SACRAMENTO, Calif. - Dumping four Asian markets from CalPERS' list of eligible emerging markets was part of a grand scheme to encourage workers rights' and democratic processes in emerging markets, but the plan has run into some serious snafus.
Now, the $151 billion California Public Employees' Retirement System, Sacramento, is poised to back down on excluding the Philippines from its eligible markets list. And some board members fret the policy will be substantially weakened by a technical loophole. The credibility of the policy - the result of a two-year process to incorporate factors such as political stability, transparency and meeting International Labor Organization principles into CalPERS' existing eligible countries factors - now is on the line.
The labor-backed policy set off howls of protests from Asian governments, generated hundreds of critical newspaper articles in the foreign press and roiled Asian equity markets when it was announced in February. "It was amazing to us, amazing to me, certainly, what the reaction was worldwide," said Charles Valdes, a CalPERS trustee.
February's announcement that CalPERS was dropping the Philippines, Malaysia, Indonesia and Thailand from its list landed like a bomb in some foreign equity markets. Thailand's market dropped 6.7% over two days, while the Philippine and Malaysian markets fell by 3.9% and 1.7%, respectively, according to Business Week. Indonesia's market was essentially flat.
CalPERS has $15.7 million invested in the Philippines, $100.5 million in Malaysia, $22.3 million in Indonesia, and $36.9 million in Thailand. No stocks will be sold until CalPERS irons out the wrinkles in its new policy.
Asian governments and newspapers have made scathing remarks about CalPERS. The South China Morning Post wrote: "When God made the United States, he first tipped it on its side, and all the loose ends fell into California."
CalPERS staff proposed restoring the Philippines to the list because the fund had relied on outdated information. During an April 19 visit from Philippine Finance Minister Jose Isidro N. Camacho, CalPERS officials discovered that the country had dropped manual settlement of stock trades three years ago and had adopted T+3 settlement. Wilshire Associates, Santa Monica, Calif., which had provided the information, now says the accurate information pushes the Philippines over the cut-off point on the eligible countries list, and it recommends restoring the country. Mr. Valdes hopes that Thailand, which sent a delegation of top government finance officials to Sacramento April 5, will be the next country restored to the list, although the staff did not change Thailand's score.
Another critical issue lies in a seemingly technical matter that will be reconsidered by the CalPERS investment committee on May 13. That issue is whether CalPERS' emerging markets equity managers - which run $1 billion for the system - may invest in American depository receipts and global depository receipts issued by companies that are based in countries excluded from CalPERS' eligible markets list.
Three of CalPERS' four newly hired emerging markets managers - Alliance Bernstein, New York; Capital Guardian Trust Co., Los Angeles; and Genesis Asset Managers Ltd., London - say they would invest between 14.2% and 18.6% of their portfolios through depository receipts issued by companies from ineligible markets if given that flexibility. For example, Alliance Bernstein would invest 7.4% in China, 5.3% in India and 1.5% in Indonesia. (The fourth manager, Dimensional Fund Advisors, Santa Monica, Calif., would be unaffected.)
The active managers say investing in ADRs and GDRs would allow them to create less risky portfolios.
While apparently benign, giving managers permission to invest in ADRs and GDRs could severely undercut the impact of CalPERS' revised list. Because the largest companies in each market often list on major exchanges to attract foreign capital, some board members worry that permitting investment in ADRs and GDRs still would expose CalPERS to substantial risk from these markets.
Some experts note that ADRs and GDRs primarily address accounting and disclosure standards, but do nothing to mitigate political repression or instability concerns. "Political instability, labor unrest, social inequity in a particular country doesn't (sic)change because you're utilizing ADRs and GDRs traded in permissible markets," said Sean Harrigan, vice chairman of CalPERS' investment committee, according to the minutes of an April 15 investment committee meeting. Mr. Harrigan, who also is international vice president and Western regional director for the United Food and Commercial Workers International Union, urged the board to exclude ADRs and GDRs.
California Treasurer Philip Angelides, who had spearheaded the effort to add the workers' rights and democratic factors to CalPERS' existing criteria, observed that, of emerging markets excluded from CalPERS' list, 68% of China's market capitalization is traded in ADRs and GDRs. For Indonesia, it's 42%; the Philippines, 44%; and Russia, 47%.
Mr. Angelides said a compromise proposal by state Controller Kathleen Connell to cap ADR and GDR investments at 25% of the emerging-markets portfolio "would really eviscerate the policy that we had worked on for two years, because it would make available half the market cap from emerging markets."
While some observers think the ADR and GDR issue was raised as a way of sidestepping the revised policy, CalPERS staff and Wilshire Associates officials point out that CalPERS' 15-year-old eligible markets list always permitted investing in such instruments.
"Sir, we are not trying to circumvent the board's policy. This is one issue that did not come up in the original policy. That is why we're bringing it back to you today, not to circumvent, but to seek clarification," Mark Anson, CalPERS' chief investment officer, told the investment committee last month.
Some observers think the introduction of country factors, such as political stability and financial transparency, to what previously was a list of market factors, such as liquidity and regulatory issues, changes the analysis, and therefore banning ADRs and GDRs is appropriate.
After a lengthy debate, the investment committee voted to return with a compromise proposal for the May meeting.