CalPERS' equity managers are hobbling the $100 billion pension fund's otherwise superior investment performance.
At least seven of 17 external active equity money managers failed to meet the California Public Employees' Retirement System's minimum benchmarks or performance objectives, or both, in recent years. Together, the 17 manage more than $11 billion.
A report from CalPERS' consultant, Wilshire Associates, Santa Monica, Calif., reveals domestic equity managers RCM Capital Management, San Francisco; State Street Global Advisors, Boston; Spare Kaplan Bischel & Associates, San Francisco; and Valenzuela Capital Management Inc., New York, underperformed one or more minimum benchmarks in recent years.
In addition, three international equity managers - Morgan Grenfell, Oechsle International Advisors and Schroder Capital Management International - have also underperformed their performance objectives in recent periods, according to Wilshire figures.
If fund officials decide against issuing requests for proposals for domestic equity managers, Wilshire would recommend the contracts for the four existing managers expire.
Officials at two of the firms - State Street and Spare Kaplan Bischel - have said their longer term performance has been good for the California fund.
Identified as mainstream equity money managers, RCM and State Street managed more than $1 billion each for the fund. Spare Kaplan Bischel manages more than $300 million and Valenzuela manages more than $220 million, according to CalPERS.
In other areas the California fund is a winner. For the one, three and five years ended June 30, its fixed-income performance outperformed Trust Universe Comparison Service median returns for public funds; its real estate managers have outperformed the NCREIF-Property Index returns; and its cash portfolio has outperformed 90-day Treasury bill returns.
But because the fund's equity performance trails the TUCS public fund equity median performance for the three time periods, total fund returns lag the public fund median returns.
CalPERS' total fund returns were 15.7% vs. the TUCS median of 16.7% for one year, 10.2% vs. 11.7% for three years and 11.3% vs. 12.3% for five years. Performance cited for more than one year is compound-annual.
Its equity returns vs. the TUCS public fund equity median are 23.4% vs. 25.2% for one year; 15% vs. 17% for three years; and 15.1% vs. 16.5% for five years.
Equity makes big impact
Equity performance has a significant impact because the fund has 61% of its assets in equities. Because its equity portfolio is so large, a one percentage point difference in investment return on equity investments in one year equals $610 million. The dollar difference compounded over five years is considerably more.
RCM, managing a large-capitalization growth equity account, trails both its performance objective and the modified Standard & Poor's 500 Stock Index that the fund uses as a benchmark for all three time periods.
RCM's returns and the performance objectives were 25.25% vs. 28.07% for one year; 16.54% vs. 18.95% for three years; and 15.88% vs. 18.1% for five years.
The modified S&P 500 index returns for the same periods were 26.07%, 16.95% and 16.13%, respectively.
State Street competes against the same modified S&P 500 and performance objectives as RCM.
Domestic equity performance for the large-cap value/growth portfolio was 21.65% for one year, putting it more than 400 basis points below the modified S&P benchmark and more than 600 basis points below its performance objective. State Street scored returns of 15.63% for three years and 17.4% for five years.
State Street's five-year numbers were above the modified S&P benchmark but below its performance objective.
Performance problems also exist for some of the fund's active small and emerging firms.
Spare, Kaplan Bischel, an active large-cap value equity manager, lagged the modified S&P 500 for all three periods, with returns of 23.9% for one year, 14.52% for three years, and 15.5% for five years.
Valenzuela Capital, a small-cap value equity manager, also underperformed the modified S&P 500, returning 23.81% for one year; 14.56% for three years and 15.3% for five years. No performance objectives were identified for the small and emerging firms.
While the four managers have performed below expectations, their performance hasn't been poor enough to justify placement on a watch or probation list, according to the Wilshire performance report. But the report said if a manager search were held today, Wilshire consultants wouldn't recommend the underperforming managers.
Some of the fund's equity underperformance also stems from other managers the fund has dropped in the past five years.
Internal index fund lagged
The fund's internally managed passive index fund - which is tied to a modified Wilshire 2500 index and has more than $31 billion invested - also failed to outperform the TUCS public fund median: 16.4% vs. 17% for three years. However, the internally managed index fund did roughly meet the 16.6% performance of the index itself.
For one year, the index fund return of 25.6% surpassed the TUCS median return of 25.2%. No five-year performance figure was available for the index fund.
Index performance vs. the public fund median is significant because about 80% of the fund's domestic equity money is internally managed, according to Brad Pacheco, a spokesman for the fund. Mr. Pacheco said CalPERS is studying ways to establish a new peer review that would compare it only to large public and corporate funds. Information on how the fund would have fared in such a group wasn't available.
Domestic troubles aren't the fund's only performance woes. CalPERS trailed some of its objectives on the international equity side as well.
Morgan Grenfell outperformed its performance objective by 420 basis points, 19.3% vs. 15.1%, in the year ended June 30. But the firm, which manages more than $700 million in international equities for the fund, still trails its performance objectives for the three and five years ended June 30.
Morgan Grenfell returned 11.4% vs. its performance objective of 13.5% for three years and 11.5% vs. 13% for five years.
Another international equity manager, Oechsle International Advisors, Boston, bettered its performance objective -17.7% vs. 15.1% - for one year, but still trails its three-year objective 11.3% vs. 13.5%, and its five-year objective, 12% vs. 13%. Oechsle manages more than $700 million for the fund.
Schroder Capital Management International, New York, bested its one-year objective, 18% vs. 15.1%, and trails its three-year objective slightly 13.1% vs. 13.5%. In the five-year period, it trails its objective, 10.6% vs. 13%. It also manages more than $700 million for the retirement system.
Another source of suboptimal performance is global asset allocator Trust Company of the West, Los Angeles, the performance report shows.
TCW trailed its performance objective 980 basis points for one year, 10.6% vs. 20.4%. For three years, TCW scored 7.5% vs. 13.9% for its objective, and for five years 10.7% vs. 14.5%.
The fund's other major managers had better performance or relatively smaller amounts of assets under management.
Fixed-income scores high
The pension fund sharply topped the TUCS median public fund fixed-income performance for three and five years, and virtually tied it for the year.
For total fixed income, the pension fund scored 6.7% vs. 5.4% for three years and 10.3% vs. 8.7% for five years. For the year, the fund returned 5% vs. 5.1% for TUCS.
Although the fund uses external money managers for international fixed-income investment, its domestic bond investments are done in-house.
The fund's real estate performance against the NCREIF-Property Index, is 7.9% vs. 6.8% for one year, 6.3% vs. 4.4% for three years and 3% vs. -0.2% for five years. Its cash performance is 5.7% vs. the 90-day T-bill performance of 5.6% for one year, 5% vs. 4.9% for three years and 5% vs. 4.6% for five years.
In response to the CalPERS performance numbers, Jeffrey P. Adamas, a State Street Global Advisors portfolio manager, said since State Street first began managing the domestic equity portfolio in June 1990, the firm has topped its benchmark 15.7% vs. 14.8%, although it didn't meet its performance objective, 16.8%, for that same period.
He said State Street takes a "longer-term perspective on performance" and has "done quite well" for the fund except in 1995. He said 1995 was a difficult year for active managers; the S&P 500 outperformed approximately 75% of active equity money managers.
Doug Holmes, a State Street Global managing director, said one, three, and five years are considered short-term performance. Mr. Holmes said over the long term, the firm's investment strategy has been "very sound." Recent performance should only be part of the screening criteria used in selecting a money manager, said Mr. Holmes.
"I think everyone would appreciate the need to look at the overall strategy and to evaluate whether that strategy has the potential for outperforming in the future," he said.
Ken Kaplan, a principal with Spare Kaplan Bischel, said his firm has had "very strong performance" for the fund over the longer term.
Through year-end 1995, Spare, Kaplan Bischel had outperformed its benchmark through almost any time period measured, said Mr. Kaplan.
Mr. Kaplan said performance through the first six months of this year lagged the S&P 500, 4.36% vs. 10.2%, and that had pulled down his firm's numbers.
Mr. Kaplan predicted the portfolio his firm is managing for the California fund will outperform the market in the next movement of the market cycle.
TCW officials declined comment. Other managers couldn't be reached for comment.