Losing sheen of good governance
Its assets have shrank by around $23bn (E24bn) during the last two years. It’s still the largest US pension fund, with $149.3bn under management and $1.3m beneficiaries. But the California Public Employees’ Retirement System (CalPers) is experiencing maybe the worst period in its over 70 year history: its performances are no longer better than those of its peers and its image has lost glamour on the American press.
Significantly, BusinessWeek concluded a recent critical article about CalPers with these sharp words: “The champion of corporate governance should smell like a rose. Instead, there is an unpleasant whiff of pork-barrel politics rising from the board. Can anyone produce a CalPers effect on CalPers?”. The reference is to the Californian fund’s activism that has such a powerful impact on stock prices that finance professors have dubbed it “the CalPers effect”. The trouble today is many critics think CalPers itself needs a reminder that it should serve first of all its members’ interest, not its board’s political goals. These critics claim it’s not only the stock market downturn that explains CalPers’ poor performance, but also its investment strategy that has often followed political principles more than financial ones.
The last two years were the two only negative ones in a row for CalPers’ investments when returns were respectively –1.4% and –6.2%. This was one percentage point worse than the average similar pension fund, according to Wilshire Associates (other negative years were 1990 and 1994 that performed respectively – 0.8% and –1%). The 12 months ending March 31, 2002 (last available data) showed a 1.2% loss.
The fund is still financially sound. But the next asset-liability workshop, scheduled for August 22, will be the occasion for reviewing its strategy. At a June board meeting evaluating 2002/2003 perspectives, the global equity in-house managers warned that the strength of the US economic recovery is still uncertain and warned to expect only single digit domestic equity returns, while international stock markets (except Japan) should outperform US. Maybe this will encourage reducing portfolio’s exposure to equities from the 64% target adopted in May 2000 and the current 62% allocation; and it will further push in favour of international diversification.
But last May its international policy was indeed a cause of big embarrassment for CalPers. In February the fund had announced a new system for evaluating emerging markets: its criteria included both financial and political factors, such as market regulation and trading liquidity, as well as a free press and an active labor movement. The Philippine stock market was declared non-suitable for CalPers’ investments and the exclusion triggered a swift decline of Manila stocks. Three months later, CalPers had to admit that its analysis was flawed because of an error in data collected by its consultants and the Philippine market went back to join the ranks of ‘politically correct’ investments.
One important member of CalPers board who didn’t approve the new emerging markets’ rating system was Kathleen Connell, who is also California’s state controller. “My concern is that you can’t look singularly at an entire country and determine if it’s going to be suitable”, she declared to The Wall Street Journal. The big supporter of the system was Philip Angelides, who is California’s state treasurer and then an ex-officio Calpers board member (the majority of the board is not elected by the pension fund’s participants).
Connell and Angelides are two typical examples of the political tensions involving CalPers. He is heavily backed by unions, which gave him more than $430,000 in campaign funds in past two years (state treasurers are elected) and which are very much in favour of investing according to social criteria. Among other things, unions promote CalPers’ investing in Californian venture capital, biotech, real estate and private businesses, which in all currently account for some 16% of the fund’s assets, up from 13% last year and more than the majority of State funds commit to their local economy. Angelides is up for re-election in November.
Last year, Connell ran in the Democratic primary elections to become Los Angeles mayor and lost. Her campaign targeted women to gain popular support. In the meantime, as a CalPers board member, she fought in favour of hiring an investment firm owned by a woman as an external manager of the fund, against the staff’s opinion. It was not the only case of Connell opposing CalPers’ investment staff proposals: for example, she took legal action against the fund to block it from increasing the pay of in-house money managers. That’s why at the end of 2001 the chief investment officer Daniel Szente resigned.
Another two prominent managers are going to leave by the year’s end: the CEO James Burton, who unexpectedly announced his retirement; and the head of the board’s investment committee Michael Flaherman, who said he’d pursue “other aspirations”.
The latter has had a hard time explaining why CalPers didn’t blow the whistle on Enron, although it was a big investor in Enron’s off-balance-sheet partnerships and its private equity managers knew about Enron CFO Andrew Fastow’s role in one of these investment vehicles.
Flaherman explained that CalPers invested only in Enron partnerships that were “clean, transparent and appropriate structures”. When CalPers rejected the structure involving Fastow because of the inherent conflicts of interest, it didn’t flag it in public, since its private equity managers didn’t share their knowledge with the public equity division and with those who manage the corporate governance programme. Flaherman promised this lack of internal communication will be fixed with new procedures.
In the meantime, CalPers is trying to refurbish its image as a shareholder activist with a new wave of initiatives. Last June’s board meeting approved an addiction to CalPers’ website dedicated to executive compensation issues It will be a sort of online rogue’s gallery of managers receiving “abusive” compensations. The board is also sponsoring forums about the same issues, considering whether to recommend that US companies account stock options as a business expense. The ultimate goal is to convince the American Congress, the Securities & Exchange Commission and other US authorities to adopt a package of financial market reforms to prevent another Enron. It’s bankruptcy cost over $105m of losses to the Californian fund.