California Public Employees’ Retirement System has adopted a new asset-allocation strategy in order to better prepare for risk-adjusted performance in the investment world.
The nation’s largest pension fund, with a $220 billion portfolio, will focus on risk and return as economic growth, inflation, liquidity and interest rates — and has outlined asset-allocation mandates. CalPERS, like most investors, battled a difficult market and disappointing results during the recession, but has posted much-improved performances recently.
“We learned in the financial crisis and the past recession that a liquidity crunch or inflation can have a significant impact on portfolio performance in ways that many investors didn’t anticipate,” CalPERS board president Rob Feckner said in a news release Monday. “We focused on assets and returns, but not enough on the risk of our allocations.”
The board adopted the new strategy after a yearlong review.
CalPERS will place assets in five major groups determined by how they function in high- or low-growth markets:
• Liquidity — Cash and government bonds, which can be converted quickly into cash. Target allocation of 4 percent.
• Growth — Stocks and private equity at 63 percent of assets.
• Income — Fixed-income securities with established income returns, with an allocation of 16 percent.
• Real — Real estate, infrastructure and forestland to provide long-term returns and considered less volatile to inflation. Target allocation of 13 percent.
• Inflation — Commodities and inflation-linked bonds, with an allocation of 4 percent.
The board also approved set ranges for investing, for example, a 7 percent positive or minus range for public and private equity.
“While the allocation won’t change much, we’re going to be looking at these assets differently than we did before,” said George Diehr, chairman of the CalPERS Investment Committee. “We now have a better way to look at risk and account for what’s happening in the markets and to re-categorize our assets according to what drives them. We’ll be able to better anticipate overall performance and its potential impact on employer contribution rates and our retirement system’s funded status.”
Historically, investment earnings have accounted for about 64 cents to 75 cents of every pension dollar. The remainder comes from employers and active employees.
“You can’t get solid returns without taking risk, but we want to make sure we know what risk is and that we’ll be paid to take it,” said Joseph Dear, CalPERS chief investment officer.
CalPERS handles retirement benefits for about 1.6 million state and local public agency employees.
I am glad to see that CalPERS is taking a strong look at risks they're taking. Beta will swamp the overall portfolio, but if they can do a better job protecting downside risk with this new asset allocation, then so much the better.
In related news, Bloomberg reports that CalPERS should impose a “cooling-off” period restricting how quickly former executives may take jobs with money managers, its outside lawyers recommended:
Calpers staff and board members who leave should be prohibited for two years from taking a job with any company that was awarded $10 million or more in business during the previous five years, said a report today from Steptoe & Johnson LLP, the law firm hired to examine practices of the fund, which has $218 billion in assets.
The California attorney general’s office accused former Calpers board member Alfred Villalobos of trying to improperly influence the fund’s personnel to favor Apollo Global Management LLC and other private-equity clients. Federal and state agencies are probing influence peddling for access to the $2 trillion in U.S. public-pension funds. Villalobos has denied wrongdoing.
“We take these matters with the utmost seriousness,” Anne Stausboll, the fund’s chief executive officer, told the board today. “Our goal is to make sure we have corrected the problems and that never again has Calpers’ credibility been called into question.”
The report recommends that board members and executive staff be prohibited from taking jobs during the cooling off period with firms known as placement agents that act as middlemen to win investment contracts for clients.
On Oct. 1, Governor Arnold Schwarzenegger signed a law prohibiting money managers from paying contingency fees to middlemen who help win state retirement-plan contracts.
The fund in November agreed to rules compelling any company seeking a contract worth more than $10,000 to report hiring a placement agent to win Calpers business. The rule also requires disclosure of how much was paid and for what services.
I would have put the prohibition of staff and board members to join a fund CalPERS invested with to five years or a minimum of three years. As for middlemen, get rid of them. CalPERS doesn't need them.
A special review, spurred by a scandal at the nation's largest public pension fund, recommended that the California Public Employees' Retirement System make potentially major changes in how it pays money managers.
The review, led by law firm Steptoe & Johnson LLP, urged that Calpers move to a system in which "nearly all" of a money manager's compensation come from profit-sharing, rather than "management or other fees."
Calpers's board asked the pension fund's staff to come up with a plan to implement the recommendations. Those details will be reviewed before the board votes on whether to adopt the proposed changes.
Monday's announcement could give a push to efforts already underway at some large public pension funds to rein in fees paid to investment firms that manage their assets. Many pension funds had painful losses during the financial crisis, and some are under pressure to revamp internal practices because of the pay-to-play scandal.
Calpers has about $220 billion in assets and paid $929 million in active investment-management and performance fees in the fiscal year ended June 30. The pension-fund system recently has won fee reductions totaling as much as $300 million, including from high-profile private-equity firm Apollo Global Management. An Apollo spokesman declined to comment but previously the firm said the Calpers agreement "establishes a new standard for aligning the interests of our firm with those of its largest investor."
The proposed changes by Calpers would mostly hurt private-equity and hedge funds, typically paid a management fee of 2% of the total invested, regardless of performance. Such investment firms also usually get a 20% slice of overall profits. About 14% of Calpers's assets are in private equity, while 4% are in hedge funds.
The nine-page report suggested that Calpers has been paying overly high fees and providing "an unnecessary source of profit" to money managers.
"It's a big deal," said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth College's Tuck School of Business. "With the anticipation that performance is not going to show capital gains for the next few years, management fees are a big and steady source of revenue."
Mr. Blaydon said he expects the findings to embolden other public pension funds to scrutinize investment fees.
New Jersey's $75 billion state pension-fund system recently negotiated "significant" fee reductions with about five of its alternative-asset managers, said Tim Walsh, director of the fund. "These fees in many cases were negotiated two to five years ago, and the world has changed."
Mr. Walsh said he doubts that pension funds can do away entirely with management fees because demand remains high for successful hedge-fund and private-equity firms. "The fund is not going to cut their fees in half to satisfy one client," he said.
A Calpers spokesman declined to say how broadly or deeply the fee-cut recommendation might extend. The pension system's board is expected to consider the findings in 2011. "It is really too early to say at this time," the Calpers spokesman wrote in an email.
The advisory report also recommended curbs on the use of so-called placement agents, who are paid to help secure investments from Calpers and other pension funds. The controversial practice has sparked investigations, civil lawsuits and prosecutions alleging that some placement agents improperly influenced pension-fund officials in return for hefty fees.
California's attorney general filed a civil suit earlier this year against two former Calpers officials tied to the pay-to-play scandal. Both defendants have denied wrongdoing.
In this investment environment, it's hard to justify high fees and absolutely ridiculous to pay 2 & 20 for leveraged beta! The big fat fee days are over for hedge funds and PE funds. Even the best funds will feel the heat.
You can download the report and recommendations by clicking here. Given that CalPERS is the largest US public pension plan, I wouldn't be surprised to see others following suit. Canadian public plans should also take notice as some of these recommendations might find their way up here one day.