SFERS Hires Select Equity Group for $500 Million Portfolio

The New York City firm is selected to manage an international portfolio even as other international equity strategies are being trimmed of their assets. 

The board of the $24.5 billion San Francisco Employees’ Retirement System (SFERS) has unanimously approved a $500 million allocation to Select Equity Group as part of a restructuring of SFERS public equity portfolio.

The commitment of $500 million to New York-based Select’s Baxter Street strategy, which primarily focuses on international stocks, comes as the system has reduced allocations to three other underperforming international strategies: the William Blair international growth strategy, the DFA international small cap strategy, and the AQR international strategy.

William Blair, DFA, and AQR were also added to the system’s manager under review list at the board’s Dec. 12 meeting.

A video stream of the meeting and system documents show that Select Equity Group was hired following recommendations of the system’s investment staff and its general investment consultant, NEPC.

“This is the No. 1-rated manager by NEPC,” Allan Martin, a NEPC consultant, told the SFERS board. “We have known them for a long time.” Martin said the firm offers a diversified investment approach and isn’t afraid to hold large amounts of cash when it feels the market cycle isn’t opportune.

The Baxter Street strategy, managed by portfolio managers Chad Clark and Matt Pickering, looks for companies with “predictable and growing streams of cash earnings, strong or improving results on invested capital, and sustainable competitive advantages,” said a Dec. 12 SFERS investment staff memo.

The concentrated $7 billion-plus strategy of 30 to 60 stocks has been closed to new investors since the third quarter of 2017, but the investment staff memo shows that the San Francisco system had been on a waitlist that is opening up due to other client redemptions.

The staff memo says Baxter Street’s research on companies is almost entirely independently generated, and portfolio managers and the firm’s investment staff aim to know companies they invest in, “better than anyone else.”

The approach has led to long-term strong performance since the strategy was launched in 2012, the SFERS report said. Since 2012, it has returned 8.9% on an annualized basis, net of fees, beating its benchmark, the MSCI All Country All World ex-US index, along with the performance of others international managers in the SFERS portfolio.

The staff memo also noted Baxter Street’s ability to protect in down international markets. For example, in the 12-month fiscal years ending June 30, 2014, and June 30, 2015, Baxter Street produced results of -1.2% and 3.2%, respectively, while the benchmark performed returns of -3.9 and -5.7%, respectively.

The investment strategy has a large focus on consumer-oriented companies, generally avoiding the tech sector because the product lifecycle is unpredictable, the SFERS report said. It said the firm also avoids regulated industries likes banks and pharmaceutical companies, SFERS investment staff said.

The overall firm running the Baxter Street strategy, Select Equity Group, has a unique history, the memo says.

It notes that the firm was founded in 1990 by George Loening  at the age of 23. Loening’s mother seeded the first $70,000 strategy.

“Loening was interested in finance from a young age and made his first purchase in the stock market (Mary Kay Cosmetics) at the age of 12,” the report said. “In high school, Loening ran an equity market newsletter with more than 100 paid subscribers.”

The firm also ran its own research arm that sold information to 20 of the top 35 asset managers but shut down the unit in 2000 to concentrate solely on asset management, the SFERS report said.

The SFERS report also highlighted Select’s use of a 13-person qualitative field research team. “They are typically ex-business or investigative journalists who are responsible for extensive channel checks beyond the work done by traditional analysts. The quantitative research team has grown steadily in recent years and has become a critical component of SEC’s research process,” the report said.

SFERS has a more than $8 billion equity portfolio but it has been restructuring and reducing the portfolio as part of an increase in hedge funds and its private markets portfolio.

Public equities are now 35.9% of the overall portfolio, down from 48.3% in October 2016, when the board approved asset allocation changes. The San Francisco plan’s target allocation to public equities is 31%.

Last months, SFERS officials disclosed the AQR international strategy was down to $612 million after a $100 million reduction in June 2018. 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.

The third investment strategy, the DFA international small cap strategy, was down to $367 million as of Sept. 30, following reductions by SFERS staff of $100 million in March and $100 million in June

SFERS staff had said the strategies could be trimmed further if performance does not improve.

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