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CHAIRPERSON JONES: I'd like to reconvene the Investment Committee meeting. Okay. We will
start with Item number 9a, Global Equity, Annual Program
Review. (Thereupon an overhead presentation was
presented as follows.) CHAIRPERSON JONES: Go ahead, Dan.
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Okay. Dan Bienvenue, Acting Senior Investment
Officer of Global Equity, and I'm joined by John Cole
Senior Portfolio Manager in Global Equity. In this review, we're going to cover four
main topics. First of all, an overview of the portfolios.
And by the portfolios, I'm referring, of course,
to the holistic global equity portfolio, and then
also the affiliate portfolios, with that affiliate
responsibility now resident inside global equity.
From there, we'll move onto the CalPERS Investment Beliefs and how both the portfolio
structure and the structure of the business model reflect
those beliefs. Then we'll go into the structure
and responsibilities of the global equity team,
and then our roadmap, both our accomplishments in fiscal
year 12-13 and then also our way forward. 81--o0o--
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Okay. So we'll start with the holistic global
equity portfolio, which is $137 billion portfolio representing 53 percent of the total fund.
The benchmark for this global equity portfolio is the custom
FTSE All World All-World, All-Cap Index, which 47 countries
and 37 currencies and about 10,000 securities.
--o0o-- INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
So as I mentioned, our focus is the building is
the building of the holistic global equity portfolio. To
get there though, we start with a building block approach
of 78 strategies. These are discrete strategies that
build up as building blocks into the holistic global
equity portfolio. Of those strategies, five are index oriented,
representing 66 percent of the assets, and the other 73
are actively managed representing 34 percent of the
assets. Internally, we manage 19 of those strategies,
five of which are index oriented, so 100 percent of the
indexing happens in-house with the other 14 being active
portfolios. And those active portfolios can be
alternative beta type strategies, such as fundamental or 82volatility-weighted, or other
active strategies, such as the synthetic portfolio. That synthetic portfolio
is a portfolio of fixed income assets overlaid
by equity futures. That's the portfolio that's managed
in collaboration with the fixed income team,
which has been a highly successful portfolio. And, of course,
we're very appreciative of the work by the fixed income
unit on that portfolio.
We also manage -- have, you know, externally managed strategies. There are 59 of those
managed by 51 different managers, 11 activist strategies,
33 emerging manager strategies, and 15 traditional active
strategies. --o0o--
CHAIRPERSON JONES: Hold on, Dan. There's a question.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: Dan, when
you -- excuse me, when you say strategy, do you really
mean portfolios or do you mean 78 separate investment
theses? INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
No, I mean kind of portfolios, but to differentiate -- it's a semantic question,
but to differentiate between the holistic global
equity portfolio, we've used the word strategies,
but yes it's a 83block. COMMITTEE MEMBER JELINCIC: Okay. So you could
have four low-cap value managers and it would count as
four strategies for purposes of this? INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Correct. COMMITTEE MEMBER JELINCIC: Okay. Thank you.
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Okay. So the characteristics of the capital
allocation of the global equity portfolio you can see from
this slide, from Slide 5, roughly half of the portfolio
is -- represents U.S. domestic assets, with the other half
representing international assets, eight percent of which
is emerging markets. We have the -- carry the full market cap
coverage, all the way from large and mega cap securities,
all the way down into the small and even micro-cap. And,
of course, the global equity portfolio does carry the
CalPERS customizations of exclusions around tobacco,
firearms, Iran/Sudan, and then application of the emerging
markets principles. The chart at the bottom really just is intended
to indicate a comment that we've made to the Investment
Committee in the past, which is that as you move into the
less efficient areas of the market, that's where there are 84more opportunities for active
management. So you can see that more of the money is managed externally,
because it's more actively managed as we move from U.S.
domestic into emerging markets.
--o0o-- INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Okay. So I mentioned that we start by building up the portfolio using these building blocks
or these 78 strategies, but it's very important at the
end that we then take a top-down view into the portfolio,
because again that's the focus is the holistic portfolio
to see where the exposures are and to make sure we're
comfortable with those exposures.
So currently, we look at those exposures, both on
a geographic sense, we look at them from a economic sector
sense, we look at from the factor sense. We really try to
dissect the portfolio as many ways as possible to really
see where our risks are and making sure that we're
comfortable with those risks. So regionally, we're overweight to Japan and
developed Europe ex-UK, and underweight to U.S. and Asia
ex-Japan. From an economic sector standpoint, we're
overweight to industrials, primarily coming from the
United States, and technology, primarily coming from
Japan. And we're underweight to financials, primarily 85coming Asia and Canada, and energy
coming from the United States.
From a factor standpoint, we're overweight to
volatility, value, and small cap, and underweight to
quality and large cap. --o0o--
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: So this next slide, Slide 7, really just reflects
some of the various categories of strategies that we have
managed within global equity. All the way to the right,
the column all the way to the right, shows the holistic
$137 billion global equity folio. And really a couple of comments to make there.
One is that the whole cost of the global equity asset
class is around 10 basis points. And then the other thing
is that it's managed at about 30 basis points of active
risk, which, of course, is at the low end of our policy
target of 25 to 50 basis points. Another comment to make has to do with the
internal capability, and really the cost effectiveness of
that internal capability. You can look at the column all
the way to the left and you can see that the total cost of
managing the internal assets, which is about 81 percent of
the total assets, is around $10 million, and that's the
index and the active portfolios, were less than a basis 86point.
The final conclusion to draw from this slide really has to do with the corporate governance
and emerging manager columns. And it really just
is that this is our focus around rationalizing these strategies.
You can see that the corporate governance are
the most expensive and the highest risk strategies,
followed by the emerging managers at the second most expensive.
And while not the second highest risk, still a relatively
high risk, and also there's just a number of those strategies.
I mentioned the 33 strategies on a previous
slide. CHAIRPERSON JONES: Okay. Hold on, Dan.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: Excuse me. In the
first column, the internal one-year cost. Does that -- is
that staff or does that include the cost of monitoring the
outside managers? INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
That is the Investment staff that's involved in
the management of the internal strategies, and then some
of the costs around technology, models, et cetera. I
believe that's exclusive of the external management staff,
is that correct? SENIOR PORTFOLIO MANAGER COLE: It is exclusive,
but it also includes the cost of the external managers 87that provide models, and that are
managed internally. COMMITTEE MEMBER JELINCIC: And so the cost
of the internal staff that is monitoring the
external managers shows up in the external, in that
60 million for the external?
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Correct.
COMMITTEE MEMBER JELINCIC: Okay. Thank you. --o0o--
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Okay. So next, we'll talk about the affiliate
portfolios. Again, that being a responsibility that's
resident now inside of global equity. On the left, you
can see -- on the left side of the chart is the pie chart
that reflects the -- that composition of the affiliate
portfolios with the largest slice being the long-term care
portfolio at $3.7 billion, followed by the CERBT portfolio
at $2.8 billion. Next, you can see the light blue, the kind
of purple and the teal slices. I'd just like
to briefly mention those, that those are the assets that
recently went through the transition from -- for both
the new allocations on the target date funds, and
then also the fund lineup change.
That was a multi-year effort that, of course, the 88Board I think has been made aware of
as it went on. And that was a whole lot of work by a number of
people. And I just think, you know, a thank you is kind
of deserved to those people just recognition around. It was
a cross-enterprise group, of course, the Investment
Office, but certainly Customer Service, Public Affairs,
Legal, Finance, et cetera. So a whole lot of people
involved in that effort.
The right hand of the chart, or of the slide rather, reflects the three-year performance
of the various affiliate plans.
--o0o-- CHAIRPERSON JONES: Just a minute Dan.
Dr. Diehr. VICE CHAIRPERSON DIEHR: So what is -- what
are the units on that? That's what I didn't -- it
wasn't clear to me. What's 0.19?
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Those are in percentages, so 19 basis points.
VICE CHAIRPERSON DIEHR: Nineteen. Okay. Percentage. Okay.
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Of relative performance, correct.
--o0o-- INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
89Okay. So that's the portfolios. From now, we'll
go onto how those portfolios, both the portfolios themselves, or the strategies themselves,
or the holistic global equity portfolio, and the affiliate
portfolios as well as the business model reflects CalPERS's
newly adopted Investment Beliefs.
The first being that a long-time horizon is both
a responsibility and an advantage. I mentioned the
synthetic portfolio earlier. That's a portfolio where the
underlying fixed income securities are relatively illiquid. We think they're very good credit
risks, but there is some illiquidity there, but it's
illiquidity that we're comfortable taking within global equity.
And as a result, we're compensated for that. So being
able to provide liquidity to the market is one of
the advantages of our long horizon.
Another advantage is our ability to ride out volatility. And by that volatile, I mean,
both in a beta standpoint, both in market returns, but also
in relative returns. There will be cycles to those returns,
and being able to ride out those cycles is a real advantage
for us. --o0o--
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Next, CalPERS investment decisions may reflect
wider stakeholder views provided they are consistent with 90its fiduciary duties to
members and beneficiaries. You really see this through the prohibited investments,
so tobacco, firearms, Sudan/Iran and the application
of our emerging markets principles. And then you
also see this in the integration of sustainability, so around
our monetization of the focus list, and the environmental
strategy that's internally managed. --o0o--
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Okay. The next belief to discuss is the
strategic asset allocation is the dominant determinant of
portfolio risk and return. You really see this through
our focus on the holistic global equity portfolio. Just
as with the PERF, where the most important decision is
that asset allocation decision, the same thing happens
within global equity, where that capital allocation decision is our most important decision. It's
got the highest impact.
You also see this in our collaboration, of course, with asset allocation. We work very
closely with the asset allocation team to deliver what
the team needs, so whether that's pure equity beta, a little
bit of active risk on top of that, but very risk controlled,
and then also liquidity, to the extent that the plan
needs it. That, of course, is made easier by the fact
that 91the former SIO of global equity is now the SIO of asset
allocation, so we tend to know each other pretty well.
The next Investment Belief to discuss is that costs matter and need to be effectively managed.
You really see this through the internal capabilities.
Again, greater than 80 percent of the assets are
internally managed in a very cost effective way, and
it's really not just the asset management function, but also
the fact that we manage transitions and other functions
in-house that really have very strong cost advantages. You
also see this through the work on alignment of interests.
--o0o-- INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Okay. Next is that risk to CalPERS is multi-faceted and not fully captured through
measures, such as volatility or tracking error. Volatility
and tracking error are important metrics in global
equity. However, they're -- while possibly necessary
metrics, they're certainly not sufficient metrics.
So when I mentioned previously that we look at
the factors, we look at the economic sectors, we look at
the geographic risks, we do that because the more ways
that we can slice and dice risk, it gives us a better view
into the portfolio. And finally, but also crucially, is that strong
92processes and team work and deep resources are needed to
achieve CalPERS's goals and objectives. You see this in
two main ways. Number one, the very clear vision that the
entire team is working towards two main things. Number
one, managing the portfolio, the holistic global equity
and the affiliate portfolios, in the most optimal way
possible; and, then number two, deploying the business
model, and really deploying that business model in the
most risk controlled, robust, and efficient way possible.
You also see it through staff development and
infrastructure. Joe and Carol talked earlier about the
staff development work that's going on in INVO.
Certainly, global equity is no exception to that. But
also in the infrastructure, I think we've had a real
strong focus around technology, as Carol alluded to in the
Target Operating Model, the PM² initiative that overhauls
our internal management technology, the risk dashboard
that's been a lot of the work that let's you see the
metrics that you see. And then also one of the upcoming ones is
around the technology underlying the affiliate management
capability. CHAIRPERSON JONES: Hold on, Dan.
Mr. Jelincic. COMMITTEE MEMBER JELINCIC: One of the issues
you 93raise is the need for deep resources. You know, in some
ways, that's really a Board function. How are we doing in
terms of providing the resources you need, and what should
we be doing better? INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
You know, candidly, I have to echo what Joe said
earlier that when we saw some of the red spots on the
Target Operating Model, it wasn't without some concerns
that we approached this Board. But I, for one, am very
appreciative of the support the Board has given in terms
of -- in terms of providing those resources. So we're not through the woods yet. We're
going to continue to need that support, and we'll
know exactly what that looks like as we progress, but I
think we're getting the support we need, and we just need
to continue to do that to let us evolve the business.
COMMITTEE MEMBER JELINCIC: Thank you. INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Okay. Unless there are any other questions, I'll
turn it over to John to take you through the global equity
structure and roadmap. --o0o--
SENIOR PORTFOLIO MANAGER COLE: Thanks, Dan. Now
we'll turn to a review of the functions within global
equity on page 12. To reiterate what Dan mentioned 94earlier, as we've said repeatedly over the
past year, our focus is on the aggregate or holistic portfolio.
Excuse me. Just like at the plan level where asset
allocation decisions are the most important for us where
to allocate assets here we call capital, is key. We have
a team focusing on how it all fits together.
Importantly this year, we have integrated the
affiliated investment programs as Dan referred to into
global equity and are coordinating both across asset
classes and with the administrative arm of the enterprise.
Our context, then the next bullet, for portfolio construction and trading refers to our internal
capabilities for this $111 billion worth of assets that
are currently done in-house, managed in-house. Michael
and Wilshire will speak later to the strengths in this
area. Risk oversight, on page 13, is central to
what we do. We've made major strides in the past year
in understanding better the many dimensions of
risk. And I want to reiterate our view around that, that
we are balancing. With our current efforts to build
capacity -- capability and capacity to identify investment
opportunities that fit within CalPERS' overall beliefs and
utilities. Finally, we have a good handle on each of
the 95strategies we employ in a proactive effort to review and
update, where necessary, our appropriate benchmarks, alignment with our external partners, and
this includes fees, time horizons, and well-defined expectations
to name a few.
--o0o-- SENIOR PORTFOLIO MANAGER COLE: On page 14
is a small excerpt from our risk dashboard. You've
heard us reference this over the past year and again
today. It's an important tool. This is a -- probably one
page of what would be 40 that we produce on a monthly basis
to help us understand as multi-dimensionally as possible
where we are.
Let's first take a quick tour. This illustrates in the top left the weights in our total portfolio.
Dan referenced earlier the top exposures, and
they'll be parallel to what you see in this chart. In
our total portfolio -- and, of course, this is all relative
to our policy benchmark, the FTSE All-World, All-Cap.
Sectors are down the side, and regions are across
the top. As you read the chart, you can see we are 0.5,
half of a percent, underweight in Canada and also Asia,
excluding Japan. We're overweight if you're looking -- we are
overweight in Japan one percent on this chart, and 96underweight as you go down the side,
in sector terms, both financials and industrials.
On the top right, the same dimensions are stated
in terms of one dimension of volatility, risk, in the
tracking error that we often reference. Here, these are
percentages of our total tracking error. Our predicted
tracking error again today is about 30 basis points. So
as you see in the chart, 46.5 percent of that tracking
error, or that volatility risk, from geography comes from
Japan. And 28.8 percent of our economic, or sector, risk
here comes from technology stocks. Again, you can see
mainly in Japan. Please keep in mind this is on a very low
absolute level of volatility tracking error. That 30
basis points is what is in place in the total global
equity portfolio. So put another way to make sure we're clear
on tracking error, is that the portfolio's position,
so that we can expect that if the market is up 20
percent, we will likely be up between 19.7 percent and 20.3
percent, and likewise, on the down side.
Now to the lower chart. This, too, is looking at
the aggregate global equity portfolio. Here, we're using
a statistical measure that's called a T-stat. What that
is and what it's about is it highlights whether we have a 97significant positive or negative
exposure to various characteristics. If the bar exceeds, either
plus or minus 2, you'll see a little red bar across, then
it's a notable tilt.
So here, we see across the aggregate portfolio that we have a small cap exposure - that capitalization
line is going down relative to the benchmark - and a
higher than benchmark beta, which goes along with having a
small cap tilt when you're thinking about it in aggregate
terms. Our stocks in aggregate are a bit more volatile
and have very -- value characteristics of lower safety.
The reference to safety here. This is a measure that
combines earnings variability, debt levels, and price
volatility. Plus, as you look across the other notable
tilts in the portfolio, are the -- a low next 12 months
price earnings ratio and a low price to book representation in the total.
We show you all this detail just to give you a
small taste of the depth of our diagnostic work. And this
is really critical, because we believe we understand
better today than we have ever exactly where we stand on
many risk and return dimensions. And importantly about this is that the importance
of understanding where we are is critical in order to make 98any forecast or look forward
to where we would like to be or rather be or see market opportunities.
On page 15 -- CHAIRPERSON JONES: Hold on a minute.
SENIOR PORTFOLIO MANAGER COLE: Yeah. CHAIRPERSON JONES: Mr. Jelincic has a question.
COMMITTEE MEMBER JELINCIC: Is this all from the
Barra system? SENIOR PORTFOLIO MANAGER COLE: No, it's combined
from a number of -- Barra is the foundation because we
want to be able to talk across the INVO, so we can relate
to other asset classes. But also in here, we're using
FactSet as our platform, but we're using Axioma and a,
what's called, the Global Risk Attribute Model from
Citigroup to look at risk exposures. COMMITTEE MEMBER JELINCIC: Thank you.
--o0o-- SENIOR PORTFOLIO MANAGER COLE: And page 15,
we think of this as a risk hub. The message of
this picture, this illustration, is that once more volatility
risk or tracking error alone has many dimensions,
and it is only one dimension of how to think about risk.
So the illustration here is at the hub are 30
basis points of predicted tracking error for the whole
global equity portfolio can be broken down any of several 99ways. The green bar illustrates
a look at it geographically, and you see the top two contributors
listed to the left of that green bar; or, by sector or
economic exposure you can look at the gray bar and the top
two contributors there illustrated; or, if you're thinking
about it in pure risk factor space and Barra space, the
blue bar illustrates where our exposure comes from, where
specific risk year is referring to stock selection within
the portfolio, and you can see that those top two items in
the blue explain about 18 of the 30 basis points.
But the point of this is to say that as you turn
the prism around, you are able to look at the portfolio
from a different perspective and understand exactly where
the risk is coming from. It is not unidimensional. These are only three ways of many to look
at that. And to effectively manage risk, we think
about it as a mosaic, this being kind of a central
point around which we look at it.
--o0o-- SENIOR PORTFOLIO MANAGER COLE: On page 16
is the excess return looking back over the past decade
by year. The blue bar is illustrating the excess return
itself. The green line showing the trailing three-year
cumulative return. 2009 was notable, and I'll highlight
it. It was the year that many things occurred, not the
least of which 100was financial crisis hit, the fund was hit by liquidity
requirements causing sales during that year that did lock
in losses and contributed to that down bar. And it was
also the year of transition for our policy benchmark,
where we went from two-thirds U.S. one-third rest of the
world to a cap-weighted global mix, which we have today,
which is more like 50 percent U.S. and 50 percent the rest
of the world. The trailing three-year return is back up
as you can see since fiscal year 2012. --o0o--
SENIOR PORTFOLIO MANAGER COLE: On page 17 our
policies have been -- we spent a lot of time on policies
over the last 18 months. And I think we've made progress,
and as we've talked today, there's still many things
underway. We want to highlight that in addition to the
policy clarifications, which we presented today for first
reading, we are also having a lot of time and effort spent
on thinking about our emerging markets policy, and our
overall corporate governance. I'm sure we'll soon refer
slowly as our global governance policy. And I expect -- we expect from our collaboration
that over the six months there will be substantial adjustments coming to you in both of those
areas. --o0o--
SENIOR PORTFOLIO MANAGER COLE: On page 19, a 101summary of our dedicated work with the
emerging managers. We're increasing our commitment, working closely
with our five outside advisors to make it more impactful
and to integrate with a fabric of our holistic portfolio
approach. We are working closely with our advisors.
As you know, they are Progress, Legato, Leading Edge,
FIS and Strategic Investment Group to achieve this
alignment over the next few months. A lot of work has gone
in, and we really feel confident about being better off
for our efforts together with our partners.
--o0o-- SENIOR PORTFOLIO MANAGER COLE: On page 21
is a summary of our roadmap accomplishments for
the last fiscal year. In addition to the 73 basis points over
our benchmark, we have completed or made very
significant progress in our portfolio management platform
we refer to as sometimes PM2 or PM². It's been referenced
several times today.
The integration of AIP, as Dan mentioned, is
really a true full-team effort, and we're happy with where
we are. And the hiring of a number of talented and
motivated individuals. And to the earlier question, Mr.
Jelincic, I think one of the advantages is that it's
important for us to be able to have the time to digest and 102integrate the new people
into the operation. And I think we've been on a pace that's made that pretty
natural. And hopefully we can continue that over the next
couple years, but we feel really good about where we are.
--o0o-- SENIOR PORTFOLIO MANAGER COLE: Finally, a
word about our mission and purpose. We are busy
managing the aggregate portfolio, and managing the business,
but our priority is to get a lot better by developing
alpha-generating capabilities, and working closely with
our asset allocation colleagues to develop processes, and
partners that will allow us to provide you, the Board, the
Investment Committee, with more options in the future than
simply accepting the market return or simply a small
tracking error in all market environments. There's a lot
of work that goes into that. You'll hear us refer to an
alpha dashboard in the future, which is kind of the
extension of our work around a risk dashboard and looking
forward. --o0o--
SENIOR PORTFOLIO MANAGER COLE: With that, I'll
turn back to Dan to wrap up. INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Thanks, John. So to conclude, we think it's worth just really going briefly through our
priorities. 103As John said, we're looking to manage the portfolio, and
manage the business. And in order to do that, these are
our main priorities. First of all, sophisticated risk
analysis, allowing us to dissect the portfolio in many
ways and really know what risks we're taking and why we're
taking them. Secondly, to intentionally position the
portfolio. We want to take risks where we think it makes
sense and where we think we'll be compensated, but we want
to make sure we're mitigating unintended risk. Next,
we're going to rationalize our strategies, again focusing
on the holistic portfolio, likely reducing the number of
strategies and renegotiating our terms to really enhance
alignment of interests. We're going to focus on plan level utilities
to deliver the plan what it needs, create a sustainable
process to leverage our strategic relationships and also
really to leverage -- to create a sustainable business
model. And then finally, but crucially, to execute,
execute on our roadmap to manage the portfolio, to manage
the business, and really evolve the business in the best
way possible. So that finishes our prepared remarks and
we're happy to answer any questions.
CHAIRPERSON JONES: Yeah, we have one. 104Mrs. Mathur.
COMMITTEE MEMBER MATHUR: Thank you, Mr. Chair. First of all, I just want to say I think this
is a really, really good review. I really appreciate
the focus on risk. And I think the visuals that
you provided around risk really are helpful for -- at least
for me for -- to get a better grasp of it. So I appreciate
that a lot. And that you integrated some reference
to the Investment Beliefs, even though we just adopted
them. I appreciate that as well.
I do have a couple a questions. One is you talked a bit about some of the tilts and exposures
in the portfolio, the holistic portfolio, particularly
the overweight to Japan and Europe ex-UK and some
of the sector weights, overweights and underweights.
Is that deliberate or is that sort of an artifact
of having a cap-waited benchmark or -- maybe you could
talk a little bit about how we got there.
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Certainly. That I would say was a deliberate
bet. And it's candidly the -- certainly the overweight to
Japan has worked very well for us. It's risk controlled.
It's definitely bounded by about one percent, but we've --
we are comfortable taking that bet. We have a deliberate
overweight in that space. And so that is an intentional 105bet.
COMMITTEE MEMBER MATHUR: Okay. Thank you. That's helpful. And then thinking about the
Investment Beliefs, and you've already sort of articulated
some ways in which the existing portfolio is meeting
some of the -- or demonstrating some of our Investment
Beliefs. But moving forward, how do you see -- what
ideas do you have for integrating it even further into
the portfolio the set of Investment Beliefs and/or embedding
it into the culture, especially with our external managers,
but also internally.
SENIOR PORTFOLIO MANAGER COLE: A great example of that is around sustainability, and I'll
use our old term ESG. We have one manager that we currently
work with, one external partner, who specializes
in a large cap U.S. ESG portfolio. In addition, we've engaged
two external -- other external potential partners,
who have spent a lot of time thinking about how they
incorporate environmental, social, and governance characteristics
into their investment process.
Our goal is to extend from where we are. We've already been asking the question of what do
you do and how do you think about it on a fairly routine
basis? But the next step is this is a great example
of an area where it is not proprietary to help
share and 106influence best practices. And so our goal, as we're
looking ahead, in these two outside firms and the one that
we have engaged, is to come up with items that are quite
tangible and specific around affecting the valuation of
companies or actually -- or the long-term risks of
companies around the factors. And that will take us
awhile to collect and actually digest and turn around.
But by awhile, I mean, six or nine months or sometime over
the next year. And our goal is to turn around and extend
the broad swath of that work, which is really relevant at
a practitioner level, not an academic level, to -- broadly
across our portfolio. We think our best chance is to
influence rather than demand. COMMITTEE MEMBER MATHUR: Okay. Thank you very
much. CHAIRPERSON JONES: Okay. Seeing no further
questions. So we turn now to the consultants, Consultant
Review of the Global Equity Program. Michael.
MR. SCHLACHTER: Great. Well, thank you very much. And I think Ms. Mathur hit on the two
main points that actually I raised in my letter. I think
that staff's presentation of how this portfolio complies
with the newly adopted policies, I think, is a great example
hopefully, or a great sample of how we can do this for
the rest of 107the organization. Given these are as much your beliefs as
anyone's, if there's other ways you'd like to see this
going forward from global equity or any other asset class,
obviously this is all a first try at this. So please, I
think everyone is welcoming whatever input you care to
give as far as how we can better measure compliance with
the Beliefs. Ms. Mathur also noticed the -- or discussed
the risk page, page 14. We have reviewed extensively
the risk analytics, all 40 pages that Dan or John talked
about. And we've very impressed, I think, with this
recent addition really to staff's skill set, looking
at their ability to measure risk.
The next step, Dan mentioned, that the current overweight to Japan is an intentional position.
I think that over the next couple of years we anticipate
that staff will build far more tools for taking
many other types of intentional biases. You have to measure
these things before you can really take them. So
while an overweight to Japan right now is a fairly,
no offense, simplistic, I think, position, maybe down
the road, Dan could say look -- or John could say it's time
for British consumer goods to be overweighted or small
cap value stocks in Germany or something like that.
But you have to measure these things before you 108can actually implement them. So I think
that staff building this very extensive and very impressive
risk analytic set gives them the toolkit at least
to measure the risks they're taking going forward, and
we are working closely with staff to watch and monitor how
they are developing those internal tools, so that they
can actually begin to pull farm more complicated levers
down the road. So overall, I think we are very impressed
with the overall global equity program.
The next agenda item obviously is talking about
the index -- I'm sorry, the internal -- I'm always
chastised when I say index funds, given that of the 19
internal strategies, only five are truly active and 14 are
actually quasi-active. I'm sorry, five are indexed and 14
are quasi-active or active. As you know, every year we meet with the index
team -- or the -- I did it again -- the internally managed
team to review their internal portfolio construction and
trading processes. Last month, Andrew Junkin and Tom Toth
presented our thoughts about the internal fixed income
team. As you know, we present these reviews looking at
your internally managed functions to see if they compare
well to their outside counterparts. So taking a step, I think from this, the overall
global equity portfolio to simply just that $111 billion, 10980 percent of your portfolio,
that is run by a handful of people in-house. We are -- continue to be
very impressed, very pleased about the quality of your staff.
We spent -- we have weekly calls with your equity team.
And so when issues come up, we tend to know what's happening
in the portfolio very quickly.
We also conduct many on-site meetings with staff
over the course of the year. The comments we have here
were the result of such an on-site discussion. Overall,
not a lot of changes since last year. A year or two ago
the team was structured -- restructured pretty significantly into more of a tiered structure,
where you have a portfolio construction team, and then
an execution team.
That eliminated a lot of the compliance possibilities of issues from the past. It
made the entire process far more elegant for portfolio management.
It allowed for multiple sets of eyes to review
trades as they were created and processed, which we think
made for a far more compliant or compliance friendly environment
to work in.
Our only concern with the internal index -- internal equity function is some ongoing technology
issues. The equity team has been looking for an external
vendor to provide -- I'll use the word holistic again, 110since they used it for the overall
process -- a holistic system which can allow trade -- portfolio
construction all the way through trade execution. There were
some outside vendors we reported to you last year that
appeared to be front-running candidates to take over essentially
the entire portfolio management process internally.
Those vendors have withdrawn from the marketplace. Unfortunately, their products
were not really ready for prime time. And so staff,
while not back at square one, is certainly back to the stage
where portfolios are being constructed in Excel
and executed in a trading system.
And so staff is working diligently to move forward and fix that. There are some on-site
consultants building custom systems for this. But we have
reported many times in the past that we think that
having Class A+++ technology tools is essential for a team
like this. Your team is working very hard to reach those
levels, but they have had some setbacks since last year in
trying to acquire those off the self. But again, overall, we are very pleased with
both the internal people, as well as the internal
tools that have been developed. And we have really no
concerns again beyond this, hopefully soon-to-be-resolved,
technology issue. 111CHAIRPERSON JONES: Okay. Thank you.
Seeing no further questions, I'd just like to also highlight
a comment that was made about the manner in
which the Investment Beliefs the equity staff has reported
within their presentation, and how this may be setting
a model to go forward for the whole organization. So
I think that's a commendable comment.
INTERIM SENIOR INVESTMENT OFFICER BIENVENUE: Thank you. And just to Ms. Mathur's question
again, really we view the Investment Beliefs as informing
almost every decision we make. So to the extent that
we're looking at a, you know as Michael mentioned, a
technology capability. How does it control risk,
investment risk, operational risk, efficiency, you know,
cost, all of those things? Hiring staff certainly will weigh into the
-- staff needs to resonate to these beliefs.
And if they don't, then they're probably not the right
candidate. They may be a great candidate for another
position, but probably not for this, for this organization.
And really looking at those decisions is -- looking at
all those decisions through the lens of the Investment
Beliefs is really, really crucial.
CHAIRPERSON JONES: Right. Another aspect of your presentation was your dashboard showing
where the 112risks are. And I'm wondering, you know, when we get ready
to determine our discount rate, and then you show us these
various options -- or staff shows us these various
options, and the volatility of those options, but we don't
get the incremental additional risks we take to get that
additional quarter percent return. So I'm wondering when we get to that discussion
is there any way the Board can have that kind of --
because you see it in your job, you know, what risks
you're taking when you make those decisions, but we just
look at the holistic and not knowing, you know, how we're
taking additional risk when we make those decisions.
CHIEF INVESTMENT OFFICER DEAR: You actually do
see it. Here we've been calling it tracking error. In
the asset allocation, we're calling it volatility. But
the different portfolios that are presented to you have
different return expectations and different volatilities.
And that volatility is the sum of all of those different
tracking error variances from components of the portfolio.
CHAIRPERSON JONES: Yeah, that's the total, but
what if we wanted to move from seven and a half down to
seven and a quarter, what is that additional risk we're
taking for that additional return? Is this -- can it be
stratified or is it possible to stratify it? CHIEF INVESTMENT OFFICER DEAR: I don't want
to 113get ahead of my colleague, Mr. Milligan, but I believe the
model that we're developing is going to include the
ability to assume different rates of return and then
different portfolios. But if he's in the room, let me see
if I just caused a heart attack or not. CHAIRPERSON JONES: No, he's not. Okay. We'll
wait. CHIEF INVESTMENT OFFICER DEAR: He's not here.
I'll check with Alan. We'll let you know tomorrow. CHAIRPERSON JONES: Okay. Thank you.
CHIEF INVESTMENT OFFICER DEAR: But we certainly want to make sure you -- if that's something
you're interested in, that we find a way to provide
that. CHAIRPERSON JONES: Right. Okay. Thank you.
Okay. Oh, we have -- he's gone. Mr. Beatty. ACTING COMMITTEE MEMBER BEATTY: Thank you,
Mr. Chair. Dan and John, I just wanted to comment
that, you know, I've surprisingly seen a number of these
reports through several years. And this one was much
better presented and laid out than the other ones,
not to detract from your folks who had done this previous
to you, but this was really very well done. And I think
keep it in this direction. It's a lot easier for us to
follow, and I really appreciate it.
Thank you.114INTERIM SENIOR INVESTMENT OFFICER BIENVENUE:
Thank you. CHAIRPERSON JONES: Okay. That concludes this
item. We'll move to the next one, Absolute Return
Strategies, Item 9c. (Thereupon an overhead presentation was
presented as follows.) SENIOR PORTFOLIO MANAGER ROBERTIELLO: Good
afternoon. I'm Ed Robertiello, Senior Portfolio Manager
for Absolute Return Strategies. There's three main topics that I'd like to
cover in our annual review today. The first one
is the roles and descriptions and program performance,
and then secondly, a brief update on the hedge fund
marketplace, and then lastly, the ARS roadmap initiatives,
cost savings, and a brief policy review.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: And
I'd like to start with our functional organization
structure, because without the proper team and without
the proper resources, we're -- we would not be able to
implement our roadmap or our strategic plan. So we've made
a lot of strides and a lot of progress this year in
building out that team. 115What you see here is the portfolio
management positions. And the gold-ish boxes on the bottom
are the three main hedge fund strategy categories.
So we have our macro and trading strategies. We
have our equity hedge and emerging markets strategies, and
our credit and event driven strategies. We have
portfolio -- you can see experienced portfolio managers
filling all three of those slots today. And then just moving above that in a light
blue are the risk management position, and we have
a portfolio manager in place there. That position will
help manage the aggregate risks in the total ARS portfolio,
as well as giving an independent view from the analysts
on the individual manager risks in those -- in their
portfolios. And then lastly, our last PM slot that's open
is for the head of operational due diligence.
And as you know, there are significant non-market risks
in investing in hedge funds. And this is a very critical
position for us. It's been posted. It closed on the 7th,
and I should be receiving some -- the applications today
hopefully. We are also recruiting two IO 3 positions,
so those will be additional senior analysts that
will support all of the PMs in our endeavor.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: There
we 116go. Okay. And just a reminder, so in the December and
February meetings, we discussed the role and objectives of
the ARS portfolio. So the portfolio is designed to be a
diversifier to equity growth risk. We are to provide a
return stream that demonstrates low beta to global equity.
So that's basically 0.2 beta or less. We are designed to
produce returns when another asset class may be in stress
or distress scenarios. And then to maintain the total fund long-term
returns by producing strong risk-adjusted returns, and by
also providing some significant downside protection. And
obviously, there is a component of knowledge transfer.
And we are getting market insights and risk appetites and
opportunity ideas from our underlying managers. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: So how have we done against those parameters?
So last fiscal year, we've done well, but we
still have a lot of work to do. And as Joe said, one year
and even three years does not make a program successful.
So on the return, our target was one year T-bills plus
five percent. So for fiscal year 2012-13, that number was
5.3, and the fund return 7.5 net. So a good healthy
return there. However, on the three-year number, that benchmark
117was 5.4 and we're at 4.1. And since inception on April of
2002 when the funds began, that benchmark was 7.3, and
we're 5.5. So we still have a lot of work to do.
Our volatility target was six to eight percent, annualized standard deviation. Last year,
we achieved a 2.9 percent standard deviation. So very low
vol. And on a three-year basis, it was 3.4, and inception
to date is 5.4. So we can take a little bit more risk
in this portfolio.
Our max drawdown is to be seven percent. Let's -- I don't envision us ever going there,
and we never went there even in the global financial
crisis. Liquidity targets is to have greater than
50 percent converted to cash within 90 days.
There's two ways we measure this, the terms that we negotiate
with the managers and also on their underlying positions.
So with the terms, you can see that we have a
very liquid portfolio. And even with the -- on the
position side. I have to say the position -- with the
positions, it does not include the fund of funds,
underlying managers. They all have requirements the same
as the total fund is to be at least 50 percent in -- within 90 days. They all have at least
60- to 90-day redemption periods.
The two percent that you see that is over 90 days 118are legacy or stub positions that
were holdovers from the global financial crisis, and we're working
through that. In terms of the diversification, the 0.2 or
less beta. So on a two-year rolling average our
beta to the FTSE All-World Global Index was 0.14, over
the last year three years is 0.16, and since inception it
was 0.24. The since-inception number includes the beginning
period when the fund was really a equity substitute, so
it had a lot of equity long-short allocations.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: That's
coming down. So again, as a reminder, the ARS portfolio
operates under the three pillars approach. Basically
alignment of interests in terms of fees and liquidity
terms, control of assets. So we do all separate accounts,
managed accounts, or fund of ones. We are -- excuse me --
not in any commingled funds. And this really helps us
create a true partnership with the managers, and also to
be opportunistic, and to avoid other investor's behavior,
particularly around redemptions. And then lastly, is
transparency, we require full transparency of all of our
managers. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: And then
this was our attempt at linking the newly approved CalPERS 119beliefs to the ARS beliefs.
And really we focused on those that are most directly related to the
ARS Program. Of course, you know, the number one Belief
is that liabilities drive the asset structure and
asset allocation. And, of course, we abide by that
and as does every other asset class.
But the second one was CalPERS long-term investment horizon allows staff to generate
attractive risk-adjusted returns. And this is really
critical for ARS, because everything that we do and the
managers do is active. It allows us to ride out investment
cycles, avoid panic selling, allows us to provide liquidity
when the market looks for it, and it actually allows
themes to play out that managers are trying to take advantage
of. The second one is active management. And again,
everything in ARS is active management, but we only take
that active risk when we think we can -- we are
sufficiently rewarded for it, and that the opportunity set
is strong enough to take that active risk. A critical Belief, because we do operate in
a high fee industry, is that costs matter and
incentives need to be aligned. So when we are structuring
our terms with managers, we -- our performance fees
are usually based on a three-year payout with clawbacks
for losses, we have hurdle rates, and we have sliding scales
as well, 120both on management and performance fees.
Diversification again is critical. There was a
belief about strategic asset allocation. In order to
produce an absolute return strategy, we definitely have to
have multiple sources of diversified alpha. And we'll go
through that in a minute as well. And also this kind of speaks to Belief 9 about
risks are multi-faceted. So we have many different risks
in our portfolio, and we balance those risks against each
other. Again, this is in Belief number 4 that talks
about the three main -- managing three main cap -- sources
of capital or three main capitals. This is really focused
on our human capital. And we're -- we really believe that
experienced and motivated investment professionals working
as a team is the way to manage this, and the way to bring
in-house those critical investment functions that we have
previously relied on advisors to help us with. We have a strong governance process within
ARS and within the INVO office. We have an effective
investment process, and we have a motivated and strong
team. And all of that really relies on bringing those
proper professionals in-house. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: So just a 121little bit more on performance. I mentioned
our performance versus the benchmark. The only
thing I want to point out on this slide is that the column
on the right is the HFRI fund of funds composite index,
which is basically what the hedge fund industry provided.
And we did outperform that secondary benchmark across
all time frames. But honestly, that is to be expected.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: Now
talking about diversification and multiple sources of
alpha. This is our return attribution for the fiscal year
2012-13 return, which was 7.46 percent. So as you can
see, there are many different colored boxes here. We got
a lot of return from our multi-strategy managers, 150
basis points, from our fixed income arbitrage about
another 150 basis points, from emerging managers 100 basis
points, long/short equity 100 basis points. And really
the only strategy that didn't perform well was our CTAs,
commodity trading advisors, and they detracted 43 basis
points from performance. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: And then
just the next slide shows that this is every month of last
year. And you can see where through just a simple cycle
like one year is where some strategies will outperform 122others, and where -- and so
this really shows that it is critical to be diversified and to have those
multiple sources there in the portfolio.
Again, on downside protection, so these are --
the blue bars are the worst single-month performance of
the FTSE All-World Index since April of 2002 when the
strategy started, and then the red bars are the ARS
portfolio. So on average, those 10 worst months were
down about 10 percent for the equity market, and
we were down about two percent. So it's kind of consistent
with a 0.2 beta. We hope to do better in the future.
We like the results of January 2009 where the market was
down, and the program was up. And we hope to have more of
those months coming, although we do not wish for down months
in equity. (Laughter.)
SENIOR PORTFOLIO MANAGER ROBERTIELLO: It's the
life blood. CHAIRPERSON JONES: Hold on, Ed, just a minute.
We have a question. Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: If you gave us a
chart that showed ARS versus equity's best months, what
would that look like? SENIOR PORTFOLIO MANAGER ROBERTIELLO: So we
have 123an upside capture of about 36 percent in all equity
markets that are all markets of the -- all monthly equity
markets that are up, and about 20 percent capture on down
markets. And so -- and actually took a look at that. So
on average, the 10 best markets since April '02 for the
world index were up about on average 9.2 percent, and ARS
during those same months were up about 1.6 percent.
So, again, kind of consistent with a 0.2 beta. COMMITTEE MEMBER JELINCIC: Thank you.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO:
Allocation. So the bar -- the chart on the left -- the pie chart on the left is where
we were at year-end -- fiscal year-end 2012-13. We have
identified some strategies and managers that we want
to allocate to. And those are all in some stages of due diligence
right now. We'll be reporting on those later, but
-- so if you fast forward to the end of this fiscal year,
this is a snapshot of what we think the portfolio would
look like in terms of diversification.
So some of the significant additions or changes are -- we will be adding to event driven to
the tune of about 10 percent. This is something that's
kind of been missing from the portfolio. We think that
corporate events will continue to increase, in terms
of M&A, 124spin-outs, combinations, restructurings and so on.
We will be adding to discretionary macro, and
we'll have a guest speaker at the closed session talk
about that macro today. The macro that we have today is
quantitative and not necessarily discretionary. And then
lastly, we will be adding to our quantitative equity
market neutral. So this is pretty much getting alpha from
equity markets and then -- and really global equity
markets without necessarily taking equity direction.
I'll switch gears just briefly to focus a little
bit on the multi-asset class portfolios and partners.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: Again,
that is under our responsibility. And the objective of
the MAC Partners Program is to outperform the total
CalPERS fund benchmark over a market cycle with similar or
less volatility and some downside protection. And a significant part of the program is to
-- is to get knowledge transfer from these strategic
partners to the CalPERS staff, in terms of -- in terms
of market insights, but even more importantly about
investment process. So how are they going -- what are
they analyzing, how are they measuring it, and
how are they turning those into tilts in their portfolios
and so on? And all four of the partners that we pick
each 125take a different tack at that. The program was launched
in January of 2013 with one manager. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: And you
can see their performance chart there on page 16. They
stumbled a bit this summer and are behind the benchmark by
about 70 basis points. We are funding the second manager.
I was hoping to have it done before this meeting, but it
will happen tomorrow, and we're in negotiations now with
the last two, which we hope to have funded in the next
four to six months. So then we will have all four partners
participating within six months, and we'll be bringing
updates to you as we fund those new managers. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: A little bit about the hedge fund market, and I'll
be brief here, but -- so the hedge fund industry continues
to grow. And at the end of June 2013, it had two and a
quarter trillion in assets. Three hundred and thirteen billion
came in over this past year, mostly from institutional
investors, public and private pension funds, endowments
and foundations.
And all except for equity hedge, all of the major
strategies experienced in-flows, and -- but actually 126equity hedge had very strong performance.
And their outflows were outpaced by their performance.
So we had growth across all of the different strategies.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: And
not surprising, good performance brings more assets,
and the -- across most of the strategies hedge
funds performed well in the last fiscal year, obviously except
for the short bias managers who really lost money
in a -- in a climbing equity market, and the macro strategies,
which is a combination of CTAs, quant, macro, and discretionary
macro. And you can see the year-to-date numbers. So the
beginning of the year was a bit more stronger than the
second half of the year so far. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Some of
the opportunities that we are going to take advantage of,
and themes that we're taking advantage of in adding new
managers are -- you know, there's been a lot of talk about
the European credit opportunity where banks -- were --
needed to sell assets because of Basel III and Basel III
capital requirements there. And it's been talked about
for a couple of years. It has not come to fruition. But
in speaking with some of our trusted advisors, this has
really come into fruition now. But it's really important 127to have the right partners here,
because the European banks are not just selling assets out into
the public. They prefer to structure deals with private
investors, where there's a structure around it, and where
they don't have to take the full write-down immediately.
So we're looking at a couple of managers that have
those relationships and have strong teams in Europe.
Again, macro, we think discretionary macro is
going to be a good place to be in the near and mid future.
And our guest speaker will talk about that later, but, you
know, there are many, many economic themes to play in the
market right now. One that just has arisen was
this -- the debt ceiling, but, you know, we do still have
the fed tapering issue. We have Abenomics. We have the
European recovery. We have a fast recovery in the UK
economy. We have China slow down, and also their new
economy, going from an export economy to a internally
driven economy. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: A couple of other themes are more around the mortgage
industry and mortgage strategies. Now, there's been a lot
of good alpha made in kind of the more plain vanilla
mortgage-backed securities and CMBS and subprime, but
there are really two themes that we think are the next 128evolution in diversified alpha
from the mortgage business. And part of it has to do with the banks being
disintermediated out of these non-performing loans and
mortgage servicing rights, because again of capital
requirements that they have. So we're looking at a couple of partners that
actually own their own servicing business. So this is
more about servicing non-performing loans that are -- that
they're buying at a significant discount, and also just
the -- taking the business from the banks in terms of
mortgage servicing. And again, it's a highly specialized area.
It is -- we feel it is a good -- also a good
hedge to rising interest rates, because these are variable
rate loans and deals.
--o0o-- CHAIRPERSON JONES: We have a question. Just
a minute.
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Sure. CHAIRPERSON JONES: Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: Well, when you talk
about partners that strikes me as somebody who shares in
our upside and our downside, so we're really talking about
managers who just share in the upside. But non-performing loans, I mean, that's 129something
that has been there for a long time. We keep hearing well it's going to come, it's going
to come, it's going to come. The banks have not, to date,
been willing to really start blowing them out, partly because
the fed has been subsidizing them to keep them on
the books. What makes you think it's going to start
happening now? SENIOR PORTFOLIO MANAGER ROBERTIELLO: Well,
it has started. And again, some of the capital
requirements are starting to come into fruition now. And
so the banks are going to have to -- are going to have
to start dealing with this. And there's been a lot of lawsuits
in terms of banks and how they have been servicing certain
loans and whatnot, as well. They want to avoid that
as well. And on the comment on just sharing on the
upside. I mean, the -- most of our performance fees
have the clawback, so if they -- and they are crystallized,
so -- over a three-year period. Some of them are
a bullet at the end of three years, some of them are a
third, a third, a third. So they always have something at
risk. So that if they have a good year and then a bad year,
we can kind of clawback on those two-thirds piece that
they have deferred from their first year to offset their
losses and what they would have been paid.
It's not perfect, but we think it's -- it helps 130align interests much better.
COMMITTEE MEMBER JELINCIC: I agree that it helps, if we can take back some of the profits
they had previously made to offset some of the losses,
but it's still pretty much a one-sided option. That's
the nature of the business.
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yep. We're trying.
COMMITTEE MEMBER JELINCIC: Thank you. CHAIRPERSON JONES: Yeah. Do you have any
concerns in this area where residential housing, as you
mentioned since 2007, has taken a beating? And now we
have a private equity firm, the largest residential housing owner in the country, and if they
start to package these collateralized -- these mortgages and
then we're right back to the way the banks did and then
sell them off. And then the underlying assets is the
ability for people to pay. And if they don't -- if they're
not able to pay, we've got the same kind of problem.
Could you comment on that potential?
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yeah. I
mean, I -- this is just a personal view is I'm really not
a big fan, even though there are very big and very
successful firms that are implementing this strategy, in
terms of, you know, own-to-lease. It's completely 131untested. It is labor intensive. You really
have to know the markets, I think. They're partnering with
dozens and dozens of real estate agents around the country.
And our -- one of our most successful hedge fund
managers was in this business, one of the first, and
they're exiting, and have been exiting. And I think
they're ahead of some curve as well. CHAIRPERSON JONES: Okay. We have a couple
more questions.
Mr. McGuire. ACTING COMMITTEE MEMBER McGUIRE: Thank you,
Mr. Chair.
Ed, when we get to the point where there are four
MAC Partners, what's the size of the funding to each one
of them? I seem to recall something like 500 million is
what you're targeting. Will they all be the same and is
that correct? SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yeah.
Well, five -- right, we start with 500, and then build it
to a billion, right? And then there's one partner who's
smallish, which we will build to 500 million. So at the
end of the day when we have the full program funded, it
will be about three and a half billion. ACTING COMMITTEE MEMBER McGUIRE: All right.
And secondly, I think when you came on board,
the hedge fund 132program was about 5.1, 5.2 billion. It still is about
that amount, but I think that we had about 100 partners
or -- when you probably count the fund of funds, you know,
participants. Are we still at that number? I know we are
at the 5.2 billion, but what about the number of hedge
fund relationships? SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yeah.
So we have 12 direct managers. And, as you know,
we are eliminating the fund of hedge fund programs
and going more direct, as part of the strategic plan. So
when -- after the entire process is complete, we will be
probably at about 25 to 30 direct relationships. So, yeah,
I mean we're a little less than the 100 right now,
because we have been eliminating the fund of funds. And
the assets are -- do remain the same, because we haven't
re-deployed those assets yet.
ACTING COMMITTEE MEMBER McGUIRE: Thank you. CHAIRPERSON JONES: Mr. Lind.
COMMITTEE MEMBER LIND: Just a general observation on hedge funds. I know in the
Taft-Hartley world a lot of funds are stepping back to
take a look at do we want to continue to have hedge funds
as an investment class? And it's partly because
-- and it goes back to a question that J.J. asked earlier
about the 10 best periods for equities and how did hedge
funds stack 133up? And the question is, is the diversification
on the downside versus the diversification on
the upside worth all the complexity and all the fees,
and does it make sense to continue?
I mean, how often do we do this analysis? How do
we look at that? SENIOR PORTFOLIO MANAGER ROBERTIELLO: All
good questions. Obviously, I think it's worth it.
And what we have to stay focused on is what are the objectives
of our hedge fund program, right? So there -- we
are not designed to add significant value on the upside
of equity markets, right. And we would jump for joy
every month if the equity markets were up five percent every
single month, because we have a lot of risk there.
We really need to be focused on protection when
there is a correction in the equity markets. And at the
same time is to add value on a regular -- on a consistent
basis, not necessarily from equity beta or any market
beta. It is complicated, because we have many different
strategies and many different managers. And again, that
is why we need a team of experienced professionals to
carry this out. We are getting the costs down pretty 134significantly,
and we -- I have a slide in here that we'll go over. And, you know, every dollar that
we take out of that cost adds to the bottom line of the performance.
You know, we need -- I believe that it supplies
a unique return stream to the total portfolio that
you're not getting from any other asset class, and that
we are getting alpha from sources, and some natural
arbitrages, some created arbitrages that we don't get
from any other source as well.
And a fund like CalPERS is very fortunate that we
can apply the resources to it to have our own fund of
ones, or managed accounts, to be opportunistic with the
managers, to negotiate down the fees, to get the
transparency, and to get the control that we need to
properly manage the portfolios. CHIEF INVESTMENT OFFICER DEAR: I think that's
a fundamentally good Board question. You'll
be able to think about it next month in the asset allocation
discussions. I think the case is not proved here, but we
did a lot of really good work, Ed and company, in terms of
defining the objective of the program. So risk
diversification doesn't imply we're going to capture a lot
of the upside. We're really looking for protection from
the downside. But, yes, the portfolio's -- hedge fund portfolio
135is expensive, complicated, and requires a high degree of
professionalism to keep on top of the portfolio. So your
question, is it worth it, is a good one. I remember one member of Congress used to
give me a really hard time when I was running a regulatory
agency, and he would go, "Well, the juice just ain't
worth the squeezing".
(Laughter.) CHIEF INVESTMENT OFFICER DEAR: And I think
that's one of the questions here. The year that Ed has
run the program, the performance has been significantly
different. We just have to wait a little while to find
out whether that was skill or luck. SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yeah,
agreed. MR. SCHLACHTER: If I may add just very briefly.
I mean, if you look at -- there was an article about a
year and a half ago that came out in the Financial Times -- I'm sorry a year ago -- that showed
that over the last 10 years showed a 60//40 equity fixed
income portfolio has outperformed the average hedge
fund over the last 10 years. I've done some research for
another project that showed a 50/50 allocation basically
matches the fund of funds index.
But hedge funds are one of those asset classes 136much like private equity, where the dispersion
between those that are good and those that are bad
is very, very wide. So between the best and the worst fixed
income manager, over a market cycle, it might be
one or two percentage points difference. Private equity
is probably 40 or 50 percentage points difference.
For hedge funds you're looking at five or ten or
more percentage points difference between those that are
good and those that are bad. So to the extent that you
have a dedicated team who hopefully is, as Ed discussed,
negotiating better terms for you, better transparency for
you, able to allocate to you unique managers that others
don't have access to, that allows you hopefully to be at
the higher end of that distribution. Many clients, Taft-Hartley plans among them,
who invest in generic fund of funds, hoping for
superior returns found they got the market returns,
which as the studies have shown simply are not superior
to the things you can get far mere cheaply. The whole point
of having an active team running this in-house is hopefully
-- as Joe said, hopefully skill will rule luck.
And again, in an asset class where there is such dispersion,
you will see the benefits of value added over the course
of time. COMMITTEE MEMBER LIND: Yeah. We had at the
other pension fund that I happened to be the chair of, a 137similar conversation a couple
months ago. You know, we use obviously all external managers. And we
were, you know, outperforming the benchmark. But so
I -- I sort of asked the question to our consultants, okay,
so we're outperforming the benchmark of a underperforming
asset class, right?
And he said, "Well, yeah. I guess, if you put it
that way, that's probably true". So it's, you know, a
question we have to look at and we have to continue to
deal with. I appreciate the great work your team does. I
wasn't casting any aspersions on it. Just the big picture
question we have to ask about hedge funds. CHAIRPERSON JONES: Mrs. Mathur.
COMMITTEE MEMBER MATHUR: Thank you, Mr. Chair. So you mentioned, I think back on page 18,
that you see a sort of a flight of assets to this
asset class that more and more money is going into hedge
funds. What do you see as the implications for us of more
money chasing this type of talent? Do you see our
ability to deliver exceptional -- you know, to deliver
to the mandate eroding as a result or our ability to negotiate
good terms eroding, what's your vision?
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Yeah, I
mean -- well, in terms of the opportunity set, I think
there are some strategies that are challenged today, but 138there are a lot of new opportunities
out there being created by Dodd-Frank and what have you, and
other economic activities.
I think our emerging managers program is critical, because we can get into the smaller
managers who are more nimble and who can still take advantage
of opportunities that the bigger ones just don't
-- can't do in size.
And there will always be managers out there that
have more than enough capital, and have decent performance
and are never going to deal with us, right? But the
bottom line is we do have choices, and we're sticking to
our three pillars. We're not paying 2 and 20. We're not
being locked up, and we demand the control and
transparency. Honestly, I have not found any issue -- I
mean, my biggest issue is everyone wants to come
to Sacramento.
(Laughter.) SENIOR PORTFOLIO MANAGER ROBERTIELLO: And
so it's more of a kind of screening out what
you want and who you want to deal with, and finding the best
trader in those types of strategies, so -- but it is
something to watch as the industry does grow and mature,
and become more institutional. 139There's always more
-- as more institutions come in, there's always more demands in terms of
risk control, risk management, and there are -- now there
are barriers to entry, I mean, with a lot of new regulations,
with foreign PF and FACTA and everything. You know,
it's hard to say that this is an unregulated industry.
The CFTC monitors what they do as well, and as does
the SEC, and requiring registration and everything else.
So it -- but so far, we have not had any issues.
COMMITTEE MEMBER MATHUR: Thank you. SENIOR PORTFOLIO MANAGER ROBERTIELLO: So just
getting back on the presentation. I wanted to go over
some of the roadmap initiatives and cost savings that we
have been -- we have initiated so far. Again, this is in
conjunction with our strategic plan that we presented in
February, as well as the strategic initiatives of the
Investment Office. We have been restructuring our advisory
relationships and divesting from the fund of funds. And
those activities, to date, have given us 8.8 million in
annualized savings. We are -- have started the process to allocate
to more direct managers, four Asian focused managers
that we're recycling the Asian fund of funds manager
-- money into. Some credit and equity related strategies,
you 140know, going back to some of those themes that I mentioned
earlier. And then probably later in the year we'll be
coming with some macro manager ideas that we're working
on. Again, building out the internal team to
internalize those crucial investment functions. We hired
three PMs this year. We are actively searching for again
the final PM and our additional two IOs that -- IO 3s to
support all the functions that we do. We have 11 people
now. When the dust settles, we'll have 14 on the --
professionals on the team. And again, we continue to
implement the MAC Partners Program. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: Future roadmap. Again, more of the same really is
to continue to implement the strategic plan, continue to
negotiate to eliminate the remaining fund of funds. And
we think that there's another six and a half million or
so savings in the program annual. So that would bring our
total up to somewhere around 15 million annualized savings.
And again, to continue to build out the team. We
talked about our hires. We have a request for just two
more in the next fiscal year, and hopefully we can get
those. Those are IO positions, so -- support team.
And then lastly is really the plumbing that Joe 141talks about and the table stakes that
you mentioned today is we have done a lot of research on a managed
account platform for the program. And as you saw in
the TOM, it was number 20. In 2014, we'll be doing a lot
of the heavy lifting to do an RFP, to review service providers
and then to implement a managed account platform. So
really moving from the fund of one to a true managed account
platform, where all of our managers will be on a single
platform. We will have significantly enhanced portfolio
management capabilities, significantly more control of
the assets, and a much better view of the risks and exposures
that are in the portfolio.
So those are what we're going to be up to in the
next year or so, in terms of activities. --o0o--
SENIOR PORTFOLIO MANAGER ROBERTIELLO: And then
lastly, our total program costs. If you remember, we had
a similar slide in the February review, so the columns on
the left are where we were at the end of the fiscal year.
As you can see the column all the way to the left is our
asset allocation. We had 70 percent in the direct book,
30 percent in the fund of funds. Of the 70 percent, 20
was still in commingled funds, and then projected. And so
our costs then are -- were about 3.2 percent of AUM. And
you can see that our advisory and admin costs were 17 142basis points.
So if you project forward to the end of this fiscal year, we anticipate having a 100 percent
in our fund of ones or managed accounts, our average
management fee on that will be about 120 basis points,
and the performance fee is a variable fee. And so
we just did some assumptions. We assumed that we would
get an eight percent return on the fund. And actually our
average performance fee is 15 percent, plus we have
hurdles and whatnot. So that would come out to about 150
basis points.
And I think if you look all the way on the lower
right-hand corner, we anticipate cutting our advisory and
admin fees to about eight basis points, so basically
cutting those in half for a total cost of about 278 basis
points, or a savings of just over $20 million a year.
--o0o-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: And
then lastly, the ARS and MAC Program each have
their own investment -- Statement of Investment Policy.
They were recently reviewed and modified. And so we
don't believe that there are any need to revise those policies
at this point. We're operating both programs within
those policies.
CHAIRPERSON JONES: Thank you. And I see no 143requests to speak. So we'll move to the
consultant's review of the Absolute Return Strategies.
Michael. MR. SCHLACHTER: Thank you. Michael Schlachter,
Wilshire Associates. I'll make this fairly short. This
review was actually presented to you as well in February,
following Ed's last annual review. And there were -- it's
a misnomer calling this annual reviews, but it's kind of
worked out that way this year. I have updated, in this document, reviews
of all the external fund of funds managers following
some business we made with some of them in Asia
in May. This is a review somewhat in progress, or -- sorry,
rather, a team or a strategy in progress. As Ed mentioned,
his staffing is rapidly increasing from five to
about, I think, 14 was his final count.
He also, as you can see from some of these slides, is in the process of restructuring
many of the external relationships rather significantly.
So we will conduct further reviews of this as the new
team comes into play -- into place. And as the managers are
terminated or eliminated and the portfolio is restructured,
we will return and review this again as the new team
again begins to demonstrate or design how they will begin
to manage this portfolio going forward. 144There's a
fair amount of legacy assets here. As just one example of that, the page 11 chart
that Ed showed talking about ARS's worst performance. Of
those 10 worst monthly periods, I think one was actually
with you at CalPERS, right? Nine of those were actually
before Ed even joined us. So hopefully the world has
gotten better since Ed got here. Only one of those 10 worst
-- SENIOR PORTFOLIO MANAGER ROBERTIELLO: No,
I wasn't even there then.
MR. SCHLACHTER: Twelve, May 12. SENIOR PORTFOLIO MANAGER ROBERTIELLO: Oh,
yeah. MR. SCHLACHTER: Yeah, So one of the 10 Ed
was actually here for. The other nine were obviously
somebody else's fault, not Ed's for having terrible
market environments. So this is, again, a very new
team with some -- a big change within the portfolio.
And so I think we'll change -- we'll edit this going forward.
I will say as well that some of the discussions of the external managers, internal managers,
the staffing -- sorry, the direct managers and
the staffing decisions are, quite frankly, rather subject
to what happens in about a month at the asset liability
workshop. The allocation to ARS Program has been pretty
widely discussed. If it was to come back, that you
recommended - don't have a heart attack - zero or one 145percent, then you have a different
staffing level than if we recommended 10 percent for ARS.
So I think that this program, while the staffing certainly is in flux, the manager relationships
are in flux, and quite frankly, so much is dependent
really on what number comes out of a November workshop,
to determine the final structure of this portfolio.
But that being said, performance has certainly improved, fees have come down in this portfolio,
the level of staffing overall has improved as well.
So we certainly think that the trends are very much in the
right direction. And as to many of the changes Ed
has talked about are implemented and finalized, we'll
come back to you with revised versions of this to reflect
the new team once it's fully in place.
CHAIRPERSON JONES: Okay. Thank you for the report.
We're moving on to Item 9e, consultant's review of Focus List Program performance.
Anne and Andrew. SENIOR PORTFOLIO MANAGER SIMPSON: This is
Anne Simpson, director for global governance, and
I'm responsible for the Focus List Program led
by Craig Rhines on my team. But I'd like to just hand this
to Andrew, as your Board consultant, as the purpose of this
item is 146really to give the Board an update on how the performance
is doing. Thank you.
MR. JUNKIN: So this annual report actually comes
once a year. So we've got that part right. This is an
update of how the performance of the engaged companies has
been doing. And you can see that we've gone back to 1999
as we did last year, in terms of the cohort years. So
we're actually measuring 14 cohort years. At this point, I'm going to jump ahead to
page four of 24 of Attachment 1 and show you the
graph there, the graph on the next page. The graph on page
four is versus the Russell 1000. This is relative
returns. And so you can see leading up to the engagement
by CalPERS, the companies -- the 183 companies that were
engaged generated cumulative negative excess returns
of almost 40 percent. So there was a severe decline in
performance relative to the market.
CalPERS engaged with them and you can see a
pretty steady improvement over the subsequent five-year
periods. And this is the same kind of good news that
we've had to report in the last several years. Page five breaks that out a slightly different
way, so we're measuring the performance of each company
relative to its sector in the Russell 1000 just to make 147sure that there aren't any
sector effects where maybe you decided to engage with financials at the bottom
and that really was a boost to performance just because
of one particular sector. So we're going to try to
erase that effect. And you can again see poor performance
leading into the engagement and good performance coming
out of the engagement.
So again, the engagement process seems to work,
and has led to improved returns in those 183 companies
going in all the way out through 143 that have a full five
years worth of track record. So some have four, some have
three. We haven't finished the full five-year window with
all of them. I'm just going to hit a couple of other points
here, and then I'll open it up for questions. On page
seven, there's a table -- there are two tables. The top
table again shows versus the Russell 1000. And this is
the sort of characteristics of the return at different
points in time post engagement. You can see that one year
out actually more companies have negative excess returns
than positive excess returns. It takes a little while for
the engagement to start to work. But the positive excess returns that flips
by the time we hit year two, where more are positive
rather than negative. That same effect holds when we look
at the next 148table, which is versus the sector. So just over 50
percent have negative excess returns one year in, but
nearly 60 have positive excess returns two years in.
I won't walk you through the rest of the report, but we break it down year by year in the appendix.
You can see how each cohort year has done. It's
not that every single cohort year has positive returns.
There are some time periods where the engagement process,
there may be a specific company that has an event that
happens that drags return down for that entire cohort year.
But more often than not, the cohort years have a positive
experience and have added to the return of these
companies, the engagement process that CalPERS leads.
I'll stop there for any questions. CHAIRPERSON JONES: Yes. Mr. Jelincic.
COMMITTEE MEMBER JELINCIC: If you take any group
of stock that is down 40 percent below the benchmark, and
you looked at them five years later, whether there had
been engagement or no engagement, you would expect a
positive return just on regression to the mean, unless the
company was down so far it went out of business. Have you
made any attempt to try and figure out how much of this
excess return that we keep claiming really can be
attributed to just a regression to the mean? MR. JUNKIN: We've not. So I think that -- a
149couple of points that I would make here. One, you could
view your question as do value stocks tend to outperform,
stocks that have been beaten up or are cheaper? And I would submit that the academic evidence
says that that is the case. I would also submit that it's
typically not by this magnitude, that the edge is closer
to half a percent a year or a percent a year not a percent
and a half or two or three percent a year. The other, and this I would probably turn
to Anne to speak to, I don't think that there's a
requirement that the company has to have underperformed by
a huge magnitude. I think that they do have to have
underperformed to get themselves noticed certainly, and
more than just a little, but I don't think that there's
anything magic about the 48 -- the 38 percent or anything
like that. So, you know, we've never -- to be very specific
to your question, we've never screened the universe and
said how do companies that are down 38 percent perform
five years out? I would suspect that you would see some
positive results, but I'm not sure you'd see it in the
magnitude that you do with the CalPERS effect. SENIOR PORTFOLIO MANAGER SIMPSON: Yeah, just
on Andrew's point. I think what's significant
about the financial screen is we screened for underperformance
-- 150significant underperformance, but on a five-, three-, and
one-year basis. We introduced the one-year screen not to
stop being more short-term, but because we would have
missed the financial crisis. You know, things that
happened -- happened very fast. And the other thing in the selection process
is that the other tests that you have to fail,
if you like, to get onto the focus list, is that you have
abysmal governance. And I think the studies that have
been done on reversion to the mean don't factor that
in. But, I mean, I think this is all ripe for academic
study for sure.
I would say that really what's going on is, as we
all know, whether it's the Heisenberg Uncertainty Principle or the impact of being in the media,
but behavior changes under observation. And when
we go into a boardroom and its CalPERS paying attention,
that changes behavior in boardrooms. And I think that's
really what's at work here is the attention of owners.
COMMITTEE MEMBER JELINCIC: And over the years, there's been academic work on governance.
And I can find studies that show that staggered boards have
better performance. I can find studies that show
the opposite. I can show the same thing about poison pills.
I could show either side, so -- but one of the other
things, and 151I -- that we did is we changed -- when we looked at the
corporate governance, we said look, those people who we
had historically engaged in privately outperformed those
that we did publicly. But those that we engaged in privately were
those that we had identified as a problem, and they
agreed to work with us. So what we really established
is that those managements that were willing to recognize
there was a problem and work with us did better than those
managements who dug in their heels and said we're not
going to work with you.
And I think you -- you know, I, for one, would expect that those who were cooperative and
working with shareholders would almost automatically do
better. So I'm not sure that we really proved the value of
private versus public engagement.
SENIOR PORTFOLIO MANAGER SIMPSON: Yeah. No, I
think you make a very good point, which is if often when
we go to see a company, it's a very rare situation that
the whole board thinks it's terrific that the company is a
financial disaster. I would say typically we walk in and
people are feeling embarrassed and defensive and some
people are looking for a way out or someway to throw the
chief executive out the window. I mean, often what we are
doing is sitting there, asking questions, and allowing the 152Board to take the decisions
that need to be taken. And you make a very good point, the traditional
measures of good governance, the things you could observe
and study, because you could get a data point, were things
like a poison pill, a staggered board, a this, a that, or
the other. What I think we're coming to appreciate that
really what we are being is a catalyst, and we are a
catalyst which starts a dynamic process that's somewhat
uncertain. It involves human beings and judgment, but
that actually the presence of an engaged and active owner
improves your chances of recovery. A bit like following
doctors orders. It doesn't give you a free pass through
the problems you've got to get through, but if you're
willing to, you know, work with what's good for you,
you've got better outcomes than likely. COMMITTEE MEMBER JELINCIC: And I can remember
a number of years ago we had picked a target.
The CEO came in and we talked about what our objections
were and the CEO said you're right, you're right, you're
right. We're trying to change it. And so we said, well,
as long as you're working on trying to change it, we
won't include you on the focus list, because that was in
our shame days. And he panicked. I mean, he actually said,
no, don't take me off, because if you do -- if you take me
off, I don't have the juice to get these changes made.
So there is 153some value to the engagement. SENIOR PORTFOLIO MANAGER SIMPSON: Yeah, I
agree with you. I think also -- remember, I think,
what was called, name and shame, which was CalPERS
going to the media, was in a time when often we couldn't
vote against board directors. Majority voting has been
a big campaign for CalPERS in the last three years. And we've
addressed that issue with a lot of companies. So in
other words, you know, we were firing blanks. So I think
the media was CalPERS friend. It highlighted really important
issues. What's happening now is we go public is when
we file a proposal, and then we're running a
shareholder campaign. And you can see that at companies
as diverse as Chesapeake and Nabors and Hospitality Properties
Trust, where we've really pulled everything out to
win a vote. And that's where we've gone to our other shareholders
to get change. And that's a very powerful evolution
in the program.
COMMITTEE MEMBER JELINCIC: Thank you. CHAIRPERSON JONES: Thank you. Because we've
made the decision to go this way, so now we've got to wait
to see the results as we go forward. Okay. So that leads us to Item 10, Public
Comment. I have not received any requests to speak.
So therefore, the open session Investment Committee meeting is adjourned. And we will
start our closed session meeting in 10 minutes, as soon as the
auditorium can be cleared.