E217: How to Manage $15B: Insights from Sacramento County's Pension Fund

0:00Today, I'm speaking with Brian Miller, a senior investment officer at the Sacramento County Employee Retirement System, a pension system that today manages$15 billion. We discuss Brian's formative years at Tuckman Grossman, a public equity manager who counted the Stanford and Yale Endowment as LPs, as well as his past eight years running the public equity and absolute return book at Sacramento County, which stands at roughly$6 billion today. Without further ado, here's my conversation with Brian. Brian, I'm very excited to chat. Welcome to the How to Invest podcast. Yeah, thanks, David. Appreciate it.

0:39Thanks for having me on. So I want to go back to the beginning of your career, two years out of your undergrad. You started Tuckman Grossman Capital Management. You spent 16 years there. Tell me about your time at Tuckman. Yeah, a couple of really interesting stories about the timing of when I joined. Tell me about what you did and tell me about your main lessons that you learned while working there. The firm was founded by Mel Tuchman in 1980, joined by Dan Grossman just over a year later. And Dan worked for Warren Buffett kind of in the early days. So, yeah, I remember him telling stories about their annual meetings when it was just a handful of people in a conference room before it got to be what it is today.

1:24And the auditoriums in Omaha at the time, it was the two owners who were the portfolio managers. I switched over, became an analyst. And then we had another analyst as well. So really four people on the investment team. And as a single product, single strategy firm, they did really well in the niche they had. They got up to, I think, north of$12 billion in assets under management at the time, managing assets for predominantly institutional clients. Yale, Stanford, a lot of state public pension plans, so a really great client list. And it was really, I'd say, a great time to be in active management in those early years.

2:09And then we faced a lot of headwinds for active management in the year subsequent, which I'm sure we'll talk about here. As you mentioned, Tuchman Grossman had LPs like Yale, Stanford, Rockefeller, and even, I believe, Vanguard at some point sub-advised to Tuchman. So really the cream of the crop. And Tuchman was a value investor. What did you learn about value investing that helped shape the rest of your career even to today? The reason they were able to be so successful is kind of the role they played in for those clients, for those public pension plans. You say the value slash core component of an active equity portfolio.

3:00So obviously those are large institutions. They've got, you know, well-diversified equity programs, and we fit a really nice niche, I think, for them in their public equity portfolios. And one of the things that I think made Tuchman so successful was their consistency. I think they followed a really consistent approach over a long number of years that led them to kind of fill that niche in the face of a lot of headwinds in the market, whether that was a shift towards international, a shift towards global, a focus on technology and growth stocks. They faced a number of headwinds, but really stayed true to who they were as investors.

3:43And so that really taught me a lot of lessons about, you know, finding what you do that you can be successful at and then staying consistent with it. The other thing I would say is just the focus on long term investing. Right. Allowing your the ability for those investments to compound over time and not getting swayed by, you know, shifts in the market. but finding a great company, finding attractive opportunities and entry points from a valuation perspective to enter those positions, and then really hold those things long-term and let the value of those things compound in the face of market pressures.

4:20You had a recent guest on, I think, talking about how active investing can be successful, but it has to have kind of a long-term timeframe. Obviously, active investing comes with variations of markets, variations in performance, And, you know, you're not going to perform, you know, outperform the markets every year. And so you've got to have that kind of long term perspective and being able to weather those storms and kind of ride the up and downs. And that allows active investors, especially fundamental kind of concentrated investment strategies like Tuckman to be successful over time. Rahul Mugdal, who's at Parvis, explains this as buying public positions that if the stock market closed for five years, you'd want to hold.

5:06So almost like an illiquid type of investing into the public markets. From that perspective, it's if you have great quality companies that you think can weather storms in markets, I think that helps you sleep better at night. As an investor, you can weather some of those storms, right? And you're not as concerned in the day-to-day price movements because you are looking long-term. You're looking at what the future potential for these companies can be several years out. I've had to come up with this term that I believe describes something that happens to managers, public or private, LP capture.

5:46so GPs could be highly affected by their capital base, by their LP base, both negatively in that they could pressure them to sell just because there's noise in the market, but also positively if you have somebody like a Yale Endowment or Stanford as you had a Tuckman, maybe they could even double down when things are going bad. How much of the quality of the LP base allowed Tuckman to build this amazing franchise over so many decades and over so many different market cycles? in a lot of ways, all comes back to performance, right? So the fact that the firm was able to deliver really strong performance helped it grow.

6:24That, you know, obviously is the first foundation of that pillar. That then leads to great clients. And that can then obviously build on itself, right? I think in those early years, the firm, as they were able to, you know, attract great clients, then that feeds on itself and allowed them to, you know, help grow that client base and be successful. The interesting thing about kind of that LP capture part of it and how the LP base can impact a firm is I think we saw it go both ways over market cycles. If you think back to the financial crisis, 08, 09, firms like Tuckman were almost a source of liquidity when other parts of those investors' portfolios were struggling.

7:09When you had kind of a liquidity crunch, say, in private equity and those distributions coming back to LPs kind of dried up, then those liquid parts of the market that maybe held up a little bit better, even in the face of strong market declines or a source of liquidity. And we certainly saw that in 08, 09. And then on the flip side, like you said, when they do recognize there's drawdowns, they do then put capital in. And I know we saw that a little bit with Vanguard. Vanguard was able to do that at times when, you know, because they have a stable of portfolio managers within the portfolios, you know, that they were having sub-advised.

7:50Tuchman is maybe one of several underlying PMs. And so they were actually able to shift capital between their underlying PMs. And so you were seeing that. You definitely saw both sides of that part and the side of the business. It's almost like the same dynamic with liquidity providers in the private markets, which are secondary funds. You're almost able to get that liquidity discount in the public markets because so many people are going towards the doors. And if you're just around, you could buy the same asset at a discount. I think back to what happened in the financial crisis. That's what a lot of great investors were able to do that had liquidity.

8:27They were able to step in when the markets were really struggling and be a liquidity provider, get great assets at discounts to long term intrinsic values. And so if you're able to be opportunistic and have kind of that cash flow opportunity to invest when the markets are struggling, I think it's a great value opportunity. But having that liquidity is not always there. It kind of comes, there's a lot of different dynamics on whether you have the liquidity and the ability as an investor, you know, on the management side to take advantage of those things. And so a lot of our ability to do that at the firm level was kind of somewhat dictated by your client base and then the movements they made from a cash flow perspective as they're managing their portfolios.

9:14So yeah, a lot of interesting dynamics there that you face as a manager for that type of a portfolio. I graduated undergrad in 2008, so I was not an actor in the market. So I only know from secondhand. But my understanding is that the difficult behavioral thing during a crisis is you have to sell some things for a loss in order to buy other things at higher discounts. So in other words, nobody's portfolio is up. So you have to make that relative trade, which makes you have to realize the loss in parts of your portfolio, which is behaviorally difficult. Is that the right way to think about it? Or are there people really hoarding cash on the sidelines that wait for the next crisis that really move the market?

9:59I would kind of answer that in two ways, both on the investment side, you know, as an asset manager versus on the allocator side. Right. As as an investment manager managing a single portfolio, right, dedicated to large cap stocks. Yeah, you definitely have to kind of weigh what the future opportunity set is for all the stocks in your portfolio. And yes, some of everything is going to be down at that point. But are you able to get into a higher opportunity stock that's, you know, maybe sold off more and creates greater value in the future? And so, yeah, you definitely are kind of making those trade-offs and evaluating all the stocks in your portfolio and then the future opportunities set.

10:43And you definitely, I think you saw that a lot in the financial crisis. You saw a lot in 2020 as well when stocks sold off. And then a lot of people took the chance and opportunity to upgrade their portfolios, get into stocks that maybe were higher priced that they really liked but couldn't get into due to valuations or other considerations. And so that's on the asset management side. On the allocator side, I think it's a little different because then you have pockets of liquidity in your portfolio because you are diversified across asset classes that allow you then to take advantage of those.

11:18So same example when you have negatively or uncorrelated assets within your portfolio and equities are selling off strongly, that's the opportunity to maybe rebalance and put money to work in those areas that have sold off. And that's where the diversification comes into play as an allocator that allows you to take advantage of those opportunities. Starting with this global financial crisis, 2009 to 2020, obviously growth outperformed value. Values a little bit back in the beginnings of the 2020s. Fundamentally, let's put aside active versus passive, but fundamentally, do you believe the Fama French three-factor model that held for 70, 80 years until 2008.

12:06Do you believe that's back in play, meaning that small cap value will outperform other asset classes in the public markets or has something fundamentally changed, whether the alpha is being traded out in the market or something fundamentally about the underlying business has changed that will make it kind of the century for growth over the next 75 years? It's a really good question. And it's really hard to answer in, say, in a vacuum in a short-term time period of what we're seeing. Think back to different segments of that. And to kind of repeat your question, it's like, is there a small cap premium, right?

12:50Does that still exist? Is there a value versus growth dynamic? What's interesting in the last several years is I think the dispersion you're seeing in the market and that obviously the mega cap stocks, which have really outperformed, but then you see the dispersion underneath that. But those mega cap stocks are growing earnings, right? It's not just as pure speculative speculative growth in multiples. Those are fantastic companies that have been growing earnings, have tremendous cash flows. They would be considered, I think, high quality companies if you think about factors. And so I don't think in the short term that those long-term dynamics are dead, but I think you're definitely seeing a dispersion that's playing out in the markets.

13:42The one caveat I'd say to that is markets, I think, have changed to a certain extent. You don't have the same number of public companies that you used to, right? So the small cap universe is not the same universe it used to be. You're seeing companies almost bypass that small cap segment and go straight from an IPO to a mid cap to a large cap company. And so I think there are other market dynamics at play, but those short-term value versus growth dynamics, I think are going to play out over time. And I kind of follow the belief that over the long-term stocks follow earnings. And so those small cap companies have to deliver the level of earnings growth to justify the return profile.

14:28And that's what I think you're seeing in a large cap segment. Those companies are really delivering strong earnings growth. And I think it's shown up in performance. And so I think that's where it's going to take time for some of those dynamics to play out to decide, well, is growth going to continue to dominate over the large, you know, over the long term and, you know, the next 15, 20 years like they have in the last 10. I think it's to be determined. We'll see. CIO of Hurdle Callahan, Brad Conger, went on the podcast and he talked about that small cap value is fundamentally different today.

15:01And although there are some great small cap value companies, many of them fit one of two new categories. One is basically large cap companies that have fallen angels, and two, those are no longer able to raise in the private markets, adversely selected companies that now are going public as a last resort. Whereas to your point, you now have these private companies, both in venture capital and private equity that are able to raise a bunch of private capital and now go public when they were already are large cap. So these quality small cap value companies are certainly there's fewer of them in the market.

15:43So it's fundamentally different asset class. I think that's right. And I think it shows it in the numbers when you look at some of those small cap companies that have negative earnings, right, that are under, you know, under forming low quality companies, does present an opportunity set for small cap managers, particularly small cap value managers to generate alpha when you're thinking about can they identify high quality small cap value companies that can deliver good results and returns. So I do think it presents an attractive opportunity set for small cap active managers to deliver alpha. But from an asset class perspective, I think it does make it challenging for that segment of the portfolio to perform as a whole relative to what large caps have been able to deliver.

16:32Let me ask you an odd question. If I believed in the fundamental thesis behind small cap value, which is hype gets overbought and value kind of accretes and compounds over time. But I did not believe in the public version of that. And I wanted to buy that in the private markets. What would that asset class be? You're actually seeing some, I think, crossover between public and private opportunity sets. You know, I'll name a firm that we're not invested with, but it's been interesting as Cotu, I think, launched a new series where it's almost a public-private type opportunity set to take advantage of those kind of burgeoning opportunities where, you know, small companies that you would like to invest in and would have historically via public markets stay private, and therefore they can invest along that side, but they also can invest in public companies.

17:27And so I think that kind of answers the question, which is you're going to see more market participants creating an opportunity set to have these crossover vehicles that cross over between public and private markets to take advantage of investing in great companies, irrespective of those really dedicated silos of private markets, public markets. And I think that is just a development of what you're seeing in those markets and how long companies are staying private. And that's on the venture side. Is there an equivalent on the private equity side? On the private equity side, I think it's a little different.

18:07I don't tend to see that as much on the private equity side. Private equity tends to stay more private. They tend to do what they want to do because they have the levers to make change at those companies that are just more suited for private markets. Their ability to come in and take over the company, change it, turn it around, improve operations, improve the growth opportunities, I think in some cases are just suited for private markets. And I think that's why the private equity opportunity set has been so good. So yeah, maybe a little bit less of a crossover there with private equity, because like I said, I think it's just suited for how those firms operate and the transition and change they like to implement in companies is just more suited for private markets versus the public eye.

18:59So after spending 16 years at Tuckman Grossman Capital Management, you then moved to Sacramento Mento County Employees Retirement System, or SSERS. Tell me about that move from going from manager to allocator. What was that like? Yeah, it was really interesting. I recall one of my very first meetings with one of our existing managers was a firm very similar to Tuckman Grossman, which was large cap, concentrated U.S. equity core portfolio. And I had to resist the temptation or, you know, I was just naturally inclined to want to dig into each stock within the portfolio, being so focused on individual stocks and company analysis.

19:42That's what you're naturally drawn to. But you quickly learn that you just don't have the bandwidth as an allocator to dig into the individual stocks at that level. And so you really have to shift your focus from individual company analysis to portfolios and how you're evaluating managers. And so that was the biggest shift for me. I think I still like to dig into the individual stocks within our managers portfolios. But now it's under the lens of understanding their decision making, understanding their process and philosophy to evaluate how they're making their decisions versus the individual stocks.

20:23And so you really have to, like, say, step back, look at managers from a more holistic, higher level, and then you're doing it across asset classes. So when I joined Sacramento County, I was the third member of the investment team. You know, we had our deputy CIO join just after a year after I was there. So we have essentially we've had a four person investment team for many years. And so we're really working across asset classes. When I joined, I led public equity and also Absolute Return, which I still do. And so, like I say, it's that focus on manager decisions and allocations. And that's where you shift your focus.

21:06And it was really an interesting transition. Yeah, I was going to say probably the best way to diligence the public managers is actually to go through the individual stocks and to see their thinking on a micro level. instead of, I guess the default is just listening to their narrative, listening to them talk about meta decisions versus kind of going into a company, seeing how they analyze it and then doing it multiple times. And then maybe after you invest, you don't have to do that. But isn't that kind of a great place to start, which is like, what are your actual decision making? Why did you do that?

21:39Why did you not do that? Rather than kind of listening to this theoretical portfolio construction approach? There's definitely a top down view where you're looking at, You know, the firm, the people, you know, their investment philosophy, their process. But then ultimately you are digging down and especially for fundamental active managers, what is their investment making decision making process? How do they actually choose stocks that build up into the portfolio that they're constructing, which is ultimately what you're investing in as a fundamental active equity manager? And so it does give a great insight into their decision making, how they view individual companies.

22:20And it's, you know, it's hard to do initially, you know, with a with a manager, but it is definitely something you can build into over time. Understanding their security selection process and see how that may change over time through conversations you have with them as you've invested with them over a number of years. And so there's definitely a learning curve to getting to know a manager. And you kind of do your best to do that as fast as you can when you start at a new firm. But now that I've been in this role for many years now, you kind of learn how to narrow that process down and be really more efficient in how you're evaluating and selecting managers.

23:01How do you go about making that process more efficient? Obviously, you still have to spend a lot of time, but where can you expedite and or simplify your manager selection process? As I've been in this role now for, gosh, eight years, you know, time goes by quick, right? You really learn to target your conversations with managers on where you're focusing. You know, when I first joined Sacramento County, we would if we were doing a search for a manager, it would be starting with a really large laundry list of managers and working from there, which would make the process very long, very tedious.

23:42and it would take a long time to implement. We've gotten a lot better at, you know, part of its mind knowing the manager universe, knowing the areas I want to focus in, and really being targeted on the types of firms and strategies that we would, you know, look to invest in. So instead of starting with that large laundry list, it's a much more tailored, narrowed list of, okay, I'm doing a, you know, a U.S. small cap growth search. Who's the manager that I'm looking at? Okay, there's five names really that I want to consider. The one part I would say that is, I think, really invaluable, and this was kind of a learning out of COVID, which was the importance of meeting managers at their location and visiting them at their shop versus them traveling just to us or even doing anything virtually.

24:31I think virtual meetings are great for existing managers where you know them and you can kind of just do the check ins. But on the due diligence process, I think it's been invaluable of, you know, you need to go visit the managers and really spend time with them, digging into the details. And I think that's something you get from visiting their their shops and visiting their location. I think it's just that's how you get to spend the time with those managers and get into knowing them better than you might might otherwise. I've never met an asset allocator that did not say they were understaffed.

25:05I do tend to think that that's directionally accurate. And I think one of the patterns I've seen among the most effective ones is that they really focus on preventing false positives and they let false negatives go through the crack. So you gave that example. They will focus on these five managers that their staff or an OCIO has sent to them and they focus on the final decision. They don't worry about the manager that might have not made it to the process, even though directly they could have been good. Their job is to make sure there's no mistakes. And if they make no mistakes, then they're going to do just fine.

25:42Yeah, it's really hard because you could spend a lot of time spinning your wheels, trying to evaluate all the managers. And there are great managers out there that I'm sure, obviously, it's a huge universe. And if you start from scratch, well, maybe you would select other managers, but there's a time component and there's a trade cost perspective of switching managers. It's not an easy thing to do. and obviously you don't want to be just chasing and trailing performance or chasing you know the hot manager and so yeah there's definitely a a component of that i think you know when you're selecting manager i look back at you know in hindsight now the managers that we've hired since i've been at sacramento county i think you know knock on wood right we've had a pretty good success rate.

26:33It's been interesting because often, right after you hire a manager, they tend to underperform immediately. The year after you hire them, it's like, okay, then you're really second guessing, oh gosh, did I hire the right manager? Did I make a mistake? You're always kind of second guessing your process. But obviously, you invest hopefully with a long-term perspective of these are managers that we're going to keep in our portfolio for five, 10 plus years. And like I say, knock on wood, things have turned out quite well. We've had a fairly good success rate of the managers that we've hired delivering what we would have expected of them.

27:10And that is a combination for us. It is staff driven, but it also is consultant driven. We do utilize consultants since we have, you know, a very lean staff and it is always a joint recommendation. So that's kind of, I think, the safety rails perspective of, you know, the consultants help and make sure you're not making any big mistakes of, you know, of hiring a manager. That really isn't the right, you know, institutional quality. You know, they're the safety check on checking your decisions. but we also pride ourselves on being staff driven as well and identifying managers and identifying opportunities to allocate the summer's here which for me means occasionally trying to escape new york city on the weekend when i get time off the last thing i want to do is worry about keeping my personal finances organized and my budget and balance with a little advanced planning and powerful software tools i can enjoy the summer knowing my money is taken care of monarch is the personal finance app that tracks everything accounts investments saving goals and spending Get your first year of Monarch Core for half off, just$50 with promo code INVEST.

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