SACRAMENTO, Calif. - The $80 billion California Public Employees' Retirement System board approved a $200 million investment - and potentially hundreds of millions of dollars more - in underperforming midsized companies by using outside talent to improve the companies management practices.
Retirement system officials see the area, relationship or activist investing, as consistent with the fund's corporate governance goals.
However, the new area of investment will put the fund more directly into the business of improving companies - an investment approach some companies may not relish.
The first relationship fund approved by CalPERS is led by a former executive of Mesa Petroleum Co., a company accused of being the base for a corporate raider, and another executive who was president of a nationwide shareholder advocacy group founded by Mesa Petroleum Chairman T. Boone Pickens Jr.
Once management of companies is improved through relationship investing, CalPERS officials expect the corporate values of the affected companies to go up as net profits improve. And as a result, fund officials anticipate, the system will get a return above the Standard & Poor's 500 Stock Index return. In addition, the relationship investment companies also could be held in other CalPERS investment portfolios, boosting those returns also.
The relationship investing proposal would complement CalPERS' corporate governance policies that seek to persuade companies to make changes - such as more independent outside directors - to improve performance.
A key difference between relationship investing and corporate governance is that corporate governance policies are aimed at improving or holding accountable companies in which the fund already invests. Relationship investing specifically targets for investment companies with troubled management policies or other repairable problems.
But the new investment area might not be something many companies like.
Typically, the targeted companies "are not happy" with outsiders coming in to not only invest in companies but also change management practices, according to Nell Minow, a principal with Lens Inc., a relationship or activist firm in Washington.
"I think they (targeted companies' management) are hoping no one will notice. Nobody wants interference. Everybody thinks their intentions are good and prosperity is just around the corner," said Ms. Minow.
Even though some company managements don't like someone looking over their shoulder and making suggestions, Ms. Minow believes many companies are better off with relationship or activist investing.
"Everybody does a better job if they know somebody is watching them," she said.
The first investment approved by the CalPERS board is a $200 million allocation to Relational Investors L.P., a limited partnership formed by David H. Batchelder, president of Batchelder & Partners Inc., San Diego, and Ralph V. Whitworth, president of Whitworth and Associates, Washington.
Batchelder & Partners Inc. is a financial advisory and investment banking firm. Whitworth & Associates is a corporate advisory firm.
Mr. Batchelder led a team responsible for many of the investments of Mesa Petroleum Co., according to a CalPERS report. Mr. Pickens, chairman of Mesa Petroleum, was accused during the 1980s of being a corporate raider. Mr. Batchelder was a member of the board of directors of Mesa from 1984 to 1987.
Mr. Whitworth was president of the United Shareholders Association from 1986 to 1994. Now defunct, United Shareholders Association was a shareholder advocacy group founded by Mr. Pickens to represent small shareholders.
The partnership will target "undermanaged" companies with market capitalizations of $200 million to $1 billion.
Although the California fund earmarked $100 million for the initial investment, the staff wants to investigate the possibility of changing the traditional structure of such investments and establish a much larger commingled pool for relationship or activist investing.
Because the pension fund is so large, a $200 million investment would have little overall effect on its returns. The staff is calling for a dramatic change in the structure of relationship investing to better align the interests of the fund and Relational Investors and give the fund more flexibility in liquidation and disposition of investments undertaken by the partnership.
According to the CalPERS report, B&P, through its Relational fund "will target undervalued companies which are underperforming due to a correctable deficiency in the company's management or operations. The key to B&P's style of relational investing is to work with a company's management, board of directors and other shareholders to build a consensus identifying the deficiency and means to correct it. Once this consensus is established, B&P will assist the company in initiating remedial action."
B&P, according to the CalPERS report, will establish an equity position of less than 10% in a company. B&P then will work to gain the support of other significant shareholders to align interests.
B&P, through the Relational Investors partnership, is expected to also take advantage of the Securities and Exchange Commission's rules easing communication and proxy solicitations among shareholders.
In cases where there is consistent underperformance, B&P might seek minority representation but not a takeover, according to Hamilton Lane Advisors, Philadelphia, an alternative investment consultant for CalPERS.
One concern the pension fund staff has about Relational Investors is the fee being asked - 85 basis points on the first $200 million with a five-year investment horizon. The pension fund board has delegated its staff to negotiate terms and fees. The staff said the fee is similar to fees paid to general partners for alternative investments, even though Relational does not perform the same level of due diligence, sourcing, negotiating and other responsibilities that most alternative investments partnerships have.
The proposed structure would have CalPERS as a limited partner, putting up a maximum of 90% of the money in the partnership. Relational Investors, the general partner, would put up from 1% to 10%. CalPERS and Relational representatives would establish an advisory committee to monitor the partnership. By putting up 90% of the money, CalPERS would be the major limited partner. Neither Mr. Batchelder nor Mr. Whitworth could be reached for comment.
