South Carolina fund adopts strategic partnerships

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Robert L. Borden still will have the final decision in selection of money managers.

COLUMBIA, S.C. — The South Carolina Retirement System Investment Commission is among the first pension plans to commit a significant portion of its assets — 19% — to a series of strategic investment partnerships with money managers.

Commissioners of the Columbia-based fund hired four money managers on May 15 that will assume management of as much as $3.5 billion. The plan already had two such arrangements, worth $1 billion each, with Morgan Stanley (MS) Investment Management, New York.

The new hires are part of a larger plan by Chief Investment Officer Robert L. Borden to ultimately give an elite group of managers more investment freedom to invest large mandates across a wide range of alternative investments.

Mr. Borden is breaking new ground as he completes the transition of the fund he termed “woefully undiversified” into one on the cutting edge of asset allocation approaches. Until a November 2006 legislative change, the fund's investments were restricted to domestic stocks and bonds.

One of Mr. Borden's innovations, for example, is to charge two of the strategic partners with creating a new wrinkle on private investments: Each manager will invest $1 billion destined for illiquid investments like private equity, real estate, infrastructure and co-investments temporarily in conservative, liquid hedge funds so the assets are fully invested until they are drawn down.

At the May 15 meeting, the system's six commissioners hired the four managers to create what are most often termed strategic partnerships. JPMorgan Asset Management, New York, and Invesco (IVZ) Ltd., Atlanta, each will direct investment of global multiasset alternatives portfolios. JPAM will manage $1 billion; Invesco's mandate size has not been set. Mariner Investment Group LLC, Boston, and TCW Group, Los Angeles, each will manage $750 million in credit-oriented opportunities.

Strategic partnership arrangements give the manager the ability to call many of the shots when it comes to asset class selection and portfolio construction (Pensions & Investments, May 12). But in South Carolina's case, investment manager selection ultimately remains in Mr. Borden's hands, although he is relying on a huge amount of input from the system's strategic partners and plan consultant Rhett Humphreys of NEPC LLC, Cambridge, Mass.

As with other strategic partnerships — dating back to 1995 when GTE Corp. pioneered the concept for its defined benefit plan — South Carolina's partnerships boast a healthy dose of knowledge transfer to help the public fund's investment professionals keep abreast of changing market conditions, new investment strategies and technology innovations.

Despite some similarities, strategic partnerships between pension funds and money managers are customized. South Carolina's new relationship with JPMorgan and a similar $1 billion mandate signed in March with Morgan Stanley Investment Management apparently are the first of their kind, sources said. Morgan Stanley already manages $1 billion in a strategic partnership that acts as a “completer” fund of funds for the commission's approximately $6 billion hedge fund portfolio.

Mr. Borden said the two managers initially will invest the assets in “a strata of conservative, liquid hedge funds” that will be used to fund less liquid alternative asset classes like private equity, real estate and infrastructure as well as co-investment opportunities.

The advantage of the model, Mr. Borden said, is that the strategic partner can avoid the J-curve effect common with private partnerships by keeping assets fully invested until they are needed and with investments in income-oriented private partnerships. The J-curve effect is the return cycle in private equity investments, with usually low or negative returns in early years because assets are invested in companies that take time to mature. South Carolina's hedge fund investment returns will help to offset the lack of investment income in the early years of the other investments.

Morgan Stanley and JPMorgan Investment Management both have extensive investment management capabilities with both internally managed alterative investment strategies such as real estate, private equity and hedge funds as well as funds of funds. The managers will invest in both internally and externally managed strategies.

'Real value'

Strategic partnerships offer the South Carolina investment commission “real value on the investment side. They are very flexible and allow the manager to be very responsive to market conditions. Managers can make swift decisions about investment opportunities and take full advantage of opportunities when they come up,” Mr. Borden said.

Giving a manager a large allocation also results in “very favorable economics,” although he declined to specify the price breaks the fund is getting.

“We set up these partnerships with a real eye toward hiring managers with broad investment capabilities and lots of quantitative and qualitative talent, and then to let them manage so we get their best ideas. The pension and consulting communities still are intent on dividing investments into tiny boxes. The ultimate iteration of this tendency is to hire talented managers and then keep them in the tiny boxes,” Mr. Borden said.

Mr. Borden said after 18 intense months of implementing a much more diverse asset allocation for the state retirement plan portfolio (P&I, Nov. 17, 2007), the commission is largely done “with most of the heavy lifting.”

As part of the expansion of the alternative investment portfolio — which went from zero to 30% of assets under the new allocation — commissioners earlier this month hired Capital Guardian Trust Co., Los Angeles, to manage $500 million in emerging markets debt. The commission also invested $225 million in the WLR Absolute Return Hedge Strategy, managed by WL Ross & Co. LLC, New York.

Commitments to private equity and hybrid alternative funds of $200 million each were made to the Selene Residential Mortgage Opportunity Fund, managed by Selene Investment Partners LLC, Uniondale, N.Y., and the Sankaty Credit Opportunities IV Fund, managed by Sankaty Advisors LLC, Boston. Another $100 million went to the D.E. Shaw Direct Capital Fund, managed by the D.E. Shaw Group, New York, and $50 million was invested with the Welsh, Carson, Anderson & Stowe Fund XI, managed by Welsh, Carson, Anderson & Stowe, New York.

Contact Christine Williamson at cwilliamson@pionline.com

Reporter Jennifer Byrd contributed to this story.