Fidelity International Small-Cap Strategy Terminated by SFERS

The board of the $24 billion San Francisco Employees’ Retirement System has approved terminating money manager Fidelity Institutional Asset Management’s Select International small cap equity strategy due to underperformance relative to its benchmark and other money managers.

A video stream of the system’s Jan. 9 meeting shows the board unanimously terminated the strategy. The system’s investment in the strategy totaled $174.5 million as of Dec. 31, but made up 6.5% of the approximate $3.5 billion small cap strategy, SFERS documents show.

Fidelity Institutional Asset Management is part of the much larger Fidelity Management & Research, commonly known as Fidelity Investments. It is one of the world’s largest assets managers with around $2.5 trillion in assets.

A SFERS memo from its investment staff gives a rare, inside view of issues inside Fidelity concerning the investment strategy.

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The Jan. 9 memo notes that the San Francisco pension system has not been the only institutional investor pulling money from the strategy, as it saw $1.9 billion in net outflows from January 2016 through Sept. 30, 2018.

SFERS first put $240 million in the strategy in August 2011, which peaked at $350 million in Sept 2016. The memo said since then, SFERS has redeemed a total of $200 million from the strategy. It placed the strategy on its under-review list in the fourth quarter of 2017.

The memo said in each of the past three years, the strategy has underperformed its benchmark while also ranking in the second half of a universal of other manager strategies.

“The strategies’ performance has been pretty pedestrian,” SFERS Chief Investment Officer William Coaker Jr. told the board. “We are looking to upgrade the portfolio and increase our excess returns,” he said.

SFERS returns data show the Fidelity strategy saw returns of -10% for the one-year period ending Nov. 30 compared to the MSCI World ex USA small cap benchmark’s return of -9.9%. For the three-year period, the strategy returned 4.8% compared to the benchmark’s return of 6.2% and for the five-year period, the strategy returned 3.7% compared to the benchmark’s 4.1%.

The SFERS memo notes that a 2010 report by its then-investment consultant, Angeles Investment Advisors, recommended that Fidelity be hired due to then-strong performance in the strategy, but also expressed caution if there were portfolio management changes. It said the memo noted the importance of portfolio manager Rob Feldman as the “key decision-maker on the portfolio” and that “his departure from the team for any reason would be a cause for immediate concern.”

The memo says that SFERS was notified by Fidelity in the first quarter of 2018 that Feldman would be stepping back from his role. It says that Feldman is listed at the strategy as a co-portfolio manager, but that he is on long-term leave because of health issues. In an email to CIO on Tuesday, Fidelity wrote, “Rob Feldman is facing health issues, but remains actively involved on the strategies as co-portfolio manager.”

SFERS noted in the memo that Feldman was replaced by Shah Badkoubei as lead portfolio manager in March 2018. Badkoubei had been associate portfolio manager since 2013.

Fidelity also appears to have been the victim of SFERS’s move to smaller money managers.

The SFERS memo said that Fidelity Institutional Asset Management, the Fidelity group that ran the SFERS strategy, was quite large.

“The public equities portfolio is shifting towards smaller, more nimble firms with a singular investment focus,” it said. “Staff believes that FIAM does not meet these criteria given their sizeable assets ($164 billion as of Sept.30, 2018) and the number of strategies (80) that they manage.”

The memo said SFERS is looking to hire concentrated, high-conviction strategies and notes the largeness of the Fidelity strategy, with approximately 200 positions.

Last month, the SFERS board approved a $500 million allocation to an international stock strategy run by Select Equity Group as part of a restructuring of its public equity portfolio. Select is a smaller manager that runs high-conviction, concentrated strategies. Coaker told the board at the Jan. 9 meeting that the hiring of Select was an example of “upgrading” the SFERS equity portfolio.

Three other international equity strategies were also added to the watch list last month by SFERS: the William Blair international growth strategy, the DFA international small cap strategy, and the AQR international strategy—all of which have had performance problems.

Public equities make up $8 billion of SFERS’s $24 billion portfolio, but Coaker expects to reduce the size of the equity portfolio by around $2 billion in the next several years as part of the restructuring that is allocating more assets to private markets.

William Blair, DFA, and AQR have all seen the amount of money they manage for SFERS trimmed and Coaker has said that additional cuts could occur without improved performance.

Tags: Fidelity, Pension, San Francisco Employees’ Retirement System (SFERS), terminations

A newly formed legislative committee tasked with examining Kentucky’s pension problems will meet for the first time on Tuesday in hopes of solving the political impasse.

The bipartisan coalition, known as the Public Pension Working Group, is to determine pension reform suggestions to the General Assembly “up to March 30, and, if necessary, can meet monthly during the 2019 legislative interim through Dec. 30,” according to the legislature’s website. The team’s deadline for making its recommendations is Feb. 15, but it may extend that request through Dec. 1, as a pension overhaul may not occur in the year’s legislative session.

Pension reform is one of the most controversial topics in Kentucky going into 2019. Carrying a $40 billion-plus deficit, the state is badly underfunded due to poor contributions as well as its investment decisions during the 2008 financial crisis. At 41%, it is one of the worst-funded states in the country. Recent attempts to change the structure of the system to plug the hole have failed.

Last year, Gov. Matt Bevin tried to overhaul the pension system by shoving a pension bill into a sewage bill at the tail emd of the legislative session. It was passed the next day, beginning an almost immediate lawsuit from Attorney General Andy Beshear, who is now seeking to run against Bevin as governor. During 2018, the law that would have enrolled new Kentucky teachers in a 401(k)-style plan was struck down twice in both the high and low courts. Bevin called a special session in December, but that too was rejected by lawmakers.

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“Last year, the intensity level, the rhetoric level got to such a fever pitch that I think it was impossible for anybody to hear over that,” GOP House Speaker David Osborne told the AP, adding the importance of this year’s pseudo-“reset button.”

The 2019 legislative session started last week. When asked about what needs to be done, Sen. Robin Webb said there were some “ideological differences on each side as to what the definition of ‘fix’ would be” as well as which areas of the pension system carry the most risk, how the plans are funded, and their future structures, according to WEKU News.

Alice Foggy Kerr, a Lexington senator, said the group’s top priority is to identify asset pools to study the unfunded liabilities of the plans.

The 14-member Pension Working Group was announced by Kentucky lawmakers on Friday. The team, which consists of GOP Senate President Robert Stivers and Minority Leader Morgan McGarvey, has 10 Republicans. The panelists are evenly split between senators and representatives, with two Democrats from each chamber. No members of the House Republican leadership team are part of the unit.

Both Stivers and Osborne want the group to propose a bill that gets passed before the 2019 session ends on March 29. However, Osborne noted that there is the possibility of waiting until the 2020 session for a reform.

Waiting that long may cause more harm than good. As new retirees begin to collect their benefits each year, the fund creeps closer to insolvency. While returns have been decent for the Kentucky funds, there is also the notion from investment professionals that we are very late in the cycle, and a lack of contributions from plan sponsors to help shore up the pension system combined with a downturn could spell disaster for the funded status and the fulfillment of its promises.

Neither the Kentucky legislature nor the Public Pensions Working Group were able to be reached for comment.

Tags: Kentucky, Matt Bevin, Pension, Public Pension Working Group