Nearly all of the nation’s larger public pension funds, 99 percent, have better investment earnings than CalPERS since the economy began a steep drop five years ago, a Wilshire consultant report said last week.
Now the nation’s largest public pension fund, a former investment leader said to have had a “herding effect” on other pension funds in one academic study, is several years into an attempted overhaul.
A conceptual change that emerged from a study two years ago is intended to use “risk” as a way to classify and monitor investments. The shift has begun, but it’s still evolving amid a search for more answers.
Another change would build up the CalPERS investment staff and rely less on outside managers. A new proposal would add 44 investment positions at a cost of $6.5 million, offset by reducing fees paid outside managers by $100 million to $200 million.
The biggest loser, real estate, has moved toward predictable leases and away from speculative developments. A new private equity manager, Real Desrochers, brings more internal management to key investments expected to yield above-market returns.
The one bright spot, bonds, has seen about $7 billion moved in-house. But overall, Wilshire said, earnings continue to be hampered by a stock portfolio skewed toward foreign holdings and a real estate debacle that may be felt for another 10 years.
In a report marking his third anniversary on the job, Joe Dear, the chief investment officer of the California Public Employees Retirement System, last week talked about the problems and the progress.
“From October 2007, our peak value of $260 billion, to March 2009 to $160 billion — we dropped $100 billion of assets,” Dear said. “We got most of that back. We are at $235 billion of assets.”
Dear mentioned three lessons learned: classic portfolio theory that aims to reduce risk by investing in different types of assets faltered, having “silos” or little exchange between units is dangerous, and ready access to cash or “liquidity” is important in a crisis.
The move toward a risk-based view of assets is a response to the nearly lockstep plunge of most types of assets. Dear said managerial “silos” that kept one unit in the dark about the actions of another may have contributed to real estate losses.
“Fixed income on the third floor . . . was getting out of mortgages because they didn’t like the market, and on the fourth floor the real estate group was selling assets at a very good profit and then turning around and buying more expensive assets with more leverage (debt),” he said. “That produced a return disaster for us which to this day has impacted our long-term performance.”
CalPERS sold $16 billion worth of income-producing and other low risk real estate, a staff report said in April 2010, and then spent the money while buying $30 billion worth of higher risk real estate as the market peaked in 2005 and 2006.
When the financial crisis hit in the fall of 2008, CalPERS and other major investors had to scramble to get cash to cover, among other things, the “securities lending” that usually provides a small profit and is said to aid market operations.
“If you don’t have liquidity, and we didn’t, then you are forced to sell your best assets at fire sale prices and mark down the portfolio,” said Dear, “and that’s what happened to us, primarily because of the securities lending portfolio.”
Most famously, CalPERS is said to have raised $370 million by selling 2.3 million shares of Apple in 2008 worth about $1.35 billion now. Apple has a $100 million cash surplus and may announce a major dividend or other action today.
Three years ago CalPERS also was hit by a pay-to-play investment scandal. A CalPERS probe found that a former board member, Al Villalobos, received $50 million in “placement fees” from private equity firms for helping them get CalPERS investments.
“What I came to learn is that when you are told there are placement agents in your organization it’s kind of like being told there are termites in your house,” Dear said. “It may be a really isolated, small infestation but you have to fumigate the whole place to get rid of them.”
Dear said placement agents provide a “valuable service” and have a market function. But during a CalPERS-sponsored special review, he said, staff had to revisit gifts received during the previous years, not the “greatest morale booster.”
The CalPERS private equity manager, Leon Shahinian, resigned. Villalobos and a former CalPERS chief executive, Fred Buenrostro, are accused of bribery-related charges in a civil lawsuit filed by the state attorney general.
Another issue that has heated up during the last three years is whether CalPERS pensions are “sustainable” or will eat up too much of state and local governments. Critics say the CalPERS earnings forecast is too optimistic and conceals massive debt.
Last week the board lowered the earnings forecast from 7.75 to 7.5 percent, increasing state and local government pension costs. The change reflects an expectation of lower inflation, not new doubt about hitting the earning target in the decades ahead.
“I’m quite confident of our ability to achieve a long-term target rate of return,” Dear said.
A board report last week showed that CalPERS is paying $1.2 billion a year in fees to outside money managers, $19.2 million for consultants and $29.5 million for CalPERS investment staff.
Board member Dan Dunmoyer suggested CalPERS think about the incentive of a high salary, perhaps $1 million, for investment staff capable of producing perhaps billions in earnings. Dear agreed with Dunmoyer that high salaries probably would be “unrealistic” politically, though a recent Economist article said Canada does it.
Janine Guillot, CalPERS chief investment operating officer, said the pension fund is not trying to compete with the private sector but can offer benefits that are attractive to many.
“My big worry is the junior people,” said Guillot. “You see it in our recruiting statistics, where our junior positions are staying open much longer.”
Board member J.J. Jelincic said a new CalPERS requirement that outside real estate managers put someone on the account full time has resulted in high salaries.
“There are people working on only our account that are making in excess of $1 million a year,” Jelincic said, “and I will tell you it is not a great staff morale booster when they collect that data.”
Board member Richard Costigan, who also serves on the State Personnel Board, said the personnel board hears cases about “contracting out” state work to the private sector, but not on the scale of the $1.2 billion CalPERS fees to outside manager.
Costigan said there is “significant pressure” on CalPERS investment staff to achieve “returns without the reward.” He said investment work is different “and I think at some point we have to acknowledge that.”
The board held a workshop last week on hedge funds, which use options, borrowing, investing across asset classes and other flexible strategies. CalPERS has about 2.3 percent of assets in hedge funds, low compared to some pension funds with 20 to 40 percent in hedge funds.
“You started the public pension plan move (into hedge funds) and other pension plans in the U.S. followed and then European pension plans followed you,” a former World Bank official, Afsaneh Beschloss of the Rock Creek Group, told the board.
A paper issued last November by researchers at the University of Dayton found that the amount of risk taken on by public pension funds is influenced by governmental accounting standards, a low funding level and state imposed financial constraints.
“There also appears to be a herding effect in that a change in CalPERS portfolio beta or equity allocation is mimicked by other pension funds,” said the paper by Nancy Mohan and Ting Zhang.
The Wilshire report shows CalPERS earnings at the end of last year: 5.29 percent for the previous 10 years (71st percentile among funds with more than $10 billion), 0.57 percent for five years (99th percentile), and 1.24 percent (44th percentile) for one year. (See Wilshire report, attachment 4, Part 1, p. 20)
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 19 Mar 12
Calpensions 
March 19, 2012 at 2:07 pm
Glad to see the positive adjustments! This is why I love Calpers— a learning organization in the Peter Senge sense of the word!
March 19, 2012 at 3:44 pm
This report is all the more reason to roll back benefits to match those in the private sector. A.B. 400 was supported by the legislature to retroactivly double pensions back in 1999 during the dotcom boom when CalPers said the market would be 29,000 by 2009 and that these benefit increases wouldn’t cost the state anything. Yea right! It is time to roll them back to match those who are paying for them, the private sector workers of this sate. Until then, there is no way anyone will vote for a tax increase which will simply cover up these problems and push the day of reckening out further. Fix it now!
March 19, 2012 at 4:59 pm
Oh Gary— no doubt…reform is comming…..but it must be lawful or it fails. Failure does no one any good. The bottom line is that we are a nation of laws. Modifications can and have occurred but in lawful and predictable processes. You would hate it if rash unlawful “fixes” were slapped together , as they have been in the past, and then of course it’s tied up in the courts for 3 years with the end result; not fixed, back to square one. I wonder how many more times we will have to do this? Thoughts?
March 19, 2012 at 7:08 pm
Don’t exaggerate, Gery. I, a miscellaneous worker, was a beneficiary of SB400, by the time it was amended, to include miscellaneous workers, in 2001. Everyone who was a recipient of the change, and many were not, benefitted, in some positive, way. But, a doubling of pension amounts–no way! I got a 20% increase, in the final analysis–it really helps me with that 32%, of my gross pension amount, that I must allocate for medical insurance premiums, for my spouse and me. Why not start caring for CA, and stop wishing downfall on others. We must pass some type, of tax increase, or the State, and all its citizens, will suffer the loss of many public services they want–and the pensions will go on, regardless.
March 19, 2012 at 7:30 pm
Ted, no doubt the existing laws are significant barriers to reform and we wouldn’t want to do anything rash that doesn’t consider them. It would meaningless to do anything else. All parties need to negotiate these things, but the taxpayers are not represented at the table despite this being a representative democracy. It’s just the unions negotiating with the people they support with votes and monitary contributions. How fair is that? Can we really expect anything to come out of this? In the private sector benefits are much less generous and not guaranteed. One would think if you had legally guaranteed benefits, they would be LESS generous, not more. There should be a trade off. There must be a better way.
March 19, 2012 at 7:37 pm
Seesaw, please understand the environment in the private sector. The last I heard, there were only about 20% of private sector workers that have a defined benefit pension like you do and the number is still falling. We were left to be entirely on our own to figure out how to finance our future. I am not wishing the downfall of others, just fairness for all and right now I don’t see that.
March 19, 2012 at 7:56 pm
If the workforce-at-large contributed to a statewide (or even nationwide) defined pension plan, wouldn’t that be the way to move forward ? I wouldn’t trade a defined plan for what most U.S. private sector workers have, but I certainly don’t get any glee from watching other people’s problems. However, some peoples’ sense of of what it takes to achieve ‘fairness’ actually lowers the bar for everyone and that’s unacceptable. Why not promote, instead, something that’s good for everyone with a REALISTIC contribution rate from the employees/ employers; something around 50/50 instead of the artificial rates employees now take for granted ? In other words, a properly funded defined pension for all workers, across the board. I have friends in Germany, where this sort of nationwide plan has been around for years. People don’t get rich, but you also don’t see the dire poverty like you do here in the States.
March 19, 2012 at 8:18 pm
CalPERS is trying to solve a problem by adding on to what created the problem in the first place.
All these million-dollar and six-figure income investment advisers CAN’T BEAT THE RETURN of the total stock market index. In order to do that, they must be able to predict the future.
They can’t.
Adding 44 more people to try to do what the others can’t do, will result in another 44 people who will not beat the index. How many billions do we pay to under perform a non-managed index?
Fire them all. Invest CalPERS assets in the total stock market index. It’s the best thing to do for those who are counting on CalPERS returns to fund retirements.
There. I said it.
March 19, 2012 at 8:32 pm
Gary– I think you’re a bit cynical there. In bargaining management represents management and all contracts are approved by YOUR reps. Pick any elected body that approves these things you want. Pick out your most favorite rep. Look at her voting record. These contrcts are approved because the gov is a business that does important work and needs to function. If you think your rep is giving away the store— you know what your democratic remedy is. Oust the bum and put in your new guy. If taxpayers (and we all pay those) are soooo fed up— then they will put in a new group of reps. Period.
March 19, 2012 at 9:32 pm
Gery, I am married to a retired carpenter, who lost the bulk of his pension, due to the illegal invasion. All my family members and friends are in the private sector–so I know very well, what is happening. I worked in the private sector myself, long ago, when I first came to CA. I support workers everywhere, whether they be private or publlic. Just because the private sector has been screwed, is no good reason to wish the same, on the public sector. I want to see workers brought up to livable standards, no matter where they work. In the meantime, I hope you viewed the 2011, Oscar-winning documentary film, “Inside Job”–if you didn’t, rent it–everyone should see it.
March 19, 2012 at 9:36 pm
Drewsky, there are groups nationwide, that are working on the subject, of DB pensions for everyone. There was a presentation, by the Director of such a group, at the CalPERS, sponsored CA Dialogue in LA, in Feb., 2010, which I attended. You are correct, in your assessment.
March 19, 2012 at 11:13 pm
People. I appreciate the good dialog here. “Fairness” can mean lowering or raising the bar. As far as the federal government is concerned I can assure you the bar will be lowered for all of us and our standard of living will decline continuously for the rest of our lives. They simply overcommitted and did not take into account the baby boom generation. Same overcommittment on the part of state pensions. We can all pay more taxes to support the current pensions, but nobody is volunteering to increase my private pension. The idea of a national system has some merit, just not in our lifetime. I did see “Inside job” and it was disgusting. Unfortunately, my vote isn’t going make any difference in the politics we have in this state. Hate to say that. but the next group will be bought off the same way.
March 21, 2012 at 8:24 pm
A contract is not a contract when it is created based on fraud and a complete misunderstanding of available money. No need to worry – this is a 5-year long term problem, not a 1-year short term problem. Just don’t think about how things will be in 5 years and everything is peachy. Don’t worry; be happy.
In 1857, California had a statewide proposition: Pay the Debt, Repudiate the Debt. In 2012, California should have a “Pay full Pensions” proposition. It would lose big.
March 23, 2012 at 9:48 am
ARCO is 100% correct. No manager can consistently beat an index. When they do beat the index they are taking on more risk. Fire all the managers and invest it in a weighted index with Vanguard. Vanguard could do it at 1/10th the cost.
March 23, 2012 at 2:27 pm
Anyone have a link to the Wilshire Consulting 2012 Pension report?