CIO Roundtable (Part 2): Alternative Investment Performance in an Alternative Environment

Bill Coaker, CIO of the San Francisco Employees’ Retirement System: We have a low net cash outflow for planned benefits of 2.0% of plan assets. That allowed us a larger allocation to long-duration, private markets assets, but over the next five years, our pension benefit payments will double. We are on a path toward becoming an older, more mature plan. 

Thus far, we’ve been able to be an equity-oriented plan because our net cash outflow is quite low. The current crisis probably results in much lower distributions from private markets. As a result, not right away but on a glide path, we may need to make some changes to enhance income and cash flow certainty. That said, the investment themes we have emphasized—technology, software, the digital economy, mobility, biotech, and innovation—these themes remain in place, and I think the current crisis accelerates their arrival.

Ash Williams, CIO of the Florida State Board of Administration: They’re doing exactly what they ought to be doing, which is protecting value when global equity is under stress. So, we’re happy with that.

And depending on how you define alternatives, hedge funds and quantitative strategies, for example, are low correlation strategies. Those have generally done their job as diversifiers. If you go a little bit further and throw in private equity and real estate, which I think are more mainstream than alternative these days (some would call them alternative), I think there are going to be longer-term opportunities in both of those areas as well. There will also be some short-term dislocation and pain because there’s been an interruption in cash flows. But if you think about how that could work, it could be a positive, longer term.

Big issues that private equity investors have wrestled with in recent years include high asset prices and increasing leverage. These inherently increase the risk to future returns and push them lower. There has also been a tremendous overhang of dry powder in committed but uninvested capital in the private equity industry. To the extent asset prices come down, it makes the acquisitions easier. There’s enough capital out there and at lower prices, [so] the need for leverage to achieve desired returns declines. So, the risk overall goes down, and the committed but uninvested capital overhang could be reduced.

Scott Chan, deputy CIO of the California State Teachers’ Retirement System: Sure, we have the risk-mitigating strategies asset class, which is roughly 10% of our portfolio, and includes some alternative asset classes, like CTAs and global macro. It also includes long-duration bonds.  We’ve been on the margin, a little bit of a seller there, to raise cash and think about some of the other upcoming opportunities we’re likely to see. The big question is when we will take more profits and look to rebalance into growth assets.

On the alternative assets side, like private equity and real estate, or our innovation portfolio and infrastructure, like Ash, we think they’re doing exactly what we hope, providing some diversification. At the same time, it’s a bit too early to be doing anything because the questions are how deep and what is the extent of the damage. Right now, as of late March, I’m hearing from our asset classes that we’re not seeing very much. People are trying to re-trade downwards to new asset prices, but there are not a lot of takers. I think folks are waiting to see whether they’re going to need to sell an asset at a much-discounted price.

For these areas, we take very much a bottom-up approach. It’s really company by company and transaction by transaction. There’s going to be some opportunities, but it really depends on the scope of the damage, and that’ll dictate the valuation and the discounts we’ll get. But I think we’re in a good position to take advantage of that. We’ve got dedicated teams and experts in each of these asset classes. We have partners. In some cases, we own the asset managers, so we have even more control. But right now, it’s wait and see because I don’t see a lot of large discounted transactions yet. However, it’s looking like, depending on the extent of the damage, we will see opportunities materialize.

Jonathan Grabel, CIO of the Los Angeles County Employees’ Retirement Association: Sure, I’ll pick up on something that Ash said, which is the fact that alternatives are pretty traditional at this point. I think that this is probably true for all of us that we do not view alternatives as unique or remarkable in 2020. At LACERA, we try to express an investment through the lowest-cost, most-liquid, least-levered, and most-transparent way possible, all other things being equal.  For example, if the public equity markets do not afford us the type of exposure we seek in a sector or in a geography, then a private equity vehicle may be the most appropriate structure.

We do not look at alternative assets as a discrete strategy or allocation. That is too simple and not much different than saying that we look at investments. Putting aside the nomenclature, of course we invest in strategies that some call alternatives. But we do it for reasons that are a couple of levels deeper than just using simple words to justify high fees.