By David G. Barry
Rodney June has been chief investment officer of the Los Angeles City
Employment Retirement System for the past 10 years. One of three city of
Los Angeles pension plans, LACERS serves the city’s civilian employees
and has about 47,000 members – one of whom is June. During June’s time as CIO, the
pension fund’s assets have doubled from $10.6 billion to $22 billion. For the
fiscal year ended June 30, 2021, the plan generated a 29% return. A big reason
for those numbers was the 55% return it saw from its private equity program. In
an interview with Markets Group, June discussed his path to becoming a
CIO, LACERS’ investment strategy and the steps he’s taking to prepare the fund
for a changing environment.
Markets Group: Rod, describe if you would, your path to becoming a CIO.
Rod June: My educational background is in business and finance. Coming
out of graduate school, I first started working as a management consultant for
small businesses across the U.S., but travel got to be too much. So, I decided
to find a job that was a little bit more stable in terms of where I would be
from day to day, decided to explore government work, and was hired on as a
management assistant with the City of Los Angeles. Eventually I moved over to [LACERS]
as an investment officer. I did that for about 10 years from 1998 to 2008…and after
10 years of working in the industry, I felt that I was able to lead an
investment program. So, I started looking around for a CIO position, and lo and
behold, the State of Hawaii Employees Retirement System (HIERS) was looking for
a CIO, so I threw my hat in the ring and, very fortunately, was able to secure
that position in 2008.
MG: Describe that first role?
RJ: That was a really challenging moment in my life
because I’d never been a CIO. I did find that the work, responsibilities, and
accountability were much higher than those
of an investment staffer. My plan was to stay at Hawaii for five to 10 years,
but then my previous boss at LACERS, who was the CIO, retired and eventually
that position opened up. And I thought this is probably a great time for me to
get back to California, go back to a plan that I really know, understand, and
love. And very fortunately, I did get that position in 2012.
MG: How did your background prepare you to be a CIO?
RJ: What was helpful was that in working for a smaller plan like LACERS,
I was able to work in a lot of different asset classes. There were only three
investment professionals. So, when you consider becoming a CIO, you really have
to have that breadth of working across different asset classes and understand
how they work, so that was very helpful. I think it can be harder for people
who are in a larger public pension plan or any large organization where they
can get pigeonholed into an asset class and may not be able to move around from
asset class to asset class. Without that breadth and experience, I think it
would be more difficult and challenging to move up. But of course, there’s
other skills just besides working in asset classes: you have to be a great
leader, a great manager. I think those who have those skills can certainly help
you move up to a CIO position.
MG: What does it take to be a public pension CIO, i.e.,
dealing with diverse boards and a range of questions.
RJ: Yeah, that’s a great question. I would say first
that to be an effective CIO, you have to be a good people person and you have
to enjoy communicating with people who have diverse points of view who have
different desires and needs, and things that they would like to see in the
plan.
But for a public pension plan [CIO], I think it’s probably
more challenging because of public disclosure laws. And with the meetings – at
least here in California – being open and anyone being able to attend, either
virtually or in person, one has to be very artful in how one communicates with
the board when other people are listening. Because while the board may
understand what you’re saying because they have a context to work with,
somebody who walks into a board meeting who hasn’t heard the topic before might
misunderstand what is being presented, what the recommendation is, so one has
to ensure that there’s enough context provided through that communication
process for the benefit of the stakeholders and those who are listening in so
that they understand what’s going on, are sort of brought up to speed on what
staff is recommending, and what the board is ultimately approving. Some of
these decisions are multimillion or multibillion dollar decisions so we have to
be very artful about how we communicate. And I think that’s a big part of being
an effective CIO.
MG: Discuss how LACERS’ investment strategy evolved
while you’ve been CIO.
RJ: It’s certainly changed. It [originally consisted of] U.S. public
equities, non-U.S. public equities, fixed income, private equity, real estate,
and cash, and the strategies were very straightforward, nothing complex, no
derivatives, just very straightforward, simple to understand strategies. [And
then] I left for Hawaii, and when I came back in 2012, the plan still hadn’t
changed [its asset allocation]. It had maintained its asset allocation and its
exposure…simple, easy-to-understand strategies. But it became more challenging
after the great financial crisis…it was harder to identify places to generate
alpha. We had to do a lot more homework to get those returns…we had to start diversifying
while we maintained a core presence. We started looking at emerging markets,
increasing private equity; and we now have a private credit allocation, with
high-yield bonds and bank loans.
MG: How did the events of 2008 drive this change?
RJ: We wanted to generate alpha, but also to enhance our diversification
so that we wouldn’t get into a situation like we found ourselves in during the
great financial crisis where many plans like LACERS had an overexposure to U.S.
public equities. There has been a trend
here at LACERS to reduce that type of exposure and to become better
diversified. So, when we get into situations like what we find ourselves in
today with a higher inflation, interest rates going up and geopolitical events,
that no one part of our portfolio takes an enormous hit. So, diversification
has been a really important part of that. But we’ve also increased the risk of
the plan.
MG: And going forward?
RJ: Certainly, with the great returns we had through 2021 the funded
status actually increased a lot, but I do think that’s going to drop over time.
So, I don’t want to say we’ve “chased returns,” but we’ve had to find new
strategies that we think can generate more alpha, and that’s why we’ve gone
into some of these strategies like high-yield bonds, greater private equity
exposure, private credit—because those all return higher levels of performance
versus just plain old U.S. public equities. But it’s not to say that we are neglecting
any one area over the other. We’re
trying to take a very balanced approach and ensure that we’re not putting all
of our eggs in one basket. I know that sometimes is a cliche that’s overused,
but it’s really true: diversification is essential to what we do for any type
of large institutional investment program, and we’re constantly seeking ways to
diversify and then also find new opportunities out there.
MG: What was the percentage of U.S. public equities
when you joined and what is it today?
RJ: Our U.S. public equities when I joined was over
30%. I want to say it was somewhere between 33% and 38% to U.S. public equities
but that has since dropped down to 15% in (U.S.) large cap and we have a (U.S.)
small cap exposure of 6%. So, we’ll say 21% is our policy target. So that’s
quite an enormous decline over those number of years. But we’ve seen a lot of
other public pension plans do the same thing. I can’t say that we’ve got the corner
on what is the best course of action. Most consultants look at the capital
market assumptions, and they all pretty much use the same process to come up
with an asset allocation for their clients. And I’ve taken a look at many other
plans, and everyone has started to reduce their public equity exposure but we’re
doing what’s in our best interests and we’re not trying to copycat others.
MG: Why do you avoid copycatting?
RJ: We think that our plan is a very unique and we have unique
circumstances. We have a unique set of board members who care deeply about our members,
and we have a certain risk-reward profile that we’re trying to achieve in order
to get to our assumed rate of return. So, we’re doing what’s in our best
interest; and I don’t necessarily like looking at what CalPERS (California
Public Employees’ Retirement System) is doing or what the State of Wisconsin
(Investment Board) is doing. We’ve got
some smart people both on our board, our consultants and staff, and we’re able
to figure out and chart our own course to fulfill all of our financial
objectives.
MG: LACERS’ allocation to private equity has increased
under your leadership. Talk, if you would, about how you view the sector and
how you’ve sought to invest more heavily in it.
RJ: Certainly. When I started at LACERS many years ago, our target
allocation to private equity was 6% and it was a relatively new asset class; we
had only been doing it for about three years and the market was much smaller
back then; there was less transparency. We know that private equity in general
is somewhat opaque, but I think back then it was even harder to understand what
managers were doing. But over time, we increased our allocation upward from 6%
to 7% to 8%. Then, we moved to 10%, 11%, 12%, 14%; now we’re at 16%. Why have
we done that? We need [higher] returns to achieve our assumed rate of return
and putting all of our money just in emerging markets or U.S. public equities
or high-yield bonds is not going to allow us to achieve our 7% assumed rate of
return. So, we have to get exposure to those assets that can return a higher
performance than other assets, and we know that in the capital markets, the
assumptions change over time. Public equity and fixed income assets
particularly are hardly earning anything out there. But private equity by and
large is still a very good place to be if you’re willing to give up some of
your liquidity. If you have the luxury to lock in your assets for 10 to 15
years, which we are able to do here at LACERS, it’s a good way to get that type
of return, but it is our highest risk asset class, and we understand that. So,
we’re very prudent about how we construct our portfolio.
MG: And how do you think about constructing such a portfolio?
RJ: In private equity, we’re constantly asking all kinds of questions
about where we should be invested, what sectors [to be in] and geographically
where we should be. Fifteen years ago, a consultant would bring us a fund
opportunity and we never questioned it much. We looked at the due diligence
report and we signed off on the documents. It’s a far cry from that now. We
spend a lot of time looking at the deal. We do use a consultant, but there are
cases where even my staff will conduct independent on-site due diligence of a
private equity general partner. Before we invest, we’re much more engaged now
than we ever have been, and that’s something I’ve really pushed for. I do respect consultants. I think they’re
very valuable, and they can bring great opportunities to clients, but they have
a certain business model that they follow, and they don’t really know all of
the nuances of the [LACERS] plan. My staff knows what our needs are at LACERS
with our board and what would not resonate well with the board. We try to
factor that into the process. We use a consultant and staff discretionary
[private equity] policy, so staff and the consultant get to make private equity
decisions within certain guidelines, and we don’t have to go through an
investment committee or a board before we make the commitment. That’s allowed us a lot of flexibility and
opened up more opportunity where we could move quickly to get into some of the
best funds and not have to be on the sidelines or miss out on opportunities
because we took too long to sign on the dotted line.
MG: What percentage of the private equity allocation
is venture capital?
RJ: It’s about 15% to 18% to venture capital. It has changed over time. Leading
into the pandemic, we were much more bullish on venture. Now, given what we’re seeing
out in the marketplace, we’re a little bit more cautious. That doesn’t mean
that we’ve stopped allocating the venture, but we’re very picky. I would say
that my staff and I scrutinize every venture capital fund that comes our way to
ensure that it truly is the right fit.
MG: You mentioned that 16% of your allocation is in private equity and
21% is in U.S. equities. Do you see a day where private equity could be equal
to U.S. equities?
RJ: I don’t see that happening in the next 10 years, at least in part
because as a public plan, we have to pay our benefits every month, and there’s
a certain degree of liquidity that we need to maintain. And of course, when you
are in the private markets, and that could be private equity or private real
estate or private credit, you’re locking up your money for seven, 10-15 years,
sometimes even longer. And we are very careful about risk and liquidity. Given
where we are at with our funding status and the amount of capital that we have
to pay out for benefits as well as capital calls – because we have a pretty
robust private equity program and real estate program – 16% I would say is
probably going to be the limit for at least the next 10 years. I can see
private equity maybe getting cut back just a little bit, but I think we’ll
always have a very strong presence in the private equity market because you’re
getting premiums on top of just investing money, and here’s the illiquidity
premium and the risks that you take. We
will be there {in private equity] for the long term.
MG: You mentioned the due diligence that you and your team do in
evaluating a manager. What is it that will make you and your team pull the
trigger?
RJ: The obvious thing is looking
at the performance, but that isn’t really what I consider. The most important
factor is that it really comes down to the people…[LACERS] is investing
hundreds of millions of dollars with not a firm per se, but with a team of
people. And so, while our consultants and even my own staff spend a lot of time
looking at the quantitative metrics and the very objective factors: performance, attribution, et cetera, I try to
ensure that we look at the softer side, the qualitative factors, looking at the
people and [the strength] of that team, how long have they worked together, and
looking at how they’re managed (Is there a committee or is there a sole
decision maker? And how does communication flow up and down through the
organization? How was the decision process implemented and how does it really
work?) It’s really important to have a nice balance between looking at the
obvious factors but also spending time with the leadership, the portfolio
manager, the research analysts, understanding the compensation levels, how they
retain and recruit staff. I look at what
performance they’ve achieved, let’s say over the last three or four private
equity funds, or if it’s a public equity manager, over the last 10 years of
performance, but what do they have internally in the organization to repeat
that performance? And so, you have to ensure that the organization is well
developed, that it’s well supported, that all of the pieces are in place so
that performance can be repeated.
MG: Private equity had a great 2021 for many institutional investors.
Talk, if you would, about how LACERS benefited from PE and what you are
expecting from the sector and the investing environment in general in 2022?
RJ: I think any investment professional that’s been in this business for
as long as I have understands that when you have a spectacular year, it does
not repeat itself in the next year. And I told my board that we had a
phenomenal year with private equity; we had a one-year return above 50% [for
the period ending June 30, 2021] but that’s not sustainable. We know that 2021
was one great year, but the performance is going to come down over time and
things will normalize. How long will that take? I don’t know. Sometimes it’s
harder to predict what will happen, but certainly we’re going to be moving back
towards normalization and, with geopolitical events occurring, inflation as
high as it is, interest rates rising, and actions of the Fed and supply chain
issues, things are going to be much worse in the near term. I’m going to see single-digit returns for our
portfolio this year. I’m prepared psychologically, professionally, mentally, to
have a very low return. But that’s just how markets are: they revert back to
the mean.
Overall, if you look at the markets out there, it’s getting
tougher to find places to invest where the risks and the return are in check
with each other. I think there are a lot of investments where you are going to
assume way too much risk and not be rewarded for it.
MG: So what’s the answer?
RJ: Rather than looking at the obvious places for investment
opportunities, we have on the drawing board a policy that will allow staff and
the consultant (subject to board approval), to go out and find unique
opportunities that have a short life, [strategies] that recognize the
dislocation of capital, that cause new opportunities to arise, much like what
we saw during the great financial crisis, when there were the TALF and TARP
programs. I’m thinking of things like that, but there are certain hedge funds
out there that have smart people that can take advantage of the opportunities
that avail themselves in the high-inflation environment, for example, or
interest rates – whatever it may be. We need to look at those and be able to act
very quickly to get in, because if you wait around for these opportunities and
have to go to an investment committee and the board, that window is going to
close and we’re going to miss that opportunity. I also don’t want to suggest
that we are becoming tactical per se.
MG: Would this be a significant change to LACERS’ strategy?
RJ: We are long-term strategic investors here at LACERS and there’s no
question that I believe in the long-term plan and not making knee jerk
reactions every time something happens in the market. But I also recognize that
the markets have evolved over time where there are smarter people who can
identify certain trends – economic trends, market trends – and figure out an
investment strategy that can capitalize on these new areas of growth including
geopolitical events. These can create opportunities around the world but
sometimes may be very short lived. We’re digging deep and trying to find more
off-the-radar screen opportunities.
MG: When could this plan be brought to the LACERS’
board?
RJ: I plan to bring that to the board sometime this summer. I just
looked at a second draft of it earlier this week and I think it’s about ready. I
had some changes I wanted to make because obviously when you take a policy like
this forward, it is tactical. It will not conflict with the strategies that we
already have in place. The name of the policy is the Unique Investment Opportunities
Policy, and it’s really designed to find those opportunities that we would not
be able to procure under a regular RFP process. Even in the case of private
equity, where staff and the consultant already have discretion, there could be a
private equity fund out there that staff thinks is very attractive but our
consultant may not. In this case, staff may be able to make a commitment to
this type of investment and bypass hurdles.
MG: How much would you allocate to this program and
where would it come from?
RJ: We’re thinking that it would be a total of a 5% allocation –and
would be an overlay over all of the asset classes. So essentially staff could
look at fixed income. We could look at private credit. We could look at hedge
funds, and infrastructure possibly, and make that investment as long as we
don’t breach the strategic thresholds of that asset class. As long as we’re
still within those policy ranges, that gives us the flexibility to make those
investments. We’re trying to work within the existing strategic structure, but
also want to find those kinds of pockets of opportunity where we think we can
drive more alpha.
MG: Going forward, what will you try to do to keep
LACERS and its program moving through these suddenly choppy waters?
RJ: It’s not easy being a CIO for a public pension plan. We have so many
more facets and dimensions to look at. For example, we have an emerging manager
program, we have an ESG program. DEI (diversity, equity, and inclusion) is
becoming a more important part of how we think about our organization and the
type of investments we do.
We get many inquiries from stakeholders about what we are
doing. It’s just becoming more challenging to try to juggle so many different
facets of an investment program when some of it is an overlay or additive to
the program, but it’s not an essential [core] investment function. DEI is not in and of itself an investment
function, but it certainly can impact the investment program. So, I’m having to
think about non-core investment issues, and objectives and goals that are
important to our board while trying to figure out how to integrate these types
of values into an investment program. But when adding more complexity to the
program, it makes it more challenging. It doesn’t make it impossible to do; I
think there’s always a way to address every challenge that comes on our plate,
but it does take time to think these through thoughtfully so that we do not
breach our fiduciary responsibilities.
But we also are keeping in mind that there are other factors
besides just the dollar that impacts our bottom line. It’s easy to earn a
dollar for the short term, but you think about the long-term implications like
diversity and emerging managers; these are much more long-term propositions to
consider. We are a long-term strategic investor. I think some plan CIOs might
say, ‘I don’t want to get involved with DEI or I don’t want to address emerging
managers, or I don’t care about the environment.’ That to me is maybe a short-term
thinking approach. But we do recognize that there are factors out there and everything
affects investments. It important to consider these factors and find ways to
integrate it if it can add to the bottom line over long periods of time.
MG: When it comes to DEI, does LACERS have a policy
that would keep it from backing a manager because of their team’s lack of
diversity?
RJ: We don’t have any policy in place that specifically addresses DE I.
We have been working on DEI here at LACERS in earnest over the last year, but
we’ve really thought about this for many years. It’s just that there’s much
more attention being focused on diversity, equity and inclusion and it’s
something that’s very important to our board. It’s very important to me as a
CIO to ensure that we do entertain different points of view and have diverse
teams both at our investment managers, our vendors, as well as even my own
staff. So, we don’t specifically consider DEI [as an investment criteria], but
we do ask questions when we evaluate managers such as ‘what kind of diversity
do you have? how are you building diversity within your team? What about [diversity]
at the higher levels of the organization, your board members? If it’s a board-control
type of organization, what does that composition look like?’ We’re asking these
questions to get a sense of whether we find that their values are similar to LACERS
values.
MG: Thank you for your time.
RJ: It’s a good opportunity for me to reinforce what
I think about loosely from day to day, solidify it, and then articulate it to
people who are interested in what we’re doing here at LACERS. LACERS is very
transparent; we like people to know what we’re doing. We’re trying to do the
best job we can for our members, and at the end of the day, we want to ensure
that they get their hard-earned retirement benefits. It’s a lot of work, but it’s work that’s worth
it.