South Carolina Retirement System Forays Into Alternatives
Looking forward to "enhancing and diversifying" the $29 billion investment portfolio of the South Carolina Retirement System ("SCRS"), the South Carolina Retirement System Investment Commission awards a strategic mandate to the D.E. Shaw Group. According to the July 28, 2008 press release, capital will be allocated to an "array of absolute return, direct capital, private equity, real estate, long-only and 130/30 opportunities." (The SCRS website describes the Investment Commission as consisting of six "financial experts," having been created in 2005. A designated fiduciary for the SCRS, The Commission "is now responsible exclusively for investing and managing all assets of the SCRS.)
According to the "South Carolina Retirement System Investment Commission - Annual Investment Plan, Fiscal year 2007-2008" (last updated on July 19, 2007), an asset allocation has been approved that "is significantly different from the previous asset allocation." While equity cannot exceed 70 percent of the total investment portfolio at any time, alternatives are targeted to make up fifteen percent of assets, with five percent each in private equity, real estate and "Global Asset Allocation/Absolute Return" (GAA/AR). As shown in the table below, deviations might occur, in part perhaps because "it may take five years or longer before the total allocation to private equity is fully invested." (Private equity was just approved in November 2006, via a constitutional amendment, followed by a state referendum and ratification by the state legislature.)
| Sub-Asset Class | Target | Minimum | Maximum |
| GAA/AR | 5 | 2 | 8 |
| Private Equitiy | 5 | 0 | 10 |
| Real Estate | 5 | 0 | 10 |
In reading further, investment managers are clearly held responsible for "compliance with all guidelines," using "then current market values" as a benchmark. Given that FAS 157 presents all sorts of mark-to-market (or mark- to-model) challenges for alternative fund managers, it will be informative to track how D.E. Shaw and others (a) satisfy SCRS guidelines while (b) helping this public plan giant embark on what might be construed by some as an "aggressive" foray into non-traditional strategies ("aggressive" in the sense that the minimum versus maximum totals could vary considerably, from 2 percent to 28 percent of total assets). Many questions arise, some of which are listed below.
- Will the Investment Commission create and make public a separate risk management and valuation policy(ies) for alternative investments?
- How will the use of derivative instruments for 130/30 strategies be tracked across managers in the context of asset allocation sub-sectors?
- Why does the "Derivatives Review" exclude a statement about the monitoring of collateral by those fund managers who employ derivatives, direct and embedded? (The "March 31, 2008 Quarterly Report" does describe "continued development and refinement of risk control reports to monitor liquidity, leverage and counter-party risk.")
- Will the cost of requiring "all managers" to "present book value and current market value for all securities held" on a quarterly basis turn out to be prohibitive and counterproductive? This assumes that "all securities" include those that, by their very nature, represent a bundle of "hard to value" economic rights. For example, will private equity managers be asked to get an independent, third-party appraisal of holdings every quarter?
- The aforementioned "March 31, 2008 Quarterly Report" states that "two private equity funds were approved totaling" 85 million Euros. Will these non-U.S. dollar investments be hedged? If so, how will fund managers be graded in terms of performance? Will fund managers be graded differently, depending on choice of hedging instrument and/or strategy?
- How will an allocation to alternatives be determined in the context of variable funding ratios? (According to the "2007 Popular Annual Financial Report," actuarial assets as a percentage of actuarial accrued liabilities fell from 86 percent in July 2002 to 69.6 percent in July 2006. Noted is a 229.84 percent increase in cash and cash equivalents between 2006 and 2007 "until final allocations to the new asset classes could be implemented.")
Ideally, the Investment Commission will fully inform plan participants and other interested parties (state taxpayers for example) about their deep dive into alternative waters and related, but critical, issues such as valuation and risk management.
