospital-system investment portfolio management, investing in real assets, and investment portfolio decisions in the context of high inflation and rising rates.
Haque, CFA, previously held different investment roles at UPS Investment Group, where he was most recently Head of Public Markets. He was a Senior Investment Risk Analyst at Emory Investment Management before joining UPS Investment Group. He has an MBA from The Fuqua School of Business, Duke University, an MS in computer science from George Mason University, and BTech in civil engineering from IIT (BHU), Varanasi.
Before becoming CIO at Novant Health, you were head of public markets at a corporate pension plan. How has your approach to managing investment portfolios changed?
A corporate pension plan portfolio is managed in context of a well-defined liability stream. In contrast, for a hospital system, the asset pool has a long investment horizon and is managed as a total return portfolio with no defined liabilities. Investment portfolios at hospital systems have a risk profile similar to endowments and foundations, but with different cash outlays. The purpose of our investment portfolio is to maintain a good credit rating, provide for future capex spending or M&A activity, and act as a rainy-day fund. Due to the possibility of unexpected cash outlays, we at Novant have a much higher allocation to liquid assets (80%) vs. illiquid assets (20%). Liquidity is very important for a hospital system, both for possible operating purposes and to support its credit ratings, so a key portfolio allocation question for us is, what is the right mix of liquid vs. illiquid assets?
Once we have the right liquidity allocation, we can take more risk than a typical corporate pension plan because we have a long horizon and we do not have regular cash outlays for operating activities. Also, our earnings are only modestly sensitive to changes in the economic environment since we are not in a cyclical industry, so we can take market-sensitive risk for which we feel, at times, we are well compensated. Yet, determining the amount of risk is a balancing act because the investment portfolio returns, even if unrealized, impact the hospital’s income statement.
My industry has changed a lot over the past 20 years. Hospital systems used to have a small pool of assets managed through a CFO’s office, but now they have become bigger with over $5-$10 billion in assets. In addition, the systems have become more institutional with a CIO and an investment team to manage the investment portfolio.
What are your current investment objectives? What is your portfolio’s asset allocation and how do real assets fit in your portfolio?
At Novant, our investment objective is to have a total rate of return that exceeds the company’s weighted average cost of capital and, as a secondary objective, to exceed our policy benchmark over a five-year horizon.
Asset allocation is tilted to economic growth, with over 50% in both global public and private equity investments. Less than 15% is in Treasuries, and we have about 15% each in hedge funds and real assets. The remainder is in cash.
To classify real assets as a single asset class is very difficult as gold, commodity-sensitive equities, commodity futures indexes, TIPS, and farmland are all different in terms of their market risks and inflation and growth exposures. Each type of real asset has a specific investment purpose. Commodity-sensitive equities have more growth and inflation exposure and are meant for inflation-protection but with a growth bias.
Our allocation to gold, when its opportunity cost is low, is meant for providing protection in a deflation scenario or when VIX is high. In contrast, real estate is meant for diversification purposes and generally offers inflation protection.
How do you interpret the current market and economic environment, with inflation already high, and the Fed set to tighten?
It is possible that we are in a high inflation and low growth environment. Supply chain disruptions will eventually resolve but it is anyone’s guess when, as it may take one year or even longer to resolve. What is crucial now is, how much do inflation expectations change if inflation is more persistent than earlier expected?
Over the long term there is a tug-of-war between big deflationary forces like shifting demographics and technological innovations against inflationary forces like de-globalization and pandemic-led changes. This competition between forces may cause both realized inflation and expected inflation to be at a different level, perhaps higher from before, for the next five years.
When constructing a portfolio of real assets do you take a more top-down (i.e., first allocating to risk factors) or bottom-up view, focused on individual assets, themes (e.g., water, sustainability, etc.), or investment opportunities (e.g., a specific infrastructure project)?
Our investment process takes a more top-down approach for asset allocation. We first decide on the risk budget; how much equity, bond, and liquidity risk do we want. Depending on our views of the economic environment (like stagflation), we decide how much inflation and growth exposure we desire, and given our risk-adjusted return assumptions of the real assets, we decide what proportion to allocate to the various real asset types. There is always a risk of having an altogether different economic environment, say if the Fed overtightens or if there is stagnation, and so, allocations to real assets should be well-diversified.
A board member, becoming concerned about high inflation, may ask, what is the portfolio’s sensitivity to inflation? How would you estimate it?
Discussion about inflation was on the back burner for many CIOs, as deflation was the fear following the Global Financial Crisis. But now, due to the unprecedented amount of fiscal and monetary stimulus, there is a concern of high inflation and its portfolio impact that is now discussed at every CIO’s board meeting.
Besides evaluating inflation sensitivity of real assets, sensitivities of other assets in the portfolio like equities also need to be determined. The inflation impact on the equity portfolio would be different depending on whether current high inflation comes down over 1 year vs. 3 years. Within equities, the impact of inflation also depends on whether companies have pricing power or not. Similarly, inflation sensitivity depends on the duration of the fixed income portfolio and the amount of TIPS exposure. However, there is also a concern that TIPS may lose value if real rates were to rise.
The impact to the portfolio from high short-term inflation numbers may not be as much, as we have not seen a change in long-term inflation expectations. If inflation expectations were to move up it would negatively impact both equity and fixed income portfolios. This is a scenario where a CIO might benefit from an allocation to inflation-sensitive real assets.
How do you benchmark real assets?
We individually look at asset-level benchmarks like S&P Global Natural Resource Index or NCREIF Property Index. RASA® Interactive helps us in evaluating macroeconomic and market exposures at different investment horizons for our real assets portfolio and we compare our portfolio to several investment-objective-driven real assets portfolios.
It would be useful to construct and monitor real assets benchmarks depending on the investment objective like inflation protection or low growth protection or those tailored for specific economic environments like stagflation or stagnation. A CIO can compare these benchmarks with their own portfolios and evaluate what portfolio changes might be required for desired inflation and growth exposures.
What other asset classes are you looking to invest in if rates were to rise?
We are looking to add to our currently small allocation in private credit as they offer floating rate plus spread exposure. Of course, private credit is correlated with equities and may sell off with equities and can have increased rates of default. Yet the risk in private credit is lower and an allocation to private credit can help with portfolio diversification.
This interview first appeared in PGIM IAS’ The Differential.