Responding to legislation, the CalPERS board last week approved a five-year plan for a program that has given $10 billion to 300 new “emerging” investment managers with limited experience, yielding mixed results during the last two decades.
The nation’s largest public pension fund, valued at $239 billion last week, makes some investments with the twin goals of social-economic benefit and hitting an earnings target, 7.5 percent, that critics say is overly optimistic and conceals massive debt.
CalPERS has another $3 billion managed by 80 firms owned by women and minorities. A staff report noted that state agencies are prohibited (Proposition 209 in 1996) from considering race, gender and ethnicity in employment and contracts.
“Women and minority managers are more likely to be emerging managers,” said the report. “As a result, an ancillary benefit of our EM (emerging manager) strategies may be the increased diversification of CalPERS external fund managers.”
The renewed commitment to emerging managers comes as CalPERS, with investment earnings trailing nearly all large pension funds, is restructuring investment programs and showing progress in some areas, notably real estate.
The CalPERS investment fund remains well below its pre-crash peak, $260 billion in the fall of 2007, despite the recovery since the market bottom in March 2009 and annual employer-employee contributions that totaled $11 billion in fiscal 2010-11.
CalPERS expects to get two-thirds of its revenue from investment earnings. When earnings fall short, actuarial methods can ease rate increases. But if earning shortfalls continue, employer rates could soar, eating up funds needed for other programs.
A CalPERS consultant, Wilshire, compares earnings (page 20)among public pension funds with more than $10 billion in investments. As of last Dec. 31, CalPERS earnings ranked dead last during the previous five years, 0.57 percent, the 99th percentile.
The top-ranked funds in the fifth percentile earned 6.12 percent. The good news for CalPERS, if only in terms of peer performance, was that its one-year earnings were in the 44th percentile, 1.27 percent.
Over the last two decades, the CalPERS earnings average hit the 7.50 percent target. But critics say that period includes a record two-decade bull market ending in 2000 that is unlikely to be repeated.
A man known as the “bond king,” Bill Gross of Pacific Investment Management Co. in Newport Beach, the world’s largest bond investor, joined the critics last month with a well-publicized prediction that “the cult of equity is dying.”
Gross said stocks historically have returned 6.6 percent after inflation, but are unlikely to do as well in the future, said the WallStreet Journal, which noted some past Gross predictions have missed the mark.
Now Gross thinks policymakers may use inflation to “worm out of fiscal holes,” said the Journal, and he thinks “inflation kills long-term bonds and stocks also fare poorly.”
A Wilshire consultant told the CalPERS board last week that the Santa Monica- based firm thinks CalPERS can hit its 7.5 percent earnings target, with an expected 7.25 percent from market investments and higher yields from private equity and real estate.
“I don’t think that is an unrealistic amount of value to be added,” said Michael Schlachter of Wilshire.
In a major turnaround, CalPERS reported a big gain in real estate, which was hit by a string of well-publicized losses when the housing bubble burst, led by a $1 billion write off for a failed development north of Los Angeles.
A shift from speculative investments to income-producing property helped produce a 15.9 percent gain in real estate last fiscal year. The real estate staff leader, Ted Eliopoulos, said it was the “first signs or seeds” of a painful five-year restructuring.
Private equity gained 5.5 percent last fiscal year, down from its 10-year average of 9.9 percent. The private equity holdings, nearly 60 percent in leveraged buyouts, are valued at $34 billion, about 14 percent of the total fund.
A CalPERS investment strategy to avoid “home-country bias” and tilt toward “global equity” has been a drag on earnings as U.S. stocks lead. Wilshire continues to think the global equity strategy will pay off in the long run.
CalPERS has had other problems with the ill-timed removal of a market “overlay” hedge against losses and forestland investments centered in the south rather than the northwest, where the timber industry currently is aided by Asian demand.
In the mixed results from the $10 billion invested with emerging managers, there has been “added value” in global equity, but not in private equity, real estate and hedge funds, Joe Dear, the CalPERS chief investment officer, told the board.
The new chairman of the investment committee, Henry Jones, said CalPERS is proud of its long commitment to emerging managers and a record of accomplishment and leadership.
“However, as we all are aware CalPERS performance is below benchmark and performance against peers has not met expectations,” he said.
Jones said restructuring to improve performance, which reduced the number of managers and established controls, caused concern among some managers and stakeholders, which should be eased by the five-year plan.
The original version of the bill calling for a five-year plan, SB 294 by Sen. Curren Price, D-Culver City, set a goal of giving emerging managers 15 percent of CalPERS investments handled by outside contractors, not by CalPERS staff.
A specific goal was removed from the bill. The $10 billion CalPERS has invested with 300 emerging managers, nearly $1 billion during the last three years, is about 12 percent of the funds handled by external managers.
The restructuring of private equity led by new manager Real Desrochers resulted in a staff proposal last week to phase out a decade-old program that has put more than $1 billion into California firms, mainly to create jobs and development in underserved areas.
The first phase of the “California Initiative” hit its earnings target only because one $40 million investment in Leslie’s Pool Supply yielded a return of 12 times that amount. The yield from the second phase was below the benchmark.
Board member Steve Coony, representing state Treasurer Bill Lockyer, and Greg Beatty, representing the Brown administration, urged Desrochers to reconsider and come back to the board with a plan to improve the program.
“It’s important to let the public in California know that we are not going to disinvest that way,” said Coony, who said he discussed the California Initiative program with Lockyer.
“This is one where we would like to see a bigger commitment than a 10-year $1 billion commitment,” Coony said, “something at least equivalent to the infrastructure proposal for starters.”
CalPERS announced a goal last September of putting up to $800 million into California infrastructure over three years, then held a series of closed-door meetings last spring with local officials to discuss investment needs and possibilities.
“We will do that,” Dear said in response to Coony‘s request for a plan to improve the program. “It’s a good idea to maybe apply lessons from the infrastructure outreach that would create more visibility.”
Ed's Note: Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/