San Bernardino overhauled its approach to bonds last year. It was ahead of the curve in increasing its exposure to distressed debt during the first half. The $6.35 billion fund also shifted half its 4% emerging market bond allocation into local currency debt to play the weak dollar and tap into developing countries’ economic growth.
The fund hired Catalyst, a Canadian distressed debt manager, and ZAIS Group, which invests in distressed tranches of collateralized debt obligations and collateralized loan obligations. It already had $25 million in a Siguler Guff & Co. distressed fund of funds, which returned 41.13% last year.
Facing low returns from core-plus bonds, San Bernardino eliminated its $600 million allocation to the sector and used the money to increase its absolute return exposure to 17%. This absolute return “alpha engine” is overlaid with a global tactical asset allocation strategy based on a model the fund designed in-house. Executive Director Tim Barrett and his team built their model using factors such as the correlation between the Chicago Board Options Exchange Volatility Index and equity prices—not on historical performance.
San Bernardino also uses its TAA model as a guide for asset allocation adjustments. Since inception two and a half years ago, the model has added 100 basis points of excess return per annum at the total portfolio level. San Bernardino has also been running a currency trading program in-house for 18 months, trading derivatives through Russell Investments.
Last year, the fund started redesigning its credit exposure. It issued an RFI this January for credit managers, keeping the criteria broad to encourage managers to be creative and suggest strategies to fit the fund’s needs. Barrett expects to select four to eight managers and build a credit opportunities fund, including bank debt, distressed debt, convertible bonds and structured credit.
San Bernardino also built out a real return portfolio last year. It hired infrastructure managers, increased its exposure to timber and invested in special situation energy funds. Then in January it selected a natural resources and a commodities fund. On the real estate side, the fund tilted its portfolio toward opportunistic and value-added strategies.