Change comes again to CalPERS portfolio
By Christine Williamson | March 18, 2013
Confident that the third time will be the charm, officials at the $254.9 billion California Public Employees' Retirement System, Sacramento, are in the midst of a hedge fund portfolio makeover.
After top-to-bottom rehabs in 2005 and 2009, Egidio G. “Ed” Robertiello, senior portfolio manager of absolute-return strategies, has a new plan.
The hedge fund portfolio had $5.2 billion in assets as of Dec. 31.
The first revamp was a 180-degree change that diversified the portfolio by reducing the allocation to long/short equity managers to 30% from 70% and broadened seven other hedge fund strategies to make the portfolio's returns less closely correlated to those of equity markets (Pensions & Investments, Dec. 26, 2005). The second was an extreme makeover that moved nearly all direct investments in hedge funds to separate accounts from commingled funds, resulting in lower fees, more transparency and better control (P&I, April 20, 2009).
Despite these improvements, performance has trailed its policy benchmark on a cumulative and annual basis.
Mr. Robertiello's iteration recasts the role of hedge funds as a diversifier to the global equity risk within CalPERS' entire portfolio and reconstructs the strategy allocation by adding yet more uncorrelated investment approaches in pursuit of improved performance.
Diversifier of risk
Hedge funds will better serve the overall portfolio as a diversifier of global equity risk by offering uncorrelated returns to long-only equity strategies, private equity and high-yield bond investments, Mr. Robertiello stressed. The initial role of the hedge fund portfolio was more of a portable-alpha strategy, he said.
“When you put all of the ingredients in the sausage-making machine and look at the results, the role of hedge funds in the portfolio is to add diversification. To do that effectively, the allocation has to be much larger than the current 2% it is now,” he said.
Among changes that Mr. Robertiello — who joined CalPERS just more than seven months ago — has proposed for the hedge fund portfolio:
- shifting the portfolio out of global equities and into a separate allocation;
- raising the hedge fund target allocation significantly above the current 2% of plan assets;
- setting a standard deviation target of between 6% and 8% annualized; and
- limiting beta to 0.20 or lower of global equity markets.
The CalPERS investment committee heard Mr. Robertiello's presentation during a Feb. 19 meeting and kept him in the hot seat for two hours. “The committee really grilled me on the hedge fund portfolio, making sure that I know what I'm doing,” he said.
The committee is expected to make a decision at its mid-April meeting about the revised investment policy statement that reflects Mr. Robertiello's recommendations for the absolute-return strategies portfolio, as the hedge fund program is known internally.
If the hedge fund portfolio alterations are approved, the funding source and the size of the hedge fund portfolio will be determined through the strategic asset allocation review under way now and scheduled for approval in November.
In the interim, Mr. Robertiello said the hedge fund investment team is empowered to revise the investment elements of the portfolio and is in the process of implementing the following changes:
- cutting the number of investments in the portfolio to concentrate more money in fewer strategies;
- increasing the allocation to direct investments by 14 percentage pointsto 85% of the portfolio;
- reducing the hedge funds-of-funds allocation to 15% from 29%, maintaining the existing 10% allocation to emerging hedge fund specialists and reducing the total invested in Asian- and European-focused funds of funds to 5% from 19%;
- introducing a first-time 10% allocation to event-driven strategies, raising equity market neutral and global macro allocations to 10% each from 3% and 2%, respectively, and upping the long/short equity target to 15% from 11%;
- creating strategic partnerships with new and existing managers to enhance knowledge transfer, opportunistic investments and macroeconomic intelligence; and
- fortifying internal hedge fund portfolio oversight by increasing the dedicated investment team to 14 from five by June 30, 2015. One of the primary goals of the revamp is to boost performance, Mr. Robertiello acknowledged.
Returns of CalPERS' hedge fund portfolio have trailed the policy benchmark — one-year Treasuries plus five percentage points since inception through 2012 by 200 basis points, according to a copy of Mr. Robertiello's committee presentation.
Adding event-driven strategies and increasing the global macro allocation will provide a stream of uncorrelated returns. And decreasing the allocation to expensive hedge funds of funds by nearly half will reduce expenses and improve performance, said Mr. Robertiello.
Further, through closer strategic partnerships with hedge fund managers, CalPERS will have access to more one-off, opportunistic investments recommended by its managers and can push for even lower fee arrangements.
Negotiations with both single- and multistrategy hedge funds and funds of funds brought management fees as a percentage of net asset value down last year by about 40 basis points and performance fees, at 0.96%, were up by 35 basis points due to improved returns.
But observers said there's still room to lower advisory/administrative fees paid to UBS Global Asset Management Alternative and Quantitative Management and Pacific Alternative Asset Management Co. Both firms manage funds of funds for CalPERS and consult with staff on issues such as strategy allocation.
“If internal staff and (the) PAAMCO team are the equivalent of "portfolio manager,' then UBS is the "research analyst,'” Michael C. Schlachter, CalPERS' lead consultant and a managing director and principal in the Denver office of Wilshire Associates Inc., wrote in a Jan. 30 review of the absolute-eturn program.
The combined fee for consultative work from UBS and PAAMCO was reduced to 0.2% of net asset value in 2012 from 0.34% in 2011, a price that's still steep, sources said.
“CalPERS has always had very high advisory and administration fees on their hedge fund program,” said one investment consultant who requested anonymity. “Fees are way above anything I have ever seen.”
“Assuming a $5 billion (portfolio), in 2011 CalPERS paid $17 million and in 2012, paid $10 million for hedge fund advisory and administration. These are levels at many multiples of what it should cost,” the consultant added.
Mr. Robertiello said lowering operating costs is a priority for the system, but he declined to provide specifics ahead of negotiations with hedge fund advisers and managers.
The big question is to how big a portfolio these new investment strategies and lower fees should be applied.
Mr. Robertiello has not made a public recommendation on the size issue. But sources agree with his contention that CalPERS' hedge fund investments have to be much larger in order to have a significant diversifying impact on the whole portfolio.
This article originally appeared in the March 18, 2013 print issue as, "Change comes again to CalPERS portfolio".