CalPERS preps to put billions in enhanced

SACRAMENTO, Calif. — CalPERS officials signaled they will make a major push into enhanced index equity strategies, allocating between $13.1 billion and $17.5 billion in the next year.

"We believe we can add tremendous value to the fund," Christianna Wood, the senior investment officer who oversees the fund's $87.5 billion global equities program, told the investment committee of the $138 billion California Public Employees' Retirement System, Sacramento.

Ms. Wood said she expects most of the enhanced index assets will be allocated to external money managers. Detailed proposals will be submitted to the board for approval during the next year. Currently, CalPERS invests only $646 million in enhanced in-dex strategies, all through internal management.

If adopted, the changes also would result in cutbacks in both pure passive and active equity strategies. Under the proposal, the range for passive equities would be trimmed to 50% to 65% of global equities from 50% to 75% now, while a combined category of active equities and CalPERS' dynamic completion fund would be cut to 15% to 20% from 28%.

The recommended revamp was outlined in a broad plan that Cal-PERS officials hope to pursue over the next fiscal year. Chief Investment Officer Mark Anson said the contemplated changes were at the asset class level. The next step will be to evaluate them at the total fund level, and then tie them into risk and return forecasts, the fund's overall asset allocation, and performance and compensation.

Among the other changes CalPERS officials will pursue during the year:

-- Boost the fund's target allocation to hedge funds to 2% to 4% of global equities, up from 1% now. That would equal $1.75 billion to $3.5 billion invested in absolute-return strategies, rivaling the $2.5 billion commitment to hedge funds made by the $20.3 billion Pennsylvania State Employees' Retirement System, Harrisburg.

-- Manage more fixed-income assets internally, including portions of CalPERS' $1.17 billion in externally managed high-yield bond portfolios, $4.7 billion in externally managed currency overlay programs and $272 million in deferred compensation plans.

-- Examine limited new opportunities in alternative investments, such as mezzanine funds and distressed debt, offering returns in the mid-teens, down from CalPERS' traditional hurdle rate of 20%. The fund also will seek out new private-equity firms and may invest in environmental funds, said Rick Hayes, senior investment officer. But the main focus would be on the existing portfolio; $8.8 billion has been committed but not yet drawn down.

-- Reduce the fund's overweighting in Western real estate to improve diversification and lower earthquake risk. Western properties now comprise of 43.7% of CalPERS' core portfolio vs. the NCREIF benchmark's 34.2% weighting. Mike McCook, senior investment officer, also noted CalPERS will pursue non-core investments, such as opportunistic funds. Timber dragged down the non-core real estate portfolio performance to -0.9% last year; excluding timber, the portfolio returned 15%.

The biggest changes, however, are contemplated for the $87.5 billion global equities area. Already, Ms. Wood has restructured the global equity staff along investment strategies; the old structure divvied staff between internal and external equity management.

The new structure creates five areas with rising risk-return relationships across the spectrum: index funds; enhanced index funds; traditional active management; corporate governance funds; and absolute-return strategies.

"Enhanced indexing seems to be the one slot where we appear to have a gap in the risk spectrum," Ms. Wood told the board.

While expected returns from enhanced indexing are roughly midway between straight passive investing and traditional active management, enhanced strategies often have a higher information ratio than offered by traditional strategies, she said.

She added that fees for enhanced indexing are not much higher than for passive management.

Ms. Wood said at the board meeting that CalPERS officials also plan to design a systematic capital allocation plan for global equity with the help of consultant Wilshire Associates Inc., Santa Monica, Calif.

Also in the works are plans to solicit a resource pool, such as proxy solicitors and lawyers, for the area's corporate governance strategies. Further research on active internal equity strategies also is planned, she said.

Ms. Wood plans to seek board approval to invest $500 million in one or two internally managed opportunistic funds.