LP update: Orange County Employees’ Retirement System

Days after the $15bn pension approved a momentous change to the way it targets real assets, we zoom in on its involvements with timber and agri.

The Orange County Employees’ Retirement System was an early bird to the timberland asset class. Unfortunately – by its own admission – it got the timing slightly wrong.

Speaking of vehicles managed by BTG Pactual and Hancock Timber Resource Group, it said in an investment committee report last year: “Both managers invest in timberland through closed-end illiquid vehicles. OCERS invested in both funds in June 2007, at the tail end of the last economic cycle, which naturally led to poor fund performance.”

Still, it has stuck with these two funds since, and added agriculture investments a few years later. The asset class could now benefit from a wind of change at OCERS. Last week, the $15 billion California pension approved proposed targets for its real assets allocation, created in April through the merger of its real estate and real return buckets.

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The institution is now aiming for real assets to represent 22 percent of its overall portfolio. That comprises 10 percent for real estate and 12 percent for real return, which includes energy, timberland and agriculture. This latter target could move within a range of 9 percent to 15 percent.

Worth noting is that OCERS is well below target, for both components of the category – at the end of February, its $1.1bn real estate holdings accounted for 7.9 percent of total assets, while its $982 million real-return portfolio came at just below 7 percent. As of end August, the latter included $125 million of timber and $119 million of agri.

Linked to its desire to speed up disbursements is its current search for an illiquid asset investment advisor, following a request for proposals it issued earlier this month. Finalists are set to present to the investment committee in February 2018.

Timber tantrum

One of the two timberland funds backed by OCERS is a separate account set up in 2007 by a dedicated arm of Brazilian bank BTG Pactual. The structure made its first acquisitions in 2008 and 2009.

In July 2016, when OCERS last produced an extensive review note on the manager, it complained about the toll taken on the fund by the weakening export market, largely due to softening demand in China.

That led it to recommend a strategy to streamline the portfolio – holding the Virginia property; reviewing options to sell the Oregon one, so as to benefit from premium prices; and selling the Wisconsin one, to cut losses on its poor performance.

At the end of August 2017, the separate account was valued at $32 million. OCERS had originally invested $40 million. Its performance, at 3 percent annualized net of fees as of July 2016, was said to be in line with returns on the NCREIF timberland index since inception.

The bigger of the pension’s timber holdings, however, is its investment with Hancock, valued at $93 million at the end of August (the pension had initially committed $100 million in 2007). In July 2016, the pension described the portfolio as underperforming, owing to its reliance on the US housing market. Net of fees, the portfolio returned 0.3 percent since inception at that date.

A key difference between the two separate account is leverage: While BTG’s includes no debt, Hancock can lever as much as 35 percent of portfolio value.

Accessing agri

It took a bit more time for OCERS to invest in agriculture. Its only commingled structure in this category is the UBS Agrivest Farmland Fund, in which the pension invested in 2012. In 2015 meeting minutes, however, OCERS notes that it “had to wait well over a year to get invested due to an entry queue that was also affected by farmland values.”

Its share of the fund was valued at $57 million at the end of August, up from an initial investment of $40 million. As of July 2016, the vehicle posted returns of 9.7 percent since inception.

The vehicle owns about $595 million of farmland assets, forming a diversified portfolio of row, vegetable and permanent crop properties (with respective target allocations of 60 percent, 20 percent and 20 percent).

OCERS’ second agri investment is with Hancock’s agricultural unit, via a separate account launched in 2011 with an $80 million commitment. As of July 2016, about half of the fund remained to be invested, though further cash has since been deployed since the account was valued at $63 million at the end of August.

Hancock invests both in row cropland, which it leases out to farmers to receive a steady 4-5 percent return, and permanent cropland, which it operates directly (the target portfolio is split 70/30). The fund targets an 8-11 percent annual total return, once the portfolio is fully mature.