A quest for alpha at the San Diego County Employees Retirement Association is being redefined in hopes of reversing recent enormous portfolio losses. The fund’s “alpha engine,” first assembled in 1998, is set to shrink this year to 14 percent of the portfolio from 19 percent.
Chief investment officer David Deutsch says some of the 16 hedge fund investments that make up the portable alpha program will be either liquidated or moved to other parts of the $6.2 billion portfolio.
Deutsch, who has been CIO since February 2004, is looking for positive performance wherever he can find it. He has devised a “beta engine” to pick up incremental return that, in less stark times, might have been overlooked. The new scheme will allow rapid shifts of up to 5 percent of the portfolio between asset classes as market conditions dictate. The beta engine will run on futures contracts rather than on bought and sold securities, which will keep the fund within its investment policy guidelines. This method is more liquid than trading in actual securities. Although labeled as a beta engine, Deutsch says it should beat the market: “The gains that we get from this allocation device are alpha — excess return on some skill.”
Every little bit helps. From its August inception through the end of December, the beta scheme produced 30 basis points of return, or $27 million, for the pension portfolio. The fund’s main engine — a portable alpha program created to juice returns by “porting” the alpha of hedge fund managers onto the returns of the Standard & Poor’s 500 index — was called into question after the market crash proved disastrous for the strategy, requiring San Diego to make huge payouts to swap counterparties. At year-end the pension fund had lost $2.2 billion of its June 30 value of $8.4 billion.
This isn’t the first hurt the Mission Valley, California–based fund has endured. In September 2006 it said good-bye to most of its $175 million investment in Amaranth Advisors when the once–$9 billion firm lost some two thirds of its assets to a bullish bet on natural gas. Deutsch responded by redoubling his commitment to the alpha engine. The county added two new investment staff members to the team of four, one devoted to the hedge fund portfolio and the other to risk management. It also hired two new investment consulting firms after Rocaton Investment Advisors — which had recommended Amaranth — was fired in late 2006. Hedge fund specialist Albourne Partners in London and Chicago-based generalist Ennis, Knupp & Associates now split advisory duties at SDCERA.
A month before the Amaranth meltdown, a San Diego civil grand jury found the county pension fund to be underdiversified. As a remedy newly hired Albourne recommended doubling the hedge fund allocation from eight to 16 managers.
