By Ed Mendel
Monday, August 20, 2012

Responding to legislation, the CalPERS board last week approved a five-year plan for a program that has given $10 billion to 300 new “emerging” investment managers with limited experience, yielding mixed results during the last two decades.

The nation’s largest public pension fund, valued at $239 billion last week, makes some investments with the twin goals of social-economic benefit and hitting an earnings target, 7.5 percent, that critics say is overly optimistic and conceals massive debt.

CalPERS has another $3 billion managed by 80 firms owned by women and minorities. A staff report noted that state agencies are prohibited (Proposition 209 in 1996) from considering race, gender and ethnicity in employment and contracts.

“Women and minority managers are more likely to be emerging managers,” said the report. “As a result, an ancillary benefit of our EM (emerging manager) strategies may be the increased diversification of CalPERS external fund managers.”

The renewed commitment to emerging managers comes as CalPERS, with investment earnings trailing nearly all large pension funds, is restructuring investment programs and showing progress in some areas, notably real estate.

The CalPERS investment fund remains well below its pre-crash peak, $260 billion in the fall of 2007, despite the recovery since the market bottom in March 2009 and annual employer-employee contributions that totaled $11 billion in fiscal 2010-11.

CalPERS expects to get two-thirds of its revenue from investment earnings. When earnings fall short, actuarial methods can ease rate increases. But if earning shortfalls continue, employer rates could soar, eating up funds needed for other programs.

A CalPERS consultant, Wilshire, compares earnings (page 20) among public pension funds with more than $10 billion in investments. As of last Dec. 31, CalPERS earnings ranked dead last during the previous five years, 0.57 percent, the 99th percentile.

The top-ranked funds in the fifth percentile earned 6.12 percent. The good news for CalPERS, if only in terms of peer performance, was that its one-year earnings were in the 44th percentile, 1.27 percent.

Over the last two decades, the CalPERS earnings average hit the 7.50 percent target. But critics say that period includes a record two-decade bull market ending in 2000 that is unlikely to be repeated.

A man known as the “bond king,” Bill Gross of Pacific Investment Management Co. in Newport Beach, the world’s largest bond investor, joined the critics last month with a well-publicized prediction that “the cult of equity is dying.”

Gross said stocks historically have returned 6.6 percent after inflation, but are unlikely to do as well in the future, said the Wall Street Journal, which noted some past Gross predictions have missed the mark.

Now Gross thinks policymakers may use inflation to “worm out of fiscal holes,” said the Journal, and he thinks “inflation kills long-term bonds and stocks also fare poorly.”

A Wilshire consultant told the CalPERS board last week that the Santa Monica- based firm thinks CalPERS can hit its 7.5 percent earnings target, with an expected 7.25 percent from market investments and higher yields from private equity and real estate.

“I don’t think that is an unrealistic amount of value to be added,” said Michael Schlachter of Wilshire.

In a major turnaround, CalPERS reported a big gain in real estate, which was hit by a string of well-publicized losses when the housing bubble burst, led by a $1 billion write off for a failed development north of Los Angeles.

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