Working the system
Fennell Betson talks to Charles Valdez, chairman of the investment committee
at the Calpers retirement system
IF anything could be daunting, it could be being chairman of the investment committee of the $157bn Calpers pension scheme, run for the public employees of the State of California. But Charles “Chuck” Valdez gives no impression that he is daunted by this or anything else for that matter.
For him, Calpers has been a matter of enthusiasm and dedication, since his election to the administration board, 16 years ago. He is one of the six board members elected by the membership, which numbers 1.15m, including both active and retired. The “system” as it is referred was started in the 1930s by way of an initiative of the state employees. “But we have broadened out since then, and now state employees comprise 25% of membership, another 25% are education, and 25% city and local government employees.” The remaining quarter are retirees.
The key thing the state employees insisted on by way of constitutional mandate is that the funding by employers be actuarially sound. There have been attempts to water this down, but he declares with evident satisfaction that “we are in the fortunate position of being fully funded for just about every plan”. Despite the fact that the elected members do not control the board, of the remaining seven, two are state officials, another is appointed by the state legislature and four are governor appointees, Calpers has remained completely autonomous. “The elected members provide the continuity,” in Valdez’s view. “I have served four terms and another representative has been on for 30 years, having just been re-elected for another four years.”
He adds: “My view is that no one group controls the board and with 13 members we do get a diversity of view points, that leads us to better informed decisions.” As he points out the whole board is governed by a number of principles, particularly that of fiduciary duties to the membership. “Our constitution says we are there to represent the interests of the members and secondarily to represent the interest of the employers.”
But on the investment side, none of the board members are there because they are investment professionals. “One or two might be in terms of past experience, but that is purely accidental.” And though the board has ultimate authority, including that of hiring and firing the chief executive officer. “We cannot interfere with his instructions, as otherwise the whole thing would not work very well!”
One of his tasks has been on the investment side to ensure that a line of demarcation is drawn. “We try to minimise the influence of politicians – as politicians and fiduciary activity can be oil and water – they simply have different motivations. We try to keep to investment standards and to keep laudable social considerations in their place.” He sees the issues clearly: “When these are a secondary or tertiary consideration, there is no problem and they can accomplish something good in terms of social investment, so long as they have met our investment criteria to begin with.”
The board works through the investment professionals under the chief investment officer. “We have a complete structure, with around 70 experts.” Compared with other big schemes, that is not huge.
“All of our investment authority is delegated to them, except for asset allocation, which is probably the most important thing we do as a board.” This is done at an annual workshop meeting, where staff, consultants and other external experts are brought together, such as Professor Sharpe of Stanford University. “We spend about two days looking at our asset allocation and trying to determine should it be tweaked in one way or another.” Usually the decision is to leave it much as it was, which does not surprise Valdez. “Most actuaries say that if you have done your homework to begin with, charges are not usually needed.”
This then is translated into policy with the appropriate staff members – by now Calpers has a policy to cover every single investment area, with the actual, investment programme itself being delegated. The equity portfolio, around 60% of the total, is handled 85% internally on a passive basis. “One reason why we do not require a great number of staff, as we just need people to oversee and monitor to see that we are tracking correctly and so on.” Around 15% is given to external managers. Most of the non-US managers are from the UK, but the aim is to expand that for the European and Asian portfolios.
For the external managers selection, the board is actively involved in the RFP process, working with the staff and consultants. “They will come to us showing their ratings of managers and suggest those we should interview. Usually we go along with the staff recommendation, though occasionally, we might enlarge it a bit.” At the beauty contest, the short-listed managers are given just 15 minutes to make their presentations.
After which the staff and consultants give their recommendations. “In about 95% of cases, the board goes along these, but there are times when there is a preference to go in another direction.” This he attributes to the size of the board and the fact that no one does control it. “So the process pretty well works on the basis of the perceived if not actual evaluation of the different contenders,” says Valdez.
Managers are very much chosen for style considerations and this aspect is monitored very closely. “We expect managers to be disciplined, we do not want them to vary from their standards.” Performance is monitored and if after a time they are not performing to expectations, the staff recommend they be put on a watch list. “If things continue as they have been, they go onto a probation list them. Finally, we will wish them well and terminate the contract. Every manager is given the opportunity at that stage to have one last say to us, but by that time it is pretty late, as we have been very generous with the time we have given them to turn things around.”
Generally, Calpers is pleased with the results obtained from their active portfolios. “In aggregate, they have added value and not gone down below the alpha line. So it has made sense for us to contract out instead of putting everything into passive portfolios. We believe the system works well.”
On the domestic fixed income side, Valdez points to the excellent record of the “bond boys,” the internal team who run these portfolios. “They are a defined team and do exceptionally well for us.” On the private equity side has been the build up of a specialist dedicated staff and it is an area that is set to grow.
One problem that is not unique to Calpers is the issue of salaries to investment staff, particularly in public sector funds. “The fund paid salaries related to civil service pay and we would get people in and after two years they would go and quadruple their salary in the outside world. We have become more competitive, and while we cannot quite match the same level of salaries and can be out bid, we have made it a lot better opportunity.”
Valdez has been involved in a number of the initiatives that Calpers has become famous for over the years. He recalls he was very cool towards the idea of investing in timberland when the idea came up in 1985. “I was quite leery at the time,” he admitted. However after being buttonholed by a group of “forestry industry types” he became quite an enthusiast and supported the original $250m investment made the next year. “Over the years, it has been one of our best performing assets,” he says, with returns at one point in the 30% per annum category, though more recently, they have fallen to the 15 to 20% pa range. Now with a portfolio of $1.5bn, Calpers is reckoned to be the country’s largest investor in the asset after the US government.
Also dating back to the mid-80s, the issue of corporate governance started to bubble up in the US, raising the question if investors started to come together to vote it could have an influence on the corporate sector, much to the alarm of some.
“We are the trustees for over 1 million people and we have the authority to vote on their behalf. In theory at least, this is an authority which can be abused,” he says. “So we have been very careful in establishing this programme and promoting it.” The ultimate objective is to increase shareholder value.
Calpers started by reviewing all major corporates and came up with a list of those not doing well. “In the beginning it was rather easy to find a list of 10 groups whose profits were going south, who were losing market share and seeing their share price decline. And their boards of directors appeared to be asleep for the entire time.” The pension fund requested meetings with the boards, all of whom refused, so resolutions were introduced at the annual meetings. “In the first year we got about 28% of these through, in the next year 37% and in the third 49%. So all of a sudden these companies were willing to meet with us.” At these meetings, the issue of having a business plan to turn things around was paramount. “Then we said we would be back in a couple of years to see how you are doing.”
Further action was developed to improve boards by having more non-executive directors and changing the compensation packages so that rewards became more performance related and other practices that favoured just the interests of management were frowned on.
“We now have a formal programme that has worked exceptionally well in the US,” says Valdez. “Now the council of institutional investors in the US has one-third corporate members.” Those who originally wanted to fight Calpers later realised that their objectives were no different to those of the fund, the increase of shareholder value.
Currently Calpers is working to spread the gospel to Europe and further afield. In the UK, it is working with Hermes, the asset manager owned by the British Telecom pension fund. “Our aim is to have a formal programme to push the idea in Europe.” Valdez has no doubts that the evidence available supports the programme’s claims that it was successful in achieving its objectives in the US and should work well elsewhere.