WSJ: CalPERS questions its own ability to execute winning trades

Brooke’s Note: As the RIA world rushes to embrace alternative investments, an early adopter of the instruments can’t stop talking about kicking the habit. Where exactly the smart money lies here is very hard to say. CalPERS swears it’s learned hard lessons from the recession, yet six years on almost no changes have been made and its decision-by-committee bureaucracy is still pondering whether a teachable moment is at hand.

The Wall Street Journal reports that California Public Employees’ Retirement System, the world’s largest pension fund with $295 billion in assets, is considering radical new moves to minimize risk by trading in its temperamental Lamborghini of an investing approach for one more like a reliable Toyota Camry.

Skeptics, however, see this as akin to examining the latch after the car has left the garage.

Hedge fund diet

Specifically, the debate is said to center around divesting small, complex, illiquid investments in favor of larger, more diversified and liquid ones, according to an article in yesterday’s Journal.

The Journal article gave three specific examples of investments CalPERS is considering scaling back or eliminating. The largest shift debated is a move out of individual stocks, currently a $55 billion stake in CalPERS portfolio, and into broader investment classes like stock sectors of countries typically purchased using exchange traded funds. See: 5 counterintuitive reasons why the investment vehicle of the decade is … stocks.

Also under the discussion is the pension fund’s allocation to hedge funds. While CalPERS has already reduced its position from $5 billion $4.5 billion in 2014, some within the pension fund are pushing to eliminate the stake entirely.

According to Chicago-based Hedge Fund Research Inc., equity hedge funds have returned just 6.49% annualized over the past five years compared to more than a 16% annual return for the S&P 500. (Hedge funds, of course, tend to do less well than index funds in bull markets, having one foot on the brake — all the better to stop careening off a cliff.) See: How the Winklevoss twins disrupted a big NYC hedgie event and distracted from the poor job most hedge funds are doing for clients.

Finally, the Journal reports that CalPERS is debating total divestment from its $2.4 billion position in commodity indexes. See: The 401(k) industry braces itself for fruits of a CalPERS rethink that reflects a cut-the-crap mentality about active investing.

The big question

The Journal also suggests that some aspects of CalPERS trading operations could be scaled back in the future, as some wonder whether they are worth the risk and expense. See: The 401(k) industry braces itself for fruits of a CalPERS rethink that reflects a cut-the-crap mentality about active investing.

“What you have to ask yourself is, can you trade your way to success with $300 billion?” says Eric Baggesen, CalPERS senior investment officer for asset allocation and risk management, in the article.

In the case of CalPERS, the answer to that question has historically been an implicit “yes.” The fund is considered to have the scale and sophistication to get the first seat for any product or deal and to have a team of sufficient size and expertise to complete the due diligence on the densest and most opaque of investing opportunities.

Beliefs 'irrelevant’ to debate

Robert Boslego: This might be a
way in which they are finally
trying to make the change.

The Journal article suggests that these changes were hinted at last September when CalPERS announced the release of their “10 Beliefs,” crafted to guide its investing process. These beliefs were the culmination of a Towers Watson study for which CalPERS paid $275,000, but which some say has had little impact at the pension fund. See: What I learned from the CalPERS meeting in which the 10 Beliefs were unveiled — and why I came away mystified.

“They hadn’t put any meat on the bones, so this might be a way in which they are trying to make the change,” says Robert Boslego, founder and managing partner at Boslego Risk Services in Santa Barbara, Calif.

But CalPERS says its newly adopted beliefs are irrelevant to the timing of the internal allocation debates.

“Asset allocation is evaluated every three years. The formation of the Investment Beliefs just happened to coincide this past year,” says Joe DeAnda, information officer at CalPERS. See: Why some pension experts believe CalPERs got 'nothing’ out of paying Towers Watson $275,000 to define its 'beliefs’.

The crash next time

“CalPERS learned many lessons in the wake of the Great Recession,” according to the pension fund, in a statement issued in response to the article. (In rather Orwellian fashion, the pension fund refers to itself in the release as “the System.”)

“As any investor would do after a significant downturn, the System began an effort to review its portfolio and operations, and make changes where appropriate, to ensure that it was better prepared to deal with a similar event in the future. While some of these discussions continue today, there is no requirement that changes be made, nor is there a timeline for this process,” reads the statement.

CalPERS is known to suffer from a large and ungainly bureaucracy — a hierarchical structure that its spokesman emphasizes remains firmly in place in California’s capital.

“As a matter of procedure, such discussions generally originate at the staff level. Any formal changes then come about after consultation with and direction from the CalPERS board of administration,” says DeAnda.

Two lessons CalPERS presumably learned during the recession are that risky stocks go down even more than indexes and exotic investments are very difficult to bail out of. See: A careful look into whether CalPERS is ticking along or a ticking time bomb.