By David G. Barry
As chief
investment officer of the School Employees Retirement System of Ohio, Farouki
Majeed would have preferred that the system had produced a positive result
for the 2021-22 fiscal year.
SERS, after all, had not shown a loss during his 10 years as CIO. But Majeed is
taking solace in how the negative 0.5% that SERS recorded for the year ended
June 30 stacked up against its benchmark and its peers.
“I’m obviously not happy to see that negative number,” he said. “But compared
to our benchmark policy of negative 3.6%, we had a very strong outperformance
of 3.1%. I have not had that level of outperformance in a single year. So even
though the return is slightly negative, from my point of view, the portfolio
performance was very strong because it was much higher than the benchmark
return.”
Additionally, SERS’ return far exceeded the median return of negative 9% for
pension funds.
Majeed credits the fund’s “escape” from worst numbers to being underweight in
equities and fixed income and getting strong results from its private equity
and real assets portfolios.
The results also illustrate that the moves Majeed has overseen over the past 10
years to enhance SERS’ investment performance are paying off.
SERS’ assets have risen from $10 billion in 2012 to $17.1 billion – a figure
that might have been higher if it was not subject to negative cash flow. The
system, said Majeed, paid out some $4.5 billion more in benefits than it
brought in from pension contributions. With fees, the system’s 10-year return
is 9.1% – almost 1% above its benchmark.
The system’s rank among U.S. pension funds also has risen significantly. In
2012, SERS ranked 48th among U.S. pension funds in one-year returns,
79th in three-year returns, 93rd in five-year returns and
73rd in 10-year returns. In 2022, it ranked 4th for one-year
returns, 4th for three-year returns, 3rd for five-year
returns and 2nd for 10-year returns, according to data presented by
Wilshire. Equally important, its funding ratio has risen from 68% to 74%.
“We’ve had value-added performance over the last 10 years,” Majeed said.
SERS’ efforts under Majeed have included moving away from hedge funds, adding
private credit and infrastructure as new asset categories, and increasing its
allocation targets to private equity and real assets. SERS also has added
co-investments to its private equity and private credit portfolios to reduce
fees, increased its passive exposure to U.S. equities, and implemented tactical
asset allocation and currency overlay programs.
Reaping the benefits of a “very supportive board,” SERS also has put in place
what Majeed describes as a “more rigorous and consistent” investment process.
“What we are most proud of in terms of accomplishing is that we’ve been able to
implement the plan that we submitted the board in terms of turning the fund
around in terms of performance,” he said.
In remarks to the SERS’ board in September, David Lindberg, a managing
director with consultant Wilshire said that SERS’ outperformance for the
fiscal year was due to asset allocation and manager value added throughout the
portfolio. He said that asset allocation added 100 basis points above the
benchmark.
Majeed arrived at SERS after serving five years as a senior investment officer
at California Public Employees’ Retirement System (CalPERS), where he oversaw
asset allocation and risk management. Prior to CalPERS, he had been CIO of the Abu
Dhabi Retirement Pensions and Benefit Fund for three years.
Seeking to once again be a CIO, Majeed said he thought that SERS – despite its
smaller size – provided “the most opportunity to make a real impact.” The fund
at that point had underperformed its benchmarks, was in some cases “bottom
quartile” when ranked against its peers,” Majeed said.
SERS’
executives, he said, “had aspirations to turn things around and I thought, ‘I
could make a good impact to turn around this fund – not only in performance but
some other things as well.”
Majeed said he also was drawn to SERS by a recently enacted governance
structure allowing investment decisions to be approved by a committee chaired
by the CIO.
Upon joining SERS, he developed a strategic plan aimed at improving performance.
The system’s hedge funds were a focus from the onset. SERS had set a 15% target
to the sector in 2010 and had, by 2012, an actual allocation of 10%.
But Majeed said that when he and his staff looked at the actual performance of
the hedge funds “it was nowhere near” the return assumptions and “obviously the
fees were very high.” Over time, he began to “educate” the board on this fact
and got their approval to reduce the target to first 10%, then 5% and
eventually zero by 2020.
Majeed, though, points out that a handful of the hedge funds have performed
well enough that they are still part of the fund, situated within the fixed
income and opportunistic portfolios. They are, he says, a “very small” part of
the total fund.
The capital that came out of the hedge fund portfolio was reallocated, in part,
to a new 5% allocation to private credit – a move that Majeed said has worked out.
Private credit, he said, has generated “much higher” returns and has lower fees
than the hedge fund index. Additionally, it also has delivered something that
hedge funds don’t produce consistently: cash distributions. Because of the
fund’s negative cash flow situation, the “income was important to us,” he said.
SERS’ private credit portfolio largely consists of managers investing in the
loans of small and middle market corporations – as opposed to loans for private
equity-sponsored deals. Majeed feels comfortable with SERS’ managers in the
current environment, pointing out that they have a loss ratio of less than 1%.
In addition to private credit, SERS over the past 10 years also has added
infrastructure to its real assets’ portfolio, which also includes real estate. The
target allocation for real assets was increased from 10% to 17% and is
currently at around 20%. Infrastructure is now 25% of the real assets’
portfolio, or 5% of the total fund. SERS has put capital into such areas as
transportation and energy.
Infrastructure is an area that he says he feels confident in and likes because
it too often produces a yield in the form of distributed cash.
Some of the transportation assets – airports and toll roads, for example – that
“came under some pressure” during the COVID-shutdown period have “recovered
quite well” and SERS, he said, “will continue to look for new opportunities to
expand our portfolio.”
SERS, like many other public pension funds, also has increased its private
equity target over the past three years, going from 10% to 12%. However, unlike
many other pension funds, SERS is not overallocated. It also is a self-funding
program, utilizing distributions to handle capital calls.
SERS’ private equity portfolio generated a one-year return of 34.5% for the 2021-22
fiscal year and has produced a 10-year return of 19.5%. As a result of those
returns, SERS was ranked among the top 10 institutional investors in private
equity by the American Investment Council, a private equity industry trade
group.
SERS’ private equity portfolio largely consists of funds investing in middle
market and small companies.
“The strategy is primarily oriented toward enhancing the growth of the
companies’ earnings,” Majeed said. “It’s adding value through operational
management and operational improvement at the company level and that’s worked
out well for us.”
SERS has steered clear of the “very large private equity funds,” he said,
because those funds seem to be more focused on executing a “financial-engineering-type
strategy” by acquiring large companies and “re-arranging the balance sheet.”
Majeed knows that the valuations of its private equity holdings will likely see
a “downward adjustment” in the coming quarters but still sees the segment as
producing returns that are “significantly higher than our public equity
return.”
Going forward, Majeed does not see SERS making any significant changes to its
asset allocation targets.
“The concern, of course, is to make sure that we have a portfolio that can
weather the sort of environment that we are entering: high inflation, slowing
growth and so forth.”
He expects returns to be “much lower” than they’ve been over the past five to
10 years.
“I’m just looking to make sure that we continue have value-adding performance
relative to the benchmark,” Majeed said.