Exclusive: CalPERS Fires Most of Its Equity Managers

Allocations for both traditional and emerging equity managers were slashed from $33.6 billion to $5.5 billion, and only four of 22 managers have been spared.

In a major investment move, the California Public Employees’ Retirement System (CalPERS) has 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, shows a memo by Chief Executive Officer Marcie Frost.

The Oct. 21 memo to CalPERS board members also reveals that CalPERS Chief Investment Officer Ben Meng has restructured the pension plan’s emerging manager program, reducing the allocation to $500 million from $3.6 billion and cutting the number of managers to one from five.

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 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.

The memo notes that the move terminating emerging managers, who are often minority-owned or women-owned enterprises, “could receive media or legislative attention.”

The $380 billion pension system, the largest in the US, has faced criticism going back more than a decade by some 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, including hosting diversity conferences with the California State Teachers’ Retirement System (CalSTRS).

However, the Frost memo indicates that emerging managers, which also included some newer managers who were not women or minorities, underperformed their benchmark on an even greater basis than the traditional equity managers.

“Over the last five years, traditional managers have underperformed their benchmarks by 48 bps and emerging mangers by 126 [bps],” the memo says.

The traditional equity managers, generally larger firms, will have no sway with the legislature. But some emerging equity managers have given campaign contributions to legislators who, at least in the past, have put pressure on CalPERS to hire more diverse managers.

Meng and other CalPERS officials have their own dagger to rise this time in defense, since the white-male owned investment firms favored by CalPERS over the years to manage a large chuck of its equity portfolio have also been fired.

Over the last decade, CalPERS has moved to managing most of its $187 billion in equities in-house, the majority of the strategies index-based. Still, just a few months ago, almost $34 billion in equity exposure was still managed by external managers.

CalPERS officials had debated over the course of the last decade whether it should fire external equity managers since they had almost universally underperformed stock index benchmarks. Until recently, investment officials had only selectively terminated managers, and gave most of its external partners a pass, with the assumption that stocks pickers would rise once again.

CalPERS documents from the system’s Nov. 18 investment committee meeting show that $9 billion was transferred recently into various in-house equity strategies. It’s likely that more money will be transferred into those accounts over the next few months since the liquidation of CalPERS accounts with the external managers will occur over several months.

CalPERS spokeswoman Megan White did not offer any immediate comment. CalPERS has not disclosed which managers it terminated.

The memo advises board members who receive questions about the changes to notify CalPERS’s office of public affairs. It says the terminations of the traditional external equity managers began three months ago and the emerging managers the day of the memo, Oct. 21.

Back in 2016, CalPERS officials pledged spending $7 billion more to expand its emerging manager program, but it’s unclear if any new managers were hired in the equity arena.

In the memo, Frost said the review of the external active equity managers began 18 months ago, before Meng started in office. She noted that the new CIO fully supported the efforts.

“This is a key part of Ben’s focus on risk and on making investments that can hit [a] 7% assumed rate of return,” she said. Frost noted that returns by external equity managers “haven’t contributed enough to achieving [the] 7% target.”

The CEO also noted that the pension plan will see “very significant savings” in fees from the manager terminations: $80 million from traditional equity managers and $20 million from the emerging managers.

The emerging manager program was particularly expensive for the pension plan since almost all of CalPERS emerging managers were part of manager of manager programs. CalPERS hired an overall manager, who was paid fees. That manager then hired a group of money managers, who were also paid fees from the pension plan. CalPERS did not hire the money managers directly because most were too small to receive a CalPERS allocation on their own.

Frost in the memo said that CalPERS was “not stopping” its emerging manager program. Without offering specifics, Frost said the pension plan will continue to engage with emerging managers across all asset classes.