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Money Management

CalPERS wants a place for ‘in-between’ managers

New program focuses on managers not too big, but not too small

Clinton Stevenson of CalPERS
Clinton Stevenson believes smaller managers are better able to pivot if necessary.

CalPERS is looking for a few growing money managers to fill a new transitional program.

The $323.6 billion pension fund's new effort focuses on firms that are too big to be part of its emerging manager program but too small to be in its regular manager lineup.

The move comes as the Sacramento-based California Public Employees' Retirement System struggles to find new sources of investment return. Economic forecasts show the most the pension fund can expect to make from its overall portfolio over the next decade is an annualized 6.2%, 80 basis points below the 7% annualized return it has set for itself beginning July 1, 2019. CalPERS' funding level is 68%.

"In the future, the alpha is going to be delivered by the smaller, not the megabillion-dollar firms," said Clinton Stevenson, the investment director of CalPERS' investment management engagement program, in an ​ interview. Mr. Stevenson said smaller firms are more agile than older larger firms and often have new investment ideas.

The retirement system has set aside $7 billion to give to smaller public equity, private equity and real estate managers eligible to graduate from its emerging managers program or that have made a name for themselves managing money for others. It issued the first solicitation for proposals on July 11.

Currently, emerging managers invest around $8 billion for CalPERS, much of it through manager-of-managers firms for public equities and funds of funds for private equity.

CalPERS current guidelines require its public equity account emerging managers to have less than $2 billion in assets under management, with the pension fund allocating generally between $75 million and $150 million to each firm. Private equity emerging managers must be raising their first or second fund and are limited to commitments from CalPERS of $8 million to $20 million. The firms cannot receive direct CalPERS commitments. Real estate emerging managers must be sponsoring their first through third fund and manage less than $1 billion; they receive commitments of between $50 million and $150 million.

Under the new transition program, equity managers could have between $2 billion and $15 billion in total AUM; private equity firms can be raising their third through sixth fund; and real estate managers, their fourth through sixth fund. The allocations from CalPERS also increase under the transition program. Equity firms can be given up to a $1 billion; private equity firms can receive direct commitments of $50 million to $400 million for individual funds they are raising; and real estate managers can obtain commitments of up to $300 million.

In its current manager solicitation, CalPERS is seeking five global equity managers, each of which would receive up to about $500 million, and five private equity managers that are raising funds of at least $100 million. Mr. Stevenson said a second solicitation planned for 2019 will include opportunities for real estate managers.

CalPERS' search comes as another major public pension plan, the $192 billion New York State Common Retirement Fund, is also considering a transition program to fill the gap between emerging managers and managers with full commitments.

Sheryl Mejia, director of emerging managers for the Albany-based fund, said such a program has the support of Chief Investment Officer Vicki Fuller and New York state Comptroller Thomas DiNapoli, the pension fund's sole trustee.

Filling a gap

"The idea was to fill the gap," Mr. Stevenson said. "In 2015 we discovered there were some managers who had grown large enough that they would go out of our definition of emerging managers but not large enough that they would be considered one of our established managers. Managers had grown but they had no place to go."

Mr. Stevenson said managers in CalPERS' new transition program will not only run strategies for the pension plan but also will be idea generators to help the retirement system with its overall portfolio.

"We want to make sure that we are partnering with the very best asset managers we can, because we should be," Mr. Stevenson said. "We are the largest pension plan in the country, one of the largest in the world; we should be partnering with the very best minds that we can."

Around $4.5 billion of the $8 billion in CalPERS' emerging managers program is run by minority- and women-owned firms. Mr. Stevenson said the transition program can be a way of expanding that representation, but ultimately the firms with the best investment track record and best investment plan will win the contracts.

"It is an attractive way of finding those diverse candidates, but we are not looking for diverse candidates, we are looking for the best managers that we can find," he said. California state law prohibits preferential treatment based on race or gender.

Growing portfolios

CalPERS emerging equity managers have been allowed to keep their contracts when they exceed $2 billion in AUM, but their allocations from the pension system have remained relatively small, said Victor Hymes, CEO and chief investment officer of Legato Capital Management LLC, San Francisco.

Mr. Hymes runs an $835 million portfolio comprising five equity managers for CalPERS. He said officials at two of the firms — Kabouter Management LLC, Chicago, and Kopernik Global Investors LLC in Tampa, Fla. — have told him they will be applying for the transition program.

Chris Yarbrough, chief compliance officer for Kabouter Capital, confirmed the firm will apply to the transition program. He would not elaborate. Officials of Kopernik did not return phone calls and emails.

Mr. Hymes said both firms had less than $2 billion in AUM before signing up with Legato in 2015, but now Kopernik has $3.6 billion and Kabouter, $2.7 billion. Both firms manage small amounts for CalPERS, $165 million and $221 million, respectively.

New York's Ms. Mejia said the state pension fund recently hired private equity firm One Rock Capital Partners, giving it a $30 million commitment, the maximum allowed under the pension fund's guidelines, for its second fund. The New York state fund also invested in One Rock's initial fund in 2014.

Ms. Mejia said One Rock would be a good candidate for a transition program, because the pension fund could have given the firm more than $30 million it received as an emerging manager but less than the $100 million to $300 million commitment the system's private equity general partners normally receive. She said a transition program would fill the space between the two.

"There is a gap and I am aware of that gap," she said.

Still paring managers

CalPERS is committed to the new program, said Chief Investment Officer Theodore Eliopoulos, but it is only selecting a few firms because the system is in the process of reducing its overall number of external managers.

"If you're going to limit the number of managers in the traditional portfolio you have less need for a number of emerging or transitional managers to fill those slots," Mr. Eliopoulos said in an interview.

CalPERS reduced its external money manager roster to 160 currently from 212 in June 2015. The system plans to pare the number to 100 by the year 2020.

Mr. Eliopoulos said CalPERS will be committing an additional $4 billion through 2020 to the emerging managers program.

At a June 19 investment committee meeting, he said some emerging managers will be cut in the next several years.

A 2013 CalPERS report found a "wide range of performance outcomes of emerging and diverse managers" in its portfolio. "Based on our experience, it is not possible to reach broad conclusions about the performance of emerging and diverse managers," the report said.

2013 was the last time CalPERS did a public analysis of the emerging manager program performance.​