How much can politics affect the investment decisions of a huge US pension fund in the public sector? A lot, judging by the latest example of the tensions between the board and the staff who manage Calpers, the California Public Employees’ Retirement System, the nation’s largest public pension fund. Following standard criteria for searching external managers, last October the staff had proposed a list of investment firms to hire. But at first the board rejected the list, claiming the search had discriminated against a firm owned by a woman.
Kathleen Connell, the California state controller and one of the 13 members of Calpers board, was leading the opposition. “We ought to be able to identify and retain qualified women – and minority-owned firms,” Connell told Knight-Ridder Tribune Business News. “The fund is largely representative of the retirement funds of women. It behoves us to see women-owned investment companies receiving the business.”
Connell is one of the seven Calpers board members (the majority) that are not elected by the pension fund’s participants: two are designated by the state governor, one by the state parliament, four are ex-officio like the state controller. Is Connell really concerned about Calpers’ performances and benefits to all its members, women included? Or is she thinking about her next political challenge? The question arises spontaneously when you know that she’s a Democratic politician running to be the next Los Angeles mayor and she targets women to gain popular support.
Probably the influence of politics can’t be avoided in a fund which was established by law, has a board mainly designated by politicians and is a key economic force in California, thanks to its assets, $165.2bn (e174bn).
The new chief investment officer, Daniel Szente, has been managing the fund since July 1 last year. Former CIO Sheryl Pressler left, together with other three top managers, because of the frequent confrontations between them and the board.

Asset allocation
The system is 70 years old and provides retirement and health benefits to more than 1.2m state and local public employees and their families.
“The starting point and most important element of Calpers’ successful returns on investments is its asset allocation, its diversification among stocks, bonds, cash and other investments”, explain spokespeople at the Sacramento headquarters. “Asset allocation is not an asset-only or liability- only decision. All factors, including liabilities, benefit payments, operating expenses and employer and employee contributions are taken into account in determining the appropriate asset allocation mix.” The declared goal is “to maximise returns at a prudent level of risk” and it is implemented “over a period of several years on market declines and through dollar cost averaging”.
Calpers investment committee, the staff and Nobel prize winner William Sharpe are working on an asset-liability study, which should be ready by the end of 2001. It will help the fund set its future strategies. Among the reasons for the study are the growth of liabilities and the clear end of a very long period of exceptional performances in the equities market. Calpers managers realise that 20–25% annual returns from equities are no longer foreseeable; they expect more moderate returns for the next years, something like 10% from equities, 5–6% from bonds, 20% from private equity. They are adjusting their investments in a coherent way.
The current target allocation was approved by Calpers board in May 2000 and suggests 28% of assets invested in fixed income (24% domestic and 4% international), 64% in equities (39% domestic, 19% international and 6% private equities or alternative investments), 8% in real estate and 0% in cash. The actual investments (as of December 31, 2000, the latest data available) slightly overweight the bond asset class (29.4% or $48.6bn) is neutral with equities (63.9% or $105.6bn), slightly underweight real estate (6.7% or $11bn) and has $1.7bn in cash.
To be more specific, alternative investments represent 4.5% of the assets, international equities 18.7%, domestic equities 40.6%, international fixed income 4.2% and domestic fixed income 24.2%.
The assets are managed partly internally and partly externally. The large internal portfolios are managed both passively and actively. The staff is elaborating a new quantitative programme to enhance performances of equity investments.

The search for external managers
The process of hiring new external managers is quite complicated. What happened to the $5.8bn invested in actively managed international equities is a good example. Last year Calpers staff decided to reshuffle the team of managers for this asset class: with the help of consultant Wilshire Associates, they selected the list of finalists to be submitted to the board, which has the last word in the appointments.
The fund’s staff has its own criteria of selection – not exactly the same as the consultants’ – a scoring system of 100 points, with a maximum of 30 points given to investment philosophy and process, a maximum of 20 to organisational issues and so on. Fees are not addressed in the scoring process, but every investment manager has to submit a performance-based fee proposal.
In October the staff recommended that the board hire 15 new managers and terminating almost all existing ones, among them Massachusetts-based ValueQuest/TA LLC, which runs a $236m core international portfolio. But the board reacted with sharp criticism, because ValueQuest was the only firm owned by women and the fund’s policy is to encourage investment managers owned by women and minorities. Moreover, ValueQuest’s president and chief investment officer is Katherine Magrat, who was at the centre of a sex discrimination case 27 years ago, when she was fired by her then employer, Keystone Custodian Funds of Boston. She sued the employer and won a settlement, claiming she had been fired because she was female; in 1982 she created her own investment firm, ValueQuest, which now manages $700m assets, down from a peak of $1.5bn in 1998.
In the staff’s scoring system ValueQuest had achieved the last but one ranking. The staff point out that the board approved the international search process in February 2000, without specifically addressing the problem of minority- or women-owned firms. But from October 2000 to the end of February 2001, any decision about hiring international managers has been stopped and tensions between the staff and the board have been growing. In the end, 14 investment firms were selected. Only four of the old managers were confirmed: Newport Pacific Management, Nomura Asset Management, Oechsle International Advisors and Schroder Investment Management. The 10 new ones are Artisan Partners, Baillie Gifford Overseas, Fidelity Management Trust Company, GE Asset Management, Grantham Mayo Van Otterloo & Co, Mastholm Asset Management, Putnam Institutional Management, Robeco Group, Blackrock International and Zurich Scudder Investments.
Calpers is also trying to innovate the search for managers. For example in 1999 the fund established the Manager Development Program (MDP), committing up to $4bn in funding this programme. MPD, explain spokespeople in Sacramento, “seeks to achieve superior investment returns while providing opportunities to new and emerging money managers that may not have the long-term track record and marketing clout to compete against institutional giants”. Calpers’ partner in this programme is Strategic Investment Group of Washington, DC. Together they select the managers, make an equity investment in the firms and provide them with assistance in business management and development. Last December they hired Golden Capital Management to manage $200m of US equities within Calpers’ MPD. Golden Capital, based in Charlotte, North Carolina, was founded in 1999 and is run by Greg Golden: it is one of the young and successful firms that can be the future of the money management industry, according to Calpers.
Calpers looks not only for new breeds of managers to hire, but also for new ways to hire managers. So last September it decided to invest in, a new internet-based company that provides online research tools for money managers, pension fund consultants and institutional investors. has a database of investment managers, who can be selected according to a variety of criteria, contacted and even interviewed online, including ‘virtual meetings’ with pension funds interested in them. Calpers invested $25m in, together with Thomas Weisel Capital Partners, a $1.3bn private equity fund, which is a partner of Calpers.
Last December Calpers announced that it would utilise the search exchange capability of, looking for a strategic investment partner for the system’s $1bn hedge fund programme. The online resources and the hedge fund database ( will be used by Calpers and its new strategic partner to search, evaluate and select hedge funds for investments and to monitor portfolio risks. “We are committed to leveraging internet technology in this process,” commented Szente. “Our hedge fund programme is a perfect example of how the internet can bring transparency and efficiency to an asset class that is relatively inefficient.”

Alternative investments
Calpers is committed in a very sophisticated way to alternative investments. It invests around 4% of its assets in private equities and it plans to increase this asset class to 6%, through its Alternative Investment Management (AIM) programme. AIM operates in three different ways: with partnerships, where Calpers assumes a limited partner role in funds that are managed by top private equity general partners; with co-investments – into companies alongside a general partner – and direct investments into companies, without a general partner; with new vehicles, including innovative investments that allow Calpers to capitalise on specialised opportunities in the market place.
Among the last examples of this programme, there are the five biotechnology investments, totalling $285m, approved last December: one in a biotech fund domiciled in New York, EuclidSR (a partnership between Euclid partners and the venture capital arm of the then SmithKline Beecham); four in California-based biotech funds, including the University of California, San Francisco (UCSF) Seed Capital Fund, which will create a biotechnology incubator at the UCSF Mission Bay campus. “The biotechnology sector offers many compelling investment opportunities,” explain Calpers’s spokespeople. “New technologies are allowing for the development of better and more cost-effective products and drugs. These advancements, backed by Calpers’ capital, can produce significant returns for the fund while addressing unmet patients needs”. Calpers expects to make other biotechnology investments with universities, institutions and biotech companies early in 2001.
Two large private equity investors that recently made deals with Calpers are San Francisco-based Texas Pacific Group (TPG) and Washington, DC-based Carlyle Group. In January 2001 Calpers invested $485m in TPG Ventures, a subsidiary of TPG, aimed to “make early and late stage investments in growing companies in the technology, communications, business resources industries that are shaping consumer trends in the economy”, according to a press release. Calpers’ investment include a $60m equity stake in TPG Ventures, in addition to the $325m to start the new venture capital fund and $100m for other initiatives.
Calpers has been an investor in Carlyle funds since 1996. But at the beginning of February for the first time it announced it had directly bought a stake in the private equity firm, best known for its specialisation in defence industries. Calpers paid $250m for a 5% stake in Carlyle and has an option to buy another 5%; it also committed $250m to several of Carlyle’s new funds, like Real Estate Partner III, Ventures Partners II, Energy Fund II and Asia Venture Partners II. “We have maintained a strong relationship with Carlyle over the past five years, and have been very pleased with the firm’s performance,”says William Crist, president of Calpers board of administration. “It was important to extend this relationship with an equity interest that will enable us to participate in the firm’s growth and success”. Another investment officer at Calpers adds: “We see the private equity landscape changing over time. Firms are offering global products, across the asset class and we think our capital can enable those firms to grow their businesses successfully.”

Securities lending
Another innovative move recently approved by Calpers was to join forces with London-based Old Mutual to form eSecLending, based in Burlington, Vermont, a firm offering an online securities lending exchange for institutional clients. The firm’s website,, claims to be “the first of its kind in the industry and is expected to revolutionise the business of securities lending by using the latest internet technology to introduce the auction process to the global marketplace”. The lending process is an investment strategy through which institutional investors, including pension funds and mutual funds, lend securities to borrowing institutions in order to earn incremental income on their portfolios. It is a market estimated at between $1.5trn and $2trn.
Calpers has a $12bn internal securities lending programme and hopes that eSecLending will increase market efficiency and enable itself and other institutional lenders to retain a larger share of the revenues associated with the lending process. In fact Calpers reckons that it could earn as much as $50m of incremental return annually by virtue of the increased efficiency gained through auctions with minimal risk; or, in another words, by eliminating the middlemen, the large custodian banks that have historically served as intermediaries in securities lending, taking a negotiated cut from the income generated by the lending process.
The specific goals of are: join lenders, borrowers and brokers in one place via the web; allow price discovery by utilising a two-stage bidding process and offering lendable securities packaged in discrete tranches; and capture a large centralised pool of data on securities lending performance that will be used for a comprehensive benchmarking system.
Real estate
Calpers real estate portfolio is diversified in office, retail, industrial and apartment properties ($8bn) and in housing, timber, franchise finance, and net-leased investments ($1.8bn).
Also in this field Calpers seeks for strategic partners in new initiatives. For example last October it selected CB Richard Ellis Investors to manage the system’s $500m joint real estate and alternative investment management technology programme. Under the programme, the Los Angeles-based global investment management company will make investments in real estate and real estate-related entities, and capitalise on opportunities created from the convergence of the technology and real estate industries.

Calpers’ performance is above the median for 15 large US pension funds measured by Cost Effectiveness Measurement of Toronto and also better than most multi-billion public pension funds, according to the Trust Universe Comparison Service (TUCS). For the one-year period ended June 30, 2000, Calpers earned a 10.5% return on its investments, marking the sixth straight year of double-digit returns. But six months later, the downturn of the stock market took its toll and Calpers’ annual performance plunged into the red: –1.38% at the end of December 2000. Previously ‘lean’ years had been 1994 (2%) and 1991 (6.5%).
The board of administration, trying not to alarm members, states that: “The news does not affect Calpers’ ability to pay benefits, nor does it mean a change in asset allocation or diversification strategy.” Moreover, the president, William Crist, says: “We are long-term investors. Our strategy to increase our exposure to real estate and alternative investments, while maintaining significant exposure to fixed income, will continue buffer us against the volatility of the stock market. We are very pleased.”
The board stresses that Calpers’ assets are still up 10.6% compounded over three years and 12.7% compounded over five years. In 2000 the fund’s public equity returns were down 8.8%, total fixed income returns were up 10.3%; real estate performance was up 17% and alternative investments posted a 25% return.
“Prospects for the fund are positive,” comments Michael Flaherman, chair of the pension fund’s investment committee. “We believe equity market fundamentals are gradually improving, especially given the direction that interest rates are going. We believe real estate will continue to be strategically attractive for us with prospects for long-term returns in the high single-digits to low double-digits. Our young and growing alternative investment strategy will continue to produce strong returns over longer periods, with the biggest payoff coming in three to five years as our investments mature.”