How a CIO Built an Alts Portfolio From Scratch

The Profile: Jeremy Wolfson, Chief Investment Officer who currently manages the $8 billion dollar Los Angeles Water and Power Employees' Retirement Plan, speaks about how he has been able to grow the fund's alternatives allocation with the support of his consultant and the eventual approval of his board.

(March 28, 2012) — When Jeremy Wolfson, Chief Investment Officer at the Los Angeles Department of Water and Power, came to the fund about five years ago, the scheme lacked a structured investment staff and a sizable allocation to alternative investments.

“When I came to the organization, I grew the organization’s staff around what I thought were best practices in the industry,” says Wolfson, who came to the public fund from the private sector. He notes that just a few years before his tenure at the fund, 100% of the fund’s assets were actively managed internally by the board, investment staff, and advisors, without external fund managers.

An implication of 100% internal management for the scheme was an inability to pursue more complex, long-term investments, such as alternatives, largely due to lack of resources. It was also a blessing in disguise, because when the financial crisis hit in 2008, the Los Angeles Department of Water and Power did not suffer the same fate of many of its peers that suffered liquidity issues.

How did Wolfson and the board go from nearly 0% in alternatives to a long-term total target of 16%? “We did it one deal and one opportunity at a time. The consultant runs models and brings opportunities to the board, so when it’s time to source a good fund manager — it’s paced appropriately.”

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In terms of roadblocks Wolfson encountered while building an alternatives allocation, Wolfson notes that funds that already have a lot of partnerships with fund managers for alternatives are more challenged to find opportunities compared to funds that are starting from about nil in gaining exposure to the asset class. “When you have no allocation, like our fund did, it’s less of a challenge to locate potential partnerships because you can go in any direction,” he says.

In 2007, the fund had been more heavily invested in public markets. “In 2008 we had a small amount of partnerships. Coming into a portfolio where I wasn’t inheriting a lot of partnerships allowed us to sit back and think on what strategies made sense,” Wolfson says. “The fund was conservative to begin with before the financial crisis and continues to be conservative, but because we were not hugely into asset classes with long lock-up periods, we did not have liquidity issues.”

Today, for the most part, the fund looks more like its peers, with 40 to 50 managers across all asset classes. Since farming the fund’s asset management out to investment managers and hiring consultants — Pension Consultant Alliance as the fund’s general consultant and Cortland Partners as the real estate consultant — the fund’s exposure to alternatives has increased substantially within the board’s allocation.

The pension has gained that exposure by starting with a secondary fund-of-funds to get initial exposure to alternatives, working with the board and consultants to pursue fund-of-funds in the primary market. From there, the fund transitioned to forming direct partnerships with private equity managers.

The fund’s current long-term asset allocation: 51% in public equity (US, international, and emerging markets), and 33% in fixed-income. Alternatives consist of private equity at 1.5% of the portfolio with a 5% target, real estate at 2.4% with a 5% target, and real returns at a 6% total — its purpose being to help hedge inflation. The fund is also pursuing commodities with the board’s recent approval of timber, Wolfson says.

Looking ahead,Wolfson says alternatives will continue to be a growing part of the fund’s portfolio — an idea echoed by a recent survey by Casey Quirk and eVestment Alliance that showed alternatives are to be the most sought after by institutional investors in the United States this year. In total, these alternatives are to make up 20% of all fund manager searches, according to consulting firms responsible for advising investors with over $9.7 trillion in assets.

(March 28, 2012) — Investors are becoming disillusioned with the performance of their equity portfolios, and questioning the validity of holding the relatively risky assets for little return, Russell Investments has said.

Since the start of this millennium, United States equities have risen 1.2% per year according to the Russell 3000 index, with international equities up only slightly more at 2.8% each year, shown by the MSCI World ex-US index.

On a dollar-invested basis – and with dividends reinvested – bonds fared better than both sets of equities.

A paper from Russell this week said: “As a result, disgruntled investors are questioning many of the traditional tenets of investing, including the role of equities, risk versus reward, and portfolio diversification.”

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Given such poor returns in the immediate past, investors, who Russell warns are often prone to having short memories, may be tempted to move out of the asset class entirely.

However, portfolio diversification remains key to a healthy exposure across all return-seeing assets and good risk management, the investment consulting firm said. They said as investors had only moved into equities relatively recently, they should stick with them.

The paper, by Mike Smith, consulting director for Russell, showed how over each decade since the 1970s a different asset class, from a choice of US and international equities, bonds and a 60/40 balanced portfolio, was the outperformer.

Socio-political and other natural events were often the major impetus for the outperformance, Russell said, showing that investors should be amply diversified to avoid being hit too hard in any instance and being able to take advantage elsewhere.

The paper said: “Both international stocks and bonds did much better than US stocks over the last dozen years. Still, it is impossible to predict the future. Market leadership can change abruptly, catching most by surprise. However, we may win by diversifying into asset classes that may not look attractive on the surface.”

Addressing the question of whether investors should move out of equities due to their recent poor performance, Russell said the asset class still offered good return potential and investors who had finally accepted it as a mainstay of a portfolio in the 1980s should stick with it.

“In reality, it took the two strong decades of the 70’s and 80’s to get investors to consider them seriously. Now they are a portfolio fixture, and deserve to be, along with fixed income and other diversifiers.

The paper concluded: “Diversification does not assure a profit and does not protect against loss in declining markets.”

It said that diversification in a portfolio allowed for returns with relatively low volatility.

“Lower volatility enables investors to stick with their plans and not chase last year’s winners because they already have some of what won. In addition, they own some of what may win next year. That’s a portfolio that can work for your clients over their investment horizon.”