Q: What is the history and scope of the fund?
TIAA-CREF has a long history of and commitment to managing Socially Responsible Assets having launched the CREF Social Choice Account (Account), an equity (60%)/fixed income (40%) balanced annuity, in 1990. At that point, the Account had approximately $3.5 billion in fixed income assets. We now manage five different Socially Responsible fixed income mandates ranging from our annuity product to a mutual fund and Separately Managed Accounts, totaling about $7.5 billion in Assets Under Management (AUM). All of the mandates are actively managed against common fixed income benchmarks with four of the five being intermediate duration and the fifth a short duration account illustrating our growing management capabilities.
The TIAA-CREF Social Choice Bond Fund is the fastest-growing mutual fund, on a percentage basis, on the TIAA-CREF platform. While only in existence since September of 2012, it is modeled on one of our larger pension plan accounts, CREF Social Choice Account.
Work performed by our Responsible Investment Team identified Millennials (76%) and women (70%) as the investor groups most interested in incorporating Environmental, Social and Governance (ESG) factors, in their investment decisions.
This is a core, actively managed, fixed-income fund that provides investors with broad, fixed-income market exposure with social criteria applied to it. Social criteria was once limited to exclusionary screening, wielding a broad brush that painted companies and industries as either good or bad, with no in-between.
Today, our investors focus on supporting those best-in-industry-class leaders and funding solutions to the issues that concern them most. In executing our strategy, we invest in and support leaders in ESG performance. Also, given the unique nature of the fixed income market, through our proprietary Proactive Social Investment (PSI) framework we identify and invest in securities that have a direct and measurable social and/or environmental impact.
Q: How does your fund differ from its peers?
We believe our approach differs in a couple of important ways from the peer group. The TIAA-CREF Social Choice Bond Fund is a core, actively managed offering that is benchmarked to the predominant fixed income benchmark, the Barclays U.S. Aggregate Index.
A prototypical investor that has a 60%/40% asset allocation mix between equities and fixed income, respectively, can feel comfortable using our fund as their entire fixed income allocation. This differs from the majority of Socially Responsible fixed income funds that tend to be more targeted in their approach and therefore aren’t typically able to represent such a large percentage of an investor’s asset allocation.
A big misperception about Socially Responsible funds is that you have to give up performance. We believe our long-term performance, the fund just eclipsed its three-year track record, proves that you do not. Generating long-term excess return is critical to establishing the virtuous cycle that will allow us to attract additional capital so that we in turn can continue to support ESG leaders and fund PSI opportunities.
As mentioned previously, Proactive Social Investments are securities that have a direct and measure social and/or environmental impact. PSIs are investments in things like solar power projects, vaccination bonds, clean water deals, and affordable housing projects. The fixed income market provides a unique opportunity to participate in these types of investments because of the ability to invest in different parts of the capital structure, non-profit entities, Non-Governmental Organizations (NGOs), agencies, private entities and structured securities.
One example of a PSI example currently in the fund is the Topaz Solar Farm. It is the largest commercially operated solar power project in the U.S., powering about 160,000 average homes and mitigating roughly 377,000 tons annually of carbon dioxide equivalent. That’s equivalent to taking about 73,000 cars off the road.
Q: How would you define your investment strategy?
We believe our approach embodies our clients’ values and is consistent with our nonprofit heritage. The Fund’s underlying philosophy is to provide the potential for competitive fixed income investment returns while offering investors an opportunity to align their portfolios with their values.
Benchmarked to the Barclays U.S. Aggregate Bond Index, the Fund is an actively managed intermediate core fixed-income offering designed to provide broad fixed income exposure while giving special consideration to certain environmental, social, and governance (ESG) criteria.
The strategy focuses primarily on undervalued, investment-grade securities and seeks to add value through duration and yield-curve positioning, sector allocation and security selection, including proactive social investments (PSI), a proprietary classification of securities that are compelling investment opportunities and also have a direct and measurable societal and environmental outcome.
We draw on the experience of our portfolio managers and senior investment professionals to assess portfolio positioning and relative value across sectors and on the strength of our credit and structured credit research teams to identify undervalued securities within sectors and industries.
Q: What are the main steps involved in your investment process?
Our investment process starts with an evaluation of the current economic environment. Portfolio construction includes both a top-down asset allocation overlay and bottom-up fundamental analysis for individual security selection. I set the broader asset allocation goals with input from the sector portfolio managers, taking the following into consideration: macroeconomic analysis, relative valuations and fundamental developments within each sector, spreads and credit trends, and supply and demand factors.
Risk analytics reports that compare the portfolio’s positioning versus the benchmark also help frame the investment process. Security selection is determined through detailed, bottom-up company analysis, incorporating not only fundamentals, but also issuer/issue liquidity, capital structure placement, and relative value along the issuer’s credit curve. The ESG criteria framework for all of the securities eligible for inclusion in the portfolio is developed by TIAA-CREF’s Responsible Investment Team and executed in partnership with independent external research partners.
Composition of sector-based sub-portfolios is determined largely by views held on individual securities and issuers. Idea generation for security/issue selection is based on an intensive, bottom-up research process, with overweights and underweights to individual securities contributing significantly to excess returns.
Q: What constitutes your research process?
Supporting the Lead and sector Portfolio Manager’s credit decisions is a team of 37 senior credit research analysts (with an average of 12 years’ experience) and 17 junior research analysts (with an average of 4 years’ experience) providing coverage of the full range of fixed-income market sectors, including sovereign and agency bonds, structured securities, investment-grade and high-yield corporate bonds, emerging markets, and municipal bonds.
Each analyst is responsible for monitoring companies or securities within a group of related industries and/or sectors. The number of issuers covered by each analyst varies by sector of coverage, with investment grade analysts covering 70 to 100 issuers, high yield analysts covering 25 to 35 issuers and structured finance analysts covering 100 to125 issuers.
Individual positions are based on an internal analysis of the issuer’s financial information and the identification of value relative to other available investment opportunities across sectors. As part of the intensive underwriting process, our analysts attempt to identify characteristics of an investment that may not be well-understood by other investors in the marketplace, thereby representing an opportunity to realize excess returns.
A team of 12 traders provide market intelligence, dealer relationship management, and execution capabilities across all sectors.
I work closely with our research team, often examining a particular transaction alongside the sector analyst to evaluate the fundamental credit exposure, the social/environmental impact, its relative value in terms of how the credit or structure looks compared to its peer group, as well as other factors. Relative value is a critical component of our investment process. Ours is unquestionably an iterative process.
Q: Can you provide any examples?
One example would be the Topaz Solar Farm that we talked about. We looked at it relative to other alternative energy projects in the marketplace, like wind farms, other solar power projects and even natural gas deals on the fossil fuel side as well as versus corporate securities.
Topaz’s equity sponsor is MidAmerican Energy, a subsidiary of Berkshire Hathaway, so we also evaluated it relative to where MidAmerican and Berkshire Hathaway debt was trading. As relative value is inter-sector not intra-sector, we also looked at it relative to distributed generation deals that fund residential and small business rooftop solar panels in the asset-backed security market.
In this particular example we utilized not only to our utility analyst and corporate traders, but also our asset-backed security analysts and traders. Ultimately, a variety of viewpoints go into determining the appropriate positioning.
We also invest in things like vaccination bonds, e.g., a security for the International Finance Facility for Immunisation (IFFIm). IFFIm works with GAVI, the Global Alliance for Vaccines and Immunisation, to solicit donations from primarily European governments and large well-known nonprofits, like the Bill and Melinda Gates Foundation, to vaccinate children in impoverished nations. To date they have vaccinated over 500 million children, preventing an estimated seven million related deaths.
IFFIm has an excellent credit rating, AA1/AA+, but it’s not a frequent issuer and therefore is not well known in the marketplace. As a result, it tends to trade a little more cheaply than other names, which represents the kind of opportunity continually seek out to leverage our credit and valuation expertise.
Q: Does government policy impact your decision-making?
Yes, absolutely—that’s always a factor in the overall assessment of a credit/security. A good example would be in the utility sector with regards to combating the impact of climate change. Most U.S.-based utilities operate under state-mandated, renewable portfolio standards (RPS) that quantify the amount of power that must be generated from alternative sources.
The percentage requirements vary by state but are material in size and generally step-up over time. This type of long-run support for renewables provides valuable insight into the potential growth, viability and fundamental credit quality of utility scale alternative energy projects.
Q: Is the fund duration-neutral to the index?
No, it’s not. Because it is a core actively managed fund, we have the ability to position both overall duration and yield curve position based on our assessment of the economy. Typically, we are long or short about 15% duration-wise of the index, but that can go higher or lower, depending upon our conviction and views on the market.
Q: Do interest rates affect your investment process?
Certainly. I have been less sanguine about the state of the economy these past two years, putting us at longer duration and much flatter on the curve than my peer group, which partially explains why the fund’s performance has been so strong.
What’s required is an in-depth understanding, expertise, and resource utilization that enables you to look through short-term patterns, numbers, and factors to establish where the economy currently is and where it’s headed. That and the freedom and flexibility we have to manage by mandate, where the portfolio managers can express their views on the portfolio, both play a role.
Duration is a critical component to core fixed-income management and so we have to get that right in order to perform over time.
Q: Can you give an example of social investing that is not so readily evident?
We own a commercial mortgage-backed security, a CMBS bond, the first mortgage position on an office building in Manhattan, One Bryant Park that serves as Bank of America’s New York headquarters. That might not sound like social investing, but it is.
One Bryant Park is the first office building in the U.S. to achieve a LEED (Leadership in Energy & Environmental Design) platinum rating, the highest efficiency category. From the time of its construction, it’s boasted a 50% reduction in water usage and has a 4.6-megawatt CoGen (cogeneration) plant onsite that covers about 70% of the building’s annual energy requirement. An under-floor air system combined with 95% filtration results air exuded into the environment that’s cleaner than what’s already outside. It also has thermal ice storage tanks in its basement that produce ice at night to reduce the energy and temperature of the core building, which reduces the building’s overall energy utilization.
This particular security is a triple-A-rated single asset deal. They typically trade more cheaply than conduit or portfolio deals, because there is no diversification in the pool. However, our fundamental credit and valuation research leads us to believe it will outperform over time.
Q: How do you construct your portfolio?
As we have discussed previously, portfolio construction is based primarily on my assessment of the current economic environment and how I expect it to evolve over time. That overall view combines with relative value analysis to inform duration and curve positioning, asset allocation, security selection and trading strategy. Our continual focus is identifying securities that we think present an attractive relative value profile that will perform well in the economic environment that we forecast to exist.
Like I mentioned earlier, we spend tremendous amount of time performing fundamental analysis prior to positioning individual securities. Once we have completed that work, we focus on the relative value that particular position presents. As relative value is inter-sector and not intra-sector we compare the security to not only its sector peers but also across sectors on both a fundamental and relative value basis to determine the appropriate positioning.
Q: How many names are there in the fund?
Right now we have about 455 issues, but there can be multiple issues from the same issuer. On average, our investment grade analysts probably cover 50 to 75 names, with high yield being about 25 to 50.
Q: How do you define and manage risk?
We measure risk as both the probability and magnitude of deviation in our results from the benchmark. To manage our risk profile, we use a variety of metrics and tools to constantly measure our risk profile, making sure that we are within our tracking error guidelines, that the tracking error exposures are consistent with my economic risk and relative value assessments.
Our objective is to make sure that when an investor puts money into our fund, they get risk exposure consistent with a core, actively managed fixed-income fund. Our tracking error guidelines are 95 to 185 basis points, 145 to 150 on average, which is well within the typical range for the core intermediate bond universe.
