CalPERS does 180-degree turn

SACRAMENTO, Calif. — The California Public Employees' Retirement System quietly revamped and diversified its $2.1 billion hedge fund portfolio in the past 18 months.

The result is a 180-degree change from what the portfolio looked like before.

CalPERS' hedge fund investments will also increase significantly in coming years — to potentially as much as $6.5 billion — thanks to a change in investment policy that ups the ranges of three subasset classes to perhaps 5% of the plan's massive global equity portfolio.

CalPERS executives were not forthcoming about the specifics of the hedge fund portfolio reconstruction. But what is clear is that the plan has gone to a more balanced portfolio of direct investments from a heavy focus on domestic long-short equity managers and will increasingly rely on hedge fund-of-funds managers for non-U.S. exposure.

"We have been working very hard, under the radar," to reconstruct CalPERS' hedge fund portfolio, said Christianna Wood, senior investment officer-global equities at the $200.2 billion fund.

Investment staff confirmed that by year's end, the plan will have 22 hedge fund relationships. Brad Pacheco, a CalPERS spokesman, confirmed the following managers when asked by Pensions & Investments: Chatham Asset Management LLC; Wayzata Capital Management Inc.; Black River Asset Management LLC; Canyon Capital Advisors LLC; Partner Fund Management LP; Deephaven Capital Management LLC; and Symphony Asset Management LLC. He declined to identify any of the others, noting that CalPERS only discloses its hedge fund managers once per year, in its annual report.

CalPERS' 2005 annual report, containing data as of June 30, will not be available until the end of January, Mr. Pacheco said.

The report, as of June 30, 2004, listed 13 hedge funds: Symphony's Rhapsody Fund; Andor Technology Fund LP; Atticus Global LP; Brookside Capital Partners Fund LP; Everglades Partners LP; Farallon Capital Offshore Investors Inc.; Lansdowne European Strategic Equity Fund LP; Liberty Square Offshore Partners Ltd.; Pentangle Partners LP; Tosca Fund; Tremblant Partners LP; Welch Entrepreneurial Fun (QP) LP; and Zaxis Institutional Partners LP.

The changes in CalPERS' hedge fund investments are the result of a systematic analysis of the plan's risk-managed absolute return strategy, which began when Ms. Wood joined Sacramento-based CalPERS in June 2002.

The goal was to build an absolute return program that provided return streams — alpha — that weren't correlated with the rest of the portfolio. "We want the … program not to act like stocks and bonds," Ms. Wood said. She said that goal was one reason for changing the hedge-fund investment benchmark to Treasury bills plus 5% from a customized benchmark made up 50% of the Wilshire 2500 index and 50% of the Treasury bill one-year return plus 7%. The hedge fund program also had to be scalable, and "we couldn't add many bodies," Ms. Wood added.

Among the first changes Ms. Wood made in the program was to dedicate Kurt Silberstein, portfolio manager-absolute return strategies, exclusively to the hedge fund effort. He had been a portfolio manager in the traditional manager program, while the risk-managed absolute return strategy had been overseen by the global equities and the alternative investment management groups.

"I knew that unless the program got someone's undivided attention, our efforts were less likely to succeed," Ms. Wood said.

The plan went from using one consultant for hedge funds — Blackstone Alternative Asset Management, New York — to using multiple advisers, bringing on UBS O'Connor LLC, Chicago, and Pacific Alternative Asset Management Co., Irvine, Calif., Ms. Wood said.

Mr. Silberstein took the helm of the program in January 2003 and spent 15 months creating an infrastructure, including hiring International Fund Services, New York, a division of State Street Bank Corp., Boston, to provide an accounting and a holdings-based risk measurement system. No capital was allocated to any new or existing managers during this period, he said.

The portfolio was restructured because it was so undiversified: About 70% was invested with domestic long-short equity managers, he said. The new portfolio has just 30% invested in long-short equity.

The program now includes eight specific hedge fund strategies, Mr. Silberstein said: domestic equity long-short; international equity long-short; event-driven; multistrategy (some with a credit focus and others very diversified); distressed debt; fixed-income arbitrage; market neutral; and credit driven (including credit long-short and convertible arbitrage).

"We have been diversifying to reduce the correlation to U.S. equity markets and to improve the return distribution characteristics," Mr. Silberstein said. He noted the portfolio's structure doesn't have hard allocation targets to each of the underlying hedge fund strategies, but rather "is determined more by opportunities in the marketplace to reduce negative returns in any month," said Mr. Silberstein.

Ms. Wood said staff determined that using hedge fund-of-funds managers for investments abroad was the most efficient way to make the program scalable and global, to further reduce correlations to the U.S. market, and to complement internal staff skill sets and capacity. Staff selected a group of hedge fund-of-funds managers from which they will hire three firms in Asia and four to five in Europe and the United Kingdom that will provide customized funds for CalPERS. Ms. Wood did not disclose how much these managers will be given, although the CalPERS' board approved a $500 million investment with hedge fund-of-funds managers earlier this year.

In all, Ms. Wood said, CalPERS is unlikely to have more than 30 or so direct hedge fund managers and fewer than 10 hedge fund-of-funds managers. "We have been able to find managers who are willing to work with us, to give us capacity. In fact, we've talked to managers who could not accept assets from us when we first asked, who came back to us later when capacity opened up," Ms. Wood said.

Ms. Wood obtained the board's approval this summer for a move to target allocation ranges in the fund's three global equity subclasses (the risk-managed absolute return strategy, the fund's manager development program and corporate governance managers) from a fixed dollar or percentage allocation. She said using a target allocation will allow the staff to be more nimble in making investments, rather than having to wait for board permission whenever they want to make a new investment.

For the hedge fund portfolio, staff can now invest from 1% to 3% of the plan's global equity portfolio ($130 billion), up from a fixed 1%.

In August, the board approved "anticipated target range" allocations for the three global equity subclasses of 3% plus or minus two percentage points. The anticipated target range of between 1% and 3% can only be exceeded if approved by the plan's chief investment officer, according to the investment policy.

The fixed allocation for the corporate governance program was 3% of global equity assets and 2% for the manager development program.