Allocation Practice in a Challenging Investment Environment

Donald Pierce has been with the investment team of the San Bernardino County Employee Pension Association since 2001, working directly with the board on developing policy and investment goals. Since taking over as CIO in 2010, Pierce has applied investment strategies, including international private equity, emerging market debt and options-based strategies, to the fund’s investment matrix.

The $13.4 billion pension fund has a lower equity risk than most of its peers. In addition, the pension fund has recently been reallocated to increase U.S. equity exposure to up to 17% of the portfolio, while reducing its exposure to emerging market debt and international developed market equities. “The outcome of any particular asset allocation is the result of the assessment of market opportunities and the ability to implement those changes.Pierce said during a CIO webinar hosted by Managing Editor Amy Resnick on September 20.

The talk was the latest in the CIO’s Discriminating Insights series. You can find the recording of the entire conversation here.

The SBCERA portfolio is diversified across various asset classes and investment vehicles. “While diversification is great,” Pierce said, “it is one of the least compelling reasons to invest.”

Pierce made a broad assessment of the fund’s asset allocation: Collectively, public markets account for 30% of the allocation. We have a fairly large 18% position in private equity and an allocation of real assets, mostly in commodities. But we also have infrastructure… mostly concentrated in energy-related MLPs. Real estate comes in at 5%, our global fixed allocation is mostly credit and our international core allocation is zero, which we adjust based on sentiment, and that’s one of the ways we keep our time low. In the US, we have 15% mostly fixed as loans, with 2% dedicated to core. We are also exposed to credit hedge funds, which we call absolute returns.”

Pierce also set expectations for commodities. “The physical infrastructure of the commodity complex has not been adequately invested in over 20 years,” he said. “We’ve seen a lot of investment in services and finance, but very little worthwhile investment in smelting and other physical commodity mechanisms.”

According to Pierce, not having a fully invested portfolio is an important feature of asset allocation. “We have cash allocation, which is an area we usually rely on and use opportunistically to add to positions; we tend not to invest fully. “We see cash as having option value and like to wait for prices to come to us and then distribute our cash.”

Pierce continued, “Poor cash doesn’t take credit because until recently it had near-zero returns and everything it buys gets all the credit. The cash that makes it easy to return gets blacked out because of the lack of interest rates. What we don’t like to do is rely entirely on the market for liquidity. When times get tough. Even treasures are hard to find.”

SBCERA is a revenue-oriented scheme that emphasizes positioning in the fixed-income loan sector as opposed to price change strategies. “We’re constructive about CLOs and specifically BB and B assets, so we definitely want to add things that benefit from a floating rate instrument and it has happened,” Pierce said.

The pension fund’s default rate of return is 7.25% and the plan is funded at just over 81%. The 2021 return was 33%, and Pierce said it’s a performance they’ll struggle to match in this year’s more challenging investment environment. Regarding the year 2023, Pierce said, “There will come a price where the stock market is quite interesting and attractive and you can make good money. In the face of a tightening cycle with the Federal Reserve, I’m not sure this is the right time to do it.”

When asked what concerns he had about the current economic and investment climate, Pierce noted that it was widely accepted that “the Fed will solve the inflation problem by raising interest rates, and that’s a very demanding outlook for the world.” In the many-money-chasing-too-goods problem where the problem is that it costs too little, interest rates don’t seem like a particularly viable way to go about it. So what I’m worried about is that all that tightening goes to waste and you run into supply constraints because high interest rates make it even more expensive for fixed-cost manufacturers to produce their own tools. It’s worrying that this experiment we’re undertaking isn’t actually working.”

Tags: Asset Allocation, diversification, Donald Pierce, San Bernardino County Employees Retirement Association

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