Stakeholders in the California Public Employees' Retirement System must be scratching their heads over the rigor (or lack thereof) of the fiduciary oversight of its board of trustees given its recently completed search for a real estate consultant.
Second, the selection process suggested an arbitrary approach, scoring the two finalist firms on only three factors: fees, willingness to include disabled veteran business enterprises, and presentation.
Third, the CalPERS process generally winds up dissuading other consulting firms from potentially bidding on searches, resulting in narrowly limiting the opportunity set.
Overall, the committee, whose entire board of trustees make up the members, asked no challenging questions during the selection process, according to a CalPERS video of the committee meeting.
This level of oversight is unacceptable in the country's largest defined benefit plan and one of the world's largest pension funds. CalPERS needs to overhaul its consultant search and selection process to include a tougher, more disciplined approach and more specific scoring for decision-making to ensure it is fulfilling its fiduciary duty in governance, as well as attracting more responses to its RFPs.
Stakeholders need to hold CalPERS trustees accountable to ensure their process is not undermining the fund's objectives in investing cost-effectiveness, and inclusiveness. The trustees must be challenged on the thoroughness of the search process. Other asset owners ought to consider whether they need to strengthen their search and selection processes in light of the example CalPERS presents.
CalPERS' governance has been challenged in recent years by corruption, and it acknowledged last year it was unable to determine how much it pays to private equity firms. CalPERS has resolved these issues, taking steps to ensure they don't repeat.
In concluding its consultant search process, CalPERS wound up rehiring PCA, which has been the system's real estate consultant since at least 2003.
As it turned out, in scoring differences between the firms, fees were no obstacle to the higher cost bidder. In fact, because of the big difference, trustees questioned the suitability of the lower fee proposal. Being the low-cost bidder hurt Courtland.
“Your fees are significantly lower,” said Theresa Taylor, trustee, during the committee meeting, according to the video. “How can you do so? Will that impact the level of services?”
Trustees never challenged the higher fee. Trustees never compared either of the fees to any industry or peer benchmark, never considered cost effectiveness, or whether the high fees would align or undermine its investment objectives.
Asset owners have a fiduciary duty to challenge fees, seeking the best fee terms. The CalPERS investment committee meeting showed no evidence that this duty was met.
Henry Jones, committee chairman, recommended subjecting PCA's hiring to negotiation to “get their bid down.” “How hard can we push to modify their bid contract?” Mr. Jones asked, not suggesting an amount.
Rob Fecker, trustee, proposed seeking a 15% reduction without explaining the basis for his recommendation. Other trustees agreed to his proposal, without asking for a rationale for the proposed limited reduction.
Another troubling aspect of the search process is a perception whether CalPERS is open to change and attracting prospective firms to bid.
Only six firms bid for the assignment to serve as consultant for CalPERS' real estate portfolio that has a 9.7%, or $26.9 billion actual allocation of CalPERS' $290 billion in total assets.
J.J. Jelincic, trustee, said at the meeting, “One of the issues Priya [Mathur, trustee] raised is we do RFPs all the time and wonder how come no one ever bids ... We find out consultants don't bid because they get locked out. There are at least valid reasons to have that perception, whether it is driving that or not. ... But given the consistency with which we choose incumbents, there is valid reason (for investment consultants) to say "I really don't want to spend the money to put together an RFP.'”
CalPERS needs to re-evaluate its governance to ensure all bidders are welcome and have a shot of winning an assignment. Otherwise it will face a tougher challenge to meet its investment objectives if it risks putting up obstacles to potentially good firms.