CalPERS – Beyond the Headlines About Hedge Fund Exit – Guide for the California System Are Its “Investment Beliefs”

by Hank Boerner – Chairman & Chief Strategist – Governance & Accountability Institute

This week’s capital markets headlines focus on the planned divestment of hedge funds by the USA’s largest public employee retirement system (CalPERS).  The US$300 billion California Public Employees Retirement System announced on September 15th that over the coming months the $4 billion invested through its hedge fund program — CalPERS “Absolute Return Strategies” — would be redirected to other investments.  (CalPERS will exit 24 hedge funds and 6 fund-of-funds.)

No doubt the Street anxiously read the Pension & Investments headline:  “CalPERS Dumping Head Funds.”  Reported the P&I editors:  Theodore Eliopoulos, interim chief investment officer said:  “Hedge funds are certainly a viable strategy for some, but at the end of the day, when judged against their complexity, cost and lack of ability to scale at CalPERS size, the ARS program doesn’t merit a continued role…”

The news-behind-the news and a very important context for the story goes back to the 2008 financial crisis.  Everyone’s portfolio took a massive hit as the nation’s bankers and investment houses drove the big yellow CMO bus over the cliff.  The CalPERS managers (with 1.8 public employee members’ short- and longer-term retirement benefits and 1.3 million health plan members in mind) explored ways to be less susceptible to future shocks.  In September 2013, the board adopted the “CalPERS Investment Beliefs,” which today guide the investment office.

The Beliefs provide very important context for decision-making, reflect CalPERS values, and acknowledge the awesome responsibility to sustain the ability to pay those millions of beneficiaries when the time comes. For generations, as CalPERs says.

So what are the CalPERs Investment Beliefs?  There are 10; here are highlights:

  • Liabilities must influence the CalPERS asset structure.
  • A long-time investment horizon is a responsibility and an advantage.
  • Investment decisions may reflect wider stakeholder views, provided they are consistent with CalPERS’ fiduciary duty to members and beneficiaries.
  • Long-term value creation requires effective management of three forms of capital: financial, physical, human.
  • CalPERS must articulate its investment goals and performance measures and ensure clear accountability for their execution.
  • Strategic asset allocation is the dominant determinant of portfolio risk and return.
  • CalPERS will take risk only where we have a strong belief we will be rewarded for it.
  • Costs matter and need to be effectively managed.
  • Risk to CalPERS is multi-faceted and not fully captured through measures such as volatility or tracking error.
  • Strong processes and teamwork and deep resources are needed to achieve CalPERS goals and objectives.

In Investment Belief #2 (about the long-time horizon), sustainable & responsible investment leaders were encouraged to see the four subsets:

  • Consider the impacts of actions on future generations of members and taxpayers.
  • Encourage investee companies and external managers to consider the long-term impact of their actions.
  • Favor investment strategies that create long-term, sustainable value and recognize the critical importance of a strong and durable economy in the attainment of funding objecdtives.
  • Advocate for public policies that promote fair, orderly and  effectively regulated capital markets.

There are great lessons learned coming out of the 2007-2008-2009 dark days of the capital markets crisis – in the USA and worldwide.

Effective corporate governance has long had a champion in CalPERS; over the years the system’s (former) annual Target List led the companies selected for attention usually improving their governance policies and practices.  More recently CalPERS has adopted “ESG” approaches (governance being the “G”), and Investment Belief #5 reflects the CalPERS views:

Long-term value creation requires effective management of three forms of capital: financial, physical and human.  Good governance [by companies in portfolio] is key to the overall ESG performance.

And so with this week’s headline about hedge fund investments by CalPERS, which is a tiny part of the system’s vast portfolio, it is I think important for analysts, asset manages (and other asset owners) to better understand the overall policies that guide the nation’s largest state retirement system’s investment strategies.  The CalPERS Investment Beliefs make a very strong case for sustainable investment, and underscore the duty of the fiduciary to look way beyond the immediate corporate financials alone.  (Remember, when Enron collapsed it was a darling of Wall Street and #7 on Fortune’s list of the Fortunate 500. Numbers alone no longer tell the whole story of the enterprise.  ESG performance data and narrative really do matter!)

You can read the complete Investment Belief text and learn more about CalPERS Asset Liability Management Process at: www.calpers.ca.gov/alm

Addition to yesterday’s commentary, above:  On September 17th, CalPERS issued a news release that clarified for everyone their investment policies and put the hedge fund story in perspective.  You can read about “CalPERS Outlines Plan for Financial Markets Principles – Guided by Beliefs, System Will Focus on Risk, Governance and Transparency” — details at:  http://www.calpers.ca.gov/index.jsp?bc=/about/newsroom/news/plan-financial-markets.xml