From “Leading the Way” to “Losing its Way”: CalPERS
In recent weeks, I’ve incorporated charts and graphs from money management firms into my paintings. While creating these works, I’ve been listening to recent committee meetings conducted at CalPERS. I suppose it’s a way of connecting my former professional life with my art. I’m listening to these sessions and perusing some of meeting materials because the nation’s largest pension plan is completing a sad transformation from “leading the way” to “losing its way.”
As I’ve written before, I frequently called upon the senior staff at CalPERS when I ran the North Carolina pension plan in the early 2000s. They were the leaders in formulating investment policies, hiring capable staff, and exploring new investment opportunities. As they shared their experience and expertise, more than one investment professional warned me not to go too far in borrowing from the CalPERS’ model. They cautioned that a portfolio could become too complicated, the range policies and procedures could become too detailed and cumbersome, and the staff and consulting relations could become too numerous.
Thanks to the tireless efforts of Naked Capitalism and those lengthy videos of CalPERS meetings, I’m seeing a troubling picture of a public pension that has lost its way. Like all too many states and municipalities, California made promises to its employees and retirees without providing adequate funding. Instead they relied on unrealistic capital market assumptions and unrealistic promises from their money managers and consultants. CalPERS was supposed to be the public pension plan that was too sophisticated to fall into this trap. While the staff and board at CalPERS acknowledge the challenges, they’re doing little to address any of their shortcomings. In fact, they’ve decided to do more of the very things that won’t work.
On the investment front, CalPERS has reaffirmed its commitment to private equity as its main strategy for meeting or exceeding its investment assumption. As Naked Capitalism has detailed in a series of posts, CalPERS conducted a lengthy private equity workshop for its investment committee. While the workshop was billed as an effort to better educate the committee, it was really a multifaceted effort to justify CalPERS’ commitment to private equity.
Meanwhile the finance and administration committee has tacitly acknowledged that the pension’s investment assumption is unrealistic by adopting a formula to lower the assumption in years when the capital markets are ebullient. For example, if the CalPERS portfolio earns 4% more than its 7.5% assumption in any given year, the future assumption would be reduced by .05%. If the portfolio beats its assumption by 7%, the assumption would drop by 0.10%. The idea is to use some of the “surplus” to fund a move toward a more realistic investment assumption. Unfortunately, excess performance in a given year isn’t a surplus; it’s just a random result that will be followed at some point by performance that falls short of the assumption. CalPERS is adopting this policy because they know that their portfolio (even with its unwavering commitment to private equity) can’t earn 7.5%, and because they know that state and local government are either unwilling or unable to increase the contribution required to meet the obligation to the beneficiaries.
To be clear, CalPERS faces a daunting challenge. When a pension plan becomes underfunded, the way forward is intimidating. The current board and professional staff didn’t create the central problem (liabilities significantly greater than assets). This problem has been building for more than a decade. However, they’re doing a poor job of confronting and addressing the problem.
Within the hours and hours of committee meeting videos, I’ve seen all sorts of troubling signs. For example, the governance committee is grappling with potential new policies to limit inquiries by board members and prevent board members from using the public records law to obtain documents when they aren’t furnished in the normal course of business. When I was CIO I didn’t particularly like pointed questions and public records requests. No one enjoys having their recommendations questioned or producing reams of documents. However, I recognized that tough questions and inquiries were a necessary part of the process. Instead of stifling inquiries, the professional staff at CalPERS needs to grow a thicker skin.
At the governance committee meeting, the members also considered reducing the number of board meetings. I think this is a sensible step, except for one big problem: the professional staff hasn’t earned the trust requisite to reducing the frequency of meetings. There’s little doubt in my mind that CalPERS’s board and committee meetings are too long and too frequent. Moreover, many of the presentations are mind-numbing expositions on overly ornate procedures, well-worn platitudes, and unrealistic promises.
At the most recent governance committee and investment committee meetings, the trustees heard from CalPERS’s outside fiduciary counsel. Naked Capitalism and others have documented that the pension plan’s fiduciary counsel, Robert Klausner, has a history that does not inspire confidence in his opinions. I am also troubled by the fact that the fiduciary counsel doesn’t report directly and exclusively to the trustees. Instead Mr. Klausner’s practice appears to be yet another consultancy constructed on conflicts of interest, spending too much time mediating potential rifts between the staff and board.
When pension plans, or for that matter any organization, face big challenges its board needs to be very active. At CalPERS, we have a lot of video evidence that only one trustee is asking probing questions and that the staff and governance committee would like to limit his inquiries. In my view, all of the trustees should be asking tough and probing questions. The board and committee meetings should be interactive and at times even raucous. After all they’re facing tough problems. Moreover, the trustees should have an independent and unbiased fiduciary counsel who exclusively advises them on their role as fiduciaries.
I doubt CalPERS will change because they’ve lost their way.