The Performance Side of Pensions

A recent study found that pension portfolios are getting questionable investment advice. CalPERS may have a solution.
October 10, 2013

All eyes have been on the underfunding of public pension plans. But there is another side to the pension issue: How well are the investment arms of the plans doing, and what changes in strategy have pension portfolio managers made since the horrific losses of the Great Recession?

It is true that as of June 30, the assets of the 100 largest public employee retirement systems were the highest they have been since the federal government began tracking the information in 1968. State and local pensions now have $2.94 trillion under their belts, an 8.4 percent bump over the previous year. But a recent study by three University of Oxford scholars of U.S. equity recommendations from investment consultants between 1999 and 2011 found that the advice given was, as one of the authors put it, "worthless." The three researchers -- Howard Jones, Tim Jenkinson and Jose Vicente Martinez -- found that, on average, the consultants' recommendations underperformed their benchmarks by about 1 percent. In addition, a consultant's past performance was not disclosed and the institutions using their advice were not taking track records into account.

According to a survey conducted in 2011 by Pensions & Investments, 94 percent of pension funds use a consultant. The fees run into the millions. California's CalPERS, with assets of more than $265 billion, laid out $33 million for investment advice in 2012; the New York State and Local Retirement System, with assets around $164 billion, spent nearly $7 million in fees.

Investment performance and advice are high-profile topics on the portfolio side of pension systems. Some big systems -- CalPERS is a case in point -- have been rethinking their investment strategy and philosophy. In September, the CalPERS Board of Administration adopted a set of "investment beliefs." When they were released, Chief Investment Officer Joe Dear noted that the beliefs "are another important step in the recovery of CalPERS, providing a clear direction and philosophy for investment decisions."

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I talked with Joe DeAnda, CalPERS' information officer, about these new "beliefs" and the Oxford study's findings. Here's an edited transcript of our conversation.

Why did CalPERS decide to adopt these guidelines?

[These "beliefs" are] part of our asset liability management process. Asset manageability focuses on asset allocation but also takes into consideration risk and our liabilities on the pension side. It is a process that's done every three years. The end result is that the board adopts a new policy portfolio with regard to asset class allocations, which will then feed into a review of the assumed rate of return in the first quarter of 2014. The 10 investment beliefs were adopted last month. That was purposefully done so the adopted beliefs can feed into the decisions that are made in December and early next year.

The beliefs were established to provide an overarching framework for decision-making. What had happened in the past is that staff -- especially higher-level staff leading an asset class -- would come into the investment office, maybe with different views of the investment world and how their particular asset class should be managed. So in addition to providing a framework, the beliefs are intended to help with continuity of philosophy within the investment office. As people come and go, we will still have that underlying set of beliefs about work in the investment office.

How will the guidelines be implemented?

We looked at the policy that will govern the use of beliefs. That policy will be adopted this month. The draft policy on our website is pretty close to the final version. Staff recommended the policies that the board will be voting on. That will outline in great detail how the beliefs are intended to be used. They're not meant to be a checklist for every decision that needs to be made. They are intended to be a higher-level framework for decision-making.

Is CalPERS the first to do this type of thing?

We're one of the first at least. I think there's another state fund that may have a set of beliefs. Some European funds do.

What do you see as the importance of writing a set of beliefs or investment guidelines?

Continuity is a large part of it, and having a more cohesive statement of our beliefs. Many of these beliefs had been articulated in different venues, but there was a feeling that it was important to really examine these statements and feelings and pull them together into one official document. There was a very involved process with staff, especially senior staff, with the board and with consultants to poll beliefs on different things. As this unfolded, there was more debate and discussion and they were able to hone in on a final set of beliefs.

The University of Oxford study claims there is subpar performance of most consultants and, more important, there is a lack of disclosure about this. Do the investment beliefs address the issue of holding consultants accountable and tracking their record?

One of the bullets under "Investment Belief 8" says, "CalPERS will balance risk, return and cost when choosing and evaluating investment managers and investment strategies." Another states, "Transparency of the total costs to manage the CalPERS portfolio is required of CalPERS business partners and itself."

There's a general sense of cost efficiency, and we've done work across the portfolio to work with managers and leverage the most savings that we can. Certainly there's a focus on cost. That's been well documented, especially in private equity where we've tried to negotiate better terms. So it's something we're always aware of and thinking about. The second to last bullet says that we will "seek to reduce cost, risk and complexity related to manager selection and oversight."

So in short, the answer is "yes."

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