Allocation Implementation in a Challenging Investment Environment

Donald Pierce has been with the San Bernardino County Employees’ Retirement Association’s investment team since 2001, working directly with the board on developing policy and investment goals. Since taking over as CIO in 2010, Pierce has implemented investment strategies including international private equity, emerging market debt and option-based strategies to the fund’s matrix of investments.

The $13.4 billion pension fund has a lower equity exposure in comparison to many of its peers. In addition, the pension fund recently reallocated to increase U.S. equity exposure up to 17% of the portfolio, while reducing exposure to emerging market debt and international developed market equities. “The outcome of any particular asset allocation is the result of evaluations of market opportunities and the ability to implement those changes,” said Pierce during a CIO webinar on September 20 hosted by Executive Editor Amy Resnick.

The conversation was the latest in CIO’s Allocator Insights series. You can access a recording of the entire conversation here. 

The SBCERA portfolio is diversified across various asset classes and investment vehicles. “While diversification is wonderful,” Pierce said, “it is one of the least compelling reasons to make an investment.”

Pierce gave a broad overview of the fund’s asset allocation: “Collectively, public markets make up 30% of the allocation. We have a fairly large positioning of 18% to private equity, and an allocation to real assets, most of which is in the commodities space. But we also have infrastructure … mostly concentrated in energy-related MLPs. Real estate comes in at 5%, while our global fixed allocation is mostly credit and our international core allocation is zero, which we adjust based off sentiment, and that is one of the ways we keep our duration low. We have 15% in U.S. fixed, mostly in credit, with a 2% allocation to core. We also have exposure to credit hedge funds which we call absolute returns.”

Pierce also identified prospects in commodities. “The physical infrastructure of the commodity complex has been underinvested for 20-plus years,” he said. “We have seen a lot of investment in services and finance, but precious little in smelting and other physical commodity mechanisms.”

Not having a fully invested portfolio is an important feature of asset allocation, according to Pierce. “We have an allocation to cash, which is an area we often rely on and use to opportunistically add to positions; we tend to be not fully invested. We see cash as having option value, and we like to wait for prices to come to us and then deploy our cash,” he said.

Pierce continued, “Poor cash gets no credit because up until recently it had a yield of close to nothing, and whatever it bought gets all the credit. The cash that facilitates a return gets denigrated by the lack of interest rates. What we don’t like to do is rely entirely on the market for liquidity. When times get tough, even Treasurys can be found to be tough.”

SBCERA is an income-focused plan, which emphasizes positioning in the fixed-income credit sector as opposed to price-change strategies. “We are constructive on CLOs and in particular BB and B assets, so the things that are benefiting from a floating-rate instrument we are definitely interested in adding, and have been, ” Pierce said.

The pension fund has an assumed rate of return of 7.25% and the plan is just over 81% funded. Its 2021 return was 33%, which Pierce said is a performance they will struggle to match in this year’s tougher investment environment. As for an outlook on 2023, Pierce said, “there is going to come a price where the stock market is quite interesting and attractive and you can make good money. I’m just not sure in the face of a tightening cycle with the Federal Reserve that it is the right time to do it.”

When asked about what concerns he has about the current economic and investing climate, Pierce noted that it is commonly accepted “that the Fed, in raising interest rates, will cure the problem of inflation, and that is a very demand view of the world. In a too-much-money-chasing-too-few-goods issue, where the part that is the problem is the too-few-goods part, interest rates do not strike me as a particularly apt way to with the issue. So, what I am concerned about is that all this tightening is for naught, and you get supply constraints because higher interest rates make it even more expensive for fixed-cost producers to produce their widgets. It is a concern that this experiment that we have embarked upon doesn’t actually work.”