International bond shift could be start of an accelerated trend
CalPERS is expected to formalize plans next month to bring in-house about $500 million of its $3.6 billion in international fixed income, part of a continuing effort to expand internal money management at the nation's largest pension fund.
In addition, officials at the $235.2 billion California Public Employees' Retirement System, Sacramento, are looking to gradually expand how much is managed internally in emerging markets equities, Janine Guillot, CalPERS chief operating investment officer, said in an interview.
The possible emerging markets move comes amid a larger debate over how much of CalPERS' public equity assets should be managed externally.
CalPERS already manages more than 93% of its $110.1 billion in fixed income and 83% of its $114.5 billion in public equities in-house. With internal passive management generally outperforming external active management over the past five years, said board member J.J. Jelincic, “it doesn't make any sense to continue paying fees for underperformance.”
CalPERS data back up Mr. Jelincic's point. CalPERS' nine internally managed domestic equity strategies, seven passive and two active, with a total of $43.7 billion in assets, outperformed the five external domestic traditional equity managers — Boston Co. Asset Management LLC, First Quadrant LP, J.P. Morgan Asset Management (JPM), Pzena Investment Management and T. Rowe Price Group Inc., managing an aggregate $3 billion in assets — for the one, three and five years ended Dec. 31.
For the year, the combined CalPERS portfolios returned 0.66% vs. -1.18% for the five managers. For the three years, the CalPERS portfolio showed a gain of 15.17%, while the managers returned 13.32%. For the five years, CalPERS had 0.34% compared with -1.71% for the managers. Multiyear returns are compound annualized.
Ms. Guillot said a full review addressing some of Mr. Jelincic's concerns will start this summer. It will look at how CalPERS selects external equity managers and examine their performance. She said the review could take one to two years. “We need to determine who has the proven ability over time to generate returns,” she said.
Ms. Guillot said that although Mr. Jelincic was correct on recent performance, that didn't mean those external managers won't outperform in the future.
On the fixed-income side, international, high yield and part of a currency overlay strategy are the last to move in-house. About $650 million in high-yield bonds was managed externally as of Dec. 31, less than half of what was run internally.
“We have always outsourced certain specialty mandates — high-yield fixed income, international,” Ms. Guillot said. “We look to bring them internally over time as we build the skills.”
CalPERS' investment committee on May 14 is expected to allow a portion of the international bond portfolio to be managed internally starting July 1. The $500 million will be run on a one-year trial basis. Ms. Guillot said the money will be taken from CalPERS' four international bond managers: Pacific Investment Management Co. LLC, which currently runs $1.2 billion for the system; Rogge Global Partners PLC, $939 million; AllianceBernstein (AB) LP (AB), $783 million; and Baring Asset Management, $660 million. She said it has not yet been determined how much will be taken from each manager and whether any managers would be terminated if the trial succeeds and the money stays in-house.
For emerging markets equities, five money managers ran $3.4 billion as Dec. 31: Genesis Asset Managers LLP, $943 million; Lazard Asset Management LLC, $717 million; AllianceBernstein, $695 million; Dimensional Fund Advisors LP, $642 million; and Pictet Asset Management, $389 million. In comparison, CalPERS manages $6.1 billion internally in four emerging markets equity portfolios.
Not surprisingly, a key driver of the move to internal management is fee reduction. Ms. Guillot said CalPERS spends around $100 million to manage assets internally, compared with $1.2 billion in external management fees. If CalPERS can reduce fees and get better returns with internal management, “it's a win-win situation,” she said.
But additional fee savings might only be in the tens of millions of dollars because about 87% of external fees go to managers of private asset classes, such as real estate, private equity and hedge funds, she conceded.
Ms. Guillot said CalPERS has no plans to bring those assets in-house in the near future because the specialized expertise would be difficult to assemble.
“The sky is definitely not the limit. We are focused on managing a majority of our public assets internally. To manage the private assets internally is a bigger challenge, a much longer-term strategic question.”
Ms. Guillot said CalPERS Chief Investment Officer Joseph Dear and Real Desrochers, chief portfolio officer, private equity, are examining the possibility.
But there is money to be saved with public assets. CalPERS documents show the fund would save $350,000 in base fees and $1 million in performance fees by moving the $500 million in international bond assets in-house.
CalPERS paid $7.4 million in fees to the four international fixed-income managers in the fiscal year ended June 30, 2011, the documents show.
The new in-house international bond portfolio will be managed by Michael Rosborough, CalPERS' sovereign fixed-income and index-linked portfolio manager. Mr. Rosborough was hired last year from PIMCO, where he was co-manager of fixed income.
In addition, CalPERS hired economist John Rothfield, who had worked at Merrill Lynch for 18 years. The economist will be part of the team working on the international portfolio as well as other fixed-income portfolios. A trader is also scheduled to be hired by July for the international team.
Speaking at an investment committee meeting on April 16, Mr. Rosborough said the initial $500 million in in-house international fixed income “gives us enough assets over the first year to run it, to demonstrate the competencies we need to demonstrate, and to grow it further from there.”
Wilshire Associates, CalPERS general consultant, supports the international fixed-income move. In a March 29 memo to the CalPERS board, Andrew Junkin, a Wilshire managing director in Broomfield, Colo., said the firm has confidence in staff's ability to manage the new portfolio.