The San Francisco City & County Employees' Retirement System board will consider an opportunistic allocation of roughly $400 million to actively managed China A shares listed in Shanghai and Shenzhen.
Materials presented to the board last month by William J. Coaker Jr., chief investment officer of the $20 billion pension fund, recommended allocations of up to $200 million each for two Beijing-based managers: Cephei Capital and Springs Capital.
The recommendations are the pension fund's first for “a non-U.S. country specific investment” within its public markets portfolio and will be included in the opportunistic segment of that portfolio, the materials said.
The board could take up the recommendation at its June 8 meeting.
If approved, the allocation to China A shares would be one of the largest by a U.S. pension fund. It would come, meanwhile, roughly a week before equity index heavyweight MSCI is set to announce whether it will begin adding A shares to its global and emerging markets benchmark indexes starting next year.
The materials presented to the San Francisco board said the pension fund's investment staff launched its search for A-shares managers in October with a request for information. Mr. Coaker traveled to China and Hong Kong the following month to vet the seven managers that responded.
In a separate report submitted to the board at the beginning of May, the pension fund's general investment consultant, NEPC, noted it was called in to conduct due diligence after San Francisco's investment staff had winnowed the seven down to Cephei Capital and Springs Capital.
Both managers run concentrated portfolios of roughly 30 stocks, out of a universe of 2,700. The materials NEPC presented to the board show both firms handily besting the 11.6% annualized returns of the CSI 300 benchmark of Shanghai and Shenzhen-listed shares over the seven years ended Dec. 31. For the period, Cephei Capital and Springs Capital posted annualized returns of 17.9% and 29.1%, respectively.
NEPC concluded that allocations to Cephei Capital and Springs Capital would give San Francisco opportunities to “directly access growth stories in China prior to many other investors,” in a deep market with inefficiencies to exploit.
While noting that prior to January it hadn't previously done due diligence on either firm, NEPC expressed confidence that both managers will continue to outperform benchmark returns over the long term.
The pension fund's investment staff said Cephei Capital targets annualized returns of more than 12% on a three-year rolling basis, and further endorsed Springs Capital's annualized return target of between 15% and 20%.
The materials said Cephei Capital's typical fees include a 1.5% management fee and a 20% performance fee, for returns that exceed an 8% hurdle and with a high water mark. Spring Capital's typical management fee is a lower 1.3%, but its 20% performance fee doesn't come with hurdles or high water marks.
San Francisco's materials said the staff continues to negotiate the fee structure and, helped by the size of its proposed allocation, expects fees that are lower than both firm's typical fees.
At the end of 2015, Springs Capital had assets under management of roughly $5 billion, with mandates from other large institutional investors, including Norway's 7.3 trillion kroner ($874 billion) Government Pension Fund Global, Oslo, and AP2, the 300.6 billion Swedish kronor ($36 billion) Gothenburg-based pension fund.
Cephei Capital ended the past year with AUM of roughly $3 billion, and a client list that included the Norwegian giant, South Korea's 519.7 trillion won ($437 billion) National Pension Service, Seoul, and the $22 billion Stanford University endowment, Palo Alto, Calif.
Officials from the San Francisco pension fund, Cephei Capital and Springs Capital could not be reached for comment by press time.