CalPERS Gets a D for Fixed Income Management, But B For Overall Program

Consultant Wilshire Associates also gives overall CalPERS leadership a C grade.

The main investment consultant for the California Public Employees’ Retirement System (CalPERS) has issued a D grade regarding the quality and stability of leadership for the system’s $79.1 billion global fixed income portfolio.

Wilshire Associates, CalPERS’s general investment consultant, in a report scheduled to be discussed today at the system’s investment committee meeting, also rated the entire CalPERS investment organization. Its  finding: a lackluster C grade because of senior management changes, including the impending departure of Chief Investment Officer Ted Eliopoulos.

The D rating for fixed income comes in part because of the lack of a replacement for Curtis Ishii, the managing investment director who retired in July after 40 years as the top fixed income chief, the consulting firm said.

Wilshire expressed concern that Ishii’s departure could cause other departures. “The impact on mid-level staff and a potential increase in turnover as with any significant organizational changes could be a challenge,” it said.

The consulting firm also cites a lack of compensation incentives for the fixed income investment team in computing its D rating. It notes that a lack of equity ownership and competitive compensation at CalPERS compared to outside money managers  “remain a detractor to the overall score as do recruiting challenges.”

CalPERS officials and investment committee members have discussed challenges in finding qualified investment personnel for its 400-person investment staff, including the fixed income asset class, because of a lower compensation structure than at external money managers.

Wilshire did find that the overall fixed income portfolio “is managed in an effective and risk-conscious manner, leveraging the deep expertise of the senior management team.” Arnie Phillips, a veteran fixed income staff member who headed the CalPERS fixed income structured investment team, has replaced Ishii on an interim basis.

The Wilshire report gave the overall fixed income  program a B rating. The investment team received a B rating. An A rating was given for the staff’s investment information and gathering.

However, it noted: “While the change in leadership was anticipated well in advance, the retirement of the MID-fixed income cannot help but introduce some level of uncertainty into the investment process. The lack of significant progress in naming a permanent successor adds to the uncertainty.”  

CalPERS’s global fixed income portfolio earned a 0.4% return in the 12-month fiscal year ending June 30. Despite the meager returns, the pension system beat its custom benchmark in the low-rate environment by 40 basis points. The fixed income portfolio makes up around 22% of CalPERS’s overall $357.7 billion portfolio and is its second-largest asset class.

While Wilshire’s charge centered on a review of the fixed-income portfolio of the nation’s largest retirement plan, it also made a surprise C rating of the entire CalPERS investment organization in its report, noting the level of turnover in key management positions.  

Eliopoulos plans to step aside by the end of the year and the Wilshire report also noted that the number two position in the investment office has a new occupant because of turnover. 

CalPERS officials announced the appointment of Swiss pension executive Elisabeth Bourqui as chief administrative investment officer in April. The position had been open since January, when Wylie Tollette stepped down.

The report hammered several times on compensation for CalPERS investment personnel. (Portfolio managers at CalPERS can earn several hundred thousand dollars a year compared to $1 million or more of other investment managers). It said that the lack of pay incentives can expose CalPERS to losing senior staff.

“There is a lack of long-term ownership opportunities such as direct ownership, phantom stock, and other incentive-based compensation practices,” the report said. “These long-term forms of incentives are common within private sector investment organizations and can serve as significant retention incentives.”

Eliopoulos, CalPERS’s highest-paid employee who earned $867,200 in the fiscal year ending June 30, said he was leaving because of family issues. He is expected to depart by the end of 2018. Tollette did not cite a reason for his exit, but went back to money manager Franklin Templeton, where he was a member of the investment staff before joining CalPERS in 2014.

Wayne Davis, a CalPERS spokesman, said in an email statement that “the first order is to select a CIO. After that, the process to pick a fixed income head will begin.”

Sources say that CalPERS has selected Ben Meng, a former CalPERS investment officer, to be CIO. But negotiations are continuing over his compensation. Meng, now a Chinese government investment official, has yet to accept the job, sources say.

CalPERS has another high-level vacancy in the top position for its $27 billion private equity program. Réal Desrochers, managing investment director of the CalPERS private equity program, left in April 2017 to join an overseas bank. The position is still open. Eliopoulos has said that he wanted to finalize plans for a restructuring of the private equity program before beginning a search for a new managing investment director.

CalPERS expects to launch a $20 billion direct investment private equity organization by early next year, though its plan still needs board approval. It is also exploring whether to outsource all or part of its more traditional private equity fund program to an external manager.

Ultimately, it will be up to CalPERS CEO Marcie Frost to name the system’s new CIO.  The decision does not have to come before the full CalPERS board, though several board members have been involved in interviewing candidates.

Frost has been dealing with her own controversy over her educational background. She only has a high school degree, but a CalPERS’s press release in October 2016 announcing her appointment said that she was enrolled in a dual bachelor’s and master’s degree program at Evergreen State College in Olympia, Washington.

An August 27 blog post on the website Naked Capitalism said that Frost misrepresented her educational background and that Evergreen State College does not offer a such a dual-degree program.

Frost has stated that she made it clear from the beginning of her interview process that she only has a high school education. She denies misrepresenting her educational background.

CalPERS spokesman Davis, in an email to CIO stated, “The [press] release was written off of the document prepared by [executive recruiting firm] Heidrick & Struggles.”

The recruiting firm was hired by CalPERS to find top candidates for the CEO job.

Heidrick & Struggles officials could not immediately be reached for comment, but the firm’s policy is not to discuss its executive searches for clients.

Frost has received the support of key CalPERS officials in the controversy over her educational background. In a September 19 letter to CalPERS board members and executive staff, 29 CalPERS division heads expressed support for Frost saying that she “emulates accountability and transparency.”

Frost is scheduled to receive her annual performance review on Tuesday in a closed-door session before the retirement system’s performance, compensation, and talent management committee.

Tags: , , ,