CalPERS might hawk its wares

SACRAMENTO, Calif. — Fidelity and Vanguard executives needn't lose any sleep over the prospect of CalPERS competing with them.

While the idea of an 800-pound gorilla entering money management might strike fear in the hearts of industry professionals, in reality the $228.7 billion California Public Employees' Retirement System, Sacramento, is years away from offering investment strategies to defined contribution plans and individual investors—if ever.

CalPERS officials floated the idea at a Jan. 22 off-site board meeting of creating unitized pools of its investment strategies, and potentially opening them to outside investors. The concept has created a stir among money managers.

According to Chief Investment Officer Russell Read, CalPERS could develop two types of investment products: core funds that invest in broad asset classes, including equities, bonds and REIT strategies; and "goal-oriented" funds, including the entire CalPERS main fund or subsets, asset allocation, target-date, socially responsible and inflation-protection funds.

Several other public pension funds are looking at unitizing their defined benefit holdings to make them available to their own defined contribution plans (Pensions & Investments, Jan. 22). But CalPERS is believed to the first public fund interested in marketing those unitized portfolios to a broader marketplace.

CalPERS officials face many stumbling blocks in their path. Among the biggest problems: CalPERS officials would need to meet numerous tax, securities and fiduciary tests, and would require new legal authority from the California Legislature. They also might have to create a separate organization to manage assets, balance the needs of outside investors with its own members, and avoid harming relationships with its stable of external money managers.

What's more, Chief Executive Officer Fred Buenrostro made it abundantly clear at the board meeting that officials would not do anything to jeopardize the fund's tax-exempt status. He pointed to the example of New York-based TIAA-CREF, which Congress stripped of its tax-exempt status in 1997 as part of a revenue-raising tax bill.

CalPERS officials also will need to ensure that politics don't spill over into their investment products. "Do you really want the state Legislature deciding where you should be investing your money?" said A. Richard "Brick" Susko, an ERISA attorney with Cleary Gottlieb Steen & Hamilton, New York.

CalPERS officials expect it will take three years to bring products to market. Initially, they are focused on offering some unitized versions of CalPERS offerings to the fund's $614 million 457 plan.

The first step will be straightforward, without having to jump through any of the legal and regulatory hoops: CalPERS' investment committee will discus on March 12 adding its own investment products to the 457 program, with a rollout of new investment strategies scheduled for June.

CalPERS officials then would look into offering investment products to California public and private employers, and to California residents. Current legal requirements restrict CalPERS' ability to offer products outside its home state.

In fact, CalPERS now can offer the unitized products only to about 23,000 local public agencyemployees. Offering such investments to state employees and others would require legislation.

Longer term, CalPERS officials might look at expanding the program nationally, but officials emphasize such a move would be way down the road. CalPERS spokesman Clark McKinley said strategies would be targeted to defined contribution plans, and there is no plan to offer them to other defined benefit plans.

CalPERS officials promised to bring a more detailed plan to the board's next off-site meeting in July.

In his presentation to the board, Mr. Read said CalPERS hopes to leverage its brand name and expertise in asset allocation. Creation of investment products would generate additional fee income that would help pay participant benefits. Mr. Read later told reporters that officials don't know how much revenue might be generated, although it would be "significant."

CalPERS might develop a lineup of more than two dozen investment strategies, relying on the skills of both internal and external money managers, Mr. Read suggested.

Provisionally, they might include four different fixed-income strategies: a stable value fund; a total return bond fund; a high current income fund based on high-yield, emerging market and bank debt strategies; and active international funds.

Equity funds might include: a Standard & Poor's 500 index fund; a Russell 2500 index fund; actively managed large-cap and small-cap fund, both in value and growth; an equity income fund; an international index fund; and active international equity funds. The actively managed funds would be run by external managers, while the indexed funds would be run by internal staff.

Real estate and private equity funds also might be offered. CalPERS officials would seek to make offerings through REITs and thus not dilute the fund's real estate returns, Mr. Read said. He did not address private equities.

Mr. Read said that goal-oriented funds would play off CalPERS' strengths in asset allocation. Products could include unitized versions of the entire defined benefit plan and subsets thereof; risk-based asset allocation funds; target-date retirement funds; social responsibility and environmental funds; corporate governance funds; and inflation protection funds.

Mr. Read said CalPERS offerings would vary from those offered by managers such as Fidelity Investments, Boston, and Vanguard Group Inc., Malvern, Pa. Those managers build asset allocation capability on top of their niche products, he said, while CalPERS approaches the issue from the opposite direction. "Our strength comes from providing more packaged solutions," he explained.

CalPERS board members reacted cautiously to plans to sell CalPERS products to outsiders.

"We need to take each piece one step at a time," said board member Marjorie Berte. "I love the plan, but we have more issues to confront."

CalPERS Board Vice President Robert Carlson said any legal issues should be resolved before CalPERS moves ahead, citing TIAA-CREF's loss of its tax-exempt status.

William F. Quinn, chairman and CEO of American Beacon Advisors, Fort Worth, Texas, said the biggest issues CalPERS will face will be in changing its culture to service outside customers and dealing with compensation issues. American Beacon, a unit of American Airlines Inc., invests the airline's nearly $20 billion in retirement assets and another $40 billion for outside investors.

Mr. Quinn also said one of the big challenges with offering unitized products is that "employees like to be able to look up the value of their investments in the newspaper." That's one reason American Beacon changed its offerings to institutional mutual funds from unitized products.

Some experts think the CalPERS plan might work.

Jim Keagy, managing director at Barclays Global Investors, San Francisco, said, "I think they are extraordinarily talented in investment management, and if any plan sponsor could manage assets for other plan sponsors, they could do it." He said BGI officials "stand ready to help them in any way that we can."

BGI managed more than $2.3 billion in domestic and enhanced indexed equity assets for CalPERS, according to CalPERS records.