Running the alpha engine
Rachel Oliver and Thomas Marsh find out how the San Diego County plan runs its strategy
Public pension funds in the US by their very nature are often a very staid group. However, that doesn’t mean that they can’t be innovative when it comes to portfolio diversification and enhancement strategies.
Such is the case with the $3.8bn San Diego County Employees’ Retirement Association. While a relative sapling compared to the money-tree that is the $160bn California Public Employees’ Retirement System in Sacramento, it still can take advantage of its size and in-house experience to eke out returns.
Like many pension funds, San Diego County has benefited from a well-diversified portfolio that spreads across asset classes and geographic boundaries. Its asset mix is 33% in US large-capitalisation stocks, 12% in small-capitalisation stocks, 16.5% in an international EAFE mandate, 2% in international small-cap, 5% in emerging markets, 10% in US core fixed income, 5.5% in high-yield bonds, 5.5% in convertible bonds, 4% in international fixed income, 1.5% in alternative equity and 5% in real estate.
This diversification has no doubt contributed to the fund being 112% funded. That over-funding permitted the board of trustees to enhance benefits for its 17,000 members and still have the fund 106% funded. But that does not mean its board of trustees and its chief investment officer Bob Snigaroff, can sit back on their laurels. Snigaroff says the fund is forever reviewing its fund managers making sure they are performing up to expectations.
The fund is managing internally a small, but growing value equity portfolio that currently is about 1% of the fund. So far, the portfolio has been doing extremely well and has been in the top ninth percentile in terms of performance in the Trust Universe Comparison database for the past three years. “We use the quantitative factor stock selection model devised by Robert Haugen to find attractively priced securities. We also use an optimiser to manage risk in this portfolio,” says Snigaroff.
Further, the fund participates in enhanced equity strategies for the Standard & Poor’s 500 and MSCI EAFE investments. “We gain exposure to the markets through indexed swaps with a large number of counter parties instead of buying futures. “And we manage the swap book internally,” says Snigaroff. The strategy, called the alpha engine, is another way of buying active management through managing a cash-like portfolio. The alpha engine is the cash portion of the portfolio with the futures and the swaps offering the overlaying equity exposure of the underlying collateral. “You can use these strategies in the cash-like portfolio and instead of getting a cash return, you can achieve a return above cash. We’ve been a proponent of this for many years,” he explains.
He says that one of the mental blocks many plan sponsors have with active management strategies such as these is that they concentrate too much on the beta and the total fund return and the total fund risk instead of asking themselves how much alpha, or excess return they need. “We target 1.3% as our alpha benchmark and we get there.” Indeed, Snigaroff says the fund has achieved a 2.04% alpha over the past five years. Similarly, at 2.00%, its level of risk over the same time period is well within its expected standard deviation. The ratio of the 2.04% return to 1.99% risk gives the fund an information ratio of 1.03%, a very attractive number for any active management strategy.
Meanwhile for its overall portfolio, Snigaroff says the fund does not give preference to trying to determine whether value or growth strategies are in favour and is instead staunchly neutral on those matters. “In_managers we’re looking for a good process that can add value to our overall policy benchmark. If we think your process has good prospects for creating excess return we would consider adding it, but we’d also have to see how it would fit in with the other strategies,” Snigaroff says.
And in this age of mergers and acquisitions, Snigaroff says the world is not becoming an oligarchy of a few large fund managers. Rather, it is becoming more diverse, with the number of players and investment strategies on offer growing, which in one sense is positive for the industry and pension plans. The downside, however, is that firms often offer a shotgun approach to products hoping that one or two will be successful. “We employ different strategies to produce alpha in our portfolio to capture where others often would venture,” Snigaroff concludes.