When it comes to active management fees, the philosophy of CalPERS is in line with that of Japan's ¥159.2 trillion ($1.5 trillion) Government Pension Investment Fund.
The Tokyo-based pension plan instituted a policy in 2018 that it will only pay active management fees to firms that outperform their benchmarks, said Hiromichi Mizuno, executive managing director and chief investment officer, at an Aug. 20 workshop of the investment committee of the board of the $378.4 billion California Public Employees' Retirement System, Sacramento.
"Active managers should be only paid as much as passive managers are being paid if they don't deliver extra return. It's very simple," Mr. Mizuno said.
GPIF officials had found 80% of its investment team's resources were taken up selecting and monitoring active money managers but that, historically, the retirement fund's alpha, net of fees, was zero.
"So that means we wasted our resources spending energy on selecting active managers," he said. "But the conventional reaction to that was you are not good at selecting good managers, right? … But in reality, if you look at the statistics, active never … beat the market net of fees. So that's why we thought we need to change the game, the rules of the game, to make it possible for us to win."
When investment committee members asked CalPERS CIO Yu Ben Meng whether the fund could migrate to a similar fee structure, Mr. Meng said it already had.
"Even before I came, CalPERS has been always driving the alignment of interests with our external managers and trying to cut down fees, improve transparency," said Mr. Meng, who joined the fund in January. "So we are very proud to say that we are one of the global leaders, together with GPIF and a few other asset owners."
However, the situation with its alternative investment managers might differ, he noted.
Mr. Meng added that the market is very hot right now, which can make fee negotiations tough.
"With the GP community ... we're also friendly, but not really friends because underlying we are still not on the same side of the table," Mr. Meng said."
Even so, CalPERS has been a global leader in the field of fee structures that better align the interests of general partners and limited partners, he said.
CalPERS officials later explained the pension plan has been moving toward a fee structure similar to that of the Tokyo-based plan.
"Over the years, we have also migrated toward similar sentiment and philosophies around fees for external managers," said Megan White, CalPERS spokeswoman, in an email. "Like GPIF, CalPERS' philosophy is to not pay active management fees unless the manager delivers the expected returns."
This philosophy has been an evolution, Ms. White said: "There's been no binary date at which we adopted this strategy."
GPIF already has benefited from its new fee structure, Mr. Mizuno explained at the committee workshop. In 2018, GPIF saved $200 million in active management fees as the majority of the fund's active managers failed to deliver target alpha — the alpha each had promised to deliver when hired, he said.
Mr. Mizuno said less than 20% of active managers performed as advertised and some underperformers should get out of business.
"I still believe humans can add value and active management can still add value, but we needed to change the game … so that we have better chance of winning and delivering alpha."
When the market improves, GPIF officials expect to get better performance from active managers, he said.
When GPIF instituted the performance-fee plan only three managers refused to go along with it, he added. One of the managers that walked away told GPIF officials that other asset owners are willing to pay its fixed fee. So, GPIF posted a white paper about its fee methodology on its website to encourage collaboration among asset owners, including CalPERS, to make the approach an industry practice, he said.
The $12.9 billion San Diego County Employees' Retirement Association has adopted a similar fee philosophy. In fiscal year 2019, SDCERA converted $3.3 billion in public markets equity and bond assets to a performance-fee structure in which managers are paid a fixed base fee similar to a passive fee, with a performance fee paid only for returns over the passive index, according to a report to the board.
Pension fund officials terminated active equity managers that did not agree to these fee terms. SDCERA paid 56 basis points, or $72.8 million, in fees in fiscal year 2019, down 10 basis points from fiscal year 2018, its fiscal-year fee report shows.
Chief Investment Officer Stephen Sexauer and Thomas Williams, assistant CIO, started developing the approach when they were hired in 2015 and 2016, respectively, after SDCERA moved away from its total outsourced CIO approach. The former OCIO, Salient Partners, not only acted as OCIO but also managed much of SDCERA's assets, which made it easier for the pair to institute a new fee program.
"We took the assets Salient was running and indexed them," Mr. Sexauer said.
The approach is to pay index fund fees, and if the manager outperforms, SDCERA pays a portion of the outperformance, Mr. Sexauer explained. If the manager underperforms, it has to make up for the underperformance the following year when the underperformance is deducted from any outperformance, he said.
"We pay on the net," Mr. Sexauer explained. The greater the outperformance, the higher the fee, he said.
Seventy percent of SDCERA's managers agreed to the structure. Three managers walked away, Mr. Sexauer said. He declined to identify the managers.
