SACRAMENTO, Calif. - California Public Employees' Retirement System officials are planning to offer higher money management fees - in the form of performance-based fees - to attract better-performing money managers that often ignore the $110 billion system.
"Lots of very good (active domestic equity) firms won't send in an RFP" because of the fund's low fee schedule, Robert Boldt, a CalPERS senior investment officer, told the fund's investment committee.
The conceptual decision on revamping the fund's $45 billion domestic equity program is complex; fee changes are only one part of it, according to Mr. Boldt.
Currently, CalPERS offers its small and emerging domestic equity managers flat fees and its main domestic equity managers performance fees.
But the new fee plan Mr. Boldt wants (trustees must approve specifics) will allow managers to bid their own performance fee proposal rather than being told what the performance fees will be.
But there are maximum fees that a manager can bid under Mr. Boldt's plan. The base fee maximum now planned is 10 basis points. The performance fee maximum planned is 20%. For every percentage point above the manager's benchmark, the manager will be paid 20 basis points.
A manager getting the maximum fee level, who scores two percentage points above the firm's benchmark, will be paid 50 basis points (the base fee plus 20 basis points for each percentage point over the maximum), a handsome fee for most managers.
But a manager who scores 10 percentage points over the benchmark, could make in excess of 200 basis points. That amount would be far higher than the 70 or 80 basis points some of the priciest domestic equity money managers demand from corporate funds.
A manager with just a $100 million portfolio could make $750,000 in performance fees annually under the new plan if it scored four percentage points above its benchmark, Mr. Boldt said. Currently, the manager would receive $250,000 based on flat fees.
Managers that perform only at the minimum, or below it, will be paid as little as 10 basis points - if they stay around. CalPERS plans to dispatch failing managers more quickly than in the past.
While being fired is harsh treatment, Mr. Boldt said, "This is not a welfare agency here."
Goal is to get best managers
The whole point of CalPERS' restructuring exercise is to get the best managers, said Mr. Boldt.
The new conceptual thinking on fees counters a long-standing tradition among many public funds to low-ball money manager fees.
CalPERS' board also approved the concept of hiring domestic equity managers without regard to investment style, a radical departure from the way most fund's pick managers.
Some CalPERS officials see the proposal as an important test of the effectiveness of active equity money management. CalPERS now has about 87% of its domestic equity assets in passive index portfolios.
Other aspects of the domestic equity restructuring include:
Building a pool of active money managers as ready replacements for failing managers.
Establishing in-house active quantitative money management that invests in market sectors expected to provide the highest investment returns. (The fund's staff has until October to put together a plan and identify in-house costs for board approval.)
Establishing special index funds to fill gaps in domestic equity sectors not covered by money managers.
In revealing the new strategy, Mr. Boldt disclosed what he said were the adverse effects of the fund's reputation for low-balling manager fees.
For example, one of the fund's best managers, Amerindo Investment Advisors Inc., San Francisco, has twice refused to take more money from CalPERS, Mr. Boldt told trustees. A spokeswoman for Amerindo declined comment.
It had been thought that CalPERS and other large public funds had been getting poor responses to requests for proposals because the RFPs weren't done well or didn't get enough publicity. Those factors might be part of the problem, but fees matter too, Mr. Boldt said.
Managers have the "capability" of handling only so much money, he said. Top-performing firms would rather use up that capability getting the highest fees, Mr. Boldt said.
New fee schedule coming
The board will set a specific fee schedule next month when a new RFP for domestic equity managers comes up for approval. Contracts to manage more than $6 billion are expected to be up for grabs.
Officials at Wilshire Associates, the fund's pension consultant, endorsed the new strategy, saying the fund was employing techniques used by some sophisticated private funds.
Charles Valdes, CalPERS' investment committee chairman, said he was pleased with the changes. He said he had heard managers complain that CalPERS was "too cheap."
Robert P. Follert, executive vice president with Axe-Houghton Associates, Rye Brook, N.Y., noted corporate pension plans are willing to pay a manager's fee schedule and don't ask for significant fee reductions like many public funds do.
Consequently, Axe-Houghton doesn't see a big market among public plans for some of its products, such as its $600 million small-capitalization growth fund, where the size of the fund must be constrained.
But investment managers are willing to take some discount on fees from public plans if the investment product they want has no size constraint. Public plans are often so large that even with a negotiated fee, the total fee paid to a manager is significant, Mr. Follert said.
Public reaction considered
Meanwhile, CalPERS' new fee strategy left some trustees unsure about public reaction. Robert Carlson asked Mr. Boldt to prepare material that would focus on the increased investment return potential for CalPERS.
Mr. Boldt said managers that didn't meet performance benchmarks would get a lot less than $250,000 under the program. He added the fund would improve its investment return and cut some costs by avoiding managers who are really "closet index funds."
New technology refined over the last three years will permit the staff to identify managers adding value through skilled stock selection, said Mr. Boldt. "Great tools" are now available to closely monitor managers, he added. Some of the technology provides detailed performance attribution.
CalPERS also will develop customized benchmarks for managers.
CalPERS will use returns-based technology from Zephyr Associates, Zephyr Cove, Nev., and Nobel Laureate William F. Sharpe, among others, said Mr. Boldt.
Mr. Boldt told trustees that, theoretically, all domestic equity managers could have one style, as long as they were the best managers.
Most funds pick managers by specific style guidelines. While that approach avoids making unintended sector bets, it can hurt performance if an investor misses a sector that does well. To avoid the problem, CalPERS will establish in-house "completion" investment funds designed to fill the gaps in market sectors not covered by active money managers.
Standby manager pool planned
Under the planned new system, a pool of managers will be on standby. Giving an example of a new RFP, Mr. Boldt said 25 managers might be finalists out of 100 responding. Ten might be selected to run money, but the other 15 would be monitored and could step in to fill vacancies quickly.
In addition, less competitive active domestic equity money management - market sectors, for example, that are in favor for long periods - would be done in-house. CalPERS will use active quantitative money management to invest in those sectors, Mr. Boldt said. CalPERS staff will identify the sectors.
Mainstream managers typically manage $700 million to $800 million. Small and emerging managers generally run less than $200 million. About 80% of the domestic equity assets is in an internal passive fund that mirrors the Wilshire 2500. CalPERS will continue the passive program.
