How One Small Pension Fund Added $1 Billion in Value
The $10 billion San Bernardino County retirement fund claims it found an “incredible source of alpha.”
In 2006, the San Bernardino County Employees’ Retirement Association made a decision that it credits with adding nearly $1 billion to its portfolio over time.
The fund did not hire a particularly talented manager or bet big on a hot new asset, but rather improved its investment process — specifically, how its nearly $10 billion portfolio gets rebalanced.
Rebalancing is a necessary aspect of institutional investing, the means of ensuring the actual makeup of a portfolio matches its target allocation. But it can be costly: sell equities on a down day, and those losses are locked in.
Arun Muraldihar, whose firm AlphaEngine Global Investment Solutions advised SBCERA on its rebalancing revamp, explained the asset allocation problem by comparing it to a drunk driver swerving down the street with only the guard rails on either side of the road to keep them on course.
“When these funds approve an asset allocation — let’s say they approve a 60/40 portfolio — the board gives them permission to let it drift to 65 on the high end and 55 on the low end,” he told Institutional Investor in an interview. “But just letting a portfolio drift between the guard rails is bad governance.”
By adopting a more strategic method of rebalancing, Muralidhar said, allocators like the San Bernardino County pension can tap into what he described as an “incredible source of alpha.”
Other institutions have gotten tactical with asset allocation, such as the Verizon Investment Management Company, the General Mills corporate pension fund, and the New Zealand Super Fund, Muralidhar said.
SBCERA’s “informed rebalancing program” launched in 2006. Since then, the program has added an extra $965 million to the portfolio, or about 1.25 percent in additional returns annually, according to a case study by fund CIO Donald Pierce, Muralidhar, and AlphaEngine co-CIO Sanjay Muralidhar.
“Instead of letting a portfolio aimlessly drift until some happenstance trigger occurs, a clearly identified staff member was tasked with taking ownership of the asset allocation decision and making adjustments in an explicit, rules-based, and informed manner,” they wrote.
The rules for portfolio rebalancing were based on peer-reviewed academic research, and focused primarily on asset valuations. Under this regime, decisions “were not arbitrarily triggered, but rather provided staff’s best estimates of which assets were over/undervalued and in turn, over/underweighted within the board-approved ranges,” according to the paper.
“In a way you’re building a GPS for the portfolio,” Muraldihar explained. “In this era where CIOs are struggling to meet their target returns, this is an untapped opportunity for CIOs who are willing to be innovative and creative enough.”