The largest U.S. public pension fund intends to sever ties with
roughly half of the firms handling its money, one of the most
aggressive industry moves yet to reduce fees paid to Wall Street
investment managers.
The California Public Employees' Retirement System, or Calpers,
will tell its investment board on June 15 of its plans to reduce
the number of direct relationships it has with private-equity,
real-estate and other external funds to about 100 from 212, said
Chief Investment Officer Ted Eliopoulos. The action will be made
public on Monday.
The dramatic move by the $305 billion Sacramento-based
retirement system will create some big winners and losers in the
investing world. The list of external money managers Calpers uses
include some of the biggest names on Wall Street, including
private-equity firms Carlyle Group LP, KKR & Co. and Blackstone
Group LP.
The push by Calpers to downsize could have broader ramifications
beyond its own portfolio. Calpers is considered an industry
bellwether because of its size and history as an early adopter of
alternatives to stocks and bonds, and the shift could prompt other
U.S. pensions to scale back their ties to Wall Street.
"There really will be a significant amount of discussion at
other pensions" about whether they should cut external managers in
the wake of Calpers's decision, said Allan Emkin, a managing
director at Pension Consulting Alliance who has advised the fund
since the 1980s.
The pullback would take place over the next five years and is
expected to save Calpers hundreds of millions of dollars in
management fees. It paid $1.6 billion to external managers last
year.
The reduction in outside managers won't fundamentally change
Calpers's investment strategy, or the percentage of assets managed
in-house versus externally. The remaining 100 or so outside
managers will simply get a bigger pool of funds varying from $350
million to more than $1 billion, Mr. Eliopoulos added.
The goal, Mr. Eliopoulos said, is "to gain the best deal on
costs and fees that we can."
The 50-year-old Mr. Eliopoulos became the pension fund's top
investment official last September after helping Calpers recover
from severe losses sustained during the 2008 financial crisis as
head of its real-estate portfolio. His first major move as chief
was to shed a $4 billion investment in hedge funds, part of a
movement to simplify the approach of a fund that in recent decades
loaded up on assets such as real estate, private equity and
commodities.
Fees paid to outside managers have ballooned over the past
decade as many public retirement systems followed Calpers into
hedge funds and private equity in an attempt to boost long-term
returns and meet their mounting obligations to retirees. But now
some pension officials are tiring of the high expenses often
charged by outside managers as state and local governments struggle
to make up for losses incurred during the financial crisis. Many
U.S. pensions, including Calpers, still don't have enough assets to
cover their future costs despite a run-up in the stock market in
recent years.
"Fees are becoming an increasingly scrutinized area at public
pensions," said Jean-Pierre Aubry, an assistant director at the
Center for Retirement Research at Boston College.
In New York City, outside money-management expenses are under
review after an April report from Comptroller Scott M. Stringer
said external investment firms have cost the city's local
retirement systems billions in the past decade. A similar
discussion is under way in New Jersey, where state pensions have
paid out $1.5 billion in fees over the past five years, according
to a recent report presented to the state Senate last Thursday.
In Pennsylvania, where the state is grappling with a $50 billion
pension hole, Gov. Tom Wolf declared in a March budget address that
"we are going to stop excessive fees to Wall Street managers."
California's proposed reduction in outside managers is part of a
larger effort to reduce risk and complexity at a fund that manages
investments and benefits for 1.7 million current and retired
workers. Calpers posted a total return of 18.4% for its most recent
fiscal year ended June 30, beating its benchmark, but it only has
enough assets to cover 77% of its future retirement payouts.
As recently as 2007, Calpers had about 300 external managers—a
remnant of its pioneering foray into alternative investments such
as real estate, hedge funds and private equity. Over the past eight
years, it reduced that number to 212, but it is still difficult for
the pension fund to effectively monitor all of its investments,
according to Mr. Eliopoulos.
There are so many outside managers currently that Calpers
doesn't have the ability to make sure all those funds share the
same objectives as the large California pension fund and are
performing well, according to Calpers Chief Operating Investment
Officer Wylie Tollette.
"We need to do a better job of keeping track of how those
managers evolve, what strategies they're good at, what they may not
be good at to ensure they're effectively earning their place at the
table every year," said Mr. Tollette, who currently gives Calpers a
"B-minus" at doing those tasks.
"For an organization like Calpers we need to be an A, if not an
A-plus," Mr. Tollette said.
As a measure of overall assets, Calpers currently pays about
0.34% toward management fees, Mr. Tollette said. In 2014, the $1.6
billion spent on those expenses included a one-time incentive
payment of $400 million to real-estate funds.
Mr. Tollette said that by 2020 he would like to see the amount
drop "below" 0.25% of total assets, excluding performance fees.
External funds charge management fees, plus a share of the
investing profits.
Calpers doesn't expect to immediately terminate outside firms or
liquidate holdings, according to Mr. Eliopoulos, who pushed for the
hedge-fund decision as well as the move to whittle the number of
external funds. The fund's evaluation of external managers is
expected to begin next month. Calpers will consider investing
performance, the length of the relationship and strategy, among
other factors, Mr. Eliopoulos said.
The biggest cuts are expected to occur in Calpers's
private-equity portfolio, where the number of private-equity
managers will slim to about 30 from roughly 100. Real estate will
go to 15 outside managers from 51. Fixed income and global equity,
which is largely managed in-house, will drop to roughly 30 from
nearly 60 now.
Only the group that invests in timber and infrastructure
projects like roadways is expected to rise, from about six managers
to 10. Some 15 slots will go to upstart firms that Calpers plans to
identify over the next several years.
Mr. Eliopoulos said the staff discussed a reduction higher or
lower than roughly 100 but decided to land on a whole number.
"There's no science to this. This is a judgment," he said.
Write to Timothy W. Martin at timothy.martin@wsj.com
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