Chief Investment Officer Magazine interviewed Scott Chan, CIO of the Sacramento County Employees’ Retirement System, as part of its 2014 industry innovation awards series.
Some of the more interesting topics touched upon by Chan were the idea of being a long-term, “contrarian value investor” and the fund’s dive into infrastructure and energy.
Chan, on being a “contrarian value investor”:
“The price you buy something at does dictate your long-term returns,” [Chan] says. “I’ll be at pension conferences where people say they don’t think about those things—they just buy, buy, buy. We do define ourselves as long term, but that’s only part of it. We’re also contrarian value investors.” Chan spent seven years in San Francisco managing equity long/short and opportunistic hedge funds. Two years in the trenches with JP Morgan Securities’ technology equity research team came before that, as did an MBA from Duke University. Nearly a decade of living—and living off of—the “buy low, sell high” ethos made Chan uniquely unsuited to the “buy, hold, rebalance” approach so common among US public pension funds. The man can’t help but root out deals and invest to the rhythms of the business cycle.
“Take core real estate,” he says. “A lot of people view that as a ‘safe asset,’ but real estate has a lot of cyclicality risk embedded. In a full cycle, property values could go up 80% or 90%, and then back down. What you’re really getting is net operating income. The risk coming out of a depression is actually pretty low. But as the business cycle matures, and then begins to go down, every time real estate is going to have a problem. We can’t time that, but we know it will happen. Fast-forward to today, and you’re getting maybe 5.5% returns from core real estate. From how we’ve quantified the risk, there’s 25% to 45% upside for the rest of the cycle, but also 30% downside when the economy hands off from expansionary to recession. So you have to ask yourself: Are you getting paid for that risk?”
In Chan’s mind, the answer is “no.” Including real estate investment trusts, separate accounts, and limited partner stakes, the asset class accounts for 8.6% of Sacramento County’s $7.8 billion portfolio, down from 13% when Chan arrived in 2010.
Chan also talked about his fund’s investment in energy and infrastructure:
Like any good hedge fund manager, his next opportunistic play is already underway: infrastructure secondaries. In May, the institution partnered with fund-of-funds Pantheon Ventures to buy deeply discounted energy and infrastructure assets from investors who’ve had second thoughts about the highly illiquid space. In the first deal, the pension picked up two utilities—a power provider to San Francisco and a heating operation on the Marcellus Shale natural gas formation—at a 25% discount. A few months later, the general partner marked up the asset by 40%. “We’re penciling in 15% IRR [internal rate of return],” Chan says proudly, “and we’re trading cyclical risk for non-cyclical risk. When a recession comes, people still need their electricity and heating.” It’s this kind of thinking that wins Sacramento County’s CIO an Innovation Award—if not an invite to the next brunch party.
Read the full interview here.