Allocating to Private Markets with Focus on Science, Technology, and Innovation
Bill Coaker, CIO of the $26 billion San Francisco Employees Retirement System, has put together a portfolio that combines a heavy allocation to private markets with a significant focus on science and technology in both publics and privates. During Coaker’s six-plus-year tenure, the city retirement system’s returns have ranked in the top 1% of public plans with assets over $1 billion.
Public market investments represent 40% of the fund’s portfolio (roughly 31% in equities and 9% credit) while private markets comprise 45% (including about 22% in private equity with the other 23% split between private credit and real assets, mainly real estate with some energy, and music royalties). The remaining 15% is allocated to absolute return and GTAA strategies. Most of the portfolio is managed by outside managers, but, due to the fund’s size, Coaker hopes to build up co-investing from the current 5% to 20% of AUM over the next decade.
The strategy is not a plain vanilla 70/30 or 60/40 pension fund asset allocation, but Coaker says, “One of our themes is you don’t make great money investing in asset classes but rather in great businesses.” Coaker explains, “I think it’s important to think about where the world is going and invest in the leaders in where the world will be.” The world is “in the middle of a revolution from the physical to the digital, from the industrial age to an era of science, technology, and innovation,” says Coaker, who came to the San Francisco fund in 2014 after six years at the University of California endowment. That is why “75% of our private equity book is in technology and life sciences,” he says.
Some might wonder if his focus reflects his location in the northern end of Silicon Valley, the high-tech epicenter of the universe. Is he just rooting for the home team, like a Texas fund manager investing in oil or an LA fund investing in entertainment? He insists that’s not the case, that his strategy is more a reflection of where the world is going and how to earn high returns. “Take biotech, for example. Cambridge, in the Boston area, has an amazing biotech ecosystem. San Diego, Seattle, Texas, Europe, China and others do as well. Seattle has a spectacular tech ecosystem.” That said, Coaker does acknowledge that his roots in the Bay Area have been very additive. “Our venture portfolio has posted an IRR of over 21% since inception. In venture capital and throughout our portfolio, our team has done a fantastic job building relationships with leading innovators and entrepreneurs. Our GP’s are great business partners.”
Coaker is investing in the future beyond just buying FAANG shares. Instead he says, “I think you can enhance returns by having a portfolio that emphasizes private markets, niche managers with specialist skill, and science and technology in both publics and privates.” He’s also a prominent investor in China. The fund’s investments in China have outpaced their total fund returns.
Software, the digital transformation and biotech are major themes. Coaker notes that “Every business needs a complete suite of software solutions, including human resources, financial reporting, financial planning, data analytics, procurement, security, artificial intelligence, communications, the internet of things, and mobility. Software is vital for every business and the producers of leading software generate high levels of recurring revenue in addition to expanding addressable markets.” Regarding biotech, Coaker highlights the growing demand all around the world for health care as well as “Recent advances in immunotherapy, oncology, gene therapy, CAR-T, CRISPR, protein degradation, breakthroughs in treating previously undruggable targets, and more are inspiring for the future of human health.”
Coaker’s strategy has produced high returns, and it has also reduced volatility and produced high risk-adjusted returns. “Six years ago when we began our volatility was median-like, because the portfolio had a group of highly diversified managers. Now our volatility is in the lowest 10% and our risk adjusted returns are in the top 2% to 5%.”
The San Francisco portfolio has held up very well during the recent market travail. “In 1Q2020 our returns ranked in the top 4% versus peers. The current health crisis has accelerated our strategy, pulled it forward,” Coaker says. The pandemic has accelerated the role of high-tech solutions from Zooming and online retailing to telemedicine. “Software, digital commerce, and communications,” he notes “are the vital links connecting work to mobility.” As for biotech, “The need for innovative medical solutions to save lives has never been more pressing than it is now,” he says.
While the fund’s investments in science and tech are performing especially well amidst the COVID-19 crisis, Coaker notes the fund’s mortgage related investments have suffered. He believes in March investors began pricing in a 2008 housing experience. But he notes that “Housing fundamentals now are much better than in 2008. Loan-to-Value ratios are low and credit quality is very high.” For the fund to lose money on its mortgage investments, he says, “Housing prices would have to fall 30% and unemployment would have to be 15% for several years.” He thinks the fund’s mortgage investments will be “money good” because, while he does not expect a rapid V-Shaped revival (“that would require a vaccine or treatment”), he thinks a U-Shaped recovery is much more likely than a Depression-like L-Shaped experience. He expects a U-Shaped recovery because “Policymakers have demonstrated they’ll do whatever is needed to support the economy. And because people are adaptable and creative. We’ll create new ways to do business and enjoy our lives.”
Coaker is also looking ahead and planning for how his strategy may need to be modified. He explains, “Our current pension payments as a percent of our NAV are 2% of our assets. That allows us to take duration risk and pursue investment growth.” But he notes, “Five years from now our pension payments will double, and in eight years they will be two and a half times higher, so we need to begin a glide path now to become somewhat more income-generating and more liquid.” He adds that, “We’re not talking about a sea change in strategy. Our returns in public equity, private equity, real assets, and private credit all rank in the top 10% versus peers. In public equity, our emphasis on science, tech, and specialist managers has produced over 3% excess returns among managers hired the past five years. If our private markets post the returns we project, later this decade when pension payouts will be 2.5 times higher than they are now, we will be able to pay nearly all of our pension benefits from private markets distributions. That would be an excellent position to be in.”
San Francisco is a very political city, and Coaker needs to consider stakeholder sensibilities. Some overseers are concerned about incurring a large negative fiscal-year return, so he “designed a strategy to achieve long-term returns and minimize the magnitude of large short-term loss.” In addition, he notes, “ESG sensibilities are very acute in San Francisco.” As a result, “We have an ESG assessment in every investment, created a new position as Director of ESG, hired a manager with a sustainability emphasis that has outperformed by over 5% annualized, and created an index for public equities that has essentially no tracking error yet reduces carbon emissions by 50%.” On his investment team, a majority of appointments to Managing Director have been women, and most of the hires to Management roles have been women or ethnic minorities. Coaker adds that “All of the hires have been earned by the individual’s buy-in to our team-oriented culture and strategy, achievements, professional capabilities, and personal traits.”
Even as science and tech have already disrupted retail and other industries, Coaker says, “We are still in the early days of an era of Science, Technology, and Innovation. Thus far we have experienced improvements in calculations, convenience, and communications, and disrupted retail. But the next wave of innovations will include education, energy, financial services, healthcare, and transportation.” Coaker notes that each of these are enormous segments and in need of major improvements. He adds, “There’s a huge opportunity over the next couple of decades to achieve important improvements and lift the human experience to new heights.”
Coaker also describes that there will be major changes in what we do for work, and that the jobs of the future will be much more fulfilling. “In the agriculture era, people plowed the land, work was physically demanding, and life was hard. The Industrial Age brought us improvements in travel, communications, convenience, and more entertainment. But most people still get paid to do something. There will be fewer jobs where we are paid to do something, but many more jobs will be created than lost, and we will be paid to innovate, create, and interact. The jobs of the future will be much more fulfilling than the work many of us do now.” Coaker refers to one is his favorite aspirational quotes, from Ron Hancock of Deloitte, “Let the machines do the work and humanize jobs! The mundane to the machines and purpose to the people!”
Clearly, Coaker is a futurist, and he expects that being thoughtful about where the world is going and investing in the leaders in where the world will be will continue to generate high returns for the San Francisco pension plan.
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