The California Public Employees’ Retirement System (CalPERS) continues to move money from fired external equity managers, investing nearly $14 billion into several different internally run equity index strategies, shows pension plan data prepared for its Dec.16 investment committee meeting.
The largest amount of money, $8 billion, went to an index fund representing the broad U.S. stock market, the so-called US Total Market Index 3000 Strategy. The next largest amount of money, $4 billion went to the International Developed Large Midcap Index Strategy, followed by $1.2 billion to an emerging markets large/midcap strategy.
Of the remaining money transferred, $485, 000 was moved into a international developed countries small cap index strategy and $145,000 into a emerging markets small cap index strategy.
The $15.4 billion was on top of $9 billion already transferred over the last few months following the firing by CalPERS of almost all its external and emerging equity managers.
Its unclear how long it will take CalPERS to move more than $10 billion in additional money. Transiting money for terminated managers can take six months or more.
CalPERS Chief Executive Officer Marcie Frost had disclosed in an Oct. 21 letter to pension system board members that CalPERS had terminated most of its external equity managers, slashing their allocation to $5.5 billion from $33.6 billion.
Only three of 17 external equity managers have been spared in the reduction, the memo said.
CalPERS also fired three of the four CalPERS manager of managers who ran CalPERS emerging managers equity investment program, reducing the allocation to $500 million from $3.6 billion.
The memo, which has not been publicly discussed, says the moves are necessary because of long-term underperformance. The memo obtained by CIO says that CalPERS Chief Investment Officer Ben Meng is putting a “renewed focus on performance and our ability to achieve our 7% assumed rate.”
Meng, who took over as CalPERS’s CIO in January, has repeatedly expressed concerns, not only about CalPERS achieving the 7% assumed rate of return, but of its underfunding. CalPERS is only around 70% funded.
CalPERS press office has confirmed the reductions and terminations but has not offered an explanation of the moves. The pension had refused to turn over a list of the terminated managers.
It is possible that Meng may make his first public comments on the firings at the system’s investment committee meeting today.
One CalPERS board member Margaret Brown applauded the decision by Meng to fire the external managers.
“Focusing on achieving the best risk-adjusted returns should be the priority at CalPERS,” she told CIO.
The termination of three of the four emerging manager of managers affects more than the three managers. Several dozen equity investment firms, most of them owned by minorities or women, were part of a line of firms that managed for CalPERS by the manager of managers.
The overall manager of manager program was started by CalPERS more than 25-years ago. Returns began to be questioned by CalPERS investment staff following the great financial crisis in 2008 and 2009 as underperformance compared to board market indexes became pronounced.
When CalPERS was overfunded, before the financial crisis, subpar investment performance could be tolerated or investment staff could look the other way in the name of diversity
Not only was there constant underperformance but CalPERS had to pay two sets of fees.
One set of fees was paid to the manager of managers who organized the line-up of managers, the second set of fees was paid to the individual managers.
The Frost memo notes the sensitivity of the issue.
It says that the move terminating emerging managers, “could receive media or legislative attention.”
The $380 billion pension system, the largest in the U.S., has faced criticism going back more than a decade by some state legislators for not having enough diverse money managers on its roster.
In response, CalPERS launched new initiatives to hire a more diverse base of managers.
As part of the efforts, back in 2016, CalPERS announced would invest up to $5 billion with emerging equity managers including a special program to contract with promising equity managers directly instead of through a fund of funds.
A solicitation for promising new emerging investment talent scheduled for 2019 never happened as Meng started analyzing performance data for the emerging managers, sources said.
Just how bad was the underperformance?
“Over the last five years, traditional managers have underperformed their benchmarks by 48 bps and emerging mangers by 126 [bps],” the Frost memo says.
Many pension pensions have curtailed or totally abandoned their active equity strategies since the great financial crisis.
CalPERS also gradually cut external managers and moved its money into internal strategies. While the strategies are index-based, CalPERS in the last fiscal year, also put around $50 billion into factor based strategies that aim to enhance an index, by using factors such as stock quality.
With both the traditional index and factor-based strategies largely outperforming almost all equity managers, whether they were emerging or not, Meng made he final decision over the last several months to essentially get out of external management on the equity front except for a few limit exceptions
The decision was part of a top to bottom review that Meng is still conducting of the $380 billion portfolio, the largest in the U.S.