CalPERS Makes ESG Changes

CalPERS officials hope ESG revisions will add alpha to the pension system’s $178.6 billion global equity portfolio.

Over the last eight months, the California Public Employees’ Retirement System (CalPERS) has revamped the portion of its global equity portfolio devoted to environmental, social, and governance (ESG) investing as part of efforts to improve ESG returns.

The changes were made before Southern California police sergeant Jason Perez unseated CalPERS Board President and ESG investment advocate Priya Mathur in October. Perez maintained in his election campaign that the $361.1 billion pension system had to move towards higher yields in its investment fund with less emphasis on ESG investments.

While Perez will be only one of 13 board members when he takes office in January, he is expected to put more scrutiny on the CalPERS ESG investments.

CalPERS’s ESG investments make up just $3.3 billion of its $178.6 billion global equity portfolio or less than 2% of the overall portfolio. CalPERS investment officials have kept it small on purpose, as they attempt to develop winning strategies, and reverse past underperformance.

CalPERS’s latest attempts at forging alpha from its ESG equity portfolio include the creation of two internally managed ESG strategies earlier this year.

Dan Bienvenue, CalPERS’s managing investment director, global equity, told CIO in an interview that the two strategies, each for $1 billion, are internally managed under licensing agreements from money managers QS Investments and AXA Rosenberg. Both strategies involve the selection of several hundred stocks that are picked for positive ESG factors, Bienvenue said. He said the QS strategy is quantitatively based while the AXA Rosenberg strategy uses a combination of quantitative and fundamental strategies.  

Both strategies look for undervalued companies relative to their ESG initiatives. “It’s about finding companies whose ESG strategy isn’t yet reflected in the stock price,” Bienvenue said.

The QS investment strategy was announced in April and the AXA Rosenberg in July.

Bienvenue said the new strategies have been put in place as CalPERS has scrapped another internally managed ESG strategy this year that was based on an index from HSBC. He said HSBC stopped offering the index that selected investments based on the revenue companies spent on climate change initiatives.

CalPERS had $832 million invested in the HSBC strategy as of Dec. 31, 2017, but began to liquidate it in early 2018.

Bienvenue said CalPERS started to use the HSBC index in 2010 but it had underperformed its benchmark over the long term. The index had a lot of exposure to companies working on the clean energy transformation, many of them based in Europe and dependent on government subsidies to make improvements on their sustainability policies, he said.

“A lot of those subsidies dried up and so the performance wasn’t horrible, but it definitely underperformed, I think, in certainly most, if not all, time periods,” Bienvenue relayed.

CalPERS data shows that the HSBC strategy had a net return of 24.44% for the one-year period ending on Dec. 31, in fact, beating its benchmark by five basis points. The strategy did underperform for the three- and five-year periods. It returned 9.16% for the three-year period, underperforming its benchmark by 71 basis points. For the five-year period, the HSBC strategy returned 11.47%, underperforming the benchmark by 12 basis points.

While CalPERS has developed a worldwide reputation for its corporate engagement program challenging companies about sustainability and governance, it has been far more cautious about embracing those principles in its own investments. CalPERS former CIO Ted Eliopoulos has said that CalPERS does not have an overall portfolio tilt towards ESG factors in its global equity portfolio because of inconclusive research on risk and return.

Bienvenue said that the two new ESG-tilted equity portfolios will be closely watched by CalPERS investment staff and could serve as investment models for other parts of the global equity portfolio.

“We believe these are strategies that will add value in the ESG space,” he said. “But I will tell you, that anytime you engage in active management, which is what these [strategies] look like, a certain dose of humility is always appropriate. And we are like that with every strategy we manage. Sometimes the market doesn’t do what you think it will do.”

In addition to the new internally managed strategies, CalPERS has two external ESG strategies in its global equity portfolio.

It has $475 million invested in Cartica Management LLC, an investment firm that specializes in emerging markets. The ESG strategy returned 5.75% for the one-year period ending June 30, underperforming its benchmark by 1340 basis points. For the three-year period it returned 5.11%, outperforming its benchmark by 52 basis points, and for the five-year period, it returned 2.64%, underperforming its benchmark by 243 basis points.

CalPERS has $829 million invested in the Hermes ESG strategy. It returned 5.31% for the one-year period ending June 30, underperforming its benchmark by 89 basis points. For the three-year period, it returned 5.27%, overperforming its benchmark by 23 basis points.

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