San Bernardino tilts to US equity; informed rebalancing reaps rewards

The board at $14 billion San Bernardino County Employees’ Retirement Association, SBCERA, has just approved a staff and consultant recommendation to increase the allocation to US equity (13.2 per cent of total AUM as of July 2022 with a target allocation of 17 per cent) away from international developed market equity and emerging market debt.

The asset allocation changes are an attempt to address a world where supply chains realign due to macro political factors and a de-globalization trend away from China, explains Donald Pierce, chief investment officer of SBCERA which he joined as an investment analyst back in 2001.  “Each asset allocation change also attempts to focus on resource-rich countries and lean away from net commodity importers,” he explains from the fund’s southern Californian base.

Elsewhere, current strategy is focused on income generation in a lower return environment and keeping cash on hand (currently 7.4 per cent of total AUM) for opportunities in down markets. “We continue to find spots to invest with attractive yield, and patiently wait for buying opportunities,” he says. SBCERA received a 33.3 per cent net return on investments for the 12-month period that ended June 30, 2021. It is also ranked in the top 1 per cent of US public funds with a 20.6 per cent investment return for calendar year 2021.

Pierce’s comments on key market themes are similarly expressed in quarter ending March 2022 fund documents, where the investment team highlight the transition away from China as a prevalent risk. “Sanctions on Russia highlight the global sensitivity to a USD-based system, potentially increasing the likelihood of separate spheres of influence between the U.S. and China. The regulatory reset and similar top-down initiatives may incite further volatility on the country’s long transition path, creating a tail-risk for market and economic contagion,” documents state.

Re-balancing act

Pierce attributes much of SBCERA’s success to a rebalancing strategy first broached in 2003. Back then the fund was busy navigating negative equity markets after a spate of strong equity returns in the late 1990s. “At the time, the Board was receptive to moving away from just relying on the equity market for results,” he recalls. That thought process led to discussions around the feasibility of a new balancing approach that finally came to fruition in 2006 when SBCERA partnered with Mcube Investment Technologies, a pioneer of smart rebalancing and developer of Alpha Engine, a quantitative modelling software. “They had a web-based application to help plan sponsors with rebalancing,” says Pierce.

Asset allocation decisions contribute 80-90 per cent of total fund risk and good governance requires active measurement, monitoring, and management, he explains.
“At SBCERA, we call this approach informed rebalancing.  Since going live in July 2006, the program has added over $1 billion in profits to the Plan.  This translates into over 1 per cent of excess return versus a traditional +/- 3 per cent range-based rebalancing SBCERA had prior to the implementation of Informed Rebalancing.”

It’s no secret that dynamic markets can cause a portfolio to drift around its strategic asset allocation, he continues. “When approving an asset allocation policy, a Board will generally approve policy ranges before a rebalancing of investments is triggered. Instead of letting our portfolio drift due to market movements until the trigger occurs, we’ve developed an explicit, rules-based approach using market relationships rather than just market price changes to trigger a rebalancing of investments.”

Moreover, by developing its own internal model and dynamically managing its asset allocation the strategy has survived staff departures and knowledge has been institutionalised in SBCERA’s 6 strong investment staff. In a paper written in 2018, Pierce, together with Sanjay Muralidhar and Arun Muralidhar of Mcube Investment Technologies and AlphaEngine Global Investment Solutions, argued that fiduciaries may have “overlooked a very simple and lucrative source of expected returns, that innovative pension funds captured with no change in policy or manager line-up.”

Governance

Pierce also attributes SBCERA’s success to another crucial seam: SBCERA’s governance, in place for well over a decade, ensures the investment team remain nimble enough to make quick decisions and take advantage of market opportunities that could have been lost if the team waits for its next board meeting.

SBCERA’s board has broadly delegated investment decisions to the SBCERA investment team, while retaining the authority over which investment managers it should engage with, and the approval of staff and consultant-recommended asset allocation.  “This important partnership between board, investment consultant, and investment staff has given proper oversight, while allowing our team to be nimble enough to make quick decisions to take advantage of market opportunities that may have been otherwise lost if we had to wait for the next scheduled board of retirement meeting.”

ARR

Unlike other US public pension funds SBCERA has not lowered its assumed rate of return, keeping a target to meet or exceed a 7.25 per cent actuarial assumed rate of return over the long term. “SBCERA recognizes how important it is to effectively execute our fiduciary responsibility and fulfil the long-term commitment our members are counting on.  We are committed to finding appropriate opportunities to achieve our investment return goals—no matter what the economic climate brings,” says Pierce who believes that the fund’s long-term strategy is testimony to its remarkable resilience in times of global economic stress.

“Over the last 10 years, we have earned an 8.8 per cent annualized return with 30 per cent less volatility than similarly situated pensions, and over the last 40 years, we’ve earned an average annual return of more than 8 per cent, a period which includes numerous recessions and other economic disruptions. While our fund is not immune to short-term volatility, our proactive strategy helps SBCERA provide retirement security to our members now and well into the future.”

His last word on success? “For a program to be successful, we need the board, CEO, investment consultants, and investment staff all working together cohesively, toward agreed upon goals. We’re not perfect, but I’m proud to say this is certainly the case at SBCERA,” he concludes.