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2010-09-21 13:27:52
The last of our series of profiles on financial institutions looks at America s
biggest pension fund, which is taking a stiff dose of its own medicine
Sep 16th 2010 | Sacramento
FOR years, underperforming companies have lived in fear of a tongue-lashing
from the California Public Employees Retirement System (CalPERS), which has
led a crusade to improve the quality of corporate governance in America. It is
therefore somewhat ironic that CalPERS now faces criticism for losing billions
of dollars during the downturn and for failing to run a tight ship. Anne
Stausboll, the fund s chief executive, and Joseph Dear, its chief investment
officer, are working overtime to repair the damage done to the pension behemoth
s assets and its reputation during their predecessors reign.
Much is riding on their efforts, which were reviewed at a meeting of the fund s
board in Sacramento this week. CalPERS provides health and retirement benefits
to over 1.6m beneficiaries, including doctors, firemen and policemen. If it
cannot achieve the investment returns on its $200 billion portfolio needed to
help pay for workers benefits, then these may have to be cut or the state s
taxpayers could end up picking up the bill. Given that California is already
grappling with a $19 billion budget deficit, that is an alarming prospect.
Admittedly, CalPERS is not the only public pension fund in America nursing a
nasty hangover. But its woes are striking because they stem from racy
investment bets, poor risk management and a lax attitude towards potential
conflicts of interest at an institution that was supposed to be a model of
modern fund management.
Consider those investments first. CalPERS loaded up on real estate, private
equity and other illiquid assets in the years before the crisis. These boosted
the fund s performance, helping it grow to $250 billion by mid-2007. But when
the meltdown began their prices promptly plummeted. As a result, CalPERS s
returns were -23% in its financial year to the end of June 2009 (see chart).
Returns for the median public pension fund with more than $5 billion of assets
were -19%, according to Wilshire Associates, an investment-consulting firm. In
particular, the fund made too many bets on risky properties, including a $500m
investment in a vast housing complex in Manhattan, since written off.
CalPERS has also been caught up in a furore over the activities of placement
agents , who help financial firms win investing assignments from big pension
funds in return for a fee. Some critics have claimed agents create a
pay-to-play culture in which outside firms win contracts based on whom they
know rather than on their merits a charge that agents dispute.
In May California s attorney-general filed a lawsuit against Alfred Villalobos,
a former CalPERS board member, accusing him of improperly using his contacts at
the fund to help other firms win business from it. Mr Villalobos has denied any
wrongdoing, as has Fred Buenrostro, a former CalPERS chief executive who was
also named in the suit. The attorney-general should not have filed this case
because Mr Villalobos has always acted appropriately, says Neal Stephens, Mr
Villalobos s lawyer.
They ve cashed in their CHiPs
Last year CalPERS changed its policy to force external money-managers to
disclose whether they are using placement agents to solicit business and how
much they are paying them. It has also taken other long-overdue steps to
bolster transparency, including banning staff from accepting gifts from
business partners.
Such actions are part of a broader set of initiatives designed to mark a fresh
start at CalPERS. Among other things, the fund has imposed tougher controls on
the use of leverage, cut almost $100m from the $1.2 billion it pays each year
to outside managers and reduced its exposure to troublesome real estate. I
cannot overstate our determination to make this a new day here, says Mr Dear,
who joined CalPERS in March 2009. Ms Stausboll was named chief executive in
January that year.
California risking
Mr Dear also seems determined to hit the 7.75% annual rate of return that
CalPERS says it needs to achieve to meet its commitments, though the target
could change as the result of an internal review. In its most recent financial
year, the fund made a return of over 11%, but some observers reckon it will
struggle to meet its target in future without taking more risks.
CalPERS can point to the fact that over the past 20 years it has earned an
average annual return of 7.9%. But returns from conventional assets such as
stocks and bonds are unlikely to be as helpful as they once were. That explains
why, in spite of recent history, Mr Dear remains keen to pour more money into
riskier assets such as emerging-market stocks, private-equity funds and big
infrastructure projects. In June, CalPERS agreed to pay up to 106m ($156m) for
a stake of almost 13% in Britain s Gatwick airport, marking its first big
direct investment in infrastructure.
Given CalPERS s long-term investing horizon, such bold bets could pay off. But
Mr Dear says he knows the fund also needs to get better at making short-term
tweaks to its portfolio if the need arises. Some critics think that CalPERS
should be lowering its sights instead. David Crane, who advises California s
governor on economic policy, says the 7.75% goal is wildly unrealistic and
reckons the target should be closer to 6%. These guys are swinging for the
fences and we, the taxpayers, will bear all of the risk, he cautions.
Mr Crane is not the only one who is concerned. At an open meeting of the board
s investment committee on September 13th, the treasurer of a small Californian
utility made a plea for CalPERS to reduce volatility in its portfolio. It
looks more like we re gambling, he chided, pointing to the 14% of the fund s
assets that are still invested in private equity. The snag is that if CalPERS
takes less risk, generous public-pension schemes will almost certainly have to
be renegotiated. That is one governance test that California s politicians and
unions will be loth to take.