Arizona fund considering huge revamp

PHOENIX — Officials at the Arizona Public Safety Personnel Retirement System are considering a radical shake-up of its $7 billion investment portfolio.

Staff members are proposing restructuring the pension fund into an “index-plus master manager” program for up to 90% of assets, and an absolute-return portion for the remainder. The latter eventually could subsume much of the master manager program.

If approved by the fund's board at its April 16-18 meeting, it would mark a dramatic change at the fund, 93% of whose assets were run internally as of Sept. 30.

The components of the proposed revamp aren't new. However, “they're being a little bit more creative, and typically, that means better outcomes,” said Rick Roberts, principal at First Quadrant LP, Pasadena, Calif., which is being considered as a master manager.

Plan officials stressed how flexible details about the plan were as of the week ending April 11. Eight managers were interviewed, and anywhere from one to all eight could be hired, if the board approves the program, said CIO Rob Brown. Mr. Brown joined the fund Jan. 7 from Genworth Financial Asset Management, Encino, Calif., where he served as CIO.If approved, the move would shutter the plan's six-person in-house management operation. No job losses are expected; staff would be shifted to researching investments for the absolute-return portfolio and to overseeing new external managers, said Executive Director James Hacking. As recently as four years ago, many of the plan's investments were picked by the plan's then-administrator Jack Cross and his staff.

Mr. Hacking, executive director since August 2005, said because the fund had been highly concentrated in one sector — technology — the amount of risk taken then was “breathtaking.” That heavy tech-stock emphasis largely explains why Arizona lost 36% of plan assets in the two years ended Sept. 30, 2002.

The plan is now 69% funded. With sharply diminished assets and ever-growing liabilities, plan officials realized a new tack was needed, which resulted in the index-plus master manager proposal.

The new proposal calls for transferring the “lion's share” — the figure was been pegged at 90% at a March investment committee meeting, but Mr. Brown said the proportion could change — to one or more index-plus master managers whose combined assets would comprise a “relative protection portfolio.” Each master manager would seek to provide an incremental return above that of a customized benchmark based on the median public pension fund's asset allocation. Managers would separately manage alpha and beta exposures.

“We want a highly risk-controlled strategy,” Mr. Hacking said.

“The objective is to do better than the index,” Mr. Brown said. “We don't want passive management.”

Mr. Brown borrowed the “master manager” term from Richard Ennis, principal at Ennis, Knupp & Associates, Chicago, who came up with it four years ago, but the Arizona CIO's concept is very different. While Mr. Ennis relies on a single index or overlay manager overseeing beta management and potentially doling out money to various “alpha” managers, Mr. Brown's concept has multiple master managers running both the alpha and beta portions of each portfolio.

Ennis Knupp is the plan's general investment consultant, according to the fund's annual report and fund officials, though Mr. Brown said the firm had “no involvement with (development of the proposal) whatsoever.”

Satya Kumar, associate at Ennis Knupp, said the firm does not comment on clients.

Mr. Brown divided possible master managers into four categories: the fixed-income shops, global tactical asset allocation firms, pure hedge fund firms, and larger firms that have expertise in both running money internally and hiring subadvisers in multiple asset classes.

The plan would likely optimize allocations to master managers, but would probably avoid rebalancing because it's costly, Mr. Brown said.

Firms being considered are fixed-income managers Fischer Francis Trees & Watts Inc., New York; Pacific Investment Management Co., Newport Beach, Calif.; and Western Asset Management Co., Pasadena, Calif.; GTAA manager First Quadrant; hedge fund Benchmark Plus Management LLC, Tacoma, Wash.; and multiasset class firms Morgan Stanley Investment Management, BNP Paribas Asset Management Inc., and Goldman Sachs Asset Management, all of New York.

First Quadrant's Mr. Roberts said the firm has expertise in providing both synthetic and physical beta exposure, and obtains alpha from “a pool of uncorrelated structures.” Spokesmen for Fischer Francis, Morgan Stanley and WAMCO declined to comment. Calls to other firms seeking comment were not returned.

The remainder of the fund would be run in an “absolute-return portfolio,” the goal of which would be simply “to make money,” Mr. Brown said.

Alternatives would dominate that portfolio in today's environment, but there would be no prescriptions for which asset classes could or could not be invested in, Mr. Brown said. “(Alternatives) have the edge now. They have the comparative advantage. But who knows what will happen in the next 12 months?”

As of Sept. 30, the fund's asset mix was 62.9% U.S. stocks, 20% U.S. bonds, 10.4% international stocks, 2.8% real estate, 1.4% private equity and 2.5% cash.

Whatever the starting allocations to the two portfolios, the relative protection portfolio would gradually give up assets to the absolute-return portfolio — as investments are made opportunistically and “as we've proven ourselves,” Mr. Brown said.

However, it's not clear how much money would flow into the absolute-return portfolio. The proposal calls for 100%, but Messrs. Brown and Hacking both say that's unlikely. “I can't conceive of it,” Mr. Brown said. “I don't think there's anything wrong with it ... but you have to stay in the comfort zone.” If the fund sought to invest entirely in absolute-return vehicles, it would take until year-end 2021, theoretically, for enough opportunities to come around to invest in, Mr. Hacking said.

Contact Drew Carter at [email protected]