Dallas pension unwinds ag program amid separate-account mismatch

Ryan Wagner, investment manager at the Dallas Police and Fire Pension System, tells Agri Investor an ongoing review at the $2.1bn pension involves assessing fund structures more appropriate for an agricultural investor of its size.

Audacious real estate projects ultimately weighed heavier on its portfolio, but it is the agricultural investments of the Dallas Police and Fire Pension System that are held up as the apotheosis of its ambitious alternatives program gone awry.

In a March update of the ongoing saga that brought DPFP’s total assets from $4 billion in 2013 to $2.1 billion today, for example, the Dallas Morning News asked why the pension was “stuck with nuts and other ‘crazy’ investments.”

Though the article went on to point out that some alternative investments – including permanent crops managed by the Hancock Agricultural Investment Group – have produced returns, it also highlighted problems with the structure of DPFP’s forays into ag, quoting board chairman Bill Quin as characterizing direct ownership of agricultural assets as “a very unusual, strange thing to do.”

As the pension continues to move forward with a comprehensive restructuring that includes the sale of timber, permanent-crop and row-crop properties, the role of separate accounts in DPFP’s agricultural investments is emerging as an instructive example of the importance of carefully matching investment structures to objectives when adding ag to a portfolio.

According to a March portfolio update, DPFP’s agricultural investments are currently housed within three separate accounts that have a total value of $208.3 million.

The oldest, a southern-pine-focused separate account with Atlanta-headquartered Forest Investment Associates, was established in 1992 and currently consists of three properties located in Georgia and Florida. Since inception, the FIA account has delivered a 7.73 percent IRR, according to the update, which showed $59.6 million in capital invested and $92.3 million in DPFP distributions.

The authors of the update wrote that FIA has recommended selling the entire portfolio, currently valued at $14.6 million, which it expected would be completed by the end of 2019.

Another timber-focused separate account – a eucalyptus, wattle and pine-focused vehicle established after a 2006 commitment of $102.3 million to BTG Pactual – produced distributions of $49.1 million through investments in Texas, Uruguay, South Africa and Brazil, according to the review. With remaining assets currently valued at $36.7 million, that translates into an IRR of -2.69 percent since inception.

Following a strategy the firm presented to the DPFP Board in 2016, according to the review, BTG sold timber properties in Uruguay and Texas and launched a sale process for a 68,000-acre portfolio in South Africa at the end of the third quarter of 2017.

The value of DPFP’s South African timber assets had dropped as of their most recent appraisal, and the review’s authors wrote that BTG had agreed to reductions in fees from 1.25 percent to 1.10 percent. The authors also noted that timberland transactions in Brazil continued to be challenging, characterizing the level of activity in that market as being “very thin.”

“DPFP has directed BTG to accelerate the disposal timeline for the 10,000-acre Brazilian portfolio due to high holding costs and low expected go-forward returns,” the review’s authors wrote.

DPFP’s agricultural investments are contained within a 26-property separate account Hancock Agricultural Investing Group established with a $74.4 million investment in 1998. Its investments have focused largely on permanent crops including almonds, pistachios and wine grapes, in addition to some row-crop investments. According to the portfolio review, the account also includes a minority share of Hancock’s Australian Fund and has delivered $100.2 million in DPFP distributions and an IRR of 16.02 percent since inception.

Hancock has advised a sale effort to bring the portfolio from its current value of $157.1 million to between $85 million and $100 million. Of the 14 sales its analysis recommended, according to the review, Hancock had completed five as of March, acknowledging that progress in the effort had been slow.

“Hancock is in the process of selectively selling all of the row crop assets in the portfolio, as well as certain permanent crop assets,” the review’s authors wrote. “Hancock expects the resulting portfolio to return circa 14 percent gross over the next 10 years, with a focus on income-producing assets.”

Hancock expects to be able to bring the value of DPFP’s ag investments down to $120 million by the end of the year and $100 million by the end of 2019, according to the review.

Hancock declined to comment. BTG Pactual and Forest Investment Associates had not responded to requests for comment at the time of publication.

‘Relatively ok’

DPFP investment director Ryan Wagner told Agri Investor that the missteps that plagued the pension were in no way exclusive to, or especially important for, its ag and timber investments.

“The timber and ag portfolio is relatively ok, relative to some of the other investments in the portfolio,” Wagner said. “I think it’s more just [a matter of] a fit for the portfolio. We dropped from $3.4 billion down to $2.1 billion in assets, so obviously, a lot of these private natural resources investments, their allocation went up, relative to the rest of the portfolio.”

A key focus in DPFP’s ongoing overhaul, Wagner said, is reducing the portion of DPFP’s illiquid investments from current levels of around 50 percent to something closer to 15 percent over the next three to five years.

Wagner said that a previous 10 percent target allocation to natural resources was reduced to a 5 percent target in 2016. Though DPFP had already exceeded that amount of natural resource investments, given that DPFP’s 5-percent allocation to all natural resources translates to just $150 million, Wagner said, a key question being examined is if ag and timber have a place in the portfolio, and if so, what the optimal structure is.

“We made the decision – on all timber – that it just doesn’t make sense given the five-percent allocation that could change. If we are only going to keep the five percent, we made the decision that we would want to keep the ag portion over the timber,” Wagner said, describing a decision that was finalized in “2016 or 2017.”

DPFP is currently working with Hancock to reduce its agricultural portfolio, currently valued at $157 million, to $100 million by the end of 2019 through the disposal of selected properties.

“They are planning to sell all of the row crops and keep a lot of the permanent crops,” Wagner said, adding that even that judgement is subject to change as a comprehensive review of all of the pension’s investments continues.

“There’s a good chance that ag and timber go away completely; go to zero. We won’t know that until September/October. We’re not going to liquidate the stuff overnight. ”

“We’re not going to do a single new private investment for probably five years. The ag and the natural resources portfolio is just a microcosm of the rest of the portfolio. We’re over-allocated in illiquids, so that will be a conversation to have at some point. But that’s not going to be implemented for another three to five years, when we return to a more normal asset allocation.”

Size matters

A manager familiar with the separate account structure’s use in ag told Agri Investor that, while it does often require more active participation on the part of the LP, they have seen clients takes both active and passive approaches. The manager described how in instances where investors look to take a more active role, retaining control over acquisitions and budgets is one common strategy.

Because separate-account managers are reluctant to take on a very small mandate, the manager said, size is often the most important factor.

“If you are smaller and you are going to give a $10 million or a $20 million allocation, you are just too small for a separate account,” the manager said. “Most investors are not $50 billion; they are smaller than that. If you become smaller, you are forced into the fund structure.”