Applying allocation in a challenging investment environment

Donald Pierce has been on the San Bernardino County Employees Retirement Association’s investment team since 2001, working directly with the board to develop policy and investment goals. Since taking over as CIO in 2010, Pierce has implemented investment strategies including international private equity, emerging market debt and option-based strategies across the fund’s investment panel.

The $13.4 billion pension fund has lower exposure to stocks compared to many of its peers. In addition, the pension fund recently reallocated to increase exposure to US equities by up to 17% of the portfolio, while reducing exposure to emerging market debt and developed international market equities. “The outcome of any particular asset allocation is the result of assessments of market opportunities and the ability to implement those changes», Pierce said during a Sept. 20 CIO webinar hosted by Executive Editor Amy Resnick.

The discussion was the latest in CIO’s Allocator Insights series. You can access a 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’s one of the least compelling reasons to make an investment.”

Pierce gave a broad overview of the fund’s asset allocation: Collectively, public purchases make up 30% of the allocation. We have a fairly large 18% exposure to private equity and an allocation to real assets, most of which is in the commodities space. But we also have infrastructure… concentrated mostly in energy-related MLPs. Real estate comes in at 5%, while 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 duration low. We have 15% in US fixed, mostly in credit, with a 2% allocation to core. We also have exposure to credit hedge funds, which we call absolute returns.”

Pierce also identified prospects in commodities. “The physical infrastructure of the freight complex has been underinvested for 20-plus years,” he said. “We’ve seen a lot of investment in services and finance, but little in smelting and other physical commodity mechanisms.”

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

Pierce continued, “Poor cash doesn’t get any credit because until recently it has had almost zero return, and whatever it buys gets all the credit. Cashback is discredited by its lack of interest. What we don’t like to do is rely solely on the market for liquidity. When times are tough, even Treasuries can be seen as tough.”

SBCERA is an income-focused program that emphasizes a position in the fixed income credit sector as opposed to price swing strategies. “We’re bullish on CLOs and BB and B assets in particular, so the things that benefit from a floating rate instrument we’re certainly interested in adding and we have,” Pierce said.

The pension fund has a hypothetical rate of return of 7.25% and the plan is just over 81% funded. Its return in 2021 was 33%, which Pierce said is a return they will struggle to match in this year’s tougher investment environment. As for the outlook for 2023, Pierce said, “there will come a price where the stock market is quite interesting and attractive and you can make good money. I’m just not sure in the face of a tightening cycle with the Federal Reserve that it’s the right time to do it.”

When asked what concerns he has about the current economic and investment climate, Pierce noted that it’s widely accepted “that the Fed, by raising interest rates, will cure the inflation problem, and that’s a lot of demand for the world. In a too-much-too-little-goods-chasing theme, where the part where the problem is is the too-few-goods part, interest rates don’t seem particularly relevant to the theme. Well, what worries me is that all this tightening is for naught and you have supply constraints because higher interest rates make it even more expensive for fixed cost producers to produce their widgets. It’s worrying that this experiment we started isn’t actually working.”

Tags: asset allocation , diversification , Donald Pierce , San Bernardino County Employees Retirement Association

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