Simplicity paying dividends for South Carolina fund

There's very little that's simple about running a $35.6 billion investment portfolio.

Take it from Michael Hitchcock, chief executive officer, and Geoffrey Berg, chief investment officer, of the South Carolina Retirement System Investment Commission, Columbia, which manages the assets of South Carolina state pension funds on behalf of the South Carolina Public Employee Benefit Authority.

The stakes are high for Messrs. Hitchcock, Berg and the other 40 full-time RSIC employees, as both large and small decisions can lead to unforeseen benefits or consequences for the South Carolina Retirement Systems' 600,000-plus members.

When Mr. Hitchcock looked at the RSIC portfolio in late 2018 as part of a regular review, he didn't see much simplicity. What he saw was a portfolio with 18 asset classes and 21 benchmarks. "It was a portfolio that we arrived at with the best of intentions but we're trying to put together something that we feel can give us a good probability of exceeding our annual rate of return," Mr. Hitchcock said. "But when we took stock, we felt that there was this unnecessary complexity and unnecessary required complexity."

The portfolio included five asset classes — like mixed credit and public and private infrastructure — with target weights of 3% or less. "Not that some of those options weren't bad to have in the portfolio but requiring (the RSIC) to always have those in the portfolio was probably not necessarily the best course of action for us," he added.

The portfolio was set up so that "complexity was the default," Mr. Hitchcock said, so he and his team went to work on simplifying it.

Over the course of roughly 15 months, with the help of its general consultant, Meketa Investment Group, and the commission, staff came up with a plan to reduce portfolio complexity and make simplification its default.

In April 2020, the commission approved a simplified policy portfolio consisting of five asset classes: public equity (with a 46% target), bonds (26%), real assets (12%), private equity (9%) and private debt (7%).

The new policy portfolio, which went live July 1, preserved the RSIC's ability to go off benchmark — its bond portfolio can include emerging market debt, for instance — but unlike in previous iterations of the portfolio, there are no required allocations to other asset classes. "We could use those (additional asset classes) when we had conviction that adding that level of complexity … would be rewarding, rather than having it to be always on," Mr. Hitchcock said.

To get the current allocation, the RSIC in 2019 created a reference portfolio — a two-asset-class benchmark portfolio composed of stocks and bonds — that most closely expressed the risk required to earn a return that is expected to exceed the portfolio's assumed annual rate of return — 7.3% — while also avoiding a greater than 5% probability of requiring additional contribution increases in the next five years. The reference portfolio is made up of 70% public equities benchmarked to the MSCI ACWI IMI and 30% bonds benchmarked to the Bloomberg Barclays Aggregate. South Carolina law provides that a maximum of 70% of the portfolio can be invested in equities, so the RSIC limited equity exposure of the reference portfolio accordingly, Mr. Hitchcock said.

In launching its policy portfolio, the RSIC wanted to anchor itself in the thought that it's a long-term investor with an infinite investment horizon, Mr. Hitchcock said.

"We wanted to make sure that we weren't making changes just for the sake of making changes, but we wanted to arrive at a portfolio that we felt comfortable, a policy allocation that we felt comfortable having for decades rather than years, and something that we had conviction in and weren't necessarily trying to time the markets," he added.

On the public side of the portfolio — the combined 74.2% allocated to public equity and bonds as of Sept. 30 when the plan had $32.5 billion in assets — the RSIC has implemented a nearly entirely passive strategy, managed externally. Previously, its equity and bond portfolios were about 40% and 25% passive, respectively.

"From an organization perspective, that allows us to focus the organizational resources on the parts of the portfolio where we really think that we can get a consistent outperformance above what you can get in public markets," Mr. Hitchcock said. The RSIC has hired an additional private equity officer and repurposed other staff members to the private side of the portfolio from the public side, he added.

Moreover, the passive strategy on the public side will save the RSIC roughly $30 million to $40 million annually in management fees, Mr. Hitchcock said.

In the fiscal year ended June 30, the commission posted a net return of -1.6%, below its benchmark of 0.13%, due in large part to the early economic impact of the COVID-19 pandemic.

The RSIC would've been better off had the new strategy been in place before the markets sunk in March, Mr. Hitchcock said. "There's a whole lot of 'woulda, coulda, shoulda,' and there have been some moments where if only we would've put our foot on the gas a little bit faster, we would've gotten here (sooner), but that's also having the benefit of hindsight," he added.

Still, much like investors of all sizes, the RSIC has enjoyed strong returns in recent months. "When you do something and you think about the time period over which you expect to see the benefit as years, and when you see more benefit than what you expected in six months, you scratch your head a little," Mr. Berg said.

The system has "more than made up for" its less-than-stellar performance last fiscal year, he added.

The RSIC has posted a net return of 15.9% fiscal year to date as of Dec. 31, paced by a 25.2% return in its public equities, which accounts for 48.9% of the total portfolio.

How long the period of solid returns will last is anyone's guess, but the current situation gives Mr. Berg pause. "Any time the market's up a lot, I get cautious," he said. "I think the only appropriate perspective right now is caution, (but) we're not scared, we're not heading for the hills or anything. As far as the quality of execution on our asset allocation, I feel really good."

That's putting things simply.