Tuesday, August 19, 2014

Moving Around the Pieces: San Diego County Rejiggers Its Asset Allocation -- Part 2

Moving Around the Pieces: San Diego County Rejiggers Its Asset Allocation -- Part 2

How did San Diego County Retirement System let their external strategist, Salient Partners, run two dynamic strategies (risk parity and trend) for its pension plan?  Was it Salient’s track record?  It doesn’t seem likely, since Salient hasn’t been managing these types of strategies for very long.  Salient’s more established product, the Endowment Fund, has had a host of well-publicized problems over the years (see, “Overweight Duck:  The Laden Version of the Endowment Model” [October 30, 2012]), so it can’t be an endorsement for this mandate.[1]

SDCRS has been through more than its share of investment turmoil.  During the tenure of David Deutsche, its last CIO, the pension suffered major losses in a couple of hedge fund investments (Amaranthe and WG Trading).  Six months after Mr. Deutsche’s departure in March 2009, SDCRS decided to engage an external strategist and hired Integrity Capital, a new firm founded by Lee Partridge.  Mr. Partridge had just resigned as the deputy CIO at the Teacher Retirement System of Texas.   He entered into a contract with SDCRS.  The utilization of an outsourced investment officer isn’t all that unusual, especially among smaller pension and endowment plans.

Within a year Mr. Partridge sold his fledgling firm to Salient Partners for an undisclosed price.  At that point, he still seems to have had only one client.  In acquiring Integrity, Salient touted Mr. Partridge’s turnaround of the SDCRS’s pension plan.  While Mr. Partridge may have taken some positive steps, as best I can tell most of the improvement in performance was due to the sharp rally in the financial markets.  Salient also touted the cost savings created by Mr. Partridge.  It looks to me like he simply fired some of the hedge fund managers hired by Mr. Deutsche.

Doing business as Integrity, Mr. Partridge generated $762,000 in fees from SDCRF in fiscal 2010.  In Salient’s first year of ownership the fees jumped to $1.05 million and to $1.7 million in 2012.  By 2013, Salient was generating $4.7 million in fees from its relationship with SDCRF, and that was before the recent revision in the pension’s strategy, which should be extremely good for Salient’s bottom line.  According to Pensions & Investments, Salient now earns about $10 million in fees.

Normally, internal staff analyzes a potential investment opportunity.  However, in this instance, Salient proposed an expansion of its own role.  It would seem that there’s a lack of checks and balances.  SDCRS hired Wurts &Associates about a year ago, and they blessed Salient’s management of the new strategies.  I am sure Mr. Partridge and Salient were instrumental in getting SDCRS to replace Hewitt Ennis Knupp with Wurts.   Thus there is no way that this consultant can objectively evaluate Salient or the new strategies. As a result, I’m a big skeptic about the independence of Wurts’s work product.  Moreover Wurts’s presentation to the SDCRS’s board of trustees is less than convincing.  While Wurts compares Salient to a series of other managers over extended periods of time, the analysis is pretty shallow.[2]  The most telling part of the presentation is Wurt’s footnote at the bottom of every chart:

All managers [sic] returns are net of fees except Salient returns that are gross of fees.  BlackRock and First Quadrant are actual starting from 9/2013.  Bridgewater returns are actual starting from 6/2006.  Salient are actual starting from 3/2012.  All other returns are simulated by the managers.

In Wurts’s analysis, Salient is being given an unwarranted advantage by using gross versus net performance for Salient’s returns.  In addition, all the return and risk analysis is next to meaningless as it based on self-serving back tests.  Interestingly, Wurts does a detailed presentation on the fees charged by other managers.  Only Salient’s fees are excluded from the analysis.

SDCRS is making a big bet on Salient.  Sadly they haven’t created the checks and balances to properly monitor the relationship.  Moreover, they’ve eliminated a great deal of transparency by allowing Salient to manage the new dynamic portfolios outside of public purview.

[1] Lee Partridge is the CIO for the Endowment Fund.  He replaced Mark Yusko of Morgancreek.  Mr. Partridge also manages a series of small mutual funds that utilize alternative strategies.
[2] http://sdcera.granicus.com/MetaViewer.php?view_id=2&clip_id=530&meta_id=57606

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