SACRAMENTO, Calif. — CalPERS' Dan Bienvenue found a simple way to solve the complex problem of how to cut down tracking error in the pension giant's $30 billion internally managed international equity portfolio.
Mr. Bienvenue, portfolio manager for global equities at the $228.7 billion California Public Employees' Retirement System, Sacramento, turned to a relatively new instrument, the Chicago Mercantile Exchange's 10-month-old E-mini MSCI EAFE futures contract.
The new contract, based on Morgan Stanley Capital International's Europe Australasia Far East index, which tracks 1,140 stocks, provides a one-stop, U.S. dollar-denominated solution with a tighter predicted tracking error than multiple futures baskets.
"To get an EAFE exposure, a single U.S. dollar-denominated contract that trades in the U.S. time zone is very helpful. Its simplicity and tight predicted tracking make the difference, with the ability to simply own one contract, margin in one currency, and get both the equity and the necessary currency exposure," Mr. Bienvenue said.
The new contract helps Mr. Bienvenue handle a difficult challenge: adding foreign exposure in a universe that spans 21 countries, 11 currencies and 13 time zones. Using multiple country or region index futures can push tracking errors way above a 20 basis-point risk budget due to currency conversion, foreign exchange hedging and related costs.
CalPERS' international equity portfolio is benchmarked to the FTSE All-World Developed index ex-U.S., a corollary to the MSCI EAFE index, which tracks 1,140 stocks.
"For a core index portfolio with a stock-selection, long/short overlay on top, we have a roughly 20 basis-point risk budget vs. the benchmark. If we're wasting part of that risk budget on our futures basket, that is risk that we'd rather ‘spend' elsewhere," Mr. Bienvenue said.
"The (CME's) contract roll has gone very smoothly; the contract is based on something we like, and it gives us better exposure. The only thing we are not happy about, so to speak, is that there is not more liquidity," he added.