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San Francisco CIO proposes major asset allocation overhaul

Plan includes new 15% hedge fund, 12% alternative equity allocations

San Francisco City & County Employees’ Retirement System’s chief investment officer is proposing a major overhaul of the $20 billion pension fund’s investment strategy, including drastically cutting public equities and fixed income and creating new allocations to hedge funds and alternative equities.

William Coaker Jr. presented his plan to the pension fund’s investment committee on Wednesday, saying it would reduce the volatility of the pension fund’s assets during market downturns. He proposed reducing the retirement system’s allocation to long-only public equities to 28% from 47%, reducing long-only fixed income to 17% from 25% and creating a new hedge fund allocation of 15% and a new alternative equity strategy of 12%. The pension fund’s current target allocations to private equity of 16% and to real assets at 12% would stay the same.

The alternative equity strategy would consist of hiring external managers in various categories including activist managers, country specialists, sector specialists and long-short managers, Mr. Coaker said.

But it might not be an easy sell as the proposed plan prompted debate by board members as to whether Mr. Coaker’s plan would create additional risk.

One board member, Herb Meibeger, read a handwritten response he received from Warren Buffett that the pension fund should not invest in hedge funds. Mr. Buffett offered no explanation in his short note.

Mr. Meiberger had written Mr. Buffett on May 6 inquiring as to whether he would have any recommendations for the pension fund about a hedge fund allocation.

Mr. Meiberger said he was opposed to investing in hedge funds because of long-term performance issues with the asset class. He called on the investment staff to investigate purchasing some type of insurance, such as investing in a covered call option strategy, for downside protection.

Joseph Driscoll, another board member, said such insurance would be too expensive and also questioned Mr. Coaker about the riskiness of the hedge fund strategy.

Mr. Coaker insisted that the pension fund would assemble a top-grade hedge fund staff and a top hedge fund consultant, and would do extensive due diligence to ensure that only top-grade hedge funds with strong return potential would be hired.

“We need to be very selective,” he said.

Mr. Coaker argued to the board that hedge funds have provided a superior risk-return as compared to traditional equity and fixed-income mandates. He said the HRFI Fund Weight Composite index, returned an annualized 9% over the last 20 years, outperforming the MSCI All Country World index of 7.15% for the same period.

Mr. Coaker told the board that the way the pension fund’s assets are currently allocated exposes the pension fund to potential severe losses in a market meltdown scenario. He said the pension fund had cumulative returns of -22% in the March 2000 to October 2002 bear market.

During the financial crisis from August 2007 to March 2009, Mr. Coaker said the pension fund had a cumulative return of -33%.

“During that time, our asset values fell from $17.4 billion to $11.1 billion,” he said. “It took us until August 2013 for our asset values to recover from that decline.”

Mr. Coaker said that two major bear markets had taken the retirement system’s funded status from 178% in 2000 to 83% currently, noting that an investment decline of 25% in the portfolio would bring the funded status to 55%.

Wednesday’s meeting ended with Mr. Meiberger questioning pension fund Executive Director Jay Huish and demanding to know why the retirement system is considering implementing a hedge fund strategy when the nation’s largest public pension fund, the $289.6 billion California Public Employees’ Retirement System, Sacramento, is cutting its hedge fund allocation in half.

Pensions & Investments reported on May 12 that CalPERS is cutting its hedge fund allocation to 1% from 2% of the total portfolio.

Mr. Huish said he would investigate but said he supported Mr. Coaker’s asset allocation plan.

Mr. Coaker said he will work with the board over several meetings to fully explain his plan and answer any concerns board members have.

In a separate action before the investment committee meeting, the pension fund’s full board approved a second commitment of up to $50 million to Carlyle International Energy Partners, managed by Carlyle Group. The fund seeks to invest in middle-market companies participating in the energy supply chain outside of North America. The board on May 14 had approved an initial commitment of $50 million to the fund.