Why some pension experts believe CalPERs got 'nothing' out of paying Towers Watson $275,000 to define its 'beliefs'

Brooke’s Note: I’m no pension expert. But when I hear that a pension plan paid — on top of the hundreds of millions in annual expenses — a Florida condominium-sized fee to an outside consultant in a move designed to avoid making bad decisions, I want to know if the hiring of the consultant wasn’t a bad decision. Robert Boslego did, too. Was anything accomplished here or was this $275,000, formerly in CalPERS bank account, used as a sacrificial offering to atone for billions in assets squandered in bad investments in 1999 and 2008-'09? CalPERs is not part of the RIA business but the point here may be that at the rate that it’s going, the assets well end up in a defined-contribution environment.

In an effort to create an instant, better culture to ensure sound decisions by the stewards of hundreds of billions of dollars in assets, the California Public Employees’ Retirement System — metaphorically behind by three touchdowns in the fourth quarter — paid a consultant $275,000 to create its own 10 commandments to guide that new culture.

But the decision to give a boatload of cash to Towers Watson & Co. to come up with 10 bedrock beliefs to save a bigger boatload of assets appears to itself have been done in a manner devoid of clear thinking, according to a number of experts in the financial industry, including Michael Falk, partner at Focus Consulting Group of Long Grove, Ill.

“I don’t personally care for the document as it doesn’t seem to be about investment beliefs,” he says. “These [CalPERS] investment beliefs did not establish any governance or decision rights, and I have no idea what they believe after reading them.” See: What I learned from the CalPERS meeting in which the 10 Beliefs were unveiled — and why I came away mystified. Falk is co-author of the white paper “Investment Beliefs: Separating the Real Stuff from the Fluff.”

Wisdom to know the difference

The idea of the “beliefs” certainly sounded promising. The Towers Watson work product would identify and hone the CalPERS philosophy without dictating virtually every micro-movement of its strategy. CalPERS, which manages close to $300 billion of assets, hired New York- and London-based Towers Watson in 2012. See: The 401(k) industry braces itself for fruits of a CalPERS rethink that reflects a cut-the-crap mentality about active investing.

The plan was embarked upon in the spirit of 12-step recovery and a laudable spirit of humility.

“These beliefs are another important step in the recovery of CalPERS, providing a clear direction and philosophy for investment decisions,” Joe Dear, CalPERS’ chief investment officer, said at the unveiling of the beliefs in September, seeming to confirm that his employer was purchasing a sort of hangover pill as a remedy to years of bad investment decisions.

Political move?

Joe Dear: These beliefs are another
important step in the recovery of
CalPERS.

And CalPERS needs to recover from its former leaders’ barreling, for instance, into real estate investments at the top of business cycles in 1999 and 2007 and getting badly burned in the process.

But this CalPERS-Towers Watson reinvention project does not seem to have hit the mark, and CalPERS — racking up a big unfunded liability of $80 billion or so — may have had a more pragmatic reason for bringing in a big, branded consultant, according to Steve Winks, partner at Sr. Consultant.

“It sounds like a political move. The board can say: 'We went through an exercise and lo and behold, we’re not infallible but at least we did something.’”

Can meets road

One section of the report appears to go through the motions concerning the crucial question of what risks are appropriate for CalPERS investors to take. The report essentially states that risk needs to be defined more broadly than just tracking error and volatility and that CalPERS should develop ways to measure risk — but without saying how.

Another crucial question is whether CalPERS should strive for alpha through active management. The document asserts that CalPERS should manage money actively if it believes it can generate greater returns than a passive approach would. See: A careful look into whether CalPERS is ticking along or a ticking time bomb.

“CalPERS will take risk only where we have a strong belief we will be rewarded for it,” the belief reads. The nature of a “strong belief” went undescribed. See: Why smart diversification and risk management are your best friends.

In other words, the beliefs, in the well-worn phrase, kick the can down the road, and no attempt is made to describe how, had these beliefs been in place in 1999 or 2008, CalPERS would have avoided racking up its current unfunded liability.

Inclusive framework

Allan Emkin, managing director of the Pension Consulting Alliance in Portland, Ore., which was also hired by CalPERS for guidance, promoted the adoption of the beliefs this summer in a release that read in part:

“The proposed policy provides a well-thought-out and inclusive framework for exercising judgment in the investment-decision-making process. We believe that the policy will provide a dynamic framework for decision-making at all levels. We encourage your adoption of the policy without reservation.”

Emkin declined to be interviewed and referred questions back to CalPERS.

'Nothing changes’

But after Emkin, Dear and others talked up the beliefs in advance of their publication, CalPERS is now downplaying the importance of the beliefs post-adoption.

“There [are] no specific deliverables that come out of the adoption of the beliefs; nothing changes about the portfolio, or our operations,” CalPERS spokesman Joe DeAnda says.

That the beliefs would come out without a trace of specificity was all but preordained, according to Winks.

“They basically went with fiduciary duty [in the format of a list of investment beliefs] and really that is all they could be. It had to be Plain Jane.”

Steve Winks: The board can say:
'We went through an exercise and
lo and behold, we’re not infallible
but at least we did something.’

Myth busting

There was a time of action, input and feedback that seemed to suggest that much more was possible last spring. The Towers Watson point man in delivering no deliverables to CalPERS was Roger Urwin, global head of the firm’s investment content, a role he assumed after acting as global head of investment practice from his London office. Towers Watson is a publicly held financial services consultant with about 14,000 employees and a market valuation of around $8 billion.

Urwin’s centrality to the process first became apparent when he appeared before the CalPERS board, the particulars of which are described in some detail here. None of the “straw man beliefs” presented to the board became a final belief.

“We need to understand what we are achieving here,” Urwin said to CalPERS board of directors. “And I like to quote JFK: 'Belief in myths allows the comfort of opinion without the discomfort of thought.’ The investment world has a lot of myths, and we want to talk about them.”

CalPERS is satisfied with the results produced by Towers Watson, according to DeAnda. Urwin and Towers Watson declined comment for this article.

Theory or practice?

Towers Watson achieved nothing, according to Falk, who said its document “failed to deliver … recommendations to insure investment beliefs would be applied in practice.”

DeAnda also uses the word “nothing” in assessing the tangible effects of the belief implementation: “Nothing changed on Sept.16 when the beliefs were adopted; no material changes were made to the portfolio, our allocations, or our operations, as a result.”

Somewhat cryptically, he adds: “The intention of the beliefs are to provide a framework for future decision making. Naturally, those future decisions may lead to material changes, but the adoption of the beliefs themselves did not. The policy that was subsequently adopted this month clearly outlines how the beliefs are applied in practice.”

The policy he refers to states, “The investment beliefs are not a checklist to be applied by rote to every decision. They are a guide for making judgmental decisions that often require balancing multiple, interrelated decision factors.”

DeAnda explains that the idea was to provide “a continuity of thinking and a philosophy as senior investment staff come on board and leave” and board members, too, change as political appointments or elected offices change.

“Having these beliefs will … keep a level of continuity, no matter what personnel changes may happen,” as if the same beliefs should hold for future generations.

Towers Watson says, in seeming contradiction, that pension funds should be willing to adjust working beliefs over time in favor of improved ones.

Movable feast

RIABiz discovered the report’s $275,000 price tag when Robert Boslego, reporting for this article, filed a formal request for the letter of engagement executed by Pension Consulting Alliance.

The LOE executed by Towers Watson called for developing a common understanding between the investment committee and the staff as to the meaning of the term “investment belief,” the purpose of investment beliefs, and the criteria for choosing them; integrating the investment beliefs process into the strategic asset allocation process; and providing recommendations to ensure they would be applied in practice.

The LOE asked for an education in addition to a process. It also sets an intention that the beliefs should become part of the investment process.

Challenging truths

Alfred Slager: Investment beliefs are a
tool to help you challenge conventional
truths.

The introduction to the document states that investment beliefs are a feature of big asset owners wanting to sort out their investment process.

Further, investment decisions can be broken down into three parts: context, beliefs and analysis. To improve decision-making performance, Towers Watson advises improving each area. However, it adds that the largest competitive advantage comes through improving beliefs.

But there is a more plainspoken purpose of investment beliefs that is not mentioned in all the bureaucratic language of the LOE.

“Investment beliefs are a tool to help you challenge conventional truths,” according to Alfred Slager, professor of pension fund management at TiasNimbas Business School, director of the Center for Applied Research at the Tilburg School of Economics and Management in Amsterdam, Holland, and co-author of the site investmentbeliefs.org.

If investment beliefs are thought out badly, or ignored, such beliefs become a challenge to the investment organization — and a chronic problem in the whole pension industry, according to Slager.