SACRAMENTO, Calif. - The CalPERS' staff is close to winning board approval to manage part of the fund's active domestic equity and international bonds in-house for the first time, say fund officials.
The move toward active in-house management by the $111.5 billion California Public Employees' Retirement System comes at a time when the appeal of in-house management appears to be declining for many funds, according to a new study by Greenwich Associates.
CalPERS' staff also is proposing two other firsts for the fund - creating an internal quantitative analysis group and an internal derivatives investment group.
The goal is to boost returns. In the process, however, some outside money managers could be eliminated.
Robert Boldt, CalPERS' new senior investment officer, said it's too early to say publicly how much domestic equity and international bond money might be managed in-house, or tell if the number of external managers will be reduced. But even if it's a small percentage of assets, billions of dollars could be involved.
Mr. Boldt said he didn't think any international bond managers would be dropped, however.
The active in-house management, bolstered by quantitative investment modeling techniques, is part of the staff's "public markets plan of action."
A staff report on the public markets plan was accepted by the investment committee at its most recent meeting in February. It has been discussed in closed session by committee members.
The staff could get approval to begin acting on the plan at the upcoming committee meeting this month. Sheryl Pressler, chief investment officer, is preparing new proposals on in-house compensation, said Mr. Boldt.
The proposed equity changes are part of a planned restructuring of domestic equity assets. The restructuring will include examining the roles of external domestic equity managers and in-house passive operations.
Pivotal change for CalPERS
In-house active domestic equity and international bond management would be a pivotal change for CalPERS. Some 57% of the fund's assets now are managed in-house, and the new investment operations could significantly increase that percentage.
Mr. Boldt said the fund intends to tie investment performance of internal and external managers more closely to a sliding fee scale. Investment style benchmarks also will be more sharply focused.
The changes, if approved, could affect a request for proposals for domestic equity managers, scheduled to be issued this month or next, added Mr. Boldt. Managers selected might be given different investment goals than those of current core managers, he said.
The fund's domestic small-capitalization and emerging managers are Amerindo Investment Advisors, Brown Capital Management Inc.; Oak Associates; Tiffany Capital Advisors Inc.; Valenzuela Capital Management Inc.; Spare, Kaplan, Bischel & Associates Inc.; and ValueQuest Ltd.
Active external international bond firms manage about $20 billion for CalPERS.
Other funds may follow
CalPERS could change other funds' attitudes toward in-house active money management if it is successful. CalPERS has a high profile worldwide, any many of its actions are imitated.
The trend, however, is toward reducing in-house management. Internal money management shrank sharply between 1994 and 1996, according to the Greenwich Associates survey of about 1,600 corporate and public pension funds and endowment funds. Only 13% of corporate funds and 21% of public funds have any internal money management, Greenwich said.
CalPERS already manages the most money in-house among U.S. pension funds. As of Sept. 30, CalPERS managed $64.1 billion internally; the New York Common Fund was second with $55.2 billion (Pensions & Investments, Jan. 20).
But neither asset category now managed internally at CalPERS is considered difficult to manage. CalPERS manages $35.5 billion in indexed domestic equities, which involves only tracking one or more indexes, not making judgments about securities.
In the 1980s, CalPERS used Chancellor Capital Management as a consultant/adviser for active equity management, and actual trades were carried out by the staff in accordance with state regulations at the time concerning custody of assets. However, investment decisions were made by Chancellor.
CalPERS also actively manages $28.6 billion in domestic bonds internally. But some consultants say U.S. bond investing, although difficult, is heavily mathematical and easier to manage than some other categories.
Internal equities "scary"
Many pension fund executives see in-house domestic equity investment as "scary," said Paul Green, a vice president with BARRA Inc., a Berkeley, Calif., consulting firm.
Pension officers say top in-house managers can demand high salaries, and will move to management firms that will pay those salaries. Departures of portfolio managers for higher salaries can mean rapid turnover.
Pension executives also see problems with internal equity management because it creates an administrative headache and opens the fund to potential civil suits if severe losses are incurred.
Managing international bonds also can be "tricky," said Mr. Green. It involves managing the bonds of several foreign countries. Problems also can arise in managing currencies.
But Mr. Boldt offered suggestions on why CalPERS might avoid several of the problems. It's unlikely the fund will have problems paying its active investment talent. If the active management plan is approved, CalPERS will have domestic equity management that is "quantitatively oriented," he said. A quantitative approach should allow CalPERS to avoid "star" salaries of stock pickers.
"We will investigate whether a quantitatively based approach using models built with judgment, but based on data, could serve as the base for internal active equity," Mr. Boldt said.
In fixed income, CalPERS initially intends to invest only in international bonds that are denominated in U.S. dollars and are sovereign debt, he said. That avoids currency risk problems, he said.
But he acknowledged the fund still could face country risk, so the plan is to hire a "country specialist" in research or to buy that research information from firms like BARRA.
In addition, Mr. Boldt said the in-house staff that manages domestic bonds also has some experience with international bonds. International bonds now make up about 10% of the indexes used as a benchmark for its domestic bond portfolios.
Inflation-linked bonds eyed
In the proposed derivatives group, one focus for the fund would be inflation-linked U.S. Treasury bonds. David Gilbert, president of C*AT Software, Palo Alto, Calif., said they offer a "predictable real rate of return."
As part of the fund's planned asset allocation policy review, the fund is looking for a strategic role for the inflation-linked bonds. They will be discussed at a fund workshop scheduled for June.
Although not mentioned by California fund executives, a reduction in fees appears to be one goal of some funds investing in complicated asset categories in-house.
BARRA provides quantitative investment software models to about 10 large pension funds that do in-house investing, said Mr. Green.
He said some pension executives are "shocked" by some of the large fees they pay. One way to lower fees is to concentrate active in-house investment management on securities markets considered efficient, leaving less efficient markets to external money managers.