The resignation of Daniel M. Szente as chief investment officer of the California Public Employees' Retirement System shows the $144 billion pension fund and many other major public funds must develop a new model for organizing their internal investment professionals. The CalPERS default model risks becoming the revolving door. Mr. Szente, who joined CalPERS only in July 2000, illustrates the consequences of CalPERS' unsuccessful attempt to deal with the organizational demands of running a big fund.
The state can't continue to run the fund, or pay its investment professionals, like other government departments. Big public pension funds are too sophisticated. Their staffs are too professional; and many of these talented people too competitive.
Failure by the state to recognize this means CalPERS, which only 18 months ago completed an intensive search for a CIO, will have to undertake the process again. The risk doesn't just affect the departure of Mr. Szente, but also other investment professionals on the CalPERS staff. These people may face pay cuts after the state court disallowed CalPERS' raises for them. As a result, they might join Mr. Szente walking through the door to pursue other money management opportunities. Professionals might view CalPERS as a great stepping stone to more lucrative jobs. Talent is fungible in the public and private sector.
In a search for a portfolio manager within the last year, 193 of 221 candidates turned down a chance to work at CalPERS, the nation's largest pension fund.
Massachusetts Pension Reserves Investment Management Board officials earlier this year acknowledged the difficulty they had finding a chief investment officer, because of compensation limitations.
Even the private sector faces similar competitive distractions. Big banks had the same problem as they tried to make their trust departments competitive with the institutional money management businesses. To try to retain and attract professionals, banks created investment management subsidiaries to get out of the bank's normal salary structure, which wasn't competitive with the money management marketplace. These new units weren't always successful, but the banks that have become successful in money management generally have separate organizations for their asset advisory units.
There is an elephant of CalPERS in California that needs to be managed and nurtured to grow even bigger. Otherwise, it could severely trample the benefit security of its participants and risk chewing up more contributions from taxpayers.
There is a political resistance to offering the required nourishment, that is, competitive pay. Investment professionals are not politicians. They don't seek increased power and political advancement as remuneration. They seek to advance in their profession, which can pay very well. If necessary, the state Legislature must intervene to recognize the consequence of trying to run by civil salary standards a sophisticated money management organization that is regarded as a leader in areas such as corporate governance, merchant banking, small-manager incubation projects and private equity. If CalPERS, and other public funds, want a complex, sophisticated investment program, they will have to pay a high price for management of it.
Perhaps the state needs to review the competitive compensation for other departments and agencies as well. Perhaps the CalPERS program should be somehow privatized. These are all relevant issues, but for now the state must deal with the reality that CalPERS needs attention. Paying competitive compensation can be expensive. Some way must be found to do so.
With its assets, CalPERS approaches in size the biggest money management firms in the country and for that matter, the biggest corporations. CalPERS itself in its corporate governance recognizes none of these companies would succeed in finding talented executives offering the compensation levels it does to its own staff.
No one is irreplaceable, but CalPERS might have a hard time finding a replacement for Mr. Szente, with Kathleen Connell, trustee and state controller, determined to hold down pay levels for investment staff. Ms. Connell and the court shouldn't shortchange a great enterprise.