From the Economist:
The last of our series of profiles on financial institutions looks at America’s biggest pension fund, which is taking a stiff dose of its own medicine
FOR years, underperforming companies have lived in fear of a tongue-lashing from the California Public Employees’ Retirement System (CalPERS), which has led a crusade to improve the quality of corporate governance in America. It is therefore somewhat ironic that CalPERS now faces criticism for losing billions of dollars during the downturn and for failing to run a tight ship. Anne Stausboll, the fund’s chief executive, and Joseph Dear, its chief investment officer, are working overtime to repair the damage done to the pension behemoth’s assets and its reputation during their predecessors’ reign.
Much is riding on their efforts, which were reviewed at a meeting of the fund’s board in Sacramento this week. CalPERS provides health and retirement benefits to over 1.6m beneficiaries, including doctors, firemen and policemen. If it cannot achieve the investment returns on its $200 billion portfolio needed to help pay for workers’ benefits, then these may have to be cut or the state’s taxpayers could end up picking up the bill. Given that California is already grappling with a $19 billion budget deficit, that is an alarming prospect.
Admittedly, CalPERS is not the only public pension fund in America nursing a nasty hangover. But its woes are striking because they stem from racy investment bets, poor risk management and a lax attitude towards potential conflicts of interest at an institution that was supposed to be a model of modern fund management.
Consider those investments first. CalPERS loaded up on real estate, private equity and other illiquid assets in the years before the crisis. These boosted the fund’s performance, helping it grow to $250 billion by mid-2007. But when the meltdown began their prices promptly plummeted. As a result, CalPERS’s returns were -23% in its financial year to the end of June 2009 (see chart). Returns for the median public pension fund with more than $5 billion of assets were -19%, according to Wilshire Associates, an investment-consulting firm. In particular, the fund made too many bets on risky properties, including a $500m investment in a vast housing complex in Manhattan, since written off....
Mr Dear also seems determined to hit the 7.75% annual rate of return that CalPERS says it needs to achieve to meet its commitments, though the target could change as the result of an internal review. In its most recent financial year, the fund made a return of over 11%, but some observers reckon it will struggle to meet its target in future without taking more risks.
CalPERS can point to the fact that over the past 20 years it has earned an average annual return of 7.9%. But returns from conventional assets such as stocks and bonds are unlikely to be as helpful as they once were. That explains why, in spite of recent history, Mr Dear remains keen to pour more money into riskier assets such as emerging-market stocks, private-equity funds and big infrastructure projects. In June, CalPERS agreed to pay up to £106m ($156m) for a stake of almost 13% in Britain’s Gatwick airport, marking its first big direct investment in infrastructure....MORE