San Francisco Continues to Reduce Equity Portfolio

Dimensional Fund Advisors is the latest manager to be fired by the SFERS board due to performance issues for two of its investment strategies.

The board of the San Francisco Employees’ Retirement System (SFERS) has terminated two investment strategies run by Dimensional Fund Advisors (DFA) due to poor performance as it continues to restructure and reduce its more than $9 billion equity portfolio.

The reduced commitment to stocks is part of an aggressive plan by SFERS Chief Investment Officer William Coaker Jr. to make the San Francisco system less dependent on public equities in order to reduce the effects of a major stock market downturn. Since October 2017, the SFERS equity portfolio has been reduced from 41% of the portfolio to 35.7%.

Coaker plans to get that down to 31% of the overall portfolio in the next year or so. While reducing equities, Coaker has also been building up alternative assets like private equity. The system’s $4.9 billion private equity portfolio now makes up 19.8% of the total portfolio, up from 13.4% in late 2016.

In the last three years, he has also built a hedge fund portfolio from scratch, which now stands at more than $3 billion, or more than 13% of the portfolio.

As equities are reduced, poor performing managers are getting the axe.

Both DFA’s small cap US value strategy and its international small cap portfolio were terminated by the board at its March 13 meeting, a video stream of the meeting shows. SFERS had $197.7 million invested in the small cap US value strategy and $330.7 million invested in the international small cap portfolio.

The  international small cap strategy has been under review by the pension system’s investment staff. The board of the $25.1 billion pension system had cut the allocation to the international strategy by $100 million in March 2018, and another $100 million in June 2018. The US strategy has not been formally under review, but agenda material for the March 13 meeting show that starting in November 2017, SFERS investment officials began to reduce the size of the strategy, which totaled almost $400 million, by $175 million.

SFERS performance numbers show that the DFA small cap US value strategy had returns of -6.6% for the one-year period ending January 31 versus -4.6% for the Russell 2000 index. For the three-year period, the strategy had a 11.8% return versus the benchmark’s 13.8%. For the five-year period, the DFA strategy returned 6.1% compared to the benchmark’s 6.6%.

The DFA international small cap strategy also had performance issues. It had a -17.1% return for the one-year period ending January 31 compared to the MSCI World ex US small cap index’s returns of -15.1% for the same time period. For the three-year period, the strategy returned 8.6% compared to the benchmark’s 9.6% return, and for the five-year period, the strategy returned 3.9% compared to the benchmark’s 4.3%.

“DFA’s overweights in the energy and industrials sectors also detracted heavily from performance,” shows a SFERS review of the international strategy contained in the March 13 agenda material. The material also noted that the international strategy missed out on the best-performing stock market segment in the fourth quarter of 2018, real estate investment trusts (REITs). It noted that the strategy had no REIT investments.

SFERS’s general investment consultant, Allan Martin of consulting firm NEPC, said he and the firm were in agreement with the terminations. He said NEPC recommends several of DFA’s investment strategies, but not the ones SFERS was invested in.

DFA, based in Austin, Texas, uses a factor-based approach to investments, aiming to enhance index returns through adding investment factors, such as weighting portfolios to smaller and value companies.

 Coaker told the board that the terminations were in line with a “systematic” reductions of the system’s equity portfolio but did not publicly talk about the performance issues at DFA, though SFERS reports in the March 13 agenda material spelled out the performance issues.

Just two months ago, the SFERS board terminated money manager Fidelity Institutional Asset Management’s select international small cap equity strategy due to underperformance relative to its benchmark and other money managers. SFERS had $174.5 million invested in the strategy.

In December 2018, SFERS officials disclosed the AQR international strategy was down to $612 million after pension system officials made a $100 million reduction in June 2018. Meanwhile, officials said the  William Blair international growth strategy was down to $360 million, after a $150 million reduction in March, a $100 million reduction in July, a $50 million reduction in August, and a $50 million reduction in October.

Both the AQR and William Blair strategies remain on SFERS watch list.

Another equity manager, Advent Capital Management and its $239 million balanced convertibles strategy, remains under watch because of poor performance, shows SFERS agenda documents from the March 13 meeting. The money manager could be subject to future action as the equity portfolio continues to be reduced, the documents show.

Despite the reductions in the SFERS equity portfolio, the board did hire a new manager in January, Select Equity Group. It approved a $500 million allocation to its Baxter Street strategy, which primarily focuses on international stocks.

So far, in the fiscal year that ends June 30, 2019, Coaker’s restructuring seems to be paying off. While some pension plans are seeing negative returns, he reported at the March 13 meeting overall returns of 3.3% for SFERS.

Coaker said while equities at the pension plan in the eight-month period through February 28 saw a 0.47% return, private equity returned 11.26%. SFERS modest returns aren’t being helped by the hedge fund portfolio. The portfolio posted a 0.23% return in the first eight months of the fiscal year through February 28.

Coaker has argued that the portfolio is still a good bet, because it is defensive in nature and should do better in case of a major equity freefall.

Related Stories:

SFERS Hires Select Equity Group for $500 Million Portfolio

Fidelity International Small-Cap Strategy Terminated by SFERS

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