CalPERS staff is itching to take advantage of wide credit spreads and other fixed-income market conditions that could be short-lived through a new internal derivatives-based enhanced equity portfolio.
The life of the portfolio may be only around three years but in the meantime will add modest returns above the pension funds equity benchmark, according to Eric Baggesen, senior investment officer of global equities at the $232.5 billion California Public Employees Retirement System, Sacramento.
The new portfolio will likely total some $2 billion and will exploit current dislocations in the fixed-income markets, Mr. Baggesen told the investment committee at an Aug. 18 committee meeting. Funding will come from reducing an internal domestic equity index fund that totaled $44.7 billion as of March 30.
If approved by the investment committee, the program will use short-term, high-quality, asset-backed securities, like credit cards, student loans and auto-receivables, as the alpha engine and a futures overlay designed to replicate the Wilshire 2500 as the beta driver. The fixed-income portion would be very similar to an internal high-quality LIBOR portfolio run by CalPERS global fixed-income staff.
Officials at CalPERS plan to bring a formal pitch for the new program to the investment committee at its Sept. 15 meeting.
The new internal portfolio will be similar to the $1.6 billion in fixed-income driven enhanced indexing strategies that was run by external managers until January when the assets were brought in-house.
This is a (simpler) version of what they were doing, Mr. Baggesen said.
As of Dec. 31, CalPERS had at least three managers that ran similar, fixed-income driven, enhanced equity strategies. Western Asset Management Co., Pasadena, Calif. and Smith Breeden Associates Inc., Durham, N.C., managed $600 million each while Atlantic Asset Management LLC, Stamford, Conn., managed $400 million.
At the time, staff had discussed bringing some of the external enhanced equity index portfolios in-house since the pension funds internal, stocks-based program was outperforming the external one.
CalPERS currently runs a $4.6 billion internal enhanced indexing portfolio that uses stocks as the alpha engine, instead of fixed-income securities.
In an equities-based portfolio, an investor will hold an index fund and overweight or underweight stocks modestly within that fund, whereas with a derivatives-based strategy, an investor gains exposure to the index through futures, explained Neil Rue, managing director at consulting firm Pension Consulting Alliance Inc., Portland, Ore. Both strategies are equally common.