CalPERS set to build new manager pools
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February 20, 2006 12:00 AM

CalPERS set to build new manager pools

Long-short enhanced equity, global fixed-income portfolios aim to reduce fund’s total risk

Joel Chernoff
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    SACRAMENTO, Calif. — CalPERS will create new pools of long-short enhanced equity index managers and global fixed-income managers.

    The long-short equity portfolios are considered a major new initiative by the $204.2 billion California Public Employees' Retirement System. CalPERS officials hope to obtain better returns at a high information ratio. No dollar amount has been allocated to the new program, but assets will likely come from the fund's $55 billion internally managed domestic equity portfolio.

    The system's investment committee has been discussing adding long-short enhanced index managers since November. While earlier discussions involved both domestic and international approaches, staff decided to focus solely on domestic equities initially, disappointing some international equity managers. The investment committee approved the RFP at its Feb. 14 meeting.

    These portfolios will relax the fund's long-only constraint and will typically be invested in strategies that are 130% long and 30% short or 110% long and 10% short, said Mary Cottrill, senior portfolio manager at CalPERS. While CalPERS will cap each manager's tracking error at 6%, in reality they may be lower, more around the 4% mark.

    CalPERS officials found the new strategies might reduce the fund's total risk while increasing its active risk.

    A test of holdings of an actual 130% long/30% short portfolio "would have little to no effect on total and active risk of the fund, depending on the amount of assets allocated," according to a staff memo to the board. A $2 billion allocation to such strategies would reduce the fund's total risk while increasing active risk, the memo said. A $10 billion allocation, however, would significantly increase active risk for the U.S. equity portfolio, while modestly increasing the overall risk of the total fund.

    Pool of managers

    Staff recommended hiring a pool of managers with strategies that have low correlations to each other and to other U.S. equity managers employed by the fund. They further urged that the long-short equity managers' alpha engines should produce solid returns on a long-only basis, that they should have quantitative portfolio construction techniques, and that managers have experience in shorting securities.

    CalPERS global equities staff, now engaged in two other searches, doesn't expect to issue the long-short RFP until the second quarter.

    Rosalind M. Hewsenian, managing director at consultant Wilshire Associates, dropped previous reservations about the riskiness of the strategy: "We believe that staff fully understands the risks inherent in such a strategy and will take the appropriate steps to mitigate them," she wrote in a letter to Anne Stausboll, CalPERS' interim chief investment officer.

    The CalPERS investment committee also approved issuing an RFP for a pre-approved list of global fixed-income managers. Current managers need not apply for the pre-approved list. Those managers, who collectively manage $5.3 billion in assets, are: Baring Asset Management, Bridgewater Associates, Julius Baer Investment Management, Rogge Global Partners and Western Asset Management. An RFP is expected to be issued this month, with finalists expected to be named in June.

    Creating a pool of managers will help CalPERS staff re-optimize the portfolio in the future and make it possible to move more quickly by being able to add new managers without issuing a subsequent RFP, a staff memo noted.

    Call for clawbacks

    Separately, CalPERS revised its corporate governance guidelines to press companies to take back merit-based executive pay awarded on the basis of misstated or fraudulent company performance.

    CalPERS also will target companies with abusive practices, under a proposal put forward by Karen Ross, an aide to state Controller Steve Westly. Also, CalPERS will urge the Securities and Exchange Commission to adopt rules increasing the use of "clawbacks" in executive contracts and will support the "Protection Against Executive Compensation Abuse Act," sponsored by Rep. Barney Frank, D-Mass., which would enhance disclosure of executive pay and would mandate clawbacks.

    "I want executives to be paid according to actual performance, not cooked books," Mr. Westly said in a press release.

    Separately, CalPERS staff will propose allowing investments in American depository receipts and global depository receipts in companies whose home countries do not meet CalPERS' standards for emerging markets.

    Board members expressed concern that the fund is not allowed to invest in the rapidly growing Chinese market.

    Charles Valdes, chairman of the investment committee, said, "If companies are listed on the (New York Stock Exchange), I don't see why we can't buy (them)."

    Ms. Ross said the controller is concerned that CalPERS is not able to invest in China, "one of the fastest growing areas of the world."

    Ms. Hewsenian said qualifying companies might need to meet the Global Sullivan Principles of Social Responsibility and international labor organization standards.

    CalPERS' permissible country policy imposed political stability, financial transparency and labor practice screens on the $4.7 billion portfolio as of April 1, 2002. That policy resulted in an opportunity loss of $203 million from July 31, 2002, through Dec. 31, 2005, according to a staff memo.

    According to draft research from Wilshire Associates, CalPERS' custom FTSE All Emerging Markets index underperformed the standard FTSE All Emerging Market index by 2.2 percentage points from April 1, 2002, through year-end 2005. The permissible markets list excludes roughly 10% of available market capitalization as of April 2005.

    As a result, the portfolio is overweight in technology stocks and underweight in natural resources, including oil, Ms. Hewsenian told the investment committee.

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