CalPERS: Passive Investing – Active Monitoring

Investment News reports that California CalPERS, the second biggest U.S. public pension fund, is weighing the idea of taking its massive $255 billion assets under management and moving to an all-passive portfolio. Should we care?

Well, it would matter a lot for active managers who receive management fees from CalPERS, Josh Brown, who runs the popular financial blog the Reformed Broker, points out on Twitter.

Of course, the income of active managers could suffer if CalPERS moved the vast majority of its money management in-house. However, depending on how it is done, it could also hurt the larger society.

CalPERS already has more than half of its investible assets in passive strategies and is expected to make a decision in about five months on the bulk of the rest. (A Gigantic Pension Fund Is Reportedly Considering A Change That Should Make Investment Managers Freak Out, Business Insider, 3/25/2012)

The news prompted P&I Online to take a poll: What should CalPERS do with its active management portfolio? Readers, which include many potentially self-interested money mangers, were split: 31.5% chose “increase active equity management,” and 30.6% chose “decrease active equity management.” Almost 24% of respondents thought CalPERS should “eliminate all active equity management” from its portfolio. The remaining respondents said current levels should be maintained.  (Poll results: What should CalPERS do with its active management portfolio?, 4/1/2012)

According to a March 18th report (CalPERS committee rethinking active management, Pensions&Investments)

More than half of CalPERS’ $254.9 billion assets are in passive strategies. CalPERS investment consultant Allan Emkin from Pension Consulting Alliance told the investment committee that at any given time, around a quarter of external managers will be outperforming their benchmarks, but he said the question is whether those managers that are doing well are canceled out by other managers that are underperforming. Complicating the matter, he said, is that the outperforming managers change over time.

CalPERS ponders taking more equities in-house (Pensions&Investments, 4/1/2012) updates that information somewhat.

CalPERS already internally manages 83% of its equity portfolio, a percentage that has increased over the years, but approximately $22 billion is still managed by external managers… Regardless of the vote, massive changes to investments won’t follow immediately, said Janine Guillot, CalPERS’ chief operating investment officer, in an interview… CalPERS also manages more than 93% of its fixed-income portfolio internally in active portfolios and has been gradually increasing that allocation.

Board member  J.J. Jelincic told P&I that once fees are taken into consideration, CalPERS’ passive equity index strategies have outperformed outside managers on both a five- and 10-year basis. CalPERS could potentially save money by launching its own active strategies in-house.

When I read initial reports I was concerned that in moving more equities in-house CalPERS might become a passive indexer. As I mentioned in my recent series Agency Capitalism: Corrective Measures, current law encourages mindless indexing of portfolios and voting like lemmings to fulfill fiduciary duties. I don’t want CalPERS to join the throes of those practicing ownership without responsibility. I’ll have more to say on that topic when I review Citizens DisUnited: Passive Investors, Drone CEOs, and the Corporate Capture of the American Dream, a devastating critique of corporate America by Robert A.G. Monks. Suffice it to say, when owners don’t take responsibility for monitoring and governing their corporations bad things happen. Such companies aren’t as profitable even though they externalize more costs to society. CEOs are the primary beneficiaries of failed stewardship; the rest of us lose out.

After conferring with contacts, it now looks like there is little chance of CalPERS becoming passive in the corporate governance arena in the near future.

Friends on the Board offered assure me there are no plans for CalPERS to move away from “activist” advocacy for improved corporate governance or “sustainable” investing.  “Simple” active investing in public equity markets − e.g., stock-picking − has not produced net returns that beat the market. Over the years, not only has the percentage of the total fund managed actively − mostly externally − declined, in dollar terms it is also down. CalPERS has been putting some money into alternative passive schemes such as fundamental indexing and low-volatility methods. Investments in private equity with consideration of ESG factors is also likely to continue.

Anne Simpson

As I reported earlier in Agency Capitalism: Corrective Measures, perhaps because of the influence of Anne Simpson, CalPERS is finally committed to buying additional shares of stock in companies where CalPERS engages in seeking corporate governance reforms over a sustained period. (CalPERS Puts Money Where Mouth Is: CalPERS backing ESG engagement with stock purchases, Pensions&Investments, 3/4/2012)

I’ve been advocating such a move since starting this blog in 1995. In fact, one of the initial motivations for the blog was to get CalPERS to start a unit focused on corporate governance as a substantial part of their investment strategy. As part of that effort, I would also like to see CalPERS modify its index strategy to underweight investments in companies with the riskiest corporate governance practices. Why should CalPERS continue to hold companies headed for bankruptcy just because they remain in the Russell 3000 or similar index? Better to employ factors such as those measured by GMIRatings in building the index to be followed so the system can avoid such investments.

See pdf of survey document on investment beliefs at CalPERS.

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