CalPERS to tighten reins on consultants

California Public Employees' Retirement System trustees plan to ban the giant pension fund's consultants from doing double duty, preventing them from making policy and investment recommendations to both CalPERS staff and its board.

The move is aimed at eliminating potential conflicts of interest, Janine Guillot, CalPERS chief operating investment officer, said in an interview. She said the role of general consultants at the Sacramento-based pension fund is to advise the board on investment decisions. She noted that role gets blurred when the consultant also does work for staff.

When the investment decision ultimately comes to the board, Ms Guillot said the consultant is opining on a decision he or she already made with the investment staff. “It's an inherent conflict of interest,” Ms. Guillot said.

The board of the $240.5 billion pension fund is expected to approve the change in August.

Under the new rules, consultants would also be banned from managing money for the fund.

The change would initially apply only to consultants for private equity, real estate and infrastructure. The role of CalPERS general consultant, Wilshire Associates, Santa Monica, Calif., would be examined later.

Pension Consulting Alliance, Los Angeles, is CalPERS' consultant for both real estate and private equity; Meketa Investment Group, Carlsbad, Calif., is its infrastructure consultant.

The change would significantly reduce PCA's income from CalPERS because the consultant earned the bulk of its money from consulting with real estate staff on policy and acting as a fiduciary to ensure that investments were prudent, according to financial records.

PCA earned more than $6.6 million between June 30, 2010, and March 31 advising CalPERS real estate staff, the records show. In contrast, it received about $2 million for real estate consulting work with the board during the same time period.

Starting last June, PCA also started receiving work as a consultant to the pension system's private equity staff, earning $185,000 through March 31, records show. This is in addition to the $495,000 it makes annually as a private equity consultant to the CalPERS board. Meketa was not paid fees to advise staff on infrastructure investing, records show.

CalPERS' investment policy subcommittee endorsed the changes in February but is now tweaking the new policy, Ms. Guillot said.

Board approval would make the nation's largest defined benefit plan one of the first to forge a more limited role for consultants, said Russ Wermers, associate professor of finance at the Smith School of Business at the University of Maryland, College Park.

Mr. Wermers called CalPERS officials “courageous” for dealing with the potential conflict that could result from consultants wearing two hats — advising both the staff and the board on the same investment issues. “This is a very good and progressive idea,” he said. “I expect other pension plans will eventually follow CalPERS' lead on this issue.”

CalPERS is actually behind the curve compared to the $152.9 billion California State Teachers' Retirement System, West Sacramento. CalSTRS introduced a policy seven years ago that separated the role of board and staff consultants, said spokesman Ricardo Duran.

But the CalSTRS policy is more lenient than the proposed CalPERS one because it allows investment staff consultants to make their case before the board. “The staff consultants help develop strategies and plans for investment staff,” Mr. Duran said. “They may even go before the board to pitch why those plans should be followed. However, they do not advise the board in any way. That is what the general consultant is for.”

Separating the role of consultants, while well-intended, might not be realistic cost-wise especially for smaller plans, says William Atwood, executive director of the $10.7 billion Illinois State Board of Investment, Chicago.

“The idea of (multiple) consultants adds a whole new layer of administration and costs,” he said.

Mr. Atwood said he believes staff and board members can collaborate with consultants to make the best investment decision.

For CalPERS board members, the issue is consultant objectiveness. J.J. Jelincic, chairman of the investment policy subcommittee, said he is concerned about the board's general consultant also working for staff because the board doesn't know whether it's getting objective advice. “It reduces the ability of the board to monitor staff investment decisions,” said Mr. Jelincic, who is also an investment officer in CalPERS' real estate division.

Executives at PCA, the firm most affected by CalPERS' planned policy. say they approve of the move. In an April 11 unsigned letter to members of the CalPERS investment policy subcommittee, PCA said it supported the objectives of the new policy and believe that its adoption will “enhance focus and accountability for both staff and consultants.”

But the letter also stated there will be disadvantages. “The tradeoff is that, with less involvement in staff activities, the board consultants are likely have less informed insights into ongoing investment processes, manager selection, adequacy of resources,” it said. These are all areas in which the board consultants are expected to keep the investment committee apprised, the PCA letter added.

Allan Emkin, PCA's founder and managing director, did not return phone calls seeking additional comment.CalPERS records show that PCA helped the system's real estate staff develop a new investment plan for the system's $15 billion real estate portfolio. The new plan, which emphasizes investment in less-risky core real estate holdings, went to the board Feb. 14. The board approved the new policy after PCA executives voiced their support for the new direction.

The proposed policy changes follow a special investigative report by Steptoe & Johnson, a Washington law firm hired in October 2009 following a bribery and corruption scandal at the pension system. The 3-month-old report also looked at the role of consultants for CalPERS and said the system should make sure that their independence is maintained.

“Outside consultants should only be permitted to fulfill one of two functions with respect to a given investment: either providing opinions on the prudence of an investment being considered by CalPERS or assisting in the monitoring of the investment once made by CalPERS, but not both,” it said.

The report also noted that the concern becomes even “more acute” when the consultant in question is also running money for CalPERS.

“It is difficult to see how an external manager could objectively advise CalPERS on appropriate levels of management and other fees for its peers and competitors when that advice could raise questions about the level of its own asset management fee,” the report noted.

Ms. Guillot said the report did not influence CalPERS' decision to change its consultant policy. She said officials were working on the changes before the pension system commissioned the report.